Question

What impact does the existence of the overnight interbank market have on the level of settlement balances held by the commercial banks? Briefly explain.

Answer 1

Overnight interbank market is a market that has various constituents that are heterogeneous and each is a type of product is a short –term credit instrument.

Types of the products available in this market are:

1. Call Money Market

It deals with short term loans and is for types of builders or dealers who borrow from commercial banks.

2. Collateral loan market

It needs keeping a security in the bank and seeking a loan against it.

3. Bill Market

It involves instruments like Bills of exchange, treasury bills and are promissory notes that are exchanged if any amount is payable.

Etc.

Existence of such markets may influence the commercial banks as below:

1. Such markets offer loans even at lower rates and for short terms.

Because of this, commercial banks are also forced to lend at lower rates. This reduces the balances held by commercial banks.

2. Such system may also encourage arbitration. This influences the rates of commercial banks.

Arbitration may force commercial banks accordingly to stop arbitration in the market.

3. Such markets also bring efficiency in commercial banks, because in order to stop public from being exploited and using the facilities from such markets, they themselves also offer such facilities. However, it affects the maintenance of balance and reduces the balance kept by Commercial banks.

For example, now even commercial banks have started giving loans against collateral security.