What it means
Banks must keep enough cash and reserves to meet withdrawals and regulatory requirements at the end of each day. Some end the day with a surplus, and others with a shortfall.
The call money market lets them even things out by lending to one another until the next day. The word call refers to the fact that the lender can call the loan back at any time, or that the loan is repaid on short notice.
Most trades are overnight, though some run for a few days. Because the loans are short and usually made between banks of good standing, they are generally unsecured and carry low risk.
The interest rate that results is a key short-term benchmark. Central banks often steer this rate by adjusting the supply of reserves or by setting a target, and changes ripple through to the rates on business loans, mortgages and deposits.
When the rate rises, borrowing costs across the economy tend to follow. Interest is normally calculated on a simple basis using a day-count convention, a standard way to count days in a period.
For many currencies, including the US dollar, the convention divides by 360 days in a year. Using 360 rather than 365 slightly raises the interest calculated for a given rate.
Stress in this market is a warning sign. In a crisis, banks may lose confidence in each other and refuse to lend, which causes the call rate to spike and can force central banks to step in as lender of last resort.
The market is wholesale, meaning it deals in large sums between institutions, and individual savers and companies do not take part directly. Its effects reach them through the interest rates they see on their own loans and deposits.
In practice
Real-world examples.
Example
A regional bank ends the day with $50,000,000 more in customer deposits than it needs for loans. It lends the surplus overnight in the call market to earn interest, rather than leave it idle.
Example
A large bank finds that a heavy day of payments has left it $20,000,000 short of its required reserves. It borrows overnight from another bank, which costs a small amount of interest but avoids a penalty.
Example
A treasury analyst at a corporation notices that the overnight rate has risen by half a percentage point. She expects the bank's floating-rate lending to increase and updates the company's interest cost forecast. The treasurer in each case watches the central bank's announcements, because an unexpected rate decision changes the cost of overnight money immediately.
Formula
Calculation
Interest = Principal x Annual rate x Days / 360
A bank lends $36,000,000 overnight to another bank at an annual rate of 5%. The loan runs for 1 day. Interest = 36,000,000 x 0.05 x 1 / 360 = 1,800,000 / 360 = $5,000.
The borrower repays 36,000,000 + 5,000 = $36,005,000 the next day. Over a weekend, the same loan for 3 days would cost 36,000,000 x 0.05 x 3 / 360 = $15,000.Case study
Seen in the real world.
Marlowe Savings Bank is an illustrative, fictional institution that relies on customer deposits for most of its funding. One quarter-end, a large corporate client withdrew $80 million unexpectedly, leaving the bank short of its liquidity target.
The treasurer borrowed the amount in the call market for two days at 4.5%. The cost was 80,000,000 x 0.045 x 2 / 360 = $20,000, which she considered a small price for avoiding the sale of securities at a loss.
She then reviewed the bank's liquidity plan to cut reliance on overnight borrowing. In this illustrative story, the bank set up standby credit lines and a larger buffer of liquid assets to make sure that a similar withdrawal would be easier to handle. The treasurer reported the cost to the board as a share of the amount raised, and she showed that the borrowing had been cheaper than the alternative of selling bonds before they matured.
Watch out
Common mistakes.
- Thinking individuals or ordinary companies can lend or borrow in this market, when it is open only to banks and certain large institutions.
- Using 365 days automatically in the calculation, when many markets use 360.
- Assuming the call rate is fixed, when it can change daily and rise sharply in times of stress.
Questions
People also ask.
Why is it called call money?
Because the lender can demand repayment at any time or on very short notice, so the loan is repayable on call.
How does the call money rate affect businesses?
It influences other short-term rates, so changes can pass through to the cost of business loans and credit lines.
What happens if the market stops working?
Banks may be unable to cover shortfalls, and central banks may step in to provide emergency liquidity.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%