Money Market DefineAs per RBI definitions “A market for short terms financial assets that areclose substitute for money, facilitates the exchange of money in primaryand secondary market”.The money market is a mechanism that deals with the lending andborrowing of short term funds (less than one year). A segment of thefinancial market in which financial instruments with high liquidity and very shortmaturities are traded. It doesn‟t actually deal in cash or money but deals with substituteof cash like trade bills, promissory notes & govt papers which can converted into cashwithout any loss at low transaction cost. Features of Money Market It is a market purely for short-terms funds or financial assets called near money. It deals with financial assets having a maturity period less than one year only. In Money Market transaction can not take place formal like stock exchange, only through oral communication, relevant document and written communication transaction can be done. Transactions have to be conducted without the help of brokers. It is not a single homogeneous market, it comprises of several submarket like call money market, acceptance & bill market. The components of Money Market are the commercial banks, acceptance houses & NBFC (Non-banking financial companies).
Importance of Money MarketA developed money market plays an important role in the financial systemof a country by supplying short-term funds adequately and quickly to tradeand industry. The money market is an integral part of a country‟s economy.Therefore, a developed money market is highly indispensable for the rapiddevelopment of the economy. A developed money market helps thesmooth functioning of the financial system in any economy in the followingways: Development Of Trade And Industry: Money market is an important source of financing trade and industry. The money market, through discounting operations and commercial papers, finances the short-term working capital requirements of trade and industry and facilities the development of industry and trade both – national and international. Development Of Capital Market: The short-term rates of interest and the conditions that prevail in the money market influence the long-term interest as well as the resource mobilization in capital market. Hence, the development of capital depends upon the existence of a development of capital money market. Smooth Functioning of Commercial Banks: The money market provides the commercial banks with facilities for temporarily employing their surplus funds in easily realisable assets. The banks can get back the funds quickly, in times of need, by resorting to the money market. The commercial banks gain immensely by economizing on their cash balances in hand and at the same time meeting the demand for large withdrawal of their depositors. It also enables commercial banks to meet their statutory requirements of cash reserve ratio (CRR) and Statutory Liquidity Ratio (SLR) by utilishing the money market mechanism. Effective Central Bank Control: A developed money market helps the effective functioning of a central bank. It facilities effective
implementation of the monetary policy of a central bank. The central bank, through the money market, pumps new money into the economy in slump and siphons if off in boom. The central bank, thus, regulates the flow of money so as to promote economic growth with stability. Formulation Of Suitable Monetary Policy: Conditions prevailing in a money market serve as a true indicator of the monetary state of an economy. Hence, it serves as a guide to the Government in formulating and revising the monetary policy then and there depending upon the monetary conditions prevailing in the market. Non-Inflationary Source Of Finance To Government: A developed money market helps the Government to raise short-term funds through the treasury bills floated in the market. In the absence of a developed money market, the Government would be forced to print and issue more money or borrow from the central bank. Both ways would lead to an increase in prices and the consequent inflationary trend in the economy. Functions of the money MarketThe functions of the money Market are: It acts as an equilibrating mechanism to even out short-term surpluses and deficits. Provides a focal point for RBI‟s intervention to bring about changes in liquidity and cost of credit in the economy. Provides access to short-term finds at market cleared prices. Classification of money MarketThe instruments of Money Market fall under the broad heads shown below:
Money MarketGovt. & Semi-Govt. Inter Bank Inter Call Money Corporate (a) Auction Treasury Private Market Investment Bills of 91 days, & Deposits & 364 days. (b) Govt. Securities of Short-term duration of upto one year. (c) Repos a) Commercial & trade (d) UTI Units Bills (e) P.S.U Bonds. b) Commercial Paper c) Certificate of Deposits d) Participation Certificates e) Factorisation Bills Composition of money market The money market is not a single homogeneous market. It consists of a number of sub-markets which collectively constitute the money market. There should be competition within each sub-market as well as between different sub-markets. The following are the main sub-markets of a money market: Call Money Market. Commercial Bills Market or Discount Market. Acceptance Market. Treasury bill Market.
Instrument of Money MarketA variety of instrument are available in a developed money market. In Indiatill 1986, only a few instrument were available. They were Treasury bills Money at call and short notice in the call loan market. Commercial bills, promissory notes in the bill market. New instrumentNow, in addition to the above the following new instrument are available: Commercial papers. Certificate of deposit. Inter-bank participation certificates. Repo instrument Bankers Acceptance Repurchase agreement Money Market mutual fundCall/Notice Money Market: The money that is lent for one day in thismarket is known as "Call Money" ", and if it exceeds one day (but lessthan 15 days) it is referred to as "Notice Money". The core of the Indianmoney market structure is the inter-bank call mm which is centralizedprimarily in Mumbai, but with sub-mkts in Delhi, Calcutta, Chennai andAhmadabad. Moreover, current and expected interest rates on call moneyare the basic rates to which other money mkts and to some extent the govt.securities market are anchored. The activities in the call money areconfined generally to inter-bank business, predominately on a over nightbasis, although a small amount of business, known as notice money was
also transacted side by side with call money with a maximum period of 14days. The participants in the mkts are Commercial banks, co-operativebanks and primary dealers who can borrow and lend funds. Large mutualfunds promoted by nationalized banks, pvt. Sector mutual funds and allIndia financial institutions can participate in the mkt. as lenders only.Corporate entities having bulk lendable resources of minimum of Rs.5crores per transactions have been permitted to lend in call money throughall primary dealers provided they do not have any short-term borrowingsfrom banks. Brokers are not permitted in the market. Interest rate in themkt. is mkt. driven and is highly sensitive to the forces of demand andsupply. Within one fortnight, rates are known to have moved as high asand/or touch levels as low as 0.50% to 1% Intra-day variations as alsoquite large. Hence, the participants in the mkts are exposed to a highdegree of interest rate risk.For many years, while a set of institutions like SBI,UTI, LIC, GIC, etc.continue to be lenders, some banks which have limited branch network areregular borrowers.Inter-Bank Term Money Mkt.: This mkt. which was exclusively forcommercial banks and co-operative banks has been opened up for selectAll India Development Financial Institutions in October, 1993. The DFIs arepermitted to borrow from the mkt. for a maturity period of 3 to 6 monthswithin the limits stipulated by RBI for each institution. The interest rates inthe mkt. are driven. Is per IBA ground rules, Lenders in the mkt. cannotprematurely recall these funds and as such this instrument is not liquid. Themkt. is predominately 90-days mkt. The mkt. has shown a lot oftransactions following withdrawal of CRR/SLR on liabilities of the bankingsystem.Certificate of Deposits: CDs are similar to the traditional term deposits butare negotiable and can be traded in the secondary mkt. The CDs are
negotiable term-deposits accepted by commercial bank from bulkdepositors at mkt related rates. The CDs can be issued by scheduledcommercial banks (excluding RRBs) at a discount to face value for a periodfrom 91 days to one year. Banks are to observe CRR and SLR. It ismarketable after 45 days.In India, CDs are being issued since 1989 by banks, either directly to theinvestors or through the dealers. CDs are documents of title to timedeposits with banks. They are Interest bearing, maturity dated obligationsof banks and are technically a part of bank deposits. They represent bankdeposit account which are transferable. CDs are marketable or negotiableshort-term instruments in bearer form and are known as NegotiableCertificates Of Deposits. They represent securitized ad tradeable termdeposits. CDs are high cost liability and are issued only when depositgrowth is sluggish but credit demand is high.It is a bearer security and there is a single payment, principal and interest,at the end at the maturity period. The minimum CD should be for Rs.1crore,later lowered to Rs. 50L and in multiples of Rs. 25L, later lowered to Rs.10Lakhs and additional amount in multiples of Rs.5 lakh each. They areissued on discounting basis. Banks cannot discount them or negotiatethem.CDs are pertimmed to be issued during 1991-92 by the All India FinancialInstitutions like IDBI, ICICI, IFCI, etc. . The maturity period for them mayrange from 1 year to 3 years and the RBI may fix an aggregate limit forthem. There is no ceiling interest rate on them.Participation Certificates: As in the case of certificates of deposits,participation certificates are also issued by banks for period ranging from 3months to 6 months or upto a maximum period of one year. The Inter-bankparticipation certificate (IBPCs) is short-term instruments to even-out theshort-term liquidity within the banking system. The IBPCs is issued againstan underlying advance, classified standard and the aggregate amount of
participation in any account time issue. Two types of such certificates arebeing developed: 91 days participate certificates involving no transfer of the underlying asset risk to the borrower but subject to a ceiling rate of 12.5%. 91 to 180 days participate certificates bearing full risk on the underlying asset but not requiring statutory reserves unlike in the Vaghul committee and subject to a floor rate of 14%The first one is unsecured debt, but securitized for the purpose ofnegotiation an development of Secondary market. The second one whichmay extend upto one year is more risky and carry a higher return.Commercial Paper (CP): CP is a short-instrument of raising funds by acompany. Originally CP is carved out of the bank cash credit limits andthere was surety that on maturity, it would be repaid out of bank credit limit.CP is an unsecured debt instrument in the form of a promissory note issuedby highly rated borrowers for tenors ranging between 15 days and oneyear. CP can be issued for maturities between a minimum of 15 days and amaximum upto one year from the date of issue.Thus, CP is a short term unsecured promissory note issued by highlyquality corporate bodies to directly to investors to fund their businessactivities. It is generally issued at a discount freely determined by themarket to major institutional investors and corporations either directly byissuing corporation or through a dealer bank. CP is issued to and held byindividuals, banking companies, other corporate bodies registered orincorporated in India and unincorporated bodies, Non-Resident Indians(NRIs) and Foreign Institutional Investors (FIIs).The CP is a new money market instrument introduced by the RBI. A Co.with a net worth of more than Rs.10 Crores (later reduced to Rs.4 crores)
can issue a commercial paper. Its maximum permissible bank finance(MPBF) for working capital requirements should not less than Rs. 25 crores(later reduced to Rs.4 crores). It should have a current ratio of 1.33:1 and acredit rating of excellent should be secured from the CRISIL. The maturityperiod should be 3-6 months and the issue should be for a minimum ofRs.1Crore (later reduced to Rs.25lakh) and in multiples of Rs.25lakhs (laterreduced to Rs.5lakhs).Treasury Bills (T-Bills): Treasury bills of the Central govt. have beenissued since the inception of the bank. Treasury bills, commonly referred toas T-Bills are issued by Government of India against their short termborrowing requirements with maturities ranging between 14 to 364 days.All these are issued at a discount-to-face value. For example a Treasury billof Rs. 100.00 face value issued for Rs. 91.50 gets redeemed at the end ofits tenure at Rs. 100.00.They offer short-term investment opportunity to financial institutions, banksunder the normal borrowing programme of the central govt. and mkt.stabilization scheme (MSS). They were issued for 91 days. Banks, PrimaryDealers, State Governments, Provident Funds, Financial Institutions,Insurance Companies, NBFCs, FIIs (as per prescribed norms), NRIs &OCBs can invest in T-Bills.T-Bills are so popular among money market instruments because ofaffordability to the individual investors. They are negotiable securities andsince they can be rediscounted with the bank, they are highly liquid. Theother features are absence of default risk, easy availability, assured yield,low transaction cost etc.. They were 91 days 182 day 364 day.
Repurchase agreement (Repos): A major development in the govt.securities mkt. is the introduction of repurchase facility. Repo is a form ofovernight borrowing and is used by those who deal in governmentsecurities. They are usually very short term repurchases agreement, fromovernight to 30 days of more. The short term maturity and governmentbacking usually mean that Repos provide lenders with extremely low risk.Repos are safe collateral for loans. Now Repo mkt. is used to controlliquidity in the system. It is a transaction in which two parties agree to selland repurchase the same security. Under such an agreement the sellersells specified securities with an agreement to repurchase the same at amutually decided future date and a price. The Repo/Reverse Repotransaction can only be done at Mumbai between parties approved by RBIand in securities as approved by RBI (Treasury Bills, Central/State Govtsecurities).Bankers Acceptance: A banker‟s acceptance (BA) is a short-term creditinvestment created by a non-financial firm. BA‟s are guaranteed by a bankto make payment. Acceptances are traded at discounts from face value inthe secondary market. BA acts as a negotiable time draft for financingimports, exports or other transactions in goods. This is especially usefulwhen the credit worthiness of a foreign trade partner is unknown.Gilt edged securities: The term government securities encompass allBonds & T-bills issued by the Central Government, and state governments.These securities are normally referred to, as "gilt-edged" as repayments ofprincipal as well as interest are totally secured by sovereign guarantee. Money Market Mutual Funds (MMMFs)MMMFs enable small investors to participate in the money mkt. . Theinvestors can realize through MMMFs, a market-related yield. The RBI
outlined in April 1991, a broad framework for setting up MMMFs andfollowed it up by setting up a task force to work out operating guidelines.The RBI announced the guidelines in 1992.The MMMFs can be set up by scheduled commercial banks and publicfinancial institutions. They are allowed( 2nd November, 1999) to be set upas a separate entity n the form of a „Trust‟. Only individuals can subscribeto MMMFs. The minimum lock-in period is 15 days. There should be noguarantee of minimum return. Reserve requirements will not apply toMMMFs.The portfolio of MMMFs consists of short-term money mkt. instruments.Investors can obtain a yield close to money mkt. rates by investing inMMMFs. MMMFs can invest in rated corporate bonds with a residualmaturity up to one year within the ceiling for CP.Effective from 23 November 1995, the pvt. Sector was allowed to set upMMMFs. The size of MMMF and limits on invt. By MMMFs were de-regulated. The scheme of MMMF was made flexible in April 1996 bybringing it on par with all other mutual funds by allowing invt. By corporatesand others. By reducing the minimum lock-in period to 15 days from 9May1998, the scheme was made more attractive. MMMFs are also permitted tooffer cheque writing facility to investors. On 7th March 2000, MMMFs werebrought within the purview of SEBI regulations. Banks and FIs wererequired to seek clearance from the RBI for setting up MMMFs. Secondary market for money market instruments.The Discount and Finance House of India.( DFHI ) has been seeking todevelop an active secondary market for the money market instruments andintegrate various segments of the market in order to facilitate thesmoothening of short-term liquidity imbalances. The daily average lendingwas Rs.1,156 crore in 1996-97.
The Securities Trading Corporation of India (STCI), as a PD (Primarydealers ) deals in treasury bills. STCI has an initial capital of Rs.100 croreand the ownership includes the RBI, Comm. And Co-operative Banks,Financial institutions, mutual funds and PSUs. In 1998-99, STCI had a mkt.share of 28% in primary mkt. and 26% in secondary mkt., the highestamong all PDs. PARTICIPANTS IN MONEY MARKETThe major players in this market are: Banks. Financial Instruments. Primary dealers.Some restriction in participation e.g. call money market is open to onlybanks.Major participants: Central Govt., State Govt., PSUs, ScheduledCommercial Banks, Corporates, Provident Funds, GICs, LIC, MutualFunds, NBFCs, Primary Dealers. (1) Central Govt: Issues Dated Govt. Securities & Treasury Bills With Zero Credit Risk (Sovereign). Coupon Bearing And Non Coupon (Zero) Bearing Bonds. Fixed Coupon And Floating Rate. Benchmark For Other Financial Instruments. AverageDailyTradedVolumesVaryFromRs.3000-10000Crores. (2) State Govt: Issue state development loans-medium/ long term bonds of State Govts. Securities issued by the RBI on behalf of the State Govt.
Auction based issues. Not actively traded as most of these securities are held to maturity - small issue sizes. The major buyers are Banks, LIC and Provident funds The spreads are generally in the range of 25-40 basis over the corresponding G-sec yield.(3) CENTRAL BANK (RBI) Over-all regulation of the market. Ensuring adequate liquidity & money supply through interventions. Operates in Money market generally on behalf of Govt. As merchant banker to Govt, decides how best to raise/maintain Govt borrowings economically. Maintain short term interest rates Maintain price stability Ensure adequate flow of credit for economic growth MANAGING LIQUIDITY, INTT RATE MONEY SUPPLY BY RBI Reserve requirements (CRR & SLR) Liquidity Adjustment Facility (LAF) - Repo & Reverse Repo Interest rates (Bank Rate, Repo Rates) Open Mkt Operation Refinance - quantum, intt rate & period(4) PSUs: Issue bonds (taxable & tax free ). Issue CPs . Generate cash surpluses and invest in FDs, CDs, ,T-Bills. Some PSUs active in G.Sec also.(5)SCHEDULED COM. BANKS: Issue CDs (unsecured & negotiable) Period 7 days to one year Participate in overnight call & term markets – both as lenders & borrowers. Banks use these funds for liquidity mgt. Call money very important to manage CRR commitments.. Banks invest in Govt Sec to maintain SLR & invest surplus funds
Invest in PSU bonds as investors of surplus.. Take trading position in G-Sec and PSU bonds to profit from rate volatility.. Participate in forex markets and derivative market for covering merchant txns and for risk mgt.(6) PRIMARYDEALERS: PDs conceived and permitted by RBI in 1995. Registered with RBI. ROLE: Deal in Govt securities both in primary & capital markets. Commit participation as Principals in Govt issues through bidding in auctions. Underwrite issues and support development of underwriting and market making for govt securities outside RBI. Offer firm buy-sell / bid ask quotes for T. Bills & dated Govt securities to improve secondary market trading system. Help price discovery, enhance liquidity & turnover and widen the investor base. Strengthen the infrastructure in securities to make it vibrant, liquid and broad based. To make PDs an effective conduit for RBI to conduct open market operations.(7) CORPORATES (private): Issue CPs & debentures to finance projects. Debentures could be fully / partly convertible or non-convertible. Bonds could be secured or unsecured. Interest could fixed or floating . Some corporate are very cash rich and active investors in FD, CDs,TT. Bills & other debt instruments .(8) PROVIDENTPROVIDENTFUNDSFUNDS:: Invest their funds in short term and long term instruments as per their internal guidelines . Apart from G.Sec, they invest in State Development Loans, bonds of PSUs/FIs. PFs can also invest in private sector bonds which are rated by at least two rating agencies at acceptable rating.
(9) GENERAL INSURANCE COMPANIES: Have to maintain certain amt of funds in approved investment. Also invest in G-Sec, bonds, money market as lendersl.(10) LIC: Invest in G-Sec, bonds, & money market Certain pre-determined thresholds to invest in different categories.(11) MUTUAL FUNDS: Required to invest in money market & debt instruments. Pattern/quantum of investment vary as declared in schemes.(12) NBFCs: Required to investment minimum 15% in SLR investments. Park their surplus funds in securities/debts to earn income.