The Money Market

Sunil Kheria Shivam Sareen Srishti Mittal Sagar Sheopuri Uzair Mirza Pankaj Nehra Avinash Khasge 55 16 54 13 10 50 57

The Money Market

Money Market is a market for short term financial instruments with a maturity not exceeding one year. This market constitutes a very important component of the Indian Financial System.

Features:
A collection of a wholesale market for short term debt instruments. Credit worthiness of the participants is important. The important players are RBI, DFHI, STCI, Banks, Mutual funds, Corporates, NBFCs, Investors, Provident Funds, LIC, GIC, PSUs and NRIs. It is a need based market where the demand and supply for funds shapes the market.

Functions Of The Money Market

Provide a focal point for the Central Bank intervention for managing liquidity and general level of interest rates in the economy. It provides a stable source of funds to the banks

It helps banks in managing their risks arising out of interest rate fluctuations
The money market supports the long term debt market by increasing the liquidity of the securities.
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The Indian Money Market

The average daily turnover in the Indian money market is of the order of 150000 crores. It is not even a fraction of the trading volumes seen on the markets in developed countries. In the 1990s GOI again appointed a high level committee under the chairmanship of Mr. M. Narasimham. The RBI accepted and implemented many of these recommendations: STCI was set up in 1994 to provide an active secondary market in GOI securities and PSU bonds. Entry barriers were gradually eased by
Setting up PD system and the satellite dealer system, Increasing the number of participants and instruments.

Adhoc and on tap 91 day treasury bills were replaced by Ways & Means Advances (WMA) linked to the bank rate. Indirect monetary control instruments like the bank rate ( reactivated in 1997), strategy of combining auctions, private placements, open market operations in 199899 and the Liquidity Adjustment Facility (LAF) in June 2000 were introduced. Minimum lock in period for money market instruments was reduced to 15 days.

The Indian Money Market(contd.)

RBI started repos, both on auction and fixed interest basis, for liquidity management. The inter bank liabilities were exempted from reserve requirements to foster the development of a term money market. New money market derivative instruments like FRA (Forward Rate Agreements), IRS ( Interest Rate Swaps) were introduced in 1999. The payment and settlement system infrastructure was strengthened with the introduction of the Negotiated Dealing System (NDS) in February 2002, setting up of the Clearing Corporation of India (CCI) in April 2002 and the implementation of Real Time Gross Settlement (RTGS) System in April 2004. Collateral Lending & Borrowing Obligations (CBLO) was operationalized as a money market instrument through the CCIL in January, 2003.

Money Market Instruments

The instruments traded in the money market are Treasury Bills ( T Bills ), Call / Notice Money (Overnight & up to 14 days),

Commercial Paper ( CP ),
Certificated Of Deposits ( CD s) , Commercial Bills (CB s), Collateral Borrowing & lending Obligations (CBLO s).
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Treasury Bills
Treasury Bills are short term instruments issued by RBI on behalf of GOI to tide over short term liquidity shortfalls T- bills are issued at discount & repaid at par on maturity. They are negotiable securities. They have an assured yield, low transaction cost, and are eligible to be included in the SLR portfolios of banks. Presently, there are 91 day, 182 day and 364 day T-bills T- bills are of Rs 25000/- or multiples thereof. TDS is not applicable on T bills.
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Types Of T- bills
There are 3 categories of T- bills as under

On tap bills Adhoc bills

Auctioned T bills This is the most active money market instrument, first introduced in April, 1992.
RBI receives bids from various participants in an auction and issues the bills subject to some cutoff limits. Thus, the yield on this instrument is market determined. These are not rated and can not be rediscounted with RBI. Presently, RBI issues T- bills for 91 , 182 and 364 days.

Commercial Bills
A commercial bill is a short term, negotiable and self liquidating instrument. Working Capital Limits are met by banks in the form of Cash Credit or Overdraft limits or Bills Purchased or Discounted limits. Types of Commercial Bills
Demand Bills or Usance Bills, Clean Bills or Documentary Bills, Inland Bills or Foreign Bills,

Commercial Paper
RBI introduced the CP s in January,1990. A CP is an unsecured short term promissory note, negotiable and transferable by endorsement and delivery with a fixed maturity period. It is generally issued at a discount to Face Value by leading creditworthy corporates to meet their working capital requirements.

CP s can now be issued by Primary Dealers, all India financial institutions, Corporates etc, to get short term funds.
A CP can be issued to individuals, banks, companies and other registered and unregistered bodies. NRI s, can be issued CP s only on nonrepatriable and nontransferable basis.

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Commercial Paper ( continued )

A CP is usually privately placed with investors through banks or merchant bankers. Credit rating P2 of CRISIL or its equivalent from a recognized rating agency is to be obtained. Corporates are allowed to issue CP up to 100% of their fund based W.C requirements. A CP attracts stamp duty. No prior RBI approval is needed to issue a CP and the issue is also not required to be underwritten.
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The Process Of Issuing a CP

Board Resolution to be passed by the Issuer, Get the CP issue rated by a recognized rating agency, Select and appoint an Issuing and Paying agent (IPA) who has to be a scheduled bank, IPA verifies that all required formalities have been completed and holds the relevant documents in its custody. The issuer then has to arrange for dealers / merchant banker, brokers and banks for placement of the CP which has to be completed within 2 weeks of the opening of the issue. Every CP has to be reported to RBI through the IPA.
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Summary Guidelines For Issuance Of CP

RBI have issued new guidelines for issue of CP in October,2000.

Eligibility Corporates, primary dealers and all India financial institutions are eligible to issue CP.
For a corporate to be eligible: Tangible net worth of at least Rs.4 Cr Sanctioned working capital limit of Rs. 4 Cr from a bank Borrowal account should be a standard asset.

Rating Requirement Minimum credit rating shall be P2 of CRISIL or its equivalent by other approved agencies.
Maturity Initially minimum and maximum maturities were fixed at 3 months and 6 months respectively. Now the minimum maturity can be 7 days and the maximum maturity one year. Denomination Min. RS 5 Lakh or in multiples thereof. Limits & Amount A CP can be issued as a standalone product. Banks and financial institutions will have the flexibility to fix working capital limits duly taking into account the resource pattern of companies financing , including CP s. 13

Guidelines For Issuance Of CP ( cont )

Issuing & Paying Agent (IPA) Only a scheduled commercial bank can act as an IPA. IPA does all the required verification and issues IPA certificate to all the subscribers and reports the issue to RBI. Investment in a CP CP may be held by individuals, banks, corporates, unincorporated bodies, NRI s & FII s. Mode of Issuance A CP can be issued as a Promissory Note or in a dematerialized form. Preference for Demat form Issuers and subscribers are encouraged to prefer exclusive reliance on demat form. Stamp duty on CP It is governed by Indian Stamp Act, and is under the purview of Central Government.

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Factors Inhibiting The Growth Of CP Market

A CP is a good instrument to raise short term funds. But, the CP market in India is still underdeveloped due to Even though the minimum amount is RS 5 lakh, retail investors see little scope for investing their money. CP issue involves administrative difficulties and complex procedures. LIC, GIC and UTI are not active due to certain RBI directives to limit their short term investments. Absence of an active secondary market. Stamp duty aspect makes it a little more costly. The minimum maturity of 7 days makes it inflexible.
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Certificates Of Deposits
Certificates of Deposits are unsecured, negotiable, short term instruments in bearer form issued by commercial banks and development financial institutions. CDs were introduced in June, 1989. Initially, only scheduled commercial banks (excluding RRBs and Local Area Banks) were allowed to issue CDs. Financial institutions were allowed to issue CDs in 1992, within the umbrella limit fixed by RBI. CDs are time deposits of specific maturity similar to fixed deposits. The major difference is that CDs are in bearer form and are negotiable, transferable and tradable while fixed deposits are not. Like other deposits, CDs are subject to CRR / SLR. There is no ceiling on the amount to be raised by banks through CDs.
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Certificates Of Deposits(contd)
CDs attract stamp duty as applicable to negotiable instruments. They can be issued to individuals, corporates, companies, trusts, funds, associations and others.

NRI s also can subscribe to CDs on a non Repatriable basis.

CDs are issued at a discount to the face value. CDs are issued by banks in times of tight liquidity at high interest rates

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Guidelines For Issue Of CD s.

RBI have issued various guidelines in respect of CDs which presently are as under CD s can be issued by scheduled commercial banks Aggregate Amount Banks have the freedom to issue CDs as per their requirements. FIs can issue up to limits fixed by RBI and CDs issued by them along with other short term funds raised should not exceed 100% of net worth Minimum Issue Size & Denomination Minimum amount of a CD should be Rs. One lakh and in multiples of one lakh thereafter.

Who Can Subscribe CDs can be issued to entities like individuals, corporations, companies, trusts, funds and associations. NRIs can also be issued CDs, but on a non repatriable and non transferable basis.
Maturity Period Minimum 7 days and maximum one year. 18

Guidelines For Issuance Of CD s (cont)

Discount / Coupon Rate CDs may be issued at a discount to the face value. Banks and Financial institutions are also allowed to issue CDs on a floating rate basis, provided the methodology of computing the floating rate is objective, transparent and market based. Issuing bank is free to decide the discount rate. Reserve Requirements CDs are subject to reserves.

Transferability Physical CDs are freely transferable by endorsement and delivery. Dematted CDs can be transferred as per the procedure for transfer of dematted securities. There is no lock in period for CDs
Loans and Buybacks Banks and Financial Institutions can not grant loans against CD s .Furthermore, they can not buy back their own CD s before maturity. Format of CD s Banks and Financial Institutions should issue CD s only in demat form except where the investor insists on a physical CD. There will be no grace period for repayment of a CD. If the maturity date of a CD happens to be a bank holiday, then the payment should be made on the immediate preceding day. Hence the banks take care to see that the maturity date of the CD does not fall on a bank holiday.

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Factors Inhibiting Growth Of CD s

CD s of commercial banks form only 2% of their deposits. Hence , there is a good scope for the growth of this instrument. Factors limiting the growth of CD s are Transactions in the secondary market have not grown since the number of participants is limited. The reliance of Financial institutions on CD s has decreased. It can be increased if the tenor of CD s is rationalized. There is no facility of loans or buybacks. The market is limited to few investors as the minimum level of investment is high. Stamp duty on CD s is another deterrent. CD s carry a fixed rate of discount. To enlarge the market for CD s, it is necessary to introduce floating rate CD s. 20

Call / Notice Money Market

Call Money Market, by far, is the most visible segment of the money market. Since its inception in 1955/56, the call money market has registered phenomenal growth. Call / Notice money market is a market for very short term funds maturity one day to 14 days. No collateral is required for these transactions. Call money is required mostly by banks. Commercial banks borrow money from other banks to maintain CRR.

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Link Between Call Money Market & Other Financial Markets

There is an inverse relationship between call rates and short term money market instruments like CD s & CP s.
When call rates go up, Banks raise funds through CD s. When call rates fall , banks invest in CP s by raising money in the call market. A large issue of Government securities also affects call rates. When banks subscribe to large issues of GOI securities, the liquidity is sucked out and call rates rise. The call rates and the forex market are also closely linked as there exists an arbitrage opportunity between the two markets. When call rates go up, Banks borrow dollars from their overseas branches, swap them into rupees and lend in the call market. To repay the dollar loan, they also buy dollar forward which pushes up the forward $ premium.

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Call Money Rate - MIBOR

The interest rate paid on the call loans is the call rate. It is volatile and depends upon demand / supply of funds. It can change day to day, hour to hour or even minute to minute. Till 1973, call rate was determined by market forces. In December, 1973, the call rate touched 30% due to tight liquidity conditions and then IBA started regulating the call rate. Effective May 1989, call rates were again freed from an administrative ceiling. Now the rate is freely determined by market forces of demand and supply. A reference rate has emerged through NSE & Reuters. NSE developed and launched MIBID & MIBOR rates for overnight money markets on 15 June, 1998. These rates are calculated based on the quotes of 31 banks , financial institutions & primary dealers. MIBOR is a benchmark rate for Interest rate swaps and forward rate agreements. 23

Factors Influencing Call Money Rates

Liquidity conditions in the economy, Reserve Requirements, Structural factors,

Investment policy of non bank participants in the market

Liquidity changes and gaps in the forex market. RBI have taken the following steps to curb volatility in the call money market Increasing the number of participants in the market, Through repos, and Freeing inter bank liabilities from reserve requirements.

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The Term Money Market

Beyond the call money market, there is the Term Money Market, for maturities ranging from 3 months to one year. The Term Money Market in India is still not well developed. Volumes and turnover are quite small. RBI permitted certain select financial institutions like IDBI, IFCI, ICICI, IIBI, SIDBI, NABARD, EXIM BANK, IDFC and NHB etc. to borrow 3 to 6 months in the term money market. In April, 1997, banks were exempted from maintaining reserves ( CRR & SLR ) on inter bank liabilities to facilitate development of term money market. But the market has not really developed significantly. From April 30, 2005, all NDS members are required to report their term money deals on the NDS platform. 25

Collateralized Borrowing & Lending Obligations (CBLO)

The CCIL ( Clearing Corporation of India Ltd.) launched a new product CBLO in January,2003 to provide liquidity to non bank entities hit by restrictive access to call money market. In the auction market, minimum lot is RS.50 lakh and in multiples of RS 5 lakh thereafter.

In the normal market, the minimum lot is RS 5 lakh and in multiples of RS5 lakh thereafter.
In the auction market, on the platform provided by CCIL, lenders and borrowers will submit their offers and bids , specifying the discount rate and the maturity period. These orders will be matched on the basis of best quotations, allowing for negotiations too. The borrowers will issue the debt instrument under the guarantee of CCIL

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CBLO ( continued )
All CBLO members have to maintain margin or collateral with CCIL to cover exposure obligations. The interest rates on CBLOs mirror the call money rates. The CBLO market has emerged as the preferred overnight market since it offers anonymity to the participants and provides funds at lower costs. The interest rate charged in CBLO market was 5.56% against 5.86% in the call market. CCIL proposes to introduce internet based trading platform for its CBLO product which would provide access to corporates and other non banking entities to the institutional lending and borrowing segments of the money market.

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Money Market Mutual Funds

Money Market Mutual Funds were introduced in April, 91 to provide an additional short term avenue for investment to individuals. These MMMFs exclusively invest in the money market instruments. Several modifications have been made to make it more flexible and attractive, such as removing the ceiling for raising resources, allowing the private sector to set up MMMF s , permitting the MMMF s to invest in rated corporate bonds / debentures, reduction in the minimum lock in period to 15 days and so on. MMMF s can grow only if money market grows in depth and volume.

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Tools For Managing Liquidity In The Money Market

Reserve Requirements (CRR & SLR) Interest Rates Liquidity Adjustment Facility LAF is operated through repos and reverse repos.

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Money Market Derivatives

A Derivative is a financial contract whose value is derived from the value of an underlying asset The deregulation of interest rates has led to an interest rate risk. This is the adverse effect of interest rate movements on an organizations net interest income, and market value, depending upon the maturity profile of its assets and liabilities as well as their repricing terms.

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Interest Rate Swaps ( IRS )

An IRS is a financial contract between two parties, for exchanging or swapping a stream of interest payments for a notional principal amount during a specified period. Such a contract involves exchanging or swapping of a fixed to floating or a floating to fixed interest rate.

If participants feel that rates will fall, they could receive fixed and pay floating rates.
The converse is beneficial if interest rates rise.

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Applications Of Interest Rate Swaps

Borrowers who expect interest rates to fall can swap their fixed rate loans to floating rate loans. Borrowers who expect interest rates to rise can swap their floating rate loans to fixed rate loans.

Borrowers who have their loans benchmarked to one floating rate can swap to another floating rate to reduce their risk or take advantage of the expected movement in one benchmark rate against another.
The outstanding amount of IRS contracts more than doubled from 242983 Cr to 518260 Cr during 2003 04. The number of contracts rose from 9363 to 19867. 32

Forward Rate Agreements ( FRA )

A Forward Rate Agreement is a financial contract between two parties where the interest at a predetermined rate for a notional principal amount and for a specified period is exchanged at the market interest rate prevailing at the time of settlement. The market interest rate is agreed benchmark / reference rate prevailing on the settlement date. In India, NSE / Reuters MIBOR is used as a reference rate.
The cash payment at maturity ( settlement ) is based on the difference between the prefixed rate and MIBOR. 33

Plain Vanilla Forward Rate Agreements

A party that is seeking protection from a possible rise in interest rates would buy the FRA s, i.e., Purchaser. A party that wants protection from a possible fall in interest rates would sell FRA s, i.e., Seller.

It is assumed that the forward interest rate is certain to be realized. There is no risk of default on the part of writer of the FRA. A 360 day year convention is used in computing interest.
The specified period of the contract is the point in time when the deposit is to commence and the point in time when the deposit is to terminate. For example, a 3 x 9 FRA is read as 3 months against 9 months MIBOR which means a 6 month MIBOR deposit is to commence in 3 months and terminate in 9 months.

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Participants In The IRS & FRA Market

Scheduled commercial banks ( excluding RRB s), primary dealers and all India financial institutions are free to undertake FRA s as a product for their balance sheet management or for market making. Banks, FI s and primary dealers can also offer these products to their corporate customers to hedge their balance sheet exposures.

Mutual funds are permitted to undertake IRS s / FRA s .

The forward rate hedging facility provides fund managers an opportunity to insulate income schemes from interest rate fluctuations, which in turn helps protect the returns to the investors in a volatile interest rate scenario. No specific RBI approval is needed for IRS / FRA but there are reporting requirements. 35

THANK
YOU

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