Call money

3 key takeaways

• Call money facilitates short-term borrowing and lending among financial institutions, allowing them to manage liquidity and meet regulatory obligations.
• Transactions involving call money are typically unsecured and have a duration of one day, with funds being borrowed overnight and repaid the following business day.
• Interest rates for call money transactions are determined by market forces and can fluctuate based on supply and demand dynamics in the interbank lending market.

What is Call Money

Call money, also known as call loans or overnight loans, refers to funds borrowed by banks and financial institutions from one another for a short period, usually overnight. These loans are typically unsecured, meaning they are not backed by collateral, and are used to address temporary liquidity shortages or reserve requirements. Call money transactions are conducted in the interbank market, where banks lend excess funds to other banks in need of additional liquidity.

Importance of Call Money

• Liquidity Management: Call money enables banks to effectively manage their liquidity positions by borrowing or lending funds on a short-term basis to meet daily cash flow needs or regulatory reserve requirements.
• Interbank Market Functioning: The availability of call money facilitates the smooth functioning of the interbank lending market, allowing banks to redistribute funds among themselves and maintain stability in the financial system.
• Monetary Policy Transmission: Interest rates in the call money market serve as a key indicator of monetary policy conditions, influencing broader interest rate levels and economic activity.

How Call Money works

Borrowing and Lending

Banks that require additional funds to meet their short-term liquidity needs can borrow call money from other banks in the interbank market. Conversely, banks with excess funds can lend call money to institutions in need of liquidity, earning interest on their idle cash reserves.

Overnight Duration

Call money transactions typically have a duration of one day, with funds being borrowed overnight and repaid the following business day. This short-term nature allows banks to address immediate funding requirements without committing to longer-term borrowing arrangements.

Interest Rate Determination

Interest rates for call money transactions are determined by market forces of supply and demand in the interbank lending market. Factors such as prevailing monetary policy rates set by central banks, liquidity conditions, and the creditworthiness of borrowing institutions can influence call money interest rates.

Examples of Call Money

• Bank A: Bank A needs additional funds to meet its reserve requirements for the day and borrows call money from Bank B overnight, agreeing to repay the loan with interest the following business day.
• Bank C: Bank C has excess liquidity and lends call money to Bank D, earning interest on its idle funds for the overnight period before receiving repayment the next business day.

Real world application

In real-world banking operations, call money plays a crucial role in managing short-term liquidity needs and ensuring the efficient allocation of funds within the financial system. Banks rely on call money transactions to address daily fluctuations in cash reserves, comply with regulatory requirements, and maintain stability in the interbank lending market.

Moreover, central banks closely monitor call money interest rates as part of their monetary policy implementation framework, using changes in short-term borrowing costs to influence broader economic conditions such as inflation, economic growth, and financial stability.

By understanding the dynamics of call money markets and their implications for monetary policy transmission, policymakers and market participants can make informed decisions to support the smooth functioning of financial markets and promote economic stability.