51429594 call money market (1)

8/4/2019 51429594 Call Money Market (1)

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Call Money Market

By,

M.Tulasi Prasad


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FINANCIALMARKETS

MONEYMARKET

CAPITALMARKET


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Money Market consists of a number of sub-marketswhich collectively constitute the money market. They

are,

Call Money Market Commercial bills market or discount market Acceptance market Treasury bill market


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Introduction

Call money market is that part of the nationalmoney market where day-to-day surplusfunds, mostly of banks are traded in.

The loans made in this market are of a shortterm nature, their maturity varying betweenone day to a fortnight. As these loans arerepayable on demand on the option of eitherthe lender or the borrower, they are highlyliquid, their liquidity being exceeded only bycash.


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Call Money Market in India

Call loans in India are given:

1. To the bill market

2. For the purpose of dealing in the bullion

market and stock exchanges.3. Between banks

4. To HNIs for ordinary trade purposes in orderto save interest on cash credit and overdrafts.

Among these users, inter bank use has beenthe most significant and their use in stockexchanges and other markets has beenmodest.


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Banks borrow from other banks in order to meet asudden demand for funds, large payments, largeremittances and to maintain cash or liquidity with theRBI.

Until March 1978, transactions in the call money marketwere usually effected through brokers. Each day thesebrokers obtained information about money on offer andmoney demanded and then effected the transactions.Since then, however, RBI has prohibited banks paying

brokerage on operations in the call money market as ithas stopped payment of brokerage on deposits.


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Call loans in India have a maturity anywhere betweenone day to a fortnight.

Money at call and short notice are highly liquid assets inthe 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 bereflected in two indicators:

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

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


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The need for call money borrowings is highestaround March to meet year end tax paymentsand withdrawal of funds by financial

institutions to meet their statutory obligations. Call money borrowings tend to increase when

there is an increase in CRR.


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Participants of Call Money Market

Participants of call money market include:

1. Scheduled Commercial Banks

2. Non Scheduled Commercial Banks

3. Foreign Banks

4. State District and Urban Co-operative Banks5. DFHI

6. STCI

DFHI and STCI just like banks and other primarydealers 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 themarket has expanded to encompass also the smallbanks and non scheduled banks.


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Earlier foreign banks were primarily lenders in this market.However, now their participation as borrowers has increased formeeting CRR requirements together with their difficulty in tappingdeposits due to lack of branches and increase in the cost ofservicing FCNR deposits.

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

Earlier institutions like GIC, LIC and UTI were keeping funds witha very small number of big banks which had a sort ofmonopolyuse of vast cash resources of these institutions. Through the callmarket, it has now become possible for many banks to fall upon

these institutions in times of financial stringency. On the otherhand, these institutions have a greater flexibility in investing theirfunds and thereby increasing the income on their resources.


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Continuous participation in the call market helps tointegrate the long term and short term money marketsin 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 atall into the short term market?

2. Second, these institutions direct participation in the callmoney market has a potential for weakening themonetary policy of the RBI. An access to funds by banks

outside the banking system means that they canweaken the effect of monetary techniques, such as,changes in reserve requirements, bank rate andselective credit control.


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

On the basis of this report, the authorities have

removed the ceiling on the call rate for all theparticipants.

As per the latest RBI policy, LIC, UTI, GIC and NABARDare allowed to participate in the call money market aslenders and not as borrowers only after they provide

evidence to the RBI about their having bulk resourcesand having no outstanding borrowings from the banks.


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Furthermore they are required to observe a minimumsize of operation of Rs.20 cr per transaction. They canparticipate with prior permission of RBI and onlythrough DFHI.

There is a view that there are imperfections in callmoney market in the sense that only a few rich bankssupply funds and they tend to make quick gains bypushing 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 isa very small group of lenders and large number ofborrowers in this market.


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Location of Call Money Market

Call money markets are mainly located in big industrialand commercial centers like Mumbai, Calcutta, Chennai,Delhi, Bangalore and Ahmedabad with Mumbai andCalcutta 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 beingpresent in Mumbai, it has become the hub of call moneyactivities.

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


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Factors Affecting Call Money Market

Variations in the volume of demand for and supply ofcall 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 ofinvestment. Since call loans are one of the avenues ofinvestment, the supply of call loans would increasewhen there is an increase in deposits. If the depositsaccrue 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 ofloans for industrial and commercial purposes.


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Factors Affecting Call Money Market

The size of call loans is also determined for the possibility of quickinvestment or liquidation of government securities, treasury billsand other short term investments.

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

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

It has been observed that the system of maintaining reserves ona weekly basis, coupled with the manipulation of the SLR, makesbanks operate in the call money market as the lenders andborrowers. This pressure on the market reaches a peak towardsthe end of the banking week i.e. on Friday when there is a

scramble for funds to make up the shortfall in the amount ofrequired reserves.

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


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Call Rates

The rate of interest paid on call loans is known asthe call rate. The call rate is highly volatile andvaries from day to day, hour to hour. It variesfrom 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 creditsqueeze of RBI, call rates reached an all time highof 30% in Dec 1973. To regulate this, IBA

informally fixed a ceiling of 15% on the level of callrate which was subsequently reduced to 12.5% inMarch 1976, 10% in June 1977, 8.6% in March1978 and 10% in April 1980.


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Call Rates

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

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

2. Effective May 1989, the ceilings on the call rateand 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.


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Call Rate V/s Bank Rate

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

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

DFHI call lending rate has usually been higher thanthe average inter bank call rate. There is also

greater amount of volatility in DFHI lending ratescompared to inter bank call rates.


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Reason for Call Rate Volatility

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

1) Large borrowings on certain dates by banks to meet theCRR requirements and sharp reduction in the demand of

call money once CRR needs are meet. The rates risesharply in the first week of the fortnight and subside inthe second week when banks have covered their cashreserve requirements.

2) The credit operations of certain banks tend to be much

in excess of their own resources. These banks overextended credit position treat call market as a source offunds for meeting disequilibria in their sources and usesof funds.


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

4) The withdrawal of funds by institutional lenders to meettheir business needs and by the corporate sector forpayment of advance tax leads to steep increase in thecall rate.

5) The liquidity crisis in money market also contributes tocall rate volatility. When call money market is easy,banks invest funds in government securities, units and

public sector bonds in order to maximize earnings. Butwith no buyers in the market, these instruments tend tobecome illiquid which accentuates liquidity crisis andpushes up rates in the call market.


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6) The mismatch between asset liability of commercialbanks arising out of massive demand for non-foodcredit as against sluggish growth in bank deposits isanother relevant factor.

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

8) The technical modalities of the calculation of reservesrequirement 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 depositsalso have been important contributing factors in thiscontext.


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Inspite of intervention by the DFHI, channelisation of more fundsby the RBI through DFHI, channelisation of funds by certainfinancial institutions with surplus funds, the increase in number ofparticipants and the softening of penalties in CRR shortfalls havenot helped to moderate interest rate volatility in the call moneymarket.

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

1. Money market support

2. Repos operations

3. Foreign exchange purchases

4. Enhancing government securities refinancing.

Banks are the net lenders while PDs are net borrowers in the callmoney market. The pure inter bank call market is yet to developin India.

51429594 call money market (1)

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