What Is Call Money?
Call money refers to short-term, unsecured loans transacted between financial institutions, predominantly commercial banks, with a maturity period ranging from one day (overnight) to up to 14 days. It is a vital component of the money markets, providing a mechanism for banks to manage their immediate liquidity needs. The interest rate on call money, known as the call rate, is highly sensitive to daily supply and demand dynamics in the interbank market. Banks primarily use call money to meet their statutory reserve requirements, such as the cash reserve ratio mandated by a nation's central bank.
History and Origin
The concept of banks lending to each other on a very short-term basis has roots in the evolution of modern banking systems. Historically, banks needed to maintain adequate reserves to cover potential withdrawals and honor obligations. Before the establishment of centralized banking authorities, individual banks held reserves, and the informal borrowing and lending of these reserves between institutions helped manage short-term imbalances. In the United States, the practice of holding reserves became formalized with the National Bank Act of 1863, which imposed reserve requirements on national banks.9 This legislative development underscored the necessity for banks to manage their daily cash positions, directly fueling the need for a call money market. The Federal Reserve System, established in 1913, further formalized the regulatory framework around bank reserves and, by extension, the interbank lending market.8 The call money market evolved to allow banks to efficiently balance their accounts, often utilizing these funds to meet the reserve obligations stipulated by central banking authorities.
Key Takeaways
- Call money represents very short-term, typically overnight loans, between financial institutions.
- It serves as a primary tool for banks to manage their daily liquidity and meet mandatory reserve requirements.
- The interest rate on call money, the call rate, is highly volatile and reflects immediate supply and demand for funds in the interbank market.
- Call money transactions are typically unsecured loans, meaning they are not backed by collateral.
- It is a crucial segment of the money market, influencing other short-term interest rates.
Interpreting the Call Money
The call money rate is a key indicator of liquidity conditions within the banking system. A rising call rate generally signals a tightening of liquidity, indicating that banks are facing a shortage of funds. Conversely, a falling call rate suggests ample liquidity in the system. Central banks closely monitor the call rate as it provides immediate feedback on the effectiveness of their [monetary policy](https://diversification.com/term/monetary-policy operations) and the overall health of the interbank lending market. Significant fluctuations in the call rate can lead to instability in other short-term money market instruments and potentially impact the broader economy. Analyzing trends in the call rate helps financial analysts and policymakers understand the immediate funding pressures on banks and the overall demand for short-term capital.
Hypothetical Example
Consider two hypothetical commercial banks, Bank A and Bank B, at the end of a business day. Bank A finds itself with a temporary deficit of funds needed to meet its daily cash reserve ratio requirement. Simultaneously, Bank B has an excess of cash beyond its required reserves that it wishes to lend to earn a return.
Bank A contacts Bank B, or an interbank broker, to borrow a specific amount as call money. They agree on a call rate for an overnight loan. For instance, Bank A might borrow $10 million from Bank B at an annual call rate of 5%. The following business day, Bank A repays the $10 million plus the interest accrued overnight. This transaction allows Bank A to fulfill its regulatory obligation without disrupting its long-term investment strategy, while Bank B earns a short-term return on its surplus funds, optimizing its balance sheet.
Practical Applications
Call money plays a pivotal role in the day-to-day operations of financial markets and institutions. Its primary application is to enable banks to manage their short-term liquidity, ensuring they maintain the cash reserve ratio set by regulatory bodies. In countries like India, the Reserve Bank of India (RBI) actively supervises and regulates the call money market to ensure stability and control liquidity.7,6 The RBI, for instance, has a dedicated framework for the call/notice money market, specifying participants and reporting requirements, often through platforms like the Negotiated Dealing System (NDS).5,4 The call money market also indirectly influences the pricing of other short-term debt instruments, such as commercial papers and certificates of deposit, as banks may choose between these options based on prevailing call rates. Therefore, understanding the dynamics of call money is crucial for central banks implementing monetary policy, as changes in call rates can signal shifts in market liquidity and the effectiveness of policy actions.3
Limitations and Criticisms
While essential for liquidity management, the call money market is not without its limitations and criticisms. A significant drawback is the extreme volatility of call rates, which can fluctuate rapidly based on minor shifts in supply and demand. This volatility makes planning difficult for banks and can lead to sudden increases in funding costs. Furthermore, the unsecured nature of call money exposes lenders to counterparty risk, although this risk is generally considered low given the strong credit profiles of participating institutions.
Historically, the lack of transparency in interbank lending markets, including rates like the London Interbank Offered Rate (LIBOR), which conceptually relates to unsecured interbank borrowing, led to significant issues. The LIBOR scandal, which came to light in 2012, exposed how major banks manipulated reported rates for financial gain, undermining trust in the integrity of such benchmarks.2, Although call money is distinct from LIBOR, the scandal highlighted the potential for misconduct in loosely regulated interbank markets. Regulators globally have since pushed for greater transparency and reliance on transaction-based rates rather than polled rates, moving towards more robust and verifiable benchmarks in financial markets.
Call Money vs. LIBOR
Call money and the London Interbank Offered Rate (LIBOR) both relate to interbank lending, but they differ significantly in their scope, structure, and underlying mechanisms.
Call money is specific to very short-term, typically overnight, unsecured loans between banks, primarily used for immediate liquidity adjustments and meeting reserve requirements. The rates are determined by real-time supply and demand in a domestic interbank market.
LIBOR, on the other hand, was a global benchmark interest rate that represented the average rate at which major banks in London could borrow unsecured loans from other banks in the wholesale money market. Unlike call money, LIBOR was a polled rate, meaning it was based on estimates submitted by a panel of banks, rather than actual transaction data for many maturities. LIBOR was published for multiple currencies and for various maturities, from overnight to one year, serving as a reference rate for trillions of dollars in financial products worldwide, including mortgages, derivatives, and corporate loans. The significant distinction lies in call money being an active, transaction-based rate for immediate domestic liquidity, whereas LIBOR was a constructed benchmark used globally for a wider array of financial contracts, whose integrity was compromised by a manipulation scandal. Due to this, LIBOR has been largely phased out and replaced by alternative reference rates, such as the Secured Overnight Financing Rate (SOFR).
FAQs
What is the primary purpose of call money?
The primary purpose of call money is to help banks manage their short-term liquidity and meet regulatory reserve requirements by borrowing or lending funds for very brief periods, typically overnight.
Who are the main participants in the call money market?
The main participants in the call money market are commercial banks and other financial institutions that need to manage their daily cash positions. In some markets, primary dealers may also participate.1
How do interest rates for call money behave?
Interest rates for call money, known as call rates, are highly volatile and fluctuate frequently, even on an hourly basis, reflecting the immediate demand and supply of funds in the interbank market. They are highly sensitive to market liquidity conditions.
Is call money a secured or unsecured loan?
Call money loans are generally unsecured loans, meaning they are not backed by collateral. This distinguishes them from other short-term instruments like those in the repo market.
How does a central bank influence the call money market?
A central bank influences the call money market through its monetary policy tools, such as adjusting policy rates (like the repo rate) or conducting open market operations. These actions directly impact the overall liquidity in the banking system, which in turn affects the call rate.