How to read the signals from our call money market

What is call money and why do banks need it?

Call money is the borrowing or lending of unsecured funds for a short-term period and is used for inter-bank transactions. It caters to the day-to-day cash needs of banks and the rate at which these transactions takes place is the call rate. In order to meet cash reserve ratio and statutory liquidity ratio requirements and to fulfil sudden demands for funds, banks borrow in the call money market. Prevailing liquidity conditions influence the call money rate i.e., tightening liquidity conditions lead to a rise in call money rates and vice versa. RBI, banks and primary dealers participate in the call money market.

How is call money rate different from repo?

Call money is a short-term finance option with a maturity of one to 14 days. When borrowing takes place for a one-day time period or an overnight basis, it is termed ‘call money’ while if the borrowing is for two to 14 days, it is termed ‘notice money’. Repo rate is the rate at which the Reserve Bank of India lends money to commercial banks against securities such as Treasury Bills for meeting their short-term fund requirements. It is one of the main monetary tools of the RBI. The weighted average call rate, which is the unsecured segment of the overnight money market, is generally closely aligned to the repo rate.

Why are call money rates in the news now?

The liquidity adjustment facility, an interest rate corridor, has the interest rate on the marginal standing facility (MSF) as the upper bound (ceiling), the fixed overnight reverse repo rate as the lower bound (floor) and the repo rate in between. The RBI has been tightening liquidity conditions to check inflation, which has driven call money rate above the repo rate.

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What do rising call money rates indicate?

Demand for bank borrowings has risen due to the economic revival. In the process of meeting higher loan demand, banks have been facing a systemic liquidity mismatch in adhering to the reserve ratios. In order to avoid penalties or getting blacklisted, banks are compelled to rely on inter-bank borrowings. With the number of banks at the faultline going up, the call money rate for overnight borrowing, has started going up, resulting in a rise in short-term borrowing costs for companies as well.

What could be the policy approach now?

There is a liquidity crunch in the market now, as against the surplus liquidity of a year back. In view of the improved marginal efficiency of capital — since corporate units are not averse to the rising cost of borrowing — the RBI could explore a liberal monetary policy approach or slow down the policy tightening. Also, with retail inflation easing in July and commodity prices easing, RBI could look at ensuring availability of adequate liquidity to meet the production requirements of the economy.

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