NOVEMBER 5, 2020

AN OVERVIEW OF MONEY MARKET IN

INDIAN FINANCIAL SYSTEM
JHANVI TAYAL

A3221520099
BBA LLB (H)
Section-B
An Overview of Money Markets in Indian
Financial System

Introduction
Money Markets are financial markets which deal in short term debt instruments ranging from a
maturity period of one day to one year. It covers money and financial assets that are close substitutes
for money. Money markets have been dormant in India. They have always been considered as a
lesser substitute to Capital Markets but that is not true. Money markets have their own benefits. They
have short term maturity periods, high marketability and low risk. It acts as an intermediate between
people with surplus short term funds(buyer) and people with deficiency of the same(seller).They help
in converting savings into investments. The development of money market is crucial for Indian
economy as it helps in maintaining the liquidity in the economy. Money market is distinct from other
financial markets because of the short-term maturity of money market instruments, large
denomination of transactions, low default risk, innovation and flexibility.

Objective of the study

The study aims at giving an overview of the functioning of money markets in the Indian scenario. It
provides an insight in the development of money markets in India with time and explores the journey
of various available financial instruments .. It also highlights the feasibility, opportunities and
provisions offered by the Indian money market. The study will give an overview from the
perspective of both the seller as well as the investor.

Meaning
Money market is like a place for large institutions and government to manage their short-term cash
needs. However, individual investors have access to the market through a variety of different securities.
Money market securities are essentially IOUs issued by governments, financial institutions and large
corporations. These instruments are very liquid and considered extraordinarily safe. Because they are
extremely conservative, money market securities offer significantly lower returns than most other
securities. Eg. Treasury Bills.
Monetary transmission cannot take place without transmission of monetary policy impulses to the
rest of the efficient price discovery, particularly with respect to interest rates and exchange rates.
 Deep and liquid money market contributes significantly to efficient price discovery in various
segments of the financial market.

Description
In money market short term surplus funds with banks, financial institutions and others are bid by
borrowers, i.e., individuals, companies and the Government. In the Indian money market RBI
occupies the apical position. The Indian money market can be segregated into two sectors i.e.
unorganised and organised.
The organised sector comprises of Reserve Bank of India, SBI group and commercial banks-foreign,
public sector and private sector and has a no. of sub-markets such as treasury bills market, the
commercial market etc. The financial institutions also participate to a limited extent. The
unorganised sector consists of indigenous bankers and money lenders.
STRUCTURE OF INDIAN MONEY MARKET

ORGANISED UNORGANISED
SECTOR SECTOR

INDIGENOUS BANKERS MONEY LENDERS

RESERVE BANK OF NON-BANKING COOPERATIVE

COMMERCIAL BANKS PO SAVING BANKS
INDIA COMPANIES BANKS

SCHEDULED COMMERCIAL BANKS NON-SCHEDULED COMMERCIAL BANKS

[A] Functions of money market:

The functions of money market include the following:

1. Financing Trade:
Money Market plays crucial role in financing both internal as well as international trade.
Commercial finance is made available to the traders through bills of exchange, which are
discounted by the bill market. The acceptance houses and discount markets help in financing
foreign trade.
2.  Financing Industry:
 Money market contributes to the growth of industries in two ways:
(a) Money market helps the industries in securing short-term loans to meet their working
capital requirements through the system of finance bills, commercial papers, etc.
(b) Industries generally need long-term loans, which are provided in the capital market.
However, capital market depends upon the nature of and the conditions in the money market.
The short-term interest rates of the money market influence the long-term interest rates of the
capital market. Thus, money market indirectly helps the industries through its link with and
influence on long-term capital market.
3.  Profitable Investment:
Money market enables the commercial banks to use their excess reserves in profitable
investment. The main objective of the commercial banks is to earn income from its reserves
as well as maintain liquidity to meet the uncertain cash demand of the depositors. In the
money market, the excess reserves of the commercial banks are invested in near-money
assets (e.g. short-term bills of exchange) which are highly liquid and can be easily converted
into cash. Thus, the commercial banks earn profits without losing liquidity.
4. Promotes Self-Sufficiency of Commercial Bank:
Developed money market helps the commercial banks to become self-sufficient. In the
situation of emergency, when the commercial banks have scarcity of funds, they need not
approach the central bank and borrow at a higher interest rate. On the other hand, they can
meet their requirements by recalling their old short-run loans from the money market.
5. Benefits to Central Bank:
Though the central bank can function and influence the banking system in the absence of a
money market, the existence of a developed money market smoothens the functioning and
increases the efficiency of the central bank.
Money market helps the central bank in two ways:
(a) The short-run interest rates of the money market serves as an indicator of the monetary
and banking conditions in the country and, in this way, guide the central bank to adopt an
appropriate banking policy,
(b) The sensitive and integrated money market helps the central bank to secure quick and
widespread influence on the sub-markets, and thus achieve effective implementation of its
policy.

[B]Participants of money market

By nature, the transactions that take place in the money market are of high volumes, involving large
amounts. Hence, the market is dominated by a relatively small number of large players. Given below
is the list of intermediaries participating in the money market:
PARTICIPANT ROLE
CENTRAL BANK Intermediary
GOVERNMENT Borrower/Issuer
BANKS Borrowers/Issuers
DISCOUNT HOUSES Market Makers
ACCEPTANCE HOUSES Borrowers/Issuers
FIs Lenders/Investors
MFs Investors
 FIIs Intermediaries
DEALERS Intermediaries
CORPORATES Issuers

[C] Types of Indian Money Market

(1) Call/Notice Money Market:-

Call/Notice money market is a market where the day-to-day surplus funds, mostly of banks are
traded. Call loans in India are provided; (i) to the bill market, (ii) for the purpose of dealing in the
bullion markets and stock exchanges, (iii) between banks, and (iv) frequently to individuals of high
financial status in Mumbai for ordinary trade purposes in order to save interest on cash credits and
overdrafts. Maturity Period:2-14 days

(2) Treasury bill Market:-

Treasury bill market deals with instruments of short-term borrowing of the government. It
plays a vital role in cash management. They are risk-free and their yields at varied maturities serve as
short-term benchmarks and help in pricing varied floating rate products in the market. Treasury Bills
market has been most preferred by central banks for market interventions to influence liquidity and
short-term interest rates.
Maturity for treasury bill issues of weekly- 14-day and 91-day bill auctions and 364-day bill auctions
on a fortnightly basis combined with 14-day intermediate bills available for state governments and
foreign central banks.

(3) Term Money Market:-

The term ‘money market’ is another segment of the uncollateralised money market which
deals with financial transactions of short-term duration ranging from 15 days to one year. This
market has been somewhat dormant in India. It was also a strictly regulated market up to the late
1980s with the ceiling rates of interest (10.5-11.5%) across the various maturity periods. Historically,
statutory pre-emptions on interbank liabilities regulated interest rate structure, cash credit system of
financing, high degree of volatility in the call money rates, availability of sector-specific refinance,
inadequate Asset Liability Management (ALM) discipline among banks and scarcity of money
market instruments of varying maturities were cited as the main factors that inhibited the
development of the term money market.

(4) Discount Market: -

The establishment of discount markets was first time considered by The Banking commission
1972. Though, the Commission held there was no need for specialised acceptance and discount
houses in India. After the failed attempts of The Chore Committee to establish discount markets on
the lines of discount markets in UK , the Vaghul Committee after studying the working of the Indian
monetary system and money markets from various angles recommended for the establishment of an
autonomous public limited company, to be called the Finance House, jointly by the RBI, the public
sector banks, and the all-India financial institutions. Following the Vaghul Committee
recommendations, the RBI set up the Discount and Finance House of India Ltd. in April 1, 1935 year
with the solemn objective of deepening and activating money market. With the establishment of
DFHI, discounting facilities are now provided by it, leading to reduction in the pressure for
discounting services on the RBI. Institutions such as NABARD, Exim Bank, SIDBI and NHB also
play an important role in the discount market.

(5) Bill Market: -

 Bill market encompasses the trade of short-term papers or bills like bills of exchange and treasury
bills. In its efforts to develop and activate the bill market, the RBI launched Bill Market Scheme in
1952. According to this scheme, the RBI provided advances to scheduled banks by way of demand
loans against the security of eligible usance bills or promissory notes of their constituents.The bills
for rediscounting purpose should have usance of 90 days but in exceptional cases, it may have
usance up to 120 days, provided at the time of offering to the RBI for rediscount, it has a usance not
exceeding 90 days. For export bills, the maturity period was 180 days.

[D]Financial Instruments in Money Markets

 Commercial Bills: Commercial bill is an instrument used in the Indian money market to
finance the movement and storage of agricultural and industrial goods in domestic and
foreign trade. Bill finance has not been popular in India mainly because of the absence of
adequate number of genuine bills and lack of discounting facilities. Until 1981-82, the RBI
provided rediscounting facility to the banks whereafter this task was assumed by DFHI.
 Treasury Bills: Treasury bills constitute an important instrument of short-term borrowing of
the government. At present, the Treasury issues consist of weekly 14-day and 91-day bill
auctions and 364-day bill auctions on a fortnightly basis combined with 14-day intermediate
bills available for state governments and foreign central banks. With the introduction of the
auction system interest rates on all types of Treasury bills are determined by the market
forces. The 91-day Treasury bills are purchased by the RBI, commercial banks, state
governments and other approved bodies and financial institutions like the LIC, UTI. The RBI
and banks together account for about 90% of the sales of this bill every year. Other types of
treasury bills are purchased by foreign banks, Indian scheduled banks, cooperative banks,
financial institutions, companies, DFHI and others.
 Certificate of Deposits: Certificates of Deposits (CDs), representing essentially securitised
and tradable term deposits, were introduced by the RBI in June 1989 permitting banks to
issue CDs. The minimum denomination of CDs was reduced from ` 25 lakh to ` 5 lakh, minimum
size of a single issue reduced from ` 1 crore to ` 10 lakh further to ` 1 lakh in June 2002, having
maturity period of 91 days to 1 year.
 Commercial Paper: Commercial Paper (CP) was introduced by the RBI in India in 1989 to
enable highly rated corporate borrowers to diversify their sources of short-term borrowing
and also to provide an additional instrument to investors. The RBI stipulated terms and
conditions for issuing CP like, eligibility, modes of issue, maturity periods, denominations
and issuance procedure. The guidelines in respect of the above were revised time and again
keeping in view the experience of the working of the CP. Thus, corporates, PDs and SDs are
eligible for issuing CP for a minimum period of maturity of 7 days and maximum period of 1
year.
 Derivative Promissory Notes: The RBI introduced an innovative instrument termed as
'derivative usance promissory note', in September 1988. Under this instrument, banks were
permitted to issue derivative usance promissory note for a period not exceeding 90 days
under the strength of underlying bills. This instrument was introduced with a view to
developing the secondary market in bills by simplifying the procedures and documentation
involved in rediscounting the bill.
 Repurchase Options: REPO has emerged as an innovative instrument in the developed
money markets of the world. Repo is a versatile market instrument; it refers to a transaction
in which a participant acquires fund immediately by selling securities and simultaneously
agreeing for repurchase of the same or similar securities after specified period of time at a
given price. The transaction combines elements of both a securities purchase/sale operation
 and also a money market borrowing/lending operation. Typically, it signifies lending on a
collateral basis.
 Money Market Mutual funds: Money Market Mutual Funds (MMMFs) were introduced in
India in April 1991 to provide an additional short-term avenue to investors and to bring
money market instruments within the reach of individuals. A Task Force was constituted to
examine the broad framework outlined in April 1991 as also the implications of the Scheme.
Based on the recommendations of Task Force constituted for the purpose, detailed scheme of
MMMFs was announced by the Reserve Bank in April 1992. The growth in MMMFs has
been less than expected. Though, in principle, approvals had been granted to ten entities,
only three MMMFs have been set up, one in the private sector and the other two by IDBI and
UTI. The total size of these funds is not very large. It appears that growth in MMMFs can
really occur when money market grows in volume and acquires depth – for which a number
of initiatives will have to be taken.

Money Market Principal Borrowers Principal Investors Common

Instruments Denominations

TREASURY BILLS Federal Government Individuals, non- $10,000 and higher

financial and financial
corporations, money
market funds, foreign
and domestic
governments

FEDERAL Federally sponsored Individuals, money $10,000, $25,000, and

AGENCY agencies market funds, higher, depending on
DISCOUNT NOTES governments the issuing agency

MUNCIPAL NOTES State and local Insurance companies, $5,000 for interest-
government individuals bearing notes; $50,000
- $100,000 for
discount notes

FEDERAL FUNDS Banks Depository Institutions Flexible

NEGOTIABLE CDs Large banks and Non-financial $100,000 and higher

thrifts corporations, money
market funds,
individuals

COMMERCIAL Financial and Non- Non-financial $25,000 minimum

PAPER Financial Corporations corporations, money
 market funds

REPURCHASE Banks, Securities Non-Financial $10 million and higher

AGREEMENTS dealers and other Instruments
owners of government
securities

BANKER’S Financial and Non- Non-financial and $100,000 minimum

ACCEPTANCE Financial Corporations financial corporations,
money market funds,
governments

MONEY MARKET Financial and Non- Corporations and $1,000 retail and
FUNDS Financial Corporations individuals $100,000 wholesale

[E]Risks Associated with Money Market to Investors and Lenders

 Market Risk/Interest Rate Risk: These are primary risks which arise due to the fluctuations
in rates of the instruments. Due to the large quantum of funds involved in the money market
deals, and the speed with which these transactions are executed, the value of the assets are
exposed to fluctuations. Further, if these fluctuations are wide, it may lead to a capital
loss/gain since the price of the instruments, including the government securities, declines.
This risk can be minimized by enhancing liquidity since easy exit can help curb the capital
loss.
 Reinvestment Risk: Reinvestment risk arises in a declining interest rate scenario. Investors
who ‘warehouse’ their funds in short-term instruments will have to reinvest these funds at a
lower rate of interest at the time of redemption.
 Default Risk: Lending decisions are based on analysing the possibility of repayment since
the first risk that the lender will be exposed to is the default risk. Every investment or lending
has the probability that the same is not redeemed by the borrower or the lender except only
sovereign securities.
 Inflation Risk: Inflation leads to a rise in the average prices for all goods and services
thereby reducing the purchasing power of the lender. All money market instruments are
exposed to this risk. However, considering the short-term nature of the money market
instruments, their level of exposure to this inflation risk is minimal. The Capital Indexed
Bond (CIB) issued by the RBI is an instrument designed to minimize/eliminate the inflation
risk. With a maturity of 5 years, these CIBs earn a 6 per cent return on the investments. The
principal amount is adjusted against inflation for each of the years and the interest is then
calculated on this adjusted principal.
 Currency Risk: A risk of loss is inherent in the multi-currency dealings due to the exchange
rate fluctuations. The money market players operating in overseas money market instruments
will be exposed to this risk. Also, when the institutional investors, like banks sell foreign
currencies to play in the money market, they may be exposed to currency risk.

[F]Regulation of Money Market:

 The regulatory body of money market in India is Reserve Bank of India. RBI can exercise
authority under sections 45K, 45L and 45W of the Reserve Bank of India Act, 1934 to issue
guidelines related to Regulation of Money Market Instruments. RBI is the most important
constituent in the money market. By virtue of the implication for the conduct of monetary
policy, money market comes within the direct purview of RBI regulation. The primary aim of
the Reserve Bank of India’s operations in the money market is to ensure that the liquidity and
short-term interest rates are maintained at levels consistent with the monetary policy
objectives of maintaining price stability, ensuring adequate flow of credit to productive
sectors of the economy and bringing about orderly conditions in the foreign exchange market.
The Reserve Bank of India influences liquidity and interest rates through a number of
operating instruments, viz., cash reserve requirements of banks, operation of refinance
schemes, conduct of open market operations, repo transactions, changes in the Bank Rate,
and at times through foreign exchange swap operations.
 RBI Guidelines related to Commercial Paper -
Companies, PDs and FIs are permitted to raise short term resources through Commercial Paper. The
terms include:
 The tangible net worth of the company, as per the latest audited balance sheet, should not be
less than Rs.4 crore;
 The company should have sanctioned working capital limit by bank/s or FIs
 The borrower account of the company is classified as a Standard Asset by the financing
bank/institution.
 RBI Guidelines related to Certificates of Deposit -
CDs can be issued by:
 Scheduled commercial banks {excluding Regional Rural Banks and Local Area Banks}
 Select All-India Financial Institutions (FIs) that have been permitted by RBI to raise short-
term resources within the umbrella limit fixed by RBI.
 RBI Guidelines related to Non-Convertible Debentures -
A corporate shall be eligible to issue Non-Convertible Debentures if it fulfils the following criteria,
namely,
 The corporate has a tangible net worth of not less than Rs.4 crore, as per the latest audited
balance sheet. This shall not be applicable to Non-Banking Financial Companies (NBFCs)
including Primary Dealers (PDs)
 The corporate has been sanctioned working capital limit or term loan by bank/s or all-India
financial institution/s; and
 The borrower account of the corporate is classified as a Standard Asset by the financing
bank/s or institution/s.

Conclusions
Money markets had developed as an obscure corner of capital markets not only in India but across
the world where businesses financed short-term trades and the needs for working capital. An
overview of money market development in India and the current efforts for further development
show that though a late comer, India is not lagging behind in any significant manner. However, while
a base has been created with a variety of products in the money market, the market has not acquired
the required depth in terms of both volume and liquidity. It is our hope that the institutional and other
reforms identified as agenda will provide the necessary depth. With that, the money market should
gradually get integrated with debt and foreign exchange markets and in turn, pave way for the
Reserve Bank’s greater reliance on indirect tools of monetary regulation.
The Indian money market is still centred on the call money market although efforts have been made
to develop secondary market in post 1991 period. They’ve since grown in size in India through
various measures taken by RBI under Banking Regulation Act 1949 but still some lacunae in the
credit system of money market can be spotted.

The most prominent defect in money market is the presence of unorganised sector in which both the
purpose as well as maturity period are not clearly demarcated. There is a lack of integration among
different functionaries of the market. Due to mobility of funds from one sector to another, there are
variable rates of interest in the market at the same time like the borrowing rates of government, the
lending rate of commercial banks, the rates of co-operative banks and the rates of financial
institutions. The bill market in underdeveloped. A stable bill market or discount market is imperative
for establishing a link between credit agencies and RBI.

The factors responsible for these defects include the fact that most of the commercial transactions are
made in cash, heavy stamp duty discourages the use of exchange bills, absence of acceptance houses.
Thus , RBI should extend discounted facilities towards commercial banks as well as with approved
securities and should also promote Indian banks to invest in exchange bills.

Also, considering the amount of transactions that take place under money markets stricter guidelines
are needed to be drafted and implemented by the RBI .On one hand, this should provide security
against illegitimate exploitation of the loopholes by the investors as well as the lenders and on the
other hand, these guidelines should not curb the liquidity and high marketability of short term funds
which are the primary characteristics of money markets.

References
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