How to read signals from call money market

As the Reserve Bank of India tightened liquidity conditions to counteract the rising inflationary trend in the country, interbank call rates soared. This has resulted in higher short-term borrowing costs for companies. Mint analyzes the effect.

What is call money and why do banks need it?

Call money is the borrowing or lending of unsecured money for a short period and used in interbank transactions. It meets the daily cash needs of the banks and the rate at which these transactions take place is the call rate. In order to meet the cash reserve ratio and statutory liquidity ratio requirements and to meet sudden demands for funds, banks borrow in the demand money market. The prevailing liquidity conditions affect the price of the call money, i.e., the tightening of the liquidity conditions causes the price of the call money to rise and vice versa. The Reserve Bank of India, banks and primary dealers participate in the call money market.

How is the price of call money different from a repo?

Fund Transfer is a short-term financing option with a maturity of 1 to 14 days. When the borrowing takes place for a period of time of one day or on an overnight basis, it is called Call Money while if the borrowing is for a period of 2 to 14 days, it is called Notification Money. The repo rate is the rate at which the Reserve Bank of India lends money to commercial banks in exchange for securities such as Treasury bills to meet the requirements of short-term funds. It is one of the main monetary instruments of the Reserve Bank of India. The weighted average call price, which is the unsecured portion of the overnight money market, aligns closely with the repo price.

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Why are money call rates in the news now?

The Liquidity Adjustment Facility, the interest rate corridor, has the permanent marginal facility (MSF) interest rate as the upper bound (the cap), the fixed overnight reverse repo rate as the lower bound (the floor) and the repo rate in between. The Reserve Bank of India (RBI) has tightened liquidity conditions to check for inflation, which has resulted in the money call rate rising above the repo rate.

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What does the high price of financial calls indicate?

The demand for bank loans increased due to the economic recovery. In the process of meeting the high demand for loans, banks were faced with a systemic mismatch of liquidity in adherence to reserve ratios. In order to avoid penalties or blacklisting, banks are forced to rely on interbank loans. With the number of banks rising on the fault line, the price of call money to borrow overnight started to rise, driving up short-term borrowing costs for businesses as well.

What would be the policy approach now?

There is a liquidity crunch in the market now, as opposed to excess liquidity a year ago. In light of improving the marginal efficiency of capital – since corporate units are not averse to higher cost of borrowing – the RBI could explore a liberal monetary policy approach or slow down policy tightening. Also, with retail inflation easing in July and commodity prices declining, the Reserve Bank of India could look at ensuring sufficient liquidity is available to meet the production requirements of the economy.

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