Call funds, also known as call money, are short-term, interest-bearing loans that the borrower must repay immediately upon the lender's demand. They are a crucial part of the financial system.
Key Characteristics of Call Funds:
- Short-Term Nature: Call funds are typically overnight loans, though they can extend for a few days.
- Demand Repayment: The lender can demand repayment at any time.
- Interest Earning: Borrowers pay interest on the loan, referred to as the call loan rate.
- Interbank Lending: Predominantly used by banks to manage their short-term liquidity requirements.
Importance of Call Funds
- Liquidity Management: Call funds help banks address temporary mismatches between their assets and liabilities, ensuring they meet their reserve requirements and avoid penalties.
- Interest Earning: Banks can earn interest on their surplus funds by lending them out in the call money market.
- Monetary Policy Tool: The call money rate is an indicator of the overall liquidity in the financial system and is closely monitored by central banks.
Example:
Imagine Bank A has excess cash overnight and Bank B needs funds to meet its daily reserve requirements. Bank A lends the money to Bank B in the call money market at an agreed-upon interest rate. Bank A can 'call' the money back the next day, or later if agreed upon.
Risks Associated
While call funds provide flexibility and opportunities, they also carry risks:
- Liquidity Risk: For the borrower, unexpected calls for repayment can strain liquidity.
- Interest Rate Risk: Fluctuations in interest rates can impact the cost of borrowing and lending.
- Counterparty Risk: The risk that the borrower may default on the loan.
In summary, call funds are a vital instrument for banks to manage their short-term liquidity, earn interest on surplus funds, and maintain stability in the financial system. The ease with which these funds can be accessed and repaid makes them a cornerstone of the interbank lending market.
