The central bank is planning to scrap the fixed rate repo concept through which the RBI provides liquidity support for a fixed number of days to banks and primary dealers.

According to RBI sources, the repo and the reverse repo rates to be fixed by central bank will be market-determined. The repo and reverse repo rates will have a symbiotic relationship with the bank rate which is currently pegged at 8 per cent. The ILAF will provide a mechanism by which liquidity will be injected at various interest rates and absorbed-when necessary-to minimise the volatility in the money market.

Through this support system, the central bank wants to regulate the money market in line with its strategic regulation of the forex market. "In order to regulate the money marketrates, the central bank will fix the lending rates in accordance with the liquidity conditions," sources said. RBI will support the market through a liquidity adjustment facility (LAF) operated by way of repo and reverse repos, thereby providing a reasonable corridor for market play.

In the slack season credit policy, the Reserve Bank scrapped the general refinance facility and replaced it with an ILAF against collaterals.

The new system being put in place will increase the total liquidity available to banks from Rs 1,350 crore (under general refinance) to Rs 2,700 crore (under ILAF)-a move which is expected to deepen the market and provide an alternate corridor for the movement of funds from the overnight call market to the repo market. Unlike general refinance, which could not be on-lent, money raised under ILAF can be recycled. This will also check undue volatility in the markets.

Out of total liquidity adjustment facility worth Rs 2,700 crore, Rs 1,350 crore will be available to market participantsat the bank rate and the rest will be available at 2 per cent above the bank rate. However, the refinance facility will be available to banks for a period of two weeks. The introduction of ILFA is in keeping with the Narasimham Committee recommendation and a step towards the introduction of a liquidity adjustment facility. Last year, in the busy season credit policy, RBI governor Bimal Jalan had announced the launch of a LAF which did not come into force.

RBI officials are of the view that the interim liquidity support will provide a higher level of comfort to market players and help in pushing up the wholesale trading of bonds as banks will have to pledge the Government securities as collateral to avail of the refinance facility.

The credit policy further states that an additional collateralised lending facility (ACLF) for an equivalent amount of CLF will also be available at the Bank Rate plus 2 per cent. CLF and ACLF availed of for periods beyond two weeks will be subject to a penal rate of 2 per centfor an additional two-week period.