The call market is one of the important segments of the financial system, which enables banks and financial institutions to manage short-term liquidity. It facilitates borrowing or raising funds for short durations, generally one day (night loans). The call market operates under a predicament that fluctuates with demand and supply conditions, thus very important in influencing general interest rates in the economy.
The Reserve Bank of India governs and regulates the monetary call market in India to stabilize it and prevent any undue volatility in short-term loans. Participants in the call money market include commercial banks, cooperative banks and large dealers, all of whom rely on this market to balance their day-to-day cash requirements. This article explains the characteristics of the call money market, its functioning, the difference between call money and forward money, and the role of RBI in the call money market.
What is the Call Money Market?
The call money market is an important part where financial institutions borrow and lend for a very short period, usually one day (overnight). It helps banks meet the daily Cash Reserve Ratio (CRR) and Standard Liquidity Ratio (SLR) requirements prescribed by the Reserve Bank of India.
One of the main functions of the call money market is to ensure that banks maintain liquidity at all times. Since banks cannot afford to hold large cash reserves, they rely on borrowing from this market when they face temporary shortages. Similarly, banks with excess funds lend money to earn short-term interest income. Overnight money market rates are highly dynamic and change depending on market liquidity, Reserve Bank of India policies, and prevailing economic conditions. Higher interest rates indicate a liquidity shortage, while lower interest rates indicate excess funds in the system.
Features of the Call Money Market
The overnight money market has several characteristics that distinguish it from other money markets. Below are some of the characteristics of the overnight silver market:
Call Money Market for Short Transactions
Lending and borrowing money for up to one day (overnight). Loans in other financial markets are issued for months or years, but this market, by contrast, likes very short time frames. These short-term loans are only for the liquidity of banks and do not work out the funds any longer than that. The banks have the unique feature of adjusting their reserves on a very short notice depending upon their cash flows.
No Collateral Transactions
Opposed to any other borrowing techniques, call money transactions are not backed by or granted with any collateral. The lender, therefore, looks at the borrower’s creditworthiness instead of specific assets, which it could look at to attach as collateral. Because there is no collateral, on-demand loans are riskier than secured ones. Nevertheless, risk is minimised, as only bona fide financial institutions like the banks and primary dealers are involved.
Fluctuations in Rates
Call money rates are very sensitive to liquidity conditions and often change during the day. The rates are thus determined by the forces of supply and demand, making this one of the most volatile short-term interest rates. When liquidity is scarce, the demand for money increases, increasing the rates. The converse is true for any excess liquidity.
Regulated by Reserve Bank of India
The purpose of regulation by the Reserve Bank of India is to create a stable call money market. The Reserve Bank of India intervenes in highly fluctuating interest rates and adopts measures towards the controlled flow of liquidity. Through Open Market Operations (OMOs) and changes in repo rates, the Reserve Bank of India employs tools to control liquidity in the market and check the rate of call money.
Participation of Financial Institutions
Only registered financial institutions can participate in the money market. Thus, these transactions confined to regulated entities significantly reduce the associated default risks. Participants in the call money market include commercial banks, cooperative banks, and primary dealers, all of whom use this market to manage short-term funding requirements.
Functions of Call Money Market
Liquidity management and providing short-term borrowing and lending facilities for banks and financial institutions are the two main functions in which the call money market plays an important role in the financial system. The important functions of the call money market are as follows:
Provides Liquidity to Banks and Financial Institutions
The main function of the call money market is to provide liquidity to banks, cooperative banks, and primary dealers. Most banks suffer from liquidity problems on a day-to-day basis in their cash flows because of transactions and maintaining reserves required by the government. Banks mostly rely on the call money market for overnight loans to fulfill their liquidity requirements.
Without the call money market, most banks would maintain the CRR and SLR with extreme difficulty, causing instability in the financial system. It operates as an adjustment mechanism for liquidity over short durations so that funds flow readily to financial institutions in need.
Helps in Maintaining CRR and SLR Requirements
In India, the Reserve Bank of India (RBI) prescribes that banks should maintain a certain percentage of their deposits as cash reserve ratio (CRR) and statutory liquidity ratio (SLR). If a bank falls short of these reserve requirements at the end of the day, it can borrow from the call money market to meet the shortfall.
Adhering to the function that prevents banks from inflicting penalties on their end would also help maintain, if not promote, financial stability such that even banks would not have to compete for an unbiased and ever-ready source to meet reserve requirements.
Allows for Short-Term Loans and Borrowing Activities
The call money market allows financial institutions to borrow and lend funds for extremely short periods, generally one day (overnight lending). For the notice money market, these transactions may range up to 14 days but are classified under short-term borrowing.
This allows banks to smooth out cash reserves quickly without interfering with long-term lending. Even for banks with surplus funds, this provides opportunities to lend and earn some interest in the short term.
Decides Short-Term Interest Rates
The call money market interest rate is a very important barometer of liquidity conditions in the economy. When there is an abundant money supply, the call rate falls and becomes cheaper for borrowing. However, during tight liquidity situations, the call rate is increased when borrowing becomes expensive.
Fluctuations in the call money rates influence other short-term interest rates in the financial system, such as repo, treasury bills, and commercial paper rates. It acts as a benchmark for pricing other short-term financial instruments.
Supports RBI in Implementing Monetary Policy
As far as the Reserve Bank of India is concerned, the call money market is closely watched by the RBI to implement monetary policy. To maintain inflation and spur economic growth, the RBI alters liquidity conditions on the market through open market operations, repo rate changes, or cash reserve requirements.
In cases of heavy liquidity, the RBI could lift the repo rate or soak up excess liquidity from the banking system. If liquidity is tight, the RBI may pump liquidity into the market by reducing rates or acquiring government securities. That way, the overall conditions of the money market will stay in sync with the government objectives of the economy.
A Tool for Monetary Regulation
The call money market provides the RBI with a means of short-term regulation of the economy. By controlling money availability, the RBI can affect the importance of credit, inflation, and economic growth in the country.
In an inflation-spurt scenario, the RBI could tighten liquidity by enhancing the interest rates and, thus, increasing the cost of credit. On the contrary, the RBI could ease the liquidity supply to spur credit and investments in a recessionary trend.
Bank Efficiency Enhancement
Line of credit through call money markets contributes to the smooth operations of banks. Bank calls to ensure the institution is never caught short of cash, interrupting day-to-day operational activities.
Borrowing and lending are mechanisms to earn short-term interest with a view of enhancing the utilization of overall capital. An efficient system for inter-institutional transfer of funds is also enhanced, increasing the banking system’s efficiency.
Facilitates Better Financial Planning for Banks
The call money market allows banks to plan financially in a much better fashion, thus providing emergency liquidity possibilities for them. It permits the proper maintenance of their cash reserve position, cost-effective management of their operational expenses, and investment of that capital without being caught by sudden unanticipated cash shortages.
This is an essential function for banks that are busy and typically require flexibility in terms of their financial planning approach.
Encourage Interbank Cooperation and Stability
The call money market promotes trust and reciprocity among banks and financial institutions. Since banks borrow and lend to each other frequently, interbank relationships are strengthened, and overall economic stability is nurtured.
Such cooperation comes in handy, especially during periods of economic uncertainty when banks are expected to back each other in terms of short-term liquidity assistance. An efficiently working call money market will not let liquidity crunches build into a huge disruption in the financial sector.
Assists the Government Securities Market
The call money market and the government securities (G-Sec) market are closely tied. Primary dealers in government securities participate in the call money market for liquidity management.
Thus, through the call money market, liquidity in the banking system is indirectly maintained, which favors the government bond market’s functioning so that government borrowing programs are efficiently conducted.
Participants in the Call Money Market
Call money market is a marketplace where various types of financial institutions are active to borrow or lend for liquidity. Some of its significant constituents are:
Commercial Banks
Commercial banks borrow and lend large volumes through the call money market. By using the call money market, they manage their daily cash reserves and regulatory requirements. A bank with reserves may witness a few days of liquidity pressure; hence, borrowing from the call money market would save the day from penalties and continued running.
Co-operative Banks
Co-operative banks also participate in the call money market, principally for managing short-term liquidity. These banks are operational at the state and district levels and are important from the standpoint of banking in rural areas.
The trouble, however, is that cooperative banks, being on a smaller scale, often borrow from larger commercial banks when they need funds to satisfy their liquidity requirements.
Primary Dealers(PDs)
Primary dealers serve as market intermediaries facilitating the transaction of government securities. They participate in the call money market to balance their short-term funding requirements and investment portfolios.
Transactions in call money by primary dealers helped sustain the financial system’s liquidity and maintain efficiency in the conduct of the markets.
Non-Banking Financial Companies(NBFCs)(Limited Participation)
Despite NBFCs being one of the most important players in the Indian financial structure, their participation in the call money market is limited. NBFCs are not subjected to CRR or SLR requirements, which, in turn, lowers their need for short-term borrowings.
Nevertheless, large NBFCs with good financial backing will find funds through indirect channels to manage liquidity smoothly.
Role of RBI in Call Money Market
The Reserve Bank of India is a regulatory authority in the call money market. It is responsible for managing liquidity and moderating extreme interest rates.
1. Changes in Monetary Policy
Resource rates such as repo and reverse repo, which RBI changes according to monetary policy, determine the call money market rate. This policy aims at stabilization of the whole economy and maintains its liquidity flow.
2. Liquidity Management
The RBI injects or absorbs liquidity through Open Market Operations and thereby stabilizes interest rates, preventing undue fluctuations in the call money market.
3. Ensuring Market Discipline
The RBI, as such, controls the number of financial entities in the call money market which alleviates excessive speculation further allowing credible participants into the transactions.
Call Money Market FAQs
1. What is the Call Money Market?
The call money market is a one-day market in which banks and financial institutions borrow and lend overnight money to meet liquidity requirements.
2. What are the Features of the Call Money Market?
Short-term lending, unsecured transactions, fluctuating interest rates, regulation by the RBI, and participation of banks and financial institutions are some important features of this market.
3. Who are the Participants in the Call Money Market?
The participants in the call money market comprise commercial banks, cooperative banks, primary dealers, and NBFCs (limited participation).
4. What is the Effect of Call Money and Term Money?
Call money refers to borrowing overnight, while term money pertains to loans that exceed 14 days. The variation of call money rates is much more than that of term money rates.
5. How Does RBI Regulate the Call Money Market?
The RBI manages liquidity, controls interest rate volatility, and regulates market participation through monetary policy adjustments and open market operations (OMO).
