Call Money Rate

Call money rate refers to the interest rate charged on short-term loans between banks and other financial institutions, usually for a period ranging from one day to fourteen days. It plays a crucial role in the money market, acting as an indicator of short-term liquidity and the immediate availability of funds in the banking system. The call money market is an essential component of a country’s financial system, providing institutions with the means to meet short-term funding requirements and manage day-to-day cash flow.

Definition and Nature of Call Money

Call money is money lent for a very short duration — typically overnight — and is repayable on demand, hence the term “call”. The rate of interest charged on such loans is known as the call money rate. It represents the cost of borrowing funds for one day and fluctuates depending on the demand and supply of funds within the interbank system.
In India and many other countries, the call money market functions as the most liquid segment of the money market. Transactions are usually conducted between:

• Commercial banks, which borrow to maintain reserve requirements or fund temporary shortfalls.
• Cooperative banks, primary dealers, and non-banking financial institutions, which lend surplus funds to earn short-term returns.

The call money rate is a dynamic, market-determined rate that changes daily based on liquidity conditions.

Participants in the Call Money Market

The major participants include:

• Borrowers: Commercial banks and primary dealers who need short-term funds.
• Lenders: Banks and financial institutions with surplus liquidity.
• Regulatory authorities: Central banks such as the Reserve Bank of India (RBI) monitor and regulate the market to ensure stability.

This market operates mainly through negotiated transactions or electronic dealing systems and functions as a vital channel for redistributing liquidity among financial institutions.

Determinants of the Call Money Rate

The call money rate fluctuates due to several interrelated factors:

• Liquidity Position: When liquidity in the banking system is tight, the demand for short-term funds increases, driving up the rate. Conversely, surplus liquidity results in lower rates.
• Monetary Policy: Central bank interventions, such as open market operations, repo rate changes, and cash reserve requirements, directly influence short-term money rates.
• Seasonal Factors: During periods of high credit demand (e.g., financial year-end, festive seasons, or tax payment deadlines), call rates tend to rise.
• Market Sentiment: Expectations regarding future interest rates and inflation affect borrowing costs.
• Government Borrowing: Large-scale government borrowing programmes can temporarily absorb liquidity, pushing call money rates upward.

Functioning of the Call Money Market

The call money market facilitates borrowing and lending primarily for very short durations:

1. Overnight Call Loans: Borrowed for one day and repaid the next working day.
2. Notice Money: Funds borrowed for two to fourteen days.

Transactions are usually collateral-free, which differentiates call money from repo or collateralised lending. Since these loans are unsecured, the call money rate tends to be more volatile.
Financial institutions use the call market to:

• Maintain statutory reserve requirements such as the Cash Reserve Ratio (CRR).
• Manage temporary mismatches in fund inflows and outflows.
• Adjust liquidity positions based on daily operations.

Role of the Central Bank

The central bank, such as the Reserve Bank of India, plays a supervisory and regulatory role in the call money market. It ensures orderly market functioning and prevents excessive volatility in rates.
Key measures undertaken by central banks include:

• Liquidity Adjustment Facility (LAF): Through repo and reverse repo operations, the central bank manages liquidity and indirectly influences call rates.
• Monetary Policy Announcements: Policy rate changes affect interbank borrowing costs.
• Open Market Operations (OMO): Buying or selling government securities to inject or absorb liquidity.

In India, the Weighted Average Call Money Rate (WACR) serves as an operating target for monetary policy, providing an indicator of short-term liquidity conditions.

Importance of Call Money Rate

The call money rate is a crucial barometer of the overall health of the financial system. Its significance lies in several aspects:

• Indicator of Liquidity: Reflects the immediate availability of funds in the banking system.
• Transmission of Monetary Policy: Changes in policy rates influence the call rate, which then affects other market rates such as the repo, commercial paper, and deposit rates.
• Benchmark for Other Rates: Serves as a reference for pricing short-term instruments like treasury bills and certificates of deposit.
• Market Efficiency: Facilitates redistribution of liquidity, ensuring optimal use of funds across institutions.
• Stability Indicator: Excessive volatility in the call rate can indicate stress in the financial system, prompting central bank intervention.

Advantages of the Call Money Market

• Flexibility: Provides immediate access to short-term funds without collateral.
• Liquidity Management: Enables banks to maintain reserve balances efficiently.
• Market Integration: Links various segments of the financial system, promoting monetary transmission.
• Profit Opportunity: Institutions with surplus funds can earn interest by lending at call rates.

Risks and Challenges

Despite its advantages, the call money market has inherent risks:

• Volatility: Since call loans are unsecured, rates can fluctuate sharply based on liquidity conditions.
• Credit Risk: Though limited to banks and financial institutions, there remains a small risk of default.
• Market Concentration: Larger banks with significant liquidity may dominate, affecting rate stability.
• Policy Dependence: Heavy reliance on central bank interventions can limit market autonomy.

Trends in India’s Call Money Market

In India, the call money market has evolved considerably since liberalisation. The Reserve Bank of India has taken several measures to make the system more transparent and stable. Presently, only banks and primary dealers are allowed to borrow and lend in this market, ensuring better risk management.
The call money rate typically hovers around the repo rate corridor but can spike temporarily during liquidity shortages. The RBI continuously monitors the market to ensure that short-term rates align with its policy objectives.