MC EXPLAINER Why is the RBI focusing more on overnight rates?

Reserve Bank of India

Since the start of the rate cut cycle, the Reserve Bank of India (RBI) has been seen emphasising more on the overnight rate or call money rate as it is a key measure of liquidity in the banking system and an important channel for the transmission of rates.

The focus on the overnight rate increased after the gap between the call money rate and repo rate widened. And the heightened focus arises from the fact that the higher spread between these rates can feed inflation.

Even though there are no concerns on the inflation front right now, the prevailing geopolitical tensions, along with cheaper funds, may have an impact on the pace of price rise, forcing the central bank to reassess its projections.

Here’s more on this topic.

Since when did the RBI start focusing more on the overnight rates?

The RBI has brought the overnight rate under the lens from the start of 2025 as the central operational target for monetary policy implementation.

The increased focus follows the recommendations of an internal working group led by RBI Deputy Governor Poonam Gupta, which reviewed the existing liquidity management framework.

The panel held that the weighted average call rate or WACR was highly effective in reflecting liquidity conditions and transmitting policy signals across money market instruments.

Does this help liquidity management?

Money market experts said the call rate or overnight rate plays a crucial role in effective liquidity management for the RBI.

This is because aligning the call money rate with the repo rate allows the RBI to efficiently manage surplus or deficit liquidity. This not only ensures smoother transmission of monetary policy but also stabilises short-term interest rates across the money market, enhancing overall financial stability and operational efficiency.

Will it influence interest rates on loans?

Aligning the overnight rate close to the repo rate ensures effective transmission of monetary policy to other segments of the money market, such as treasury bills, commercial paper and interbank lending. As these short-term rates decline or rise in line with the overnight rate, banks experience changes in their cost of funds.

Usually, a lower borrowing cost in the money market for banks enables them to offer loans at more attractive rates. Hence, by calibrating the overnight rate with the repo rate, the RBI can indirectly impact lending rates in the economy.

How have the money market rates moved after the RBI's rate cuts?

According to RBI data, in response to the cumulative cut of 100 basis points (bps) cut in the policy repo rate during the current easing cycle (up to August 4), the WACR declined by 108 bps.

Since the February policy announcement, the rate on three-month treasury bills has dropped by 110 bps, on three-month commercial papers issued by non-banking financial companies by 161 bps and on 3-month certificates of deposit by 170 bps.