What is Money Market?

A market for financial assets that are close substitutes

for money.
A market for short-term funds and instruments
Having a maturity of one/less than one year.
It is an activity, not a place, conducted by telephone.
It constitutes a very important segment of the Indian
Financial System.

Characteristics of the Money Market

1. It is not a single market but a collection of markets
for several instruments.
2. It is a wholesale market for short-term debt instruments.
3. Its principal feature is honor where the creditworthiness
of the participants is important.
4. The main players are:
Reserve Bank of India (RBI),
Discount and Finance House of India (DFHI),
Mutual Funds,
Banks,
Corporate Investors,
Non-Banking Finance Companies (NBFCs),
Contd.

Contd

State Governments,
Provident Funds,
Primary Dealers,
Securities Trading Corporation of India (STCI), or
Public Sector Undertakings (PSUs),
Non-resident Indians and overseas corporate bodies.
5. It is a need-based market wherein the demand and
supply of money shape the market.

Constituents of Money Market

Money Market is divided into two spheres, by Dr.Lavington.
a. Inner Sphere-constituting a nucleous of specialized
institutions such as the banks, the market for negotiable
securities, the bill brokers, the finance companies and
the trust.
b. The Outer Sphere constitutes of the work of solicitors,
brokers of securities and the entire systems of trade
and credit.
Main Constituents:
The Central Bank, Commercial Banks, Co-operative Banks,
Savings Banks discount houses are the main constituents
of a well developed money market.

Functions of the Money Market

1. Provide a balancing mechanism to even out the
demand for and supply of short-term funds
2. Provide a focal point for central bank intervention
for influencing liquidity and general level of interest
rates in the economy.
3. Provide a reasonable access to suppliers and users
of short-term funds to fulfill their borrowings and
investment requirements at an efficient market clearing
price.
4. Minimize gluts and stringencies in the market due to
the seasonal variations in the flow of and demand for funds.

Benefits of the Efficient Money Market

1. Provides a stable source of funds to banks in addition

to deposits, allowing alternative financing structures
and competition.
2. Allows the banks to manage risks arising from interest
rate fluctuations and to manage the maturity structure
of their assets and liabilities.
3. Provides a basis for growth and liquidity in the market.
4. Encourages the development of non-banking
intermediaries, thus increasing the competition for funds.
5. A liquid and vibrant money market is necessary for
the development of a capital market, foreign exchange market.

The Indian Money Market

The average turnover of the money market in India is Rs.40,000
crore daily.
This is more than 3% of the total money supply in the Indian
economy and 6% of the total funds that commercial banks have
let out to the system.
This implies that 2% of the annual GDP of India gets traded in
the money market in just one day.

Role of RBI in the Money Market

Liquidity & Short term interest rates are maintained at a level
consistent with the monetary policy objectives of maintaining
price stability
To ensure productive flow of credit to the productive sectors of
the economy
To bring about order in the foreign exchange market
The RBI influences liquidity & interest rates through .
CRR of banks
Conduct OMOs
Repos
Change in bank rates
Foreign exchange swaps operations

Steps to Develop the Money Market in India

The money market in India is divided into the Formal (organized)
and Informal (unorganized) segments.
In the 1980s:
A committee to review the working of the monetary system under the
Chairmanship of Sukhamoy Chakravorty was set up in 1985.
As a follow up, the Reserve Bank set up a working group on the money
Market under the chairmanship of Mr.N Vagul which submitted
its report in 1987.

Based on its recommendations the RBI initiated a no.

of measures like:
1. The Discount and Finance Housed of India (DFHI) was set up as a
money market institution jointly by the RB, public sector banks and
financial institutions in 1988 to impart liquidity to money market
instruments and help the development of a secondary market in
such instruments.

Money Market instruments such as the 182-day treasury bill,

certificate of deposit, and interbank participation certificate
were introduced in 1988-89. Commercial paper was introduced
in January 1990.
3. To enable price discovery, the interest rate ceiling on call money
was freed in stages from October 1988. As a first step, operations
of the DFHI in the call/notice money market were freed from the
interest rate ceiling in 1988.
Interest rate ceilings on interbank term money (10.5-11.5%),
rediscounting of commercial bills (12.5%), and interbank
participation without risk (12.5%) were withdrawn effective
May 1989.

In the 1990s:
The government set up a high-level committee in August 1991 under
The chairmanship of Mr. M Narasimham (Narasimham Committee) to
Examine all aspects relating to structure, organization, functions, and
Procedures of the financial system.

The RBI accepted many of its recommendations.

1. The Securities Trading Corporation of India was set up in June
1994 to provide an active secondary market in government dated
securities and public sector bonds.
2. Barriers to entry were gradually eased by
a. Setting up the primary dealer system in 1995 and satellite dealer
system in 1999 to inject liquidity in the market.

b.

c.
d.
e.
3.
4.

Relaxing issuance restrictions and subscription norms in respect

of money market instruments
Allowing the determination of yields based on the demand and
supply of such paper.
Enabling market evaluation of associated risks by withdrawing
regulatory restriction such as bank guarantees in respect of
commercial papers.
Increasing the no. Of participants by allowing the entry of foreign
institutional investors (FIIs), non-bank financial institutions, mutual
funds and so on.
Several financial innovations in instruments and methods were
introduced. Treasury bills of varying maturities and RBI repos
were introduced.
The development of a market for short-term funds at
market-determined rates has been fostered.

Indirect monetary control instruments such as the bank

rate-reactivated in April 1997, strategy of combining auctions,
private placements and open market operations-in 1988-89,
and the liquidity adjustment facility (LAF)-in June 2000 were
introduced.
5. The minimum lock-in-period for money market was brought
down to 15 days.
6. The Reserve Bank started repos both on auction and fixed
interest rate basis for liquidity management.
7. The interbank liabilities were exempted from cash reserve
ratio (CRR) and statutory liquidity ratio (SLR) stipulations
for facilitating the development of a term money market.

The Indian Money Market

The average turnover of the money market in India is Rs.40,000
crore daily.
This is more than 3% of the total money supply in the Indian
economy and 6% of the total funds that commercial banks have
let out to the system.
This implies that 2% of the annual GDP of India gets traded in
the money market in just one day.
Steps to Develop the Money Market in India
The money market in India is divided into the Formal (organised)
and Informal (unorganised) segments.

Money Market Instruments

The money market instruments in India mainly comprise:
Call money,
Certificates of deposit,
Treasury bills,
Repo
Bankers acceptance/commercial bills,
Commercial paper .

Call and Notice Money

Market

Difference between Call Money and Notice Money.

Participants: Banks.
Primary Dealers.
Development Finance Institutions.
Insurance Companies.
Mutual funds.
Purpose: To meet the gap or temporary mismatch in funds
To meet CRR/ SLR requirement as stipulated by RBI.
To meet sudden demand for funds arising out of large outflows .
Thus, call money usually serves the role of equilibrating the short-term
liquidity position of banks .

Prudential norms of RBI

Lending Limit: Maximum of 50% of their capital fund on any day, during fortnight.
Maximum of 25% of their capital fund on a fortnightly average
basis.
Borrowing Limit: Maximum of 125% of their capital fund on any day, during
fortnight.
Higher of 100% of their capital fund or 2% of aggregate deposits
on a fortnightly average basis.

Interest Rate : Market determined

9.00% to 9.10% last week.
Average volume during last week:- Rs. 135.26 billion

Certificate of Deposits

Certificates of deposit are unsecured, negotiable, short-term

instruments in bearer form, issued by commercial banks and
development financial Institutions.

Introduced on July, 1989.

Issuers:-

All scheduled commercial banks and All India financial institutions

within their Umbrella limit.

Investors: Individual
Corporations
Trusts
Associations

Maturity: FI: Minimum 1 year and Maximum 3 years

Other than FI: Minimum 7 days and Maximum 12 Months

Investment limit:

Treasury Bills

Treasury bills are short-term instruments issued by the Reserve

Bank on behalf of the government to tide over short-term
liquidity shortfalls.
This instrument is used by the government to raise short-term
funds to bridge seasonal or temporary gaps between its receipts
(revenue and capital) and expenditure.
They form the most important segment of the money market.
Types Of Treasury Bills: Ad- hoc Treasury Bill
91 days Treasury Bill
182 days Treasury Bill
364 days Treasury Bill

Features:

Form: Promissory Note in Physical form

Credit to Subsidiary Ledger Account (SLA) or Gilt Account in Dematerialized

form.

Eligibility: All registered Entities and individuals.

Investment limit: Min of Rs. 25,000 and in multiple thereof.

Repayment: At par on the expiry of tenure at RBI offices.

Yield Calculation:The yield of a Treasury Bill is calculated as per the following

formula:
Y=

(100-P)*365*100
-----------------P*D

Wherein Y = discounted yield P= Price D= Days to maturity

Repo

A repo is a money market instrument that enables collateralised

short-term borrowing and lending through sale/purchase
operations in debt instruments.
A ready forward transaction.
Difference is the reflection of repo interest and coupon earned on
securities.
Factors affecting repo rate:Credit worthiness of Borrower
Liquidity of collateral
Comparable rates of other Money market instruments

Tenure of Repo:Overnight Repo

Term Repo
Open Repo
Flexible Repo
Instruments Dealt in Repo:Money Market Securities
Government Dated Securities
Equity
Corporate Bonds
Treasury Bills

Commercial Bills

Introduction of Bills Market Scheme in 1952 by RBI.

Modified into New Bills market Scheme in 1970.
Rediscounting of the Bills which were originally
discounted by them with approved institutions.
Approved Institutions:Commercial Banks
Development Financial Instruments
Mutual Funds
Primary Dealers

Commercial Papers

CPs are negotiable short-term unsecured promissory notes with

fixed maturities, issued by well rated companies generally sold at a
discount basis.
Companies can issue CPs either directly to the investors or through
banks / merchant banks (called dealers).
These are basically instruments evidencing the liability of the
issuer to pay the holder in due course a fixed amount (face value of
the instrument) on the specified due date.
These instruments are normally issued in the multiples of five
crore for 30/45/60/90/120/180/270/364 days maturity.