Call Money

Call money refers to short-term funds lent by one financial institution to another, repayable on demand or within a very short period, typically ranging from one to fourteen days. It is a crucial component of the money market, facilitating liquidity management among banks and other financial entities. The call money market enables institutions to meet temporary cash shortages or maintain statutory reserve requirements mandated by central banks.

Nature and Characteristics

Call money serves as a highly liquid, short-term borrowing instrument used primarily by banks and financial intermediaries. The loans are generally unsecured, meaning no collateral is involved, and repayment must occur when “called” by the lender. The interest charged on these funds is known as the call rate, which fluctuates daily based on market liquidity and demand-supply conditions.
Key features of call money include:

• Short-term maturity: Usually repayable on demand (call money) or within up to fourteen days (notice money).
• Participants: Primarily commercial banks, cooperative banks, and select financial institutions.
• Purpose: To manage day-to-day liquidity needs or meet reserve requirements like the Cash Reserve Ratio (CRR).
• Unsecured nature: Transactions are based on mutual trust and institutional credibility.
• Market-driven rate: The call rate varies frequently, reflecting immediate liquidity conditions.

Functioning of the Call Money Market

The call money market operates as a platform for short-term interbank lending and borrowing. Institutions with surplus funds lend to those facing temporary deficits. The borrowing banks utilise call money primarily for maintaining statutory liquidity and fulfilling short-term obligations.
The process typically involves the following steps:

1. Identification of Surplus and Deficit Banks: Banks with excess liquidity seek to lend, while those facing shortages borrow.
2. Negotiation of Terms: The lending and borrowing banks agree on the amount, duration, and interest rate (call rate).
3. Settlement: Funds are transferred through interbank accounts, generally using electronic payment systems.
4. Repayment: The borrower repays the loan on demand or at the end of the agreed period.

In India, the Reserve Bank of India (RBI) oversees and regulates the call money market to maintain stability and transparency.

Participants in the Call Money Market

The major participants in the call money market include:

• Commercial Banks: The principal borrowers and lenders in the market.
• Cooperative Banks: Participate mainly as lenders.
• Primary Dealers: Borrow or lend funds to manage their short-term financing requirements.
• Discount and Finance Houses: Facilitate transactions by acting as intermediaries.
• Central Bank (e.g., RBI): Monitors and influences the market indirectly through monetary policy instruments.

Non-banking financial companies (NBFCs) and mutual funds were once active participants but are now restricted to the notice money segment (up to 14 days) under regulatory guidelines.

Determinants of Call Money Rates

The call rate is highly sensitive to the liquidity position of the banking system and macroeconomic conditions. The following factors influence its movement:

• Monetary Policy: Central bank measures such as repo operations, open market operations, and reserve requirements directly affect liquidity.
• Seasonal Demand: Periods like the financial year-end or festive seasons often witness higher demand for funds.
• Government Borrowing: Large-scale government borrowing programmes can tighten liquidity.
• Capital Flows: Inflows and outflows of foreign capital impact domestic liquidity levels.
• Market Sentiment: Expectations regarding future interest rates also influence call money rates.

When liquidity is abundant, call rates tend to fall; conversely, during tight liquidity conditions, rates may spike sharply.

Significance of the Call Money Market

The call money market plays a vital role in ensuring the smooth functioning of the financial system. Its significance lies in:

• Facilitating Liquidity Adjustment: Banks can manage short-term mismatches in cash flow effectively.
• Supporting Monetary Policy Transmission: Central bank interventions influence short-term interest rates through the call market.
• Promoting Financial Stability: By providing a mechanism for short-term funding, the market reduces the risk of sudden liquidity crises.
• Benchmark Role: The call rate often serves as an indicator of the short-term interest rate environment in the economy.
• Efficient Fund Allocation: Surplus funds are channelled to deficit institutions, enhancing overall system efficiency.

Advantages and Disadvantages

Advantages:

• Provides flexibility in managing short-term liquidity.
• Enables banks to maintain reserve ratios without disruption.
• Enhances interbank cooperation and financial integration.
• Reflects real-time liquidity conditions for policymakers and market participants.

Disadvantages:

• Subject to volatility due to sudden changes in liquidity.
• Over-dependence on call borrowing can indicate structural weakness in liquidity management.
• Lack of collateral may increase counterparty risk.
• Speculative movements can destabilise short-term interest rates.

Regulatory Framework

In India, the Reserve Bank of India regulates the call money market under the broader framework of the money market. The RBI’s measures include:

• Setting participation limits for different institutions.
• Regulating lending and borrowing tenures.
• Monitoring daily call rate movements.
• Using monetary policy tools like repo and reverse repo to influence liquidity.