Money Market

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MONEY MARKET
As per RBI definitions A market for short
terms financial assets that are close
substitute for money, facilitates the exchange
of money in primary and secondary market
The money market is a mechanism that deals
with the lending and borrowing of short
term funds (less than one year).
A segment of the financial market in which
financial instruments with high liquidity and
very short maturities are traded.

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 It doesnt actually deal in cash or money
but deals with substitute of cash like trade
bills, promissory notes & govt papers
which can converted into cash without
any loss at low transaction cost.
It includes all individual, institution and
intermediaries.

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 In Money Market transaction cannot take
place formal like stock exchange, only
through oral communication, relevant
document and written communication
transaction can be done.
Transaction have to be conducted
without the help of brokers.

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The objectives of Money
Market
1. Providing equilibrating mechanism for
ironing out short-term surpluses and
deficits.
2. Provide liquidity and a realistic price.
3. Provide cash-rich corporations/
institutions a means for parking their short-
term surpluses. (Provident Fund/ Income tax
payments/ seasonal surpluses - otherwise
would be kept in current a/c)
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Importance of money market
Development of trade & industry.
Development of capital market.
Smooth functioning of commercial banks.
Effective central bank control.
Formulation of suitable monetary policy.
Non inflationary source of finance to
government.

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Development of money market
depends upon:
1. The number volume and variety of
instruments available for trading.
2. The number of traders (buyers/sellers)
operating in the market.
3. The nature of settlement procedure.

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Composition of money market
Money Market consists of a number of
sub- markets which collectively constitute
the money market.
They are,
Call Money Market
Commercial bills market or discount
market
Treasury bill market

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Money Market Instruments
A variety of instrument are available in a
developed money market. In India till
1986, only a few instrument were
available.
They were:-
Money at call and short notice in the call
loan market.
Commercial bills, promissory notes in the
bill market.
Treasury bills
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Now, in addition to the above the following
new instrument are available:
Commercial papers.
Certificate of deposit.
Bankers Acceptance.
Repurchase Agreement.

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Call money market
Call money market is that part of the
national money market where the day to day
surplus funds, mostly of banks are traded in.
The loans made in this market are of the
short term nature.
Banks borrow from other banks in order to
meet a sudden demand for funds, large
payments, large remittances, and to maintain
cash or liquidity with the RBI.
Thus, to the extent that call money is used
in India for the purpose of adjustment of
reserves.
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 When money is borrowed or lent for a
day, it is known as Call (Overnight)
Money.
There are now two call rates in India: one,
the interbank call rate, and the other, the
lending rate of DFHI

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Commercial Bills Market
Funds for working capital required by
commerce and industry are mainly
provided by banks through cash credits,
overdrafts, and purchase/discontinuing of
commercial bills.
Is a short-term, negotiable & self-
liquidating instrument with low risk

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BILL OF EXCHANGE:
The financial instrument which is traded
in the bill market of exchange. It is used
for financing a transaction in goods that
takes some time to complete.
It shows the liquidity to make the
payment on a fixed date when goods are
bought on credit.

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 Accordingly to the Indian Negotiable
Instruments Act, 1881, it is a written
instrument containing as unconditional
order, signed by the maker, directing a
certain person to pay a certain sum of
money only to, or to the order of, a
certain person, or to the bearer of the
instrument.

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Types of CBs

Demand bill: is payable on demand i.e., on

sight or on presentation to drawee
Usance bill: is payable after a specified
time
Clean bills: documents are enclosed &
delivered against acceptance by drawee
Documentary bills: documents are
delivered against payment accepted by
drawee & documents are held by bankers
till bill is paid.
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 Inland Bills- Be drawn or made in India,
and must be payable in India. Be drawn
upon any person resident in India.
Foreign Bills- drawn outside India &
payable inside India or vice versa (Export
& Import bills).

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Treasury Bills
Treasury Bills are short term (up to one
year) borrowing instruments of the union
government.
It is a promise by the Government to pay
a stated sum after expiry of the stated
period from the date of issue
(14/91/182/364 days i.e. less than one
year).
They are issued at a discount to the face
value, and on maturity the face value is
paid to the holder.

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Important qualities of T Bills
The high liquidity.
Absence of risk of default
Ready availability
Assured yield
Low transaction cost

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Commercial Papers (CPs)
Commercial Paper (CP) is an unsecured
money market instrument issued in the form
of a promissory note.
Commercial Papers (CPs) was introduced in
India in 1990 by RBI to enable highly rated
corporate borrowers diversify their sources
of short-term borrowings and also to
provide an additional instrument to
investors.
The biggest advantage is that by issuing CPs,
a top-rated corporate can raise funds at
even below the prime lending rate of banks.
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 CP can be issued for maturities between
a minimum of 15 days and a maximum up
to one year from the date of issue.
The aggregate amount of CP from an
issuer shall be within the limit as
approved by its Board of Directors or the
quantum indicated by the Credit Rating
Agency for the specified rating, whichever
is lower.

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Certificate of Deposits (CDs)
Certificate of Deposit (CD) is a negotiable money
market instrument and issued in dematerialised
form against funds deposited at a bank or other
eligible financial institution for a specified time
period.
Certificate of Deposits (CDs) were introduced in
the year 1989 with a view to further widen the
range of money market instruments available to
banks for raising funds from the market.
It also gave investors greater flexibility in the
deployment of their short-term surplus funds.

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 Banks have the freedom to issue CDs
depending on their requirements.
An FI may issue CDs within the overall
umbrella limit fixed by RBI, i.e., issue of
CD together with other instruments, viz.,
term money, term deposits, commercial
papers and inter-corporate deposits
should not exceed 100 per cent of its net
owned funds, as per the latest audited
balance sheet.

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Bankers acceptance
A bankers acceptance is a short-term
investment plan created by a company or
firm with a guarantee from a bank.
It is a guarantee from the bank that a buyer
will pay the seller at a future date.
A good credit rating is required by the
company or firm drawing the bill.
This is especially useful when the credit
worthiness of a foreign trade partner is
unknown.

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 The terms for these instruments are usually
90 days, but this period can vary between 30
and 180 days. Companies use the acceptance
as a time draft for financing imports, exports
and trade.
Under the bill market schemes introduced
by RBI in 1952, banks are required to select
the borrowers after careful examination of
their means, respectability, and dealings for
conversion of their advances in to bills.
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Repurchase Agreements
(Repo): Repurchase Agreements which are
also called as Repo or Reverse Repo are
short term loans that buyers and sellers
agree upon for selling and repurchasing.
Repo or Reverse Repo transactions can be
done only between the parties approved by
RBI and allowed only between RBI-approved
securities such as state and central
government securities, T-Bills, PSU bonds and
corporate bonds.
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 They are usually used for overnight
borrowing.
Repurchase agreements are sold by
sellers with a promise of purchasing them
back at a given price and on a given date
in future.
On the flip side, the buyer will
also purchase the securities and other
instruments with a promise of selling
them back to the seller.
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Money Market Intermediaries /
Institutions:
The Discount and Finance House of
India (DFHI)
Set up in April 1988 by RBI
Is a joint stock company in form and is
jointly owned by RBI, public sector banks
and FIs.
Mobilises funds / resources from
commercial / cooperative banks, FIs and
corporate entities which are pooled and
lent in the MM
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 Structure of Indian Money
Market
I. ORGANISED STRUCTURE
1. Reserve bank of India.
2. DFHI (Discount And Finance House of India).
3. Commercial banks
i. Public sector banks
SBI with 7 subsidiaries
Cooperative banks
20 nationalised banks
ii. Private banks
Indian Banks
Foreign banks
4. Development bank IDBI, IFCI, ICICI, NABARD, LIC, GIC,
UTI etc.
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II. UNORGANISED SECTOR
1. Indigenous banks
2 Money lenders
3. Chits
4. Nidhis
III. CO-OPERATIVE SECTOR
1. State cooperative
i. Central cooperative banks
Primary Agri credit societies
Primary urban banks
2. State Land development banks
Central land development banks
Primary land development banks

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Tools for Managing Liquidity in
MM
Reserve Requirements
Interest rates
Refinance from the RBI
Liquidity Adjustment Facility
Repos

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Reserve Requirements
The techniques of monetary control used by RBI
are of 2 types:
CRR (Cash Reserve ratio) &
SLR (Statutory Liquidity Ratio)
Are CRR refers to the cash that banks have to
maintain with the RBI as a % (not less than 3%) of
their total demand and time liabilities.
SLR refers to the mandatory investment that
banks have to make in government securities. It is
the reserve set aside by banks for investment in
cash, gold or unencumbered approved securities

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Interest Rates
It is used to enable certain preferred or priority
sectors to obtain funds at concessional rates of
interest.
Prime lending rate (PLR): is the minimum
lending rate charged by the bank from its best
corporate customers or prime borrowers. RBI
publishes monthly PLRs based on the rates
offered by 5 leading public sector banks.
Bank rate: is the rate of discount fixed by the
central bank of the country for the rediscounting
of eligible paper. It is also the rate charged by the
central bank on advances on specified collateral
to banks.

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Refinance from the RBI:

Used by RBI to relieve liquidity shortages in the

system, control monetary and credit conditions and
direct credit to selective sectors.
The quantum and cost of refinance facility depends
upon degree of liquidity and need for credit flow
Currently, there are only 2 refinance schemes
available to banks
Export credit refinance is formula based and is
extended to banks against their outstanding export
credit eligible for refinance (at 15% from April1,
2002).
General refinance is provided to tide over
temporary liquidity shortages faced by banks

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Liquidity Adjustment Facility:

Introduced by RBI in April 1999, to provide a

mechanism for liquidity management
Banks could avail of a collateralised lending
facility of upto 0.25% of the fortnightly
average outstanding aggregate deposits
available for a few weeks at bank rate
Primary dealers were provided liquidity
support against a collateral of government
securities

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REPOS
Is a useful money market instrument
enabling smooth adjustment of short-
term liquidity among varied participants
such as banks, FIs, etc.
Refers to a transaction in which a
participant acquires immediate funds by
selling securities and simultaneously
agrees to repurchase the same or similar
securities after a specified time at a
specified price.

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Repo (Repurchase) Rate
Repo rate also known as Repurchase rate
is the rate at which banks borrow funds
from the RBI to meet short-term
requirements.
RBI charges some interest rate on the
cash borrowed by banks.
This interest rate is called repo rate.

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 If the RBIwants to make it more
expensive for the banks to borrow
money, it increases the repo rate;similarly,
if it wants to make it cheaper for banks to
borrow money, it reduces the repo rate.

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Reverse repo rate
Reverse Repo rate is the rate at which
Reserve Bank of India (RBI)borrows
money from banks.
This is the exact opposite of repo rate.
RBI uses this tool when it feels there is
too much money floating in the banking
system.

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 If the reverse repo rate is increased, it
means the RBI will borrow money from
the bank by offering lucrative rate of
interest.
Banks feel comfortable lending money to
RBI since their money would be in
safehands and with a good interest.
It is also a tool which can be used by the
RBI to drain excess money out of the
banking system.
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Benefits of an Efficient Money
Market:
Provides stable source of funds to banks in
addition to deposits
Allows banks to manage risk arising from interest
rate fluctuation and manage maturity structure of
their assets and liabilities
Encourages development of non-bank
intermediaries, thus increasing competition for
funds leading to a wide array of instruments to
choose
Provides effective source of long term finance to
borrowers decrease in cost of raising funds

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 Necessary for development of capital
market, foreign exchange market and
derivative market
Supports trading in forwards, swaps and
futures certainty of prompt cash
settlement is possible
Facilitates government market borrowing
programme
Monetary control through indirect methods
repos, open market operations

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Role of RBI in Money Market

RBI is the most important constituent of the

money market. The money market comes under
the direct purview of RBI regulations.
Aims of RBI operation:
To ensure liquidity and maintain short term
interest rates consistent with monetary policy
objective of price stability thro cash reserve
requirements (CRR) of banks, conduct of open
market operations (OMOs) repos, change in bank
rates & foreign exchange swap operations
To ensure adequate flow of credit to productive
sectors
To bring about order in foreign exchange market

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Money Market Centres in India:
Mumbai is the active MM centre in India
with money flowing from all parts of the
country getting transacted here
Delhi &
Kolkata

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