Call money refers to short-term lending and borrowing between banks and other financial institutions in the Indian money market. It allows banks and financial institutions to meet their short-term fund requirements and manages daily liquidity in the banking system.
Table of contents
- Call money market definition
- Key aspects of call money
- How call money works
- Role of RBI in call money market
- Advantages of call money
- Interest rate in the call money market
- Participants in call money market
- Significance of call money for mutual funds
Call money market meaning
The call money meaning, as the name suggests, refers to funds that can be ‘called back’ by the lending bank at very short notice, usually one day. It involves overnight lending and borrowing of funds between banks, financial institutions, and the central bank. Essentially, the call money market definition is a very short-term loan with no set principal or interest repayment timelines.
Key aspects of call money
Call money is an unsecured borrowing arrangement used mainly by banks and primary dealers to manage temporary liquidity mismatches. Its key features include:
- Tenure: Call money transactions have an extremely short maturity period, usually overnight or for a maximum of 14 days.
- Notice period: The lending bank has the right to ‘call back’ the funds at any time during the day by giving a very short notice, usually one day.
- Interest rate: Interest rates on call money fluctuate daily based on market conditions and are decided through open market operations conducted by the central bank.
- Participating entities: Banks, financial institutions, cooperative banks, and the central bank participate in call money lending and borrowing.
- Purpose: It helps banks and financial institutions meet temporary mismatches in their daily cash flow and fund requirements.
How call money works
Call money is a mechanism for short-term borrowing and lending among financial institutions. It is primarily used to meet short-term liquidity requirements and to manage day-to-day cash flows.
- Need for funds: Financial institutions may require extra funds to maintain short-term liquidity, meet reserve requirements, fund unanticipated withdrawals by depositors or for other purposes.
- Borrowing and lending: Call money allows institutions to borrow or lend money for very short periods. Borrowing involves specifying the repayment period and the interest terms. Lending is typically unsecured.
- Interest rate: The call rate is the interest charged on call money transactions. Rates fluctuate daily depending on supply and demand for short-term funds in the market.
- Role of central banks: Central banks influence the call money market indirectly through monetary policy operations. By controlling the availability and cost of funds, they affect short-term interest rates in the system.
- Importance: The call money market is crucial for liquidity management in the financial system. It allows banks to maintain lower cash reserves while ensuring smooth day-to-day operations.
Role of RBI in call money market
As the central bank and lender of last resort in the Indian economy, the Reserve Bank of India (RBI) plays a pivotal role in regulating and managing liquidity in the call money market. Some of the key functions of RBI include the below.
- Conducting daily open market operations (OMOs) like repo and reverse repo auctions to inject or absorb liquidity. This influences call rates.
- Acting as a counterparty for banks by providing liquidity support through tools like liquidity adjustment facility (LAF).
- Announcing daily MSF and bank rate that acts as caps and floors for overnight call rates.
- Monitoring market conditions and ensuring adequate liquidity to mitigate volatility in short-term rates.
- Collecting and publishing daily call money rates to ensure transparency in the system.
- Issuing guidelines on reserve requirements and statutory liquidity ratio to influence bank liquidity.
This helps maintain relative stability in short-term interest rates and financial stability of the overall banking system.
Advantages of call money
Call money offers several features, especially for banks and financial institutions needing short-term liquidity. It provides a flexible and quick way to manage cash flow, meet regulatory requirements, and earn interest on surplus funds
- Flexibility: Call money is flexible for managing liquidity day to day. Financial institutions or organizations borrowing or lending call money do it for the shortest possible time, sometimes overnight.
- Efficiency in liquidity management: It allows banks to manage their reserve requirements efficiently. With this facility, a bank may lend or borrow from the call money market, which will ensure it meets its regulatory liquidity requirements without having to maintain excess reserves that would draw lower returns.
- Cost-effective: Borrowing through the call money market could be cheaper than other means of obtaining short-term funding. However, it’s important to note that, being mostly unsecured and for very short tenures, the rate of interest on call money is very low compared to other borrowings. This low interest rate may not always compensate for the potential risks involved.
- No collateral required: In the call money market transaction, collateral is typically not required. This eases the borrowing process and may help reduce transaction costs, giving an advantage to well-established institutions with a good credit rating.
- Supports monetary policy: The call money market is beneficial for the central bank’s conduct of monetary policy. In fact, through interventions, the central bank can indirectly impact the public’s liquidity preference and influence short-term money rates in the market.
- Stability of markets: The call money market’s presence helps maintain stability in the financial system. This assists institutions in absorbing unexpected liquidity shocks and may help reduce the related risk of default for failing to meet credit obligations by borrowers.
Interest rate in the call money market
The call rate is the overnight interest rate at which banks lend and borrow from each other. It fluctuates daily based on the supply and demand of short-term funds. It may also serve as a benchmark for short-term interest rates in the financial system.
Participants in call money market
- Scheduled commercial banks: Both public and private sector banks actively participate in call money lending and borrowing based on their daily liquidity positions.
- Cooperative banks: Urban cooperative banks and district central cooperative banks also access call money market for liquidity management.
- Financial institutions: Non-banking financial companies (NBFCs), housing finance companies, and mutual funds participate to manage temporary cash flow issues.
- RBI: As the lender of last resort, RBI conducts liquidity operations like repo, reverse repo and LAF to regulate liquidity in the system.
Significance of call money for mutual funds
Call money plays an important role for mutual funds, particularly debt and liquid funds, as it helps them manage short-term liquidity. Mutual funds with temporary surplus cash can deploy funds in the call money market to earn potential returns, while also maintaining liquidity. This may help fund managers manage redemption pressures, settlement obligations, and cash flows without disturbing the core portfolio strategy. However, returns from call money are typically linked to prevailing money market conditions and may fluctuate based on short-term liquidity dynamics in the banking system.
Conclusion
Now that you know what is call money market, you can see that it plays an important role in the financial system of an economy by providing short-term liquidity to banks and other financial institutions.
It offers a flexible, cost-effective, and efficient way to manage day-to-day cash requirements, support monetary policy, and maintain market stability. The call rate, as a key benchmark, reflects the prevailing demand and supply for short-term funds and helps guide short-term interest rates in the economy.
FAQs:
What is call money, and how does it work?
Let’s understand what is call money. It is a mechanism for short-term borrowing and lending between financial institutions, usually overnight. Banks and institutions use it to meet temporary liquidity needs, manage cash flows, and fulfil regulatory requirements. Borrowers repay the funds with interest, and lenders provide the money without requiring collateral.
Who participates in the call money market?
Participants include commercial banks, cooperative banks, primary dealers, and other financial institutions with surplus or deficit funds.
How does the RBI regulate the call money market?
The Reserve Bank of India influences the call money market through its monetary policy operations. By controlling liquidity in the banking system, the RBI affects the availability and cost of short-term funds, thereby guiding call money transactions and interest rates.
What factors influence interest rates in the call money market?
Call money interest rates depend on several factors, such as the supply and demand for short-term funds, banks’ liquidity requirements, RBI’s monetary policy actions, market expectations, and overall economic conditions
Why is it called a money market?
The money market is called so because it deals in short-term funds and highly liquid instruments that function close to cash. Participants borrow and lend for short tenures. It facilitates liquidity management for banks, financial institutions, corporates, and the government within the financial system.
What are the risks of call money?
Call money refers to overnight inter-bank borrowing and lending. Risks include interest rate volatility, where rates may fluctuate due to liquidity conditions. There is also counterparty risk, though transactions occur among regulated institutions. Sudden liquidity tightening may increase borrowing costs for participants in the call money market in India.
Who can take call money?
In India, call money transactions are permitted primarily among scheduled commercial banks and certain primary dealers, as regulated by the Reserve Bank of India. Retail investors cannot access market directly.
What is the call money rate in India?
The call money rate in India is the overnight interest rate at which banks lend and borrow funds in the interbank market. It can change daily based on liquidity and monetary conditions.
