One of the toughest job for a central bank is to provide sufficient liquidity in the system. If financial institutions including banks need immediate money, there are few arrangements for them to borrow for very small periods. Such loans are provided from the money market.
What is money market?
According to the RBI, “the money market is a market for short-term financial assets that are close substitutes of money”.
Call money market?
The call money market (CMM) the market where overnight (one day) loans can be availed by banks to meet liquidity. Banks who seeks to avail liquidity approaches the call market as borrowers and the ones who have excess liquidity participate there as lenders. The CMM is functional from Monday to Friday. Banks can access CMM to meet their reserve requirements (CRR and SLR) or to cover a sudden shortfall in cash on any particular day.
Effectively, the Call Money Market is the main market oriented mechanism to meet the liquidity requirements of banks.
What is notice money market?
The call money is usually availed for one day. If the bank needs funds for more days, it can avail money through notice market. Here, the loan is provided from two days to fourteen days.
Participants in the call money market are banks and related entities specified by the RBI. Scheduled commercial banks (excluding RRBs), co-operative banks (other than Land Development Banks) and Primary Dealers (PDs), are permitted to participate in call/notice money market both as borrowers and lenders. As per the new regulations, Payment Banks are also allowed to participate in CMM as both lenders and borrowers.
Banks are the dominant participants in the CMM and hence it is often known as interbank call money market. Surplus banks will give loans to other banks. Deficit banks that need funds will purchase it.
Functioning of the Call Money Market
Loans are availed through auction/negotiation. The auction is made on interest rate. Highest bidder (who is ready to give higher interest rate) can avail the loan. Average interest rate in the call market is called call rate. Dealing in call money is done through the electronic trading platform called Negotiated Trading System (NDS). This call money rate is an important variable for the RBI to assess the liquidity situation in the economy. The CMM is known as the most sensitive segment of the financial system.
Since the participants are banks, the call money rate tells about the overall liquidity position in the economy. Higher call rate indicates liquidity stress in the economy. In this case, the RBI may follow up with liquidity support measures by through its monetary policy instruments - cutting CRR or allowing more repos. Hence, the call money rate is taken as the operating target of monetary policy.