What Is a Call Loan and How Does It Work?

A loan is a financial arrangement where one party, the lender, provides funds to another party, the borrower, with the agreement that the funds will be repaid over time, typically with interest. While many loans follow a fixed repayment schedule, a distinct category known as a “call loan” operates under a different, more flexible structure.

Defining Characteristics

A defining characteristic of a call loan is its “on-demand” nature, meaning the lender can demand full repayment of the principal and accrued interest at any time. Lenders typically provide very short notice for repayment, often as little as 24 hours.

Call loans are almost always secured by collateral, which serves to reduce the lender’s risk. The collateral primarily consists of highly liquid, marketable securities, such as stocks, bonds, or other financial instruments that can be readily sold in the market. This requirement ensures that if a borrower fails to repay the loan upon demand, the lender has immediate access to assets that can be quickly converted to cash to cover the outstanding debt.

The interest rates on call loans are typically variable and can fluctuate frequently, often on a daily basis. These rates are usually tied to a benchmark rate, such as the Secured Overnight Financing Rate (SOFR) or a similar short-term market rate, plus an additional premium. Because of their demand feature and the liquid nature of their collateral, call loans are generally short-term financial instruments, often used for very brief periods, sometimes even overnight.

How Call Loans Work

Establishing a call loan begins with the borrower pledging eligible marketable securities as collateral to the lender. This collateral is held by the lender as security for the loan, and its value is continuously monitored to ensure it adequately covers the loan amount.

When a lender decides to “call” the loan, they issue a demand for immediate repayment. While the term “on demand” suggests instant repayment, in practice, borrowers are typically given a very short timeframe, often 24 hours, to repay the principal and any accrued interest. This short notice period necessitates that borrowers maintain sufficient liquidity or have rapid access to funds to meet this obligation.

Upon repayment, the pledged collateral is returned to the borrower. If the borrower is unable to repay the loan within the specified timeframe after a call, the lender has the right to liquidate the collateral to recover the outstanding debt. Interest on call loans accrues continuously, often calculated daily, based on the variable call loan rate. This interest is typically paid by the borrower along with the principal when the loan is repaid or called.

Common Applications

Call loans are predominantly used within the financial markets, serving specific needs for certain institutions. A primary application involves broker-dealers, who frequently use call loans to finance their operations. Specifically, these loans are crucial for funding client margin accounts, which allow investors to borrow money from their broker to purchase securities.

Banks and other financial institutions serve as the primary lenders of call loans. They provide these loans, often to broker-dealers, as a way to deploy their short-term surplus funds while maintaining liquidity due to the demand nature of the loan. This inter-institutional lending facilitates the smooth functioning of capital markets by providing a flexible and immediate source of funding for short-term liquidity needs.