Overnight call money rate hardens beyond MSF rate

August 22, 2023
Posted by: OptimizeIAS Team
Category: DPN Topics

Overnight call money rate hardens beyond MSF rate

Subject :Economy

Section: Monetary Policy

In News: Liquidity shortfall in the banking system on account of the incremental cash reserve ratio (ICRR) and other factors results in call money rate going beyond the marginal standing facility of 6.75 %

Key Points:

Overnight call money market rates have hardened, going beyond the marginal standing facility (MSF) rate of 6.75 per cent, indicating liquidity tightness in the banking system.
The liquidity shortfall from all the above has been estimated to be about ₹2-lakh crore.
Generally the interest rate for longer duration is higher as the longer the period for which money is lent, higher is the risk.
The several reasons for this liquidity squeeze are:
- Reserve Bank of India decision requiring banks to temporarily maintain incremental cash reserve ratio (I-CRR) of 10 %
- Outflow on account of companies making payment towards GST
- RBI’s intervention in the forex market to support a falling Rupee
What does RBI do when the call money rate crosses the upper end of LAF corridor?
- Usually, when call money rate touches the upper-end of the LAF corridor, RBI conducts variable rate repo auction to inject liquidity and bring the rate closer to the repo rate (of 6.50 per cent).
Decision to mandate temporary ICRR?
- With effect from the fortnight beginning August 12, 2023, RBI asked scheduled banks to maintain an incremental cash reserve ratio (I-CRR) of 10 per cent on the increase in their deposits between May 19, 2023 and July 28, 2023.
- This measure is intended to absorb the surplus liquidity generated by various factors such as return of ₹2000 banknotes to the banking system, RBI’s surplus transfer to the government, pick up in government spending and capital inflows
- The existing cash reserve ratio (CRR) remains unchanged at 4.5 per cent

Marginal Standing Facility (MSF)

Under the operating framework of the monetary policy, the RBI keeps call money in the Liquidity Adjustment Facility (LAF) corridor. The corridor width is 50 basis points (0.5%).
The LAF corridor comprises Standing Deposit Facility (6.25%) at the lower end and Marginal Standing Facility (6.75%) at the upper end.
The Standing Deposit Facility is to absorb surplus liquidity while the Marginal Standing Facility is to inject liquidity, with the repo rate being the mid-point (6.50 per cent).
RBI aims to modulate call money within this corridor.

Call Money Market

The call money market, also known as the money market, refers to a segment of the financial market where short-term funds are borrowed and lent among financial institutions, primarily banks and other financial intermediaries.
Participants in call/notice money market currently include banks (excluding RRBs) and Primary Dealers (PDs), both as borrowers and lenders. Non-bank institutions are not permitted in the call/notice money market with effect from 2005.
List of Institutions Permitted to Participate in the Call/Notice Money Market both as Lenders and Borrowers
- All Scheduled Commercial Banks (excluding RRBs).
- All Co-operative Banks other than Land Development Banks.
- All Primary Dealers ( PDs ).
The transactions in the call money market typically involve loans with very short maturities, often ranging from one day to two weeks.
The interest rate in the call money market, also known as the call rate, is determined by the demand and supply of funds. It fluctuates based on prevailing market conditions.
Financial institutions use the call money market to manage their short-term liquidity needs. Banks with surplus funds lend to those in need of funds, and this lending and borrowing activity helps institutions maintain their required reserves and manage their balance sheets effectively.
The call money market provides a crucial mechanism for financial institutions to manage their short-term liquidity needs efficiently.
It also serves as a key component of the broader money market, which includes various short-term instruments like Treasury bills, commercial paper, and certificates of deposit.