Call Money Market

Call Money Market

Prof Mahesh KumarAmity Business [email protected]

Introduction

Call money market is that part of the national money market where day-to-day surplus funds, mostly of banks are traded in.

The loans made in this market are of a short term nature, their maturity varying between one day to a fortnight. As these loans are repayable on demand on the option of either the lender or the borrower, they are highly liquid, their liquidity being exceeded only by cash.

Call Money Market in India

Call loans in India are given:1. To the bill market2. For the purpose of dealing in the bullion

market and stock exchanges.3. Between banks4. To HNIs for ordinary trade purposes in order to

save interest on cash credit and overdrafts. Among these users, inter bank use has been

the most significant and their use in stock exchanges and other markets has been modest.

Call Money Market in India

Banks borrow from other banks in order to meet a sudden demand for funds, large payments, large remittances and to maintain cash or liquidity with the RBI.

Until March 1978, transactions in the call money market were usually effected through brokers. Each day these brokers obtained information about money on offer and money demanded and then effected the transactions. Since then, however, RBI has prohibited banks paying brokerage on operations in the call money market as it has stopped payment of brokerage on deposits.

Call Money Market in India Call loans in India have a maturity anywhere between

one day to a fortnight. Money at call and short notice are highly liquid assets in

the balance sheet of the bank. Call loans in India are unsecured. Call loans in India are subject to seasonal fluctuations.

The seasonal nature of the call money market would be reflected in two indicators:

a) A decline in money at call and short notice should be greater in the slack season than in the busy season of a given year.

b) An increase in money at call and short notice should be greater in the busy season than in the slack season.

Call Money Market in India

The need for call money borrowings is highest around March to meet year end tax payments and withdrawal of funds by financial institutions to meet their statutory obligations.

Call money borrowings tend to increase when there is an increase in CRR.

Participants of Call Money Market Participants of call money market include:1. Scheduled Commercial Banks2. Non Scheduled Commercial Banks3. Foreign Banks4. State District and Urban Co-operative Banks5. DFHI6. STCI DFHI and STCI just like banks and other primary dealers

borrow and lend in the call money market. Earlier only few large banks, particularly foreign banks,

used to operate in call money market. But now the market has expanded to encompass also the small banks and non scheduled banks.

Participants of Call Money Market Earlier foreign banks were primarily lenders in this market.

However, now their participation as borrowers has increased for meeting CRR requirements together with their difficulty in tapping deposits due to lack of branches and increase in the cost of servicing FCNR deposits.

The SBI group kept itself away from call money market till 1970 but now has become a major lender and only a small borrower in the call money market.

Earlier institutions like GIC, LIC and UTI were keeping funds with a very small number of big banks which had a sort of ‘monopoly use’ of vast cash resources of these institutions. Through the call market, it has now become possible for many banks to fall upon these institutions in times of financial stringency. On the other hand, these institutions have a greater flexibility in investing their funds and thereby increasing the income on their resources.

Participants of Call Money Market Continuous participation in the call market helps to

integrate the long term and short term money markets in the economy.

Investment in call market by non banking financial institutions has raised certain important issues.

1. First whether with long term funds should they enter at all into the short term market?

2. Second, these institutions’ direct participation in the call money market has a potential for weakening the monetary policy of the RBI. An access to funds by banks outside the banking system means that they can weaken the effect of monetary techniques, such as, changes in reserve requirements, bank rate and selective credit control.

Participants of Call Money Market

In this context, the Working Group on the Money Market (Vaghul Working Group) was appointed by RBI in 1987 on the working of call money market.

On the basis of this report, the authorities have removed the ceiling on the call rate for all the participants.

As per the latest RBI policy, LIC, UTI, GIC and NABARD are allowed to participate in the call money market as lenders and not as borrowers only after they provide evidence to the RBI about their having bulk resources and having no outstanding borrowings from the banks.

Participants of Call Money Market

Furthermore they are required to observe a minimum size of operation of Rs.20 cr per transaction. They can participate with prior permission of RBI and only through DFHI.

There is a view that there are imperfections in call money market in the sense that only a few rich banks supply funds and they tend to make quick gains by pushing call rates by forming cartels.

Another view is that even if cartels are non existent, there is no call market proper in India because there is a very small group of lenders and large number of borrowers in this market.

Location of Call Money Market

Call money markets are mainly located in big industrial and commercial centers like Mumbai, Calcutta, Chennai, Delhi and Ahmedabad with Mumbai and Calcutta being important centers from the point of view of the size and buoyancy of the market.

Due to presence of head offices of RBI, many bank, LIC, UTI together with big stock exchanges of country being present in Mumbai, it has become the hub of call money activities.

The geographical integration of call markets, however, is still far from perfect resulting in considerable differences in call rates prevailing in different centers.

Location of Call Money Market

There are large number of local markets developed and operated by ingenious local banks. For example in Saurashtra in Gujarat when large payments or remittances are to be made, the local banks help each other with local funds.

Among some banks, they are regular arrangements without the payment of interest. For other banks, the price of overnight money is two paisa per hundred rupees for overnight lending.

Size of Call Money Market Vis a Vis US & UK Markets

The size of call money market has been smaller than that of the US and UK. This may be due to the following factors:

The bill market in India is underdeveloped and so the call loans to the bill market cannot but be small. In developed markets the amount of call loans depended and supplied is large.

Unlike in the UK, direct discounting facilities are available to banks with RBI as a result of which they have much less need for loans from the money market. Further Indian commercial banks have fairly large cash reserves; therefore, their need to borrow from call market is much less.

Unlike in the US, loans to security dealers is not readily available. Due to many restrictions imposed by RBI, trading activity on stock exchanges in India is undertaken by members using funds which are mostly derived from private sources.

Factors Affecting Call Money Market

Variations in the volume of demand for and supply of call loans are caused by many factors:

Extent of deposits accrual of the banking system. Increase in deposits with banks, other things being equal, would induce banks to explore possibilities of investment. Since call loans are one of the avenues of investment, the supply of call loans would increase when there is an increase in deposits. If the deposits accrue to all the banks, then supply of funds to borrowers outside banking system would increase.

Demand for call loans would depend upon the buoyancy of the stock market and the increase in the demand of loans for industrial and commercial purposes.

Factors Affecting Call Money Market The size of call loans is also determined for the possibility of quick

investment or liquidation of government securities, treasury bills and other short term investments.

Demand for call money tends to increase in Dec., Mar., June and Sept. i.e. when quarterly advance tax payments are to be made.

The speed with which the remittance and clearance system works in a country also impacts the volume of call loans.

It has been observed that the system of maintaining reserves on a weekly basis, coupled with the manipulation of the SLR, makes banks operate in the call money market as the lenders and borrowers. This pressure on the market reaches a peak towards the end of the banking week i.e. on Friday when there is a scramble for funds to make up the shortfall in the amount of required reserves.

Foreign exchange activity also has been a significant determinant of the call market activity in recent years.

Call Rates The rate of interest paid on call loans is known as

the call rate. The call rate is highly volatile and varies from day to day, hour to hour. It varies from center to center and is very sensitive to the supply and demand of call loans.

Call rates in India till 1973 were determined by market forces. In 1973 on account of credit squeeze of RBI, call rates reached an all time high of 30% in Dec 1973. To regulate this, IBA informally fixed a ceiling of 15% on the level of call rate which was subsequently reduced to 12.5% in March 1976, 10% in June 1977, 8.6% in March 1978 and 10% in April 1980.

Call Rates

Now, this ceiling in call rates have been removed in two stages:

1. Effective Oct 1988, the operations of DFHI were exempted from ceiling.

2. Effective May 1989, the ceilings on the call rate and inter bank money rate were withdrawn.

Thus call rate have been deregulated since 1989. There are now two call rates in India:1. The inter bank call rate.2. The lending rate of DFHI in the call market.

Call Rate V/s Bank Rate

Bank rate is the rate at which banks can borrow funds from their Central Bank.

In India, the call rate has always been more than the Bank Rate till 1975-76 after which it has been sometimes below and sometimes above the Bank Rate.

DFHI call lending rate has usually been higher than the average inter bank call rate. There is also greater amount of volatility in DFHI lending rates compared to inter bank call rates.

Reason for Call Rate Volatility

Volatility of the call rates can be attributed to the following factors:

1) Large borrowings on certain dates by banks to meet the CRR requirements and sharp reduction in the demand of call money once CRR needs are meet. The rates rise sharply in the first week of the fortnight and subside in the second week when banks have covered their cash reserve requirements.

2) The credit operations of certain banks tend to be much in excess of their own resources. These banks over extended credit position treat call market as a source of funds for meeting disequilibria in their sources and uses of funds.

Reason for Call Rate Volatility

3) The occasional factors in the market also affect the volatility. For example, in the recent past, the call rate has shot up due to disruption in the banking industry.

4) The withdrawal of funds by institutional lenders to meet their business needs and by the corporate sector for payment of advance tax leads to steep increase in the call rate.

5) The liquidity crisis in money market also contributes to call rate volatility. When call money market is easy, banks invest funds in government securities, units and public sector bonds in order to maximize earnings. But with no buyers in the market, these instruments tend to become illiquid which accentuates liquidity crisis and pushes up rates in the call market.

Reason for Call Rate Volatility

6) The mismatch between asset liability of commercial banks arising out of massive demand for non-food credit as against sluggish growth in bank deposits is another relevant factor.

7) Activity in forex market and call money markets have of late been inter linked.

8) The technical modalities of the calculation of reserves requirement also leads to sharp swings in the call rates.

9) The structural deficiencies in the banking system and the practice of banks to window dress their deposits also have been important contributing factors in this context.

Reason for Call Rate Volatility Inspite of intervention by the DFHI, channelisation of more funds

by the RBI through DFHI, channelisation of funds by certain financial institutions with surplus funds, the increase in number of participants and the softening of penalties in CRR shortfalls have not helped to moderate interest rate volatility in the call money market.

RBI has introduced many measures to stabilize call rate volatility. Some of them are:

1. Money market support2. Repos operations3. Foreign exchange purchases4. Enhancing government securities refinancing. Banks are the net lenders while PDs are net borrowers in the call

money market. The pure inter bank call market is yet to develop in India.