The Liquidity Adjustment Facility (LAF) is a monetary policy tool used by the Reserve Bank of India (RBI) to manage liquidity and ensure economic stability. This tool was introduced in 1998 based on the recommendations of the Narasimham Committee on Banking Sector Reforms.

LAF gives Indian banks the opportunity to borrow funds from the RBI through the use of repurchase agreements or Repos. A repo is a short-term loan where the bank sells securities, such as government bonds, to the RBI in exchange for cash. At a later date, the bank then buys back the securities at a slightly higher cost, thus repaying the loan with interest. This type of borrowing helps banks maintain liquidity in order to meet their daily needs like loan requirements and cash withdrawals from customers.

In addition, banks can also borrow from the RBI via reverse repo agreements. This involves the bank receiving cash from the RBI in exchange for securities, with the bank agreeing to buy back the securities at a later date at a slightly lower price. This type of loan increases the money supply in the economy and forms a part of the RBI's policy of managing the inflation rate.

The LAF is an effective monetary policy tool for reducing or increasing the money supply in the Indian economy. It gives the RBI the necessary control to improve liquidity and ensure economic stability. Consequently, this helps maintain the value of the Indian currency, prevent inflation and increased confidence in the banking system.