7
Money Markets Operations:
An Overview
LEARNING OBJECTIVES
After reading this chapter, you will
learn:
+ The Concept, Objectives, Features and
Functions of Money Markets in India
Structure of Money Markets in India
+ Shortcomings of Indian Money Market
+ Organized and Unorganized Money
Markets: Distinguishing Features
+ Intermediaries/Participants of Money
Markets
+ Money Market Instruments in India
Call or Notice Money
+ Treasury Bils
+ Commercial Papers
> Commercial Bills
+ Certificates of Deposit
Re-purchase Agreements (Repos)
SBI DFHIL, STCIL and MMMES
+ Money Market Reforms and its Recent
Trends in india
INTRODUCTION
As stated in the previous chapter, the money market is an
integral part of the financial market in India. It helps strike
a balance between the surplus funds of lenders and the
requirements of borrowers -for short periods of time.
Truly speaking, the money market provides a focal point for
RBI intervention in influencing financial system liquidity.
The main role of the RBIin the money
marketisto
maintain the liquidity and short-term interest rates at levels
consistent with the monetary
m policy of the nation. Financial
institutions with surplus funds for short-term use can well
invest in risk-free instruments to earn a
Financial institutions facing a short-term moderate return.
due to a temporary mismatch between thefund shortage
funds and their availability of
consumptioncan borrow the money
till the imbalance well
between the surplus and
gets equilibrated in the money market in India.the deficit
the money market is the market for Therefore.
short-term funds,
normally ranging from overnight funds to a year. The money
market--in developed and
distinctly in many senses anddeveloping countriesdiffer
the Indian mnoney market 1s
not an exXception to this. Though the Indian
not a developed money market, it is a money market is
among the developing countries in theleading money maTket
world. This chapter
intends to make an overview of money
markets in India.
 Money Markets Operations: An Overview 251

THE CONCEPT AND MEANING

Money market is a market for the lending and borrowing of short-term funds. It deals with
nonetary assets whoSe period of maturity is less-than-or-up-to-one-year. It meets the short-term
requirements off borrowers and provides short-term returns to lenders. Therefore, the money market
can be defined as a market for short-term money and financial assets that are near-substitutes for
money. In this context, while the term "short-term" means a period up-to-one-year in general:
"near substitutes for money" signify any financial asset which can be promptly converted into
money with minimum transaction cost. In fact, short-term funds are bought and sold -through
telephone or mail-in the money market in India.
According to the RBI, the money market is "he centre for dealings, mainly short-term character.
in monetary assets; it meets the short-term requirements of borrowers and provide liquidity or cash
to the lenders. It is the place where short-term surplus investable funds at the disposal of financial
and other institutions and individuals are bid by borrowers, again compromising institutions and
individuals and also government itself."

OBJECTIVES
The main objectives of a money market are as follows:
" To make available an opportunity for investing short-term surplus funds;
" To provide scope for removing short-term deficits;
To enable the RBI-as a central bankto regulate the liquidity in the Indian economy:
" To offer areasonable access to users of short-term funds in meeting requirements promptly
and at realistic costs.

FEATURES
The general features of a money market are as follows:
" It is amarket merely for short-term funds or financial assets called near substitutes for
money;
" Itdeals with monetary assets whose period of maturity is less-than-or-up-to-one-year:
" Itdeals with financial assets which can be promptly converted into money without loss
and with minimum transaction costs;
Normally, transactions-in money market-take place through phone (i.e. oral
communication) or mail;
" Relevant documents and written communications for generating funds are exchanged
subsequently in this market;
"There is no formal location of the market--like the stock exchange-where stock market
transactions take place;
Iransactions are made without the help of brokers;
The main intermediaries are the Central Bank (RBI), Commercial Banks, Non-banking
Iinancial companies, discount houses, etc.
252 Indian Financial System and Markets

FUNCTIONS
the growth of the economy of a
The development of the money market is a prerequisite for short-term funds adequately and
country. Truly speaking, a developed money market provides the financial system of a nation
quickly to trade and industry in playing an important role inhighlighted as follows:
However, the functions of a developed money market can be
recognized as a significant
Expansion of Trade and Industry: Money market is short-term working capital
finance the
source of financing in trade and industry. It helps
expansion of industry and trade at the
requirements of trade and industry and assists the
national as well as international levels.
resource mobilization
Expansion of CapitalMarket: The long-term interest, as well as of interest and the
short-term rates
in the capital market, is influenced indirectly by the to some
money market conditions. Therefore, the expansionof the capital market depends,
extent, upon the growth of the moneymarket.
" Efficient Functioning of Central Bank: The effective functioning of a central bank
always requires a developed money market. The reason is that it supports the efficient
implementation of the monetary policy of the RBI as a central bank. The RBIforces fresh
money into the economy with the help of the money market. Thus, the RBIregulates the
flow of money in promoting economic growth with stability in India.
" Formulation of an appropriate Monetary Policy: Conditions-prevailing in the
money marketare a true indicator of the monetary state of an economy. Thus, it serves
as a guide--to the Government---in formulating and revising the monetary policy in the
market.
Smooth operation of Commercial Banks: Commercial banks employ surplus
funds temporarily in easily realizable assets through the money market. Banks can also
get the funds back as promptly as the requirement demands. The money market also helps
commercial banks meet the statutory requirements of Cash Reserve Ratio (CRR) and
Statutory Liquidity Ratio(SLR).
" Source of Finance to Government: The Government may raise short-term funds
from adeveloped money market-with the help of the treasury bills floated in the market.
It isto be noted thatin the absence of a developed money market-the Government can
print and issue more money, or borrow from the central bank (RBI in India). This leads to
price rise and inflation in the economy.

STRUCTURE OF MONEY MARKETS IN INDIA

The money market in India can be divided into two components. These are: (i) the organ1ze0
money market;and (ii) the unorganized or unauthorized money market. Both components consis
of several constituents. As far as the organized money market is concerned, there is a reasonabie
real interest rate. The organized money market consists of: (i)the RBI; (i) the SBI, alongbanks.
wi
its 7associated state banks; (ii) 20 public sector commercial banks including: foreign
 253
Money Markets Operations: An Overview

Rgionalrural banks, development banks, SBI DFHIL. STCL and MMMEs: and (iv) other non-
hankingfinancial intermediaries including: LICI. GICI. UTI, etc.
bills:
The main instruments of organized money market are: (i) cal money: (ii) commercial
exorbitant
is an
bills: (iv) certifticates of deposit: and (v) commercial papers. There bankers:
(ii)treasury money
raleofinnterestin the unorganized money market which consists of indigenous
ionjers: and other unregulated non-banking tinancial intermediaries like chit-funds, etc. The main
instrument of the unorganized money market is Hundi, which is indigenous bill of
exchange. A
the
Hundi is a negotiable instrument written in a vernacular language. But they are mostly in
nature of bills of exchange. Exhibit 7.l depicts the organizational structure of the Indian money
market.

Exhibit 7.1 Money Markets Structure

Money markets

Unorganized money
Organized money market
market

Market for Market for

Short-term
Call money Commercial Treasury bills certificates commercial
loan market
bill market market of deposit papers
market

SHORTCOMINGS OF INDIAN MONEY MARKET

paradigm shift of the Indian money market in the post-economic reforms era.
Ihere has been a
are the important shortcomings of money markets in India:
Ine tolowing
Integration: The organized money market encompasses the financial
" Dearth of The unorgan1zed money market consists of various
institutions supported by the RBI.
indigenous bankerS; (1) village money lenders: and (iii) raders. The
institutions like: (i) integration between these two markets.
a dearth of appropriate
main difficulty is commercial
There is a large network of
Absence of aStructured Banking System:is not absolutely free of limitations like:
system
banks in India. However, the bankingenormous losses; and (i1) poor efticieney. There js
(i) Non-Performing Assets (NPA);(i) the development of money markets in India.
structured banking system for
aneed for a
Money Resources: The Indian cconomy faces aregular shortage of
"Inadeguate low savings and lack of banking habits amono
money resources due to low income,
people.
254 Indian Financial System and Markets

" Several Rates of Interest: There are several rates of interest in the banking system in
India. These rates, which create confusion among investors, vary frequently for lending.
borrowing, government activities, etc.
in
" Lack of Money Market Instruments: There are various money market instruments
India. However, these are not sufficient enough to meet the requirements of the population
and of the market.
" Inadequate Number of Dealers: Money market dealers basically play an important
system-in the case of
role-as mediators between the Government and the banking
dealers who are
short-term assets in India. Here again, there are a number of inadequate
unable to act as a link between end lenders and borrowers.
ORGANIZED AND UNORGANIZED MONEY MARKETS: DISTINGUISHING
FEATURES
The major differences are as follows:
Organized Money Market Unorganized Money Market
1 It is a market where money market activities are It is a market where money market activities are not
made under regulatory environment. made under appropriate regulatory environment.
2 There is a reasonable real interest rate in this There is an exorbitant rate of interest in this market.
market.

3 It consists of the RBI, SBI along with its seven It consists of indigenous bankers, money lenders and
associated state banks, twenty public sectors other no-banking financial intermediaries like chit
commercial banks including the foreign banks, funds, etc.
regional rural banks, development banks, SBI
DEHIL, STCIL, MMMFs and other non-banking
financial intermediaries including LICI, GICI, UTI,
etc.

4 The main instruments of organized money mar- The main instrument of unorganized money market is
ket are call money, commercial bill, treasury bills, hundiwhich is indigenous bill of exchange.
certificate of deposits, commercial papers.

INTERMEDIARIES/PARTICIPANTS OF MONEY MARKETS

Abrief design-about major participants or intermediaries in the organized as well as unorganized
money marketis as follows (Exhibit 7.2):
Reserve Bank of India: A central bank seeks to control the monetary conditions of
a nation through liquidity management in varied instruments. RBI-as a central bank
regulates the money market in India. It injects liquidity in the banking system when it is
deficient and contracts the same in the opposite situation.
Commercial Banks: The major participants in the Indian money market are:
(i) commercial; (ii) co-operative; (iii) regional rural; and (iv)
basically play a dual role in mobilizing the savings of the peopledevelopment banks. They
of deposits which are loaned out to business houses for their through acceptance
short-term working
capital requirements. They invest a portion of these deposits in medium- and long-tern
Government securities; and corporate shares and bonds. They also provide short-term
 Money Markets Operations: An Overview 255

Exhibit 7.2 Intermediaries of Money Markets

Reserve bank of
Unregulated India
non-banking financial Commercial banks
intermediaries

Financial
A Money lenders and investment
institution

Intermediaries
Company
Indigenous bankers organization

MMMFs SBI DFHIL

STCIL

funds to the Government through investment in treasury bills. They also invest short-term
surpluses in various money market instruments.
Financial and Investment Institutions: These institutions are LICI, UTI, GICI, etc.
lenders only.
They have been permitted to participate in the call money market as
demand for finances-from the
" Company Organizations: Companies would generate money market through
banking systemby raising short-term finances directly from the and inter-corporate
issuing commercial paper. In addition to that, they also accept public-
deposits and investments.
DFHIL): The SBI DFHIL
SBI DisCount and Finance House of India Ltd. (SBI
stimulating money market
functions as a specialized money market intermediary for
instruments. It deals both wavs as it
instruments. It develops a secondary market in these
money market instruments.
assists the growth of the secondary money market as wellas
Securities TradingCorporation of India Limited (STCIL): The STCIpromotes an
Public Sector bonds.
Securities and
active secondary market in Government
Money Market Mutual Funds (MMMFS): MMMFs bridge the gap between small
savings from small investors and
individual investors and the money market. It mobilizes
instruments. They are also
invests them in short-term debt instruments or money market
allowed to take part in the call money market.
Indigenous Bankers: As far as the unorganized money market is concerne,indigenous
production
bankers deal in short-term credit instruments--ike hundis--for tìnancing the acceptine
and distribution of goods and services. It acts as a financial intermediary by
deposits or making bank credit available. Previously, indigenous bankers would meet the
256 Indian Financial System and Markets
not
financial needs of the country as there weren't too many banks in India. They are
supposed to
directly controlled by the RBI andunlike commercial banks-were not
maintain SLR or CRR on their deposits.
in rural
Money Lenders: Money lenders lend funds through mainly cash transactions
areas. Unlike indigenous bankers, they do not accept deposits from the public. They enjoy
insufficient number of formal banks
a monopolistic position in remote areas due to an
considered
Unregulated Non-Banking Financial Intermediaries: Chit funds are
basically savings
to be unregulated non-banking financial intermediaries, which are regular members
institutions in the unorganized money market. They collect funds from
through subscription and loan is provided to members. They are not controlled by the
RBI.

Money Market Instruments in India

The money market consists of a nunber of instruments which collectively constitute the money
market. Some of the important money market instruments are given in Exhibit 7.3.
Exhibit 7.3 Money Market Instruments

Money market instruments

Call or notice Treasury Commercial Commercial Certificates Re-purchase

money bills papers bills ofdeposit Agreements

These money market instruments are briefly discussed as below:

Call or Notice Money
Introduction
Call, or notice money, refers to the market for extremely short-period loans (i.e. I day to 14 days)
which are repayable on demand at the option of either the lender or the borrower. These loans
are provided to brokers and dealers in the stock exchange. Likewise, banks--having surplus
fundslend to other banks-having deficit fundsin the call or notice money market. Thus,
it provides an equilibrating mechanism for striking a balance between short-term surpluses and
deficits. Truly speaking, commercial banks can promptly borrow from the call, or notice money
market, to meet their statutory liquidity requirements. In the case of high call rates,
enhance their profits by investing surplus funds in the cll ot notice money market. theyHowever,
can ais
money--borrowed on a day and repaid on the next working day (irrespective of the number of
intervening holidays)-is called Call Money. When money is borrowed or loaned out for mo
than Iday and up to 14 days-it is called Notice Money. There is no need for collateral securiy
to cover these transactions.
 Money Markets Operations: An Overview 257

While UT and LlC have been allowed to operate as lenders in the money market since 1971,
the call. or nottce, money market was predominantly an inter-bank market until 1990. It is to be
noted that the Vaghul Committee recomendedthat the call and notice money market should be
restrictedto banks. But the policies--relating to entry into the call or notice money markets-
made by the RBI were gradually liberalized to extend more liquidity. The RBI also announced
casier norms which facilitated non-bank institutions for deployment of short-term surpluses in
the calland notice money market. Consequently, non-bank institutions were permitted to route
their lending through Primary Dealers (PDs). The RBI keeping the recommendation of the
Narasimham Committee Iin mind--took a decision in favour of a pure inter-bank (including
Primary Dealers) call or notice money market. The RBI in its credit policy of April 2001
announced the steps to phase out these institutions (i.e.. non-bank financial institutions and
corporates) gradually. The RBI allowed corporates to route their call transactions through
Primary Dealers till June 30, 2001. Non-bank institutions were required to gradually reduce their
participation in the callmarket in 4 stages. Since May 5, 2001, non-bank financial institutions
were allowed to lend upto85 per cent of their average daily lending in the callmarket in the year
2001-02. It was decided that participation--of non-bank financial institutions--would be reduced
to70-; 40-: 10-; and Oper cent of their average daily lending in 2001-02. The reason-behind the
exclusion of non-bank financial institutions from the call money market-was to reduce volatility
in the market.

Features
The following are the important features of the call, or notice money market:
" Borrowers and lenders, in a call market, contact each other over telephone, fax
or mail;
" It is basically an over-the-telephone market;
Co-operative banks; DFHI:
The participants, in this market, include all commercial banks. IDBI; NABARD: and
Securities Trading Corporation of India (STCI); LIC; UTI; GIC;
specified mutual funds;
phonearrive at a deal specifying the
" Borrowers and lenders-after negotiations over the
amount of loan and the rate of interest:
borrower after the deal is over:
The lender issues cheque in favour of the
receipt. When the loan is repaid
" The borrower, is turn, issues the callmoney borrowing discharged receipt;
with interest, the lender returns the borrower the duly
be routed through the Discount and
The deal-instead of being negotiated directly-can
Finance House of India (DFH);
fund requirement and availability
" The borrowers and lenders inform the DFHI about their
at a specified rate of interest;
given to lender and borrower
Once the deal is confirmed, the deal settlement advice is
reverse takes place in the case of
recejves an RBIcheque for the money borrowed. The
landings by the DFHI;
The duly discharged call deposit receipt is surrendered at the time of the settlement. Call
receipt by the borrower.
loans can be renewed on the back of the deposit
258 Indian Financial System and Markets

Benefits
banks in India would borrow and lend among themseclves from the call or notice
Commercial given
market. Therefore, commercial banks gain some benefits from this market as
money
below:
nmoney market, is highly liquid as money. loaned in a call market, can be
" Call, or notice
called back at any time when required:
enhance high profitability--lend surplus funds to the call market when
" Banks--in order to
the call rates are highly volatile: In
market facilitates commercial banks to maintain statutory reserve requirements.
" Call reserve
required to maintain idle cash to meet their
the absence of a callmarket, banks are
requirements:
participants have a strong financial
Though callloans are not secured, they are safe because
position: open
the RBI in carrying out its
The existence of an efficient call money market assists
market operations effectively.
Shortcomings
There are certain limitations in the call, or notice, money market as given below:
because the market is
The call, or notice, money market is not evenly developed in India Kolkata, Chennai.
confined to only big industrial and commercial centres like Mumbai,
Delhi, Bangalore and Ahmedabad;
number of local
" The market, in different centres, is not fully integrated. Besides, a large
call markets exist without any integration;
" Another shortcoming of the market is its volatile nature, as call rates vary to great extent
in different centres on different days withina fortnight.
Treasury Bills
Introduction
Treasury Bills (TBs) are a promissory note issued under discount for a specified period by the
Central Government, which promises to pay the specified amount mentioned therein to the
holder of the instrument on the due date. Normally, the period is 1 year or less. There is no
scope for any endorsement or acceptance of such instrument as it, basically, clams aganst the
Central Government. Practically, the RBI--on behalf of the Government--issues treasury bills
for meeting temporary Government deficits. TBs play a vital role in the cash management of the
Government. It is significant to note that while revenue---in the form of taxes-is not received
by the Government on a daily or monthly basis, the Government has to meet its expenditure on a
daily or monthly basis. Therefore, the need for issuing treasury bills is to bridge this gap between
the timings of Government receipts and expenditure.
There was an active TBs market in the history of banking before the 1960s. At that time,
91-day Treasury Bills were auctioned weekly and the bills were extensively held in the money
market. There were two important developments in the early period. Firstly--in the mid-19508
the system-of ad hoc 91-day TBs--was launched to replenish--on an automatic basis-tne
 Money Markets Operations: An Overview 2599

balance with the RBI. Secondly. the auction system--for issue

Central GGovernment's cash of 91
day TBS to the market-was replaced by the tap sale of bills in the mid-1960s.
Features
The following are the important features of the Treasury Bills money market:
. In India, Treasury Bills are of 2 types. These are: () ordinary or regular Treasury Bills. and
(i) ad hoc Treasury Bills:
Ordinary, or regular, treasury bills are issued to the public and to other financial institutions
for meeting the short-term financial requirements of the Central Government. It is to be
noted that these bills are freely marketable and can be bought and sold at any time from
the secondary market:
. Ad hoc Treasury Bills are always issued in favour of the RBlalone and are not soldthrough
tender or auction. The RBI purchases these bils on top and issues currency notes against
them. Ad hoc treasury bills provide a medium for investingthe temporary surpluses of the
State Government; semi-Government departments; and foreign çentral banks;
" Treasury bills-on the basis of periodicity--are classified into 3categories. These are:
(i)91-Day Treasury Bills: (ii) 182-Day Treasury Bills; and (iii)364-Day Treasury Bills:
While 91-Day Treasury Bills are issued at a fixed discount rate of 4 per cent. as well as
is important to
through auctions, there is no fixed rate for 364-day treasury bills. Here it cut-off rate) by
note that the discount rate, on these bills, is quoted in auction (called the
the participants and accepted by the authorities;
" 364-day TBs are sold through an auction which is
conducted once in a fortnight. The RBI
through a press
notifies the date of the auction and the last date of submission of tenders
accepted bids, with prices.
release. Investors are allowed to submit more than one bid. The
auction. The successful bidders are
are notified on the next working day of the date of
deposit the same along with the
required to collect letters of acceptance from the RBI and
notification of auction results:
required cheque within 24 hours of the
with the RBI is maintained by instiutional
" A Subsidiary General Ledger (SGL) account etc.-for recording the sale and purchase
investorsike commercial banks, DFHI, STCI,
of TBs automatically; State
participants in this market are: (i) RBI and SBI: (ii) commercial banks: G)
The institutions like: LIC, GIC, UTI, IDBL
Governments: (iv)DFHI; (v) STCI; (vi)financial
and (viii) thepublic:
ICICI, IFCIand NABARD; (vii)corporate customers;
this market, in actual practice, is
Though there are several participants in the market,nearly 90 per cent of the annual sale
dominated by the banking sector, which accounts for
of TBS.

Benefits
ne tollowing are the important benefits of TBs:
TBs do not carry default risk and are highly safe because they are issued by the RBI for
"
and-on-behalf of the Central Government;
* TBs can be converted into cash at any
time at the option of the holders, Therefore
investments in TBS are also highly liquid;
260 Indian Financial System and Markets
" Idle cash can be profitablyinvested for a very short period in TBs and the yield on TBs is
also assured:
managers of financial institutions in such
The portfolio of TBs is made by the fund matched with the dates of payment on the:
way that the dates of maturity of TBs may be
liabilities like deposits of short-termmaturities:
Commercial banks are required to maintain SLR (Statutory Liquidity Ratio) as well o.
"
Reserve Ratio) in accordance with the RBI directives. Therefore, investment.
CRR (Cash converted into cash and the CRD
for these purposes. They are promptly
in TBs, are made
can thereby be maintained;
fulfilling its temporary budget deficits
" Short-term funds are raised by the Government forfinance at very low discount rates;
through the issue of TBs as it is a source of cheap
inflationary situation;
" TBs help the Central Government to control the
interest rate in the call loan market
" TBs can-in the case of heavy fluctuations of the
against TBs-in the case of
provide the hedging facility. Money can be raised promptly
market and vice versa.
high callrates--and it can be invested in the call money
Shortcomings
There are certain limitations in TBs as given below:
for TBs have shown a decline
" There is no attractive return from TBs. Hence, subscriptions
in trend in recent times;
are sold through auction
" With a view to ensuring market rates for the investors, TBs
which makes TBS
in general. Competitive bids are clearly absent in actual practice,
unpopular:
maturity
" There is a lack of active trading in TBs since these are held by investors till the
dateand do not come into circulation.

Computation of Yield on TBS

() the
TBS rate is the discount rate at which the RBI sells TBs. There are certain factors-ike:
rate of discount; (ii) difference between the issue price and the redemption value; and (i) the
time period of their maturity, which influences the determination of the effective yield on TBs.
The yield on TBs can be calculated as follows:
" Yield Rate on TBs = [{(FV - IP)/IP} x (364/MP)] x 100
Where,
" FV» Face Value or Nominal Value or Redemption Value of TBs;
" IP ’ Issue Price or Purchase Price of TBs;
" MP ’ Maturity Periodof TBs (i.e. 91days or 364days).
It is important to note that the discount is the difference between the face value and the iSbe of
price of TBs i.e. (FV - IP). Another important thing is that a yer is normally assumedto
364 days for the caleulation of the Yield Rate on TBs. The calculation of Yield Rate on TBs t
be understood with the help of the following example:
 Money Markets Operations: An Overview 261

Example
o1-day TBs were issued on tap basis at afixed price of? 97.52. The face value of it was ? 100.
In this case, Yield Rate on TBs -|1(100 97.52)/97.52} >x (364/91)) x 100 (0.0254 x 4) X1)
= 10.16 per cent.
Here, it is signiticant to note that rate of discount is 2.48% |i.e. (100 97.52)).

Commercial Papers
Introduction
A
company may issue a commercial paper (CP) approved by the RBI, which is an unsccured
promissory note with a fixed maturity. It is negotiable by endorsement and dolivery and issued in
bearer form. Commercial paper is issued at such discount on the face value as may be determined
by the issuing company. The issue of commercial paper is a significant step in dis-intermediation
which brings a large number of borrowers as wellas investors together-without the intervention
of the banking system as a financial intermediary. It is important to note that there is no lock-in
period for CP. CP was launched in India, in 1989, to facilitate highly ratedcorporate borrowers.
The companies-issuing commercial paper-are required to follow the relevant provisions
Income Tax Act 1961: and
of various statutes such as: (i) the Companies Açt 1956: (ii) the
bear all flotation
(ii) the Negotiable Instruments Act 1981. The issuing company is required to
rating agency fee. Any
costs including: (i) stamp duty; (ii) the dealers' fee; and (iii) the creditcommercial
invest in paper. Non
person, or bank, or corporate body, incorporated in India can
Only scheduled banks
resident Indians can invest in commercial paper on non-repatriation basis.
all fresh issuance and investments in
can act as issuing and paying agents. Since June 30, 2001, are freely transferable. RBI has
CPs should be made in de-materialized form compulsorily. CPs October 2000 as given below:
issued amended guidelines for issuance of commercial paper in
Commercial Paper can be issued by Primary Dealers; conditionsSecondary Dealers; All India
prescribed for the
Financial Institutions; and corporates. The eligibility (ii) it should have a sanctioned
crores;
corporates are: (i) tangible net worth should be 4 (iii) the borrowed account
working capital limit from a bank or financial institution; and
should be a standard asset;
The Instrument of CPs should have:
maximum period of upto I year: a
" Aminimum maturity period of 7days and a multiples;
thereafter its
minimum amount of 5lahhs and
CRISIL or equivalent rating by other approved credit
Minimum credit rating of P-2 of
rating agencies.
Features paper money market:
The following are theimportant features of commercial
-are ashort-term money market instrument with a
" CPs--as a usance promissory note
fixed maturity:
262 Indian Financial System and Markets

issued directly by acompany to investors, or through commercial banks, or

" It can be
merchant banks:
a certificate indicating an unsecuredcorporate debt for short-term maturity;
" It is
single investor-shall be 5 lakhs and
" The minimum amount of CPsto be invested by a
thereafter its multiples;: fund-based
amount shall be lower or cqual to 20 per cent of the issuer's
" The aggregate
working capital: form:
value basis along with interest bearing
" Itcan be issued at a discount to face
secured by any assets but the issuer promises to pay the buyer some fixed
" CPs are not
amount at some future period of time;
a maximum period of upto
CPs can be issued for minimum maturity period of 7days and maturity.
Ivear from the date of issue. There will be no grace period on
Benefits

The following are the important benefits of the commercial paper money market:
" CPs are the most simple money market instruments which involve hardly
any documentation
between the issuer and investor;
" CPs are issued by the company to maintain its balance cash flow;
" Investors can earn higher returnsthrough the investment of CPsas compared to returns
from the banking system:
" It enables securitization of loans that results in the creation of a secondary market for the
CP and efficient movement of funds;
" Companies-issuing CPs-become better k1TOWn in the financial environment. As a result.
they are placed inamore constructive position in raising long-term capital in the furure.
Commercial Bills (CBs)
Introduction
As soon as business transactions are made on credit, there is a need for a commercial bill, which
is drawn by the seller, on the buyer, for the amount due. Ultimately, CB is accepted by the buyer
who immediately agrees to pay the amount mentioned therein after acertain specified date. Thus,
a billof exchange contains a writen order to pay a certain sum to a certain person after a creation
period. ACB is a self-liquidating paper as well as is negotiable and it is drawn always for a short
period ranging between 3to 6months. According to Section 5of the Negotiable Instruments Act.
abil! exchange can well be defined as: "an instrument in writing containing an unconditional
order, signed by the maker,directing a certain person to pay a certain sum of money only to, OT to
the order of acertain person or to the bearer of the instrument", There are various types of bills in
a bill market. These are: (i) demand andusance bills; (ii) cleanand
documentary bills; (i1) inland
and foreign bills: (iv) export and import bills; (v) indigenous bills; and (vi) accommodation and
supply bills.
 Money Markets Operations: An Overview 263

Features
1he following ar the important features of the commercial bill money market:
. CBscan be traded by offering bills for
re-discounting:
" Bank customers are provided eredit by discounting CBs and the customers are supposed
torepay this eredit on maturity of the bill:
" If the banks require funds, they can re-discount the bills in the money market for having
ready money;
" CBs ensure improved quality of lending. liquidity and efficiency in managing the money
market:
" CBs are transferable by endorsement and delivery. Hence, it is a fuly secure money market
instrumnent.

Benefits
The following are the important benefits of the commercial bills money market:
" CBs are drawn and accepted by business people for the smooth functioning of business
activities. Normally, bills are honoured on the due date. There is rare possibility of
dishonour of bill:
" CBs are highly liquid assets which can be converted into cash by means of re-discounting
them with the central bank;
CBs are self-liquidating in character because of fixity of tenure and are negotiable
instruments:
" It can be transferred freely by a mere delivery or by endorsement and delivery:
Dishonoured bills should be taken note of and the whole annount should be debited to the
customer's accounts. The legal part is very simple;
" CBs represent advances for a definite period (not exceeding that of 6 months) which
helps commercial banks invest surplus funds profitably by selecting bills of different
maturities:
" Commercial banks earn a high, quick yield in the form of high rates of discount which are
dedicated at the time of discounting itself;
" The RBIcan casily influence the money market by managing the bank rate.

Shortcomings
Ihe limitations of the commercial bills money market are given below:
" There is lack of re-discounting of bills among banks requiring funds and having surplus
funds:
"The RBI has permitted financial institutions to re-discount the genuinely eligible trade
bills of commercial banks. This has been done to improve the re-discounting tacility. CB
has not been too popular:
" Users of bills are reluctant to bear the stamp duty, which discourages the use of bills:
Financial institutions have found it difficult to ascertaingenuine trade bills:
264 Indian Financial System and Markets

re-discounting bills as they hold the bills ill matut,.

" Banks are not too good at circulation of bills;
Consequently, it affects the velocity of Re-discounting facility is availahl. :
market for bills.
There is lack of active secondary apex level financial institutions.
important centres restricted to the
Computation of Yield on CBs is issued at adiscount whil. .
for bill re-discounting
promissory note buvers
We know that a usancere-discounting. Thisdiscount is re-invested and the yicldto the
realized at the time of The yield can be calculated as
follows:
than the discount rate.
bills-is more
p)}P- 1] x 100
Actual Yield = |{| + RD/(100 x
Where,
" RD-rate of discount; of
compounding in onc year {i.c., if it is a 2-month bill, the period
"pperiod of
compounding is 6 (12months/2 months)}.
The calculationof Actual Yield can be
understood with the help of the following cxample:
Example
cent.
Period of maturity is 2months, discount rate is 15 per
Actual Yield = |1 + 15/(100 x 12/2)}22-1| x 100 = |(1 +0.025)" - 1| x 100
In this case,
= [1.16- 1| × 100 = 16 per cent.

Certificates of Deposit (CDs)

Introduction
issued in dematerialized form or
Certificates of Deposit are anegotiable money market instrument
bank, or other eligible financial
as a Usance Promissory Note. It is issued for funds deposited at a latter is issued for a
institution, for a specified time period. CDs differ from a Fixed Deposit as the
the scheme of certificates of
large amount and the former is freely negotiable. The RBI announced
tradable. But, when a
deposit in March 1989. In fact, deposits, kept with banks, are not ordinarily
tradable. CDs
certificate of deposit is issued by a bank, such deposits get securitized and become (RRBs) and
can be issued by: (i) Scheduled Commercial Banks excluding Regional Rural Banks RBI to
Local AreaBanks (LABS); and (ii)select All-India Financial Institutions permitted by the
introduced in 1989.
raise short-term resources within the specified limit. In India, CDs were first
The terms and conditions for issuing CDs--like: (i) eligibility; (ii) maturity periods; (ii) siZe:
(iv) transferability; and (v) applicability of reserve requirements--are stipulated by the RBI.
Features
The following are the important features of the CDs money market:
Rural Banks)
" CDs can be issued by Scheduled Commercial Banks (excluding Regional
and specified All-India Financial Institutions;
" CDs are to be issued at a discount to the face value:
 Money Markets Operations: An Overview 265

. Itcan be issued to individuals; association; companies: and trust funds;

"CDs are freely transferable by endorsement and delivery after an initial lock-in period of
I5days:
They may be sold after an initial lock-in period of I5 days to Seheduled Commercial
Banks: spccified AlI-India Financial Institutions; or to the DFHI:
" Since October 1997, the minimum size of issue of CDs to a single investor is S 1aCs.
Thereafter they can be issued in multiples of Ilac;
" Banks and financial institutions have been requiredto issue CDs only inde-materialized
form from June 30, 2002 onwards;
" The maturity period--of CDs issued by banks-may range from 3 to 12 months. Those
issued by specified financial institutions may range from 1to 3 years.
Benefits
The importantbenefits of the commercial bill money market are as follows:
" CDs are a popular investmnent opportunity for companies to invest their short-term
surpluses in;
" It offers a risk-free investment opportunity with fair liquidity at higher rates of interest as
compared to Treasury Bills and Term Deposits:
" CDs provide commercial banks with another source of mobilizing funds in bulk.

Computation of Yield on CDs

CDs are issued at a discount at their face value. The rate of discount, currently, depends upon
on
the demand and supply of CDs. There are some factors which influence the rate of interest
CDs. These factors are: (i) urgency of requirement of funds; (ii) opportunities for investment of
mobilized funds; and (iii) prevailing situation regarding other rates in the money market.fixed It is
deposits (i.e.,
important to note that CDs are offered at interest rates higher than the time
value, it is called front
deposit) of banks. When CDs are issued at a discount rate from the face
is normally higher
end discount. In the case of front-end discounts, the effective rate of discount follows:
can be calculated as
than the quoted discount rate. Theeffective rate of interest
1]x 100
" ERR = [{1 + QDR/(100 x n/m)} " -
Where,
ERR ’ Effective Rate of Interest;
QDR ’ Quoted Discount Rate;
or 365 days):
"n’ Total period in a year (i.e. 12 months
days;
" m’maturity period in months or
The calculation of effective rates of interest can be understood with
the help of the following
example:
266 lndian Financial System and Markets

Example
per cent. In th:
" Amount of issue ? 1,000: period of maturity 2 months; quoted discount rate 15 nrien
case, amnount of discount will be 25 ( 1.000 × 15 per cent X 2/12). Therefore, the issue
CDs will be 775 ( 1,000 - 25).
[(1 + 0.025) - 11 x 100
On the other hand, ERR = |1 + 15/(100 × 12/2 ) } - 1| X 100 =
=|1.16-1] × 100 = 0.16 x 100= 16 per cent.

Re-purchase Agreements (Repos)

Introduction
ARe-purchase Agreement refers to atransaction in which two parties agree to sell and re-purchase
the same security. There are 2 aspects to a re-purchase agreement. To begin with, the seller sells
specified securities--with an agreement to re-purchase the same- -at a mutually decided future
date and a price. Likewise, the buyer purchases the securities-with an agreement to resell the
same to the seller-on an agreed date in thefuture at a pre-determined price. It is significant to
note that a Repo is viewed from the perspective of the seller of securities (i.e. the party raising
money) and aReverse Repo is described from the point of view of the supplier of funds. Therefore,
a Repo, or a Reverse Repo, depends upon the nature of the transactions initiated by the party.
There are 2types of Repos, which are currently in operation in the money market. These are:
(i) Inter-Bank Repos; and (ii) the RBI Repos. Inter-Bank Repos are permitted under regulated
conditions. The Reserve Bank Repos are exercised for absorption or injection of liquidity in the
market. Recently, the Repo Rate--fixed by the RBI-has become a sort of signalling rate along
with the Bank Rate. Currently, all Government securities have been made eligible for Repos.
Features
The important features of a Re-purchase Agreement are given below:
Repo is a transaction in which a participant acquires immediate funds by
and which he agrees to re-purchase at a specified time selling securities
and at a given price;
" The Repo transaction combines both purchase or sale
of securities; and also borrowing or
lending operations of the money market;
" It signifies lending on a collateralized basis;
" Like other instruments, it also helps strike a
term funds; balance between demand and supply of short
" Banks and primary dealers have always been permitted to
Repo transactions. Non-bank financial undertake both Repo/Reverse
institutions are also now
through reverse repos--to other eligible allowed
to lend money
" The Repos have also been participants;
permitted--as instruments in PSU bonds and priva
corporate debt securities--in transactions
de-materialized form. made through recognized stock exchange
 Money Markets Operations: An Overview
267

Benefits
The following are the important benefits of Repos:
. tassists banks to invest surplus money;
. Investor achieves good returns with sovereign risk:
. Borrowers raise funds with the help of Repos at appropriate rates;
" Abank may- -incase of an SLR surplus and CRR deficit-use the Repo as a convenient
technique of adjusting SLR as wellas CRR positions simultaneously;
" RBIexercises Repo and Reverse Repo as instruments for making liquidity adjustments in
the economy.

SBIDISCOUNT AND FINANCE HOUSE OF INDIALIMITED (SBI DFHIL)

Introduction
There were some barriers, in the money market, which were gradually eased by increasing
the number of market players. For instance, the Discount and Finance House of India (DFHI)
was set up jointly by the RBI; public sector banks; and Financial Institutions in April 1988 to
impart liquidity to the money market. It commenced its operations from July 28, 1988. In 2004,
SBI DFHILas a State Bank of India Group Company--was established through a merger of
the 2 leading playersi) the RBI promoted Discount & Finance House of India (DFHI); and
(i)SBI Gilts Ltd., asubsidiary of India's largest commercial bank-in the domestic Money and
Debt Markets. SBI DFHI has played an important role in stabilizing the Indian money market.
SBI DFHIL-as a primary dealer-supports the book building process in primary auctions of
Government securities and provides the required depth and liquidity to the secondary market in
Government securities. Its net worth is 1,109.89 crores as on March 31, 2010.

Activities
ways.
The SBI DFHIL functions as a specialized money market intermediary in a number of
These are documented below:
instruments;
" Itdevelops a secondary market in money market
approved dated
" It also undertakes short-term, buyback operations in GoOvernment and
securitics;
banks; financial
" It mobilizes financial resources from commercial or c0-operative
institutions; and corporate entities with resources to lend;
Government
" The mainactivities of SBI DFHIL include: (i) operations in treasury bills;(i) bonds:
securities; (iii) state development loans; (iv) non-SLR bonds; (v) corporate
and
(vi) certificates of deposit; (vii) commercial paper; (vii) inter-corporate deposits;
(ix) call and notice money deposits;
and it acts as the
" It involves retailing of Government securities, including small lots,
distributor of mutual fund products of all leading funds;
" It also actively participates in domestic interest rate derivatives and equities/equity futures
markets.
268 Indian Financial System and Markets

LIMITED (STCIL)
SECURITIES TRADING CORPORATION OF INDIA
Introduction
The STCI was established in May 1994 as a subsidiary of the Reserve Bank of India. The objective
of setting up the STCI was to promote an active secondary market in Government of India
Public Sector bonds. It had a subscribed and paid-up capital of 5000 crores, with
Securities and approved STCI 2e
of 50.18 per cent. The RBI
tuneThe
RBI
of the
the owning
first the Dealers
Primary Indiatoin the
majorityinstake 1996. STCI started trading in: (i) Central Government
instruments; and (1V) money market instrument
Securities: (ii) public sector bonds: (ii) non-SLR
trading in interest rate swaps both fo
Moreover, it also carried out proprietary cquity trading: and ultimatol.
was divested by the RBI and
hedging and market making. In 1997. part of its holdingcent of the total paid-up capital. In Anri
the shareholding came down from 50.18 to 14.41 per from Specified Undertaking of Unit Trst
2006. UTI Securities Limited was taken over by STCI
stake-in UTI Securities Limited to Standard
of India(SUUTI). The STCI sold 49 per cent of its partner. As a
Chartered Bank (Mauritius) Limited in January 2008--in order to find a strategic Limited. The
Markets
result. UTI Securities was re-named Standard Chartered-STCI Capital 2008:
foilowing table shows the sharcholding pattern of STCI as on March 31,
Share
Category
Public Sector Banks
78.17%
6.21%
Public Sector Insurance Companies
15.62%
Others

The STCIhas 2 categoriesof group companies. These are: (i)Subsidiaries and (ii)Associates.
Thesubsidiaries group companies are: the (i) STCIPrimary Dealer Limited (STCI PD); and (ii)
STCICommodities Limited. An associate group company is Standard Chartered- STCI Capital
Markets Limited. STCIPD was established in October 2006 as a wholly-owned subsidiary of the
STCI. STCIPD undertook trading in: (i) fixed income securities; (ii) money market instruments;
(ii) interest rate swaps; and (i) corporate bonds and equity (both cash and F&O). It also undertook
fee-based activities including portfolio management services; and mutual fund distribution.
STCICommodities Limited is a wholly-owned subsidiary of the STCI, which provides different
services like brokerage; investment; and advisory services.
Activities
The main activities that the STCIL performs are as follows:

Loan against shares; . Finance of Gold Bullion;

IPOfinancing;
Promoter Funding;
ESOPFinance;
Margin Trade Funding:
Term Loans/Corporate Loans
on competitive rates;
" Private Equity;
Discounting of Lease
Rentals/Receivables s
Finançe/Bill Discounting:
Bridge Finance;
Equipment Finance;
Equity trading:
Fixed income trading:
Commodity futures trading
 Money Markets Operations: An Overview 269
MONEY MARKET MUTUAL FUNDS
The RBI consttuted a task force to (MMMFs)
April 1991. In April 1992, the RBI
inspect the broad framework of money
markets outl1ned in
recommendations of the task
force.
announced a detailed
scheme MMMEs after having the
of
andthe iOney market. It MMMEs bridge
mobilizes savingsfrom small the gap between small individual investors
term debt instruments or money market investors-andinveststhe same in short-
instruments. MMMEs have been set up specifically for
the purpose of mobilizing short-term funds for investment in
j092, scheduled commercial banks and public money
market instruments. In April
financial
MMMEs., subject to certain terms and conditions, The institutions were permitted to launch
j995-6. It is signiticant to note that MMMEs are prescribedrestrictions werc relaxed during
permittedto
debentures with a residual maturity of l year. The minimuminvest in rated corporate bonds and
was relaxed-from 30 to 15 days-in May 1998. lock-in period for MMMFs units
Previously, MMMEs were regulated under
guidelines issued by the RB1. The SEBI has been regulating the MMMEs since March7, 2000.
Presently. there are only 3 MMMFs in operation in India.

MONEY MARKET REFORMS AND ITS RECENT TRENDS IN INDIA

Money markets, in developed economies, are encouraged by financial intermediaries out of
efficiency considerations. But the evolution of the money market, and its structure, has been
integrated into the de-regulation process of the financial sector in many developing countries
including India. Till the mid-1980s, the Indian money market was regulated greatly with regard
toparticipants as well as interest rates and it was constrained by a dearth of instruments. With a
view to reviewing the "Working of the Monetary System", the Chakravarty Committee-under
the Chairmanship of Prof. Sukhamoy Chakravarty--first underlined the need to develop money
market instruments in India in 1985. The blueprint for the institution of money markets-was
made by the Working Group on the Money Market under the Chairmanship of Shri N. Vaghul in
1987. Based on these recommendations, the RBI initiated anumber of measures-in the 1980s-
to extend the money market. Financialsector reforms-including reforms inthe money market
were undertaken in India early in the reform cycle in linewith the de-regulation and liberalization
policies in the economy since 1991.
The main initiatives of the RBI-in the 1980s and 90s for the development of the money
market in India--were as follows:
deposits: and
" It lifted the ceiling rates of: (i) the call money market: (i) short-term
ceilings-0n (i) inter
(iii) bills re-discounting. In fact, since May I, 1989, interest rate
(10.5-115 per cent):
bank call or notice money (I0.0 per cent); (V) inter-bank term money
inter-bank participation
(v) re-discounting of commercial bills (12.5 per cent); and (vi)
withdrawn;
Without risk (12.5 per cent)-were
1986-92. The auctions of
Several money market instruments were intrOduced during
182-day treasury billswere started
treasury bills-beginning with the introduction ofdeposit were launched in June 1989
from November 1986 onwards. Certiticates of
Repos in December 1992:
commercial paper in January 1990; and RBI
270 Indian Financial System and Markets

barriers inthe money market which were gradually casedHouse

by increasing
" There were some Finance of India
of market players. For instance, the Discount and Institutions :x
the number Sector Banks and Financial
the RBI, Public
(DFHI) was set up jointly by role in stabilizing the Indian money market.
DFHI has played an important Mutual Eund.
April 1988. satellite dealers, in 1999; and Money Market
The primary dealers, in 1995; established:
(MMMFs), in April 1991were subscription norms in
to relax both issuance restrictions and
" An initiative was taken
and allow determination of yields based on demand
respectof money market instruments
and supply of such paper: of CPs-were withdrawn/n and
bank guarantees in respect
Regu'atory restrictionssuch as was facilitated;
risks
market evaluation of associated
taken to promote the development of markets for short-term funds
" Another initiative was creditsystem to a loan
at market determined interestrates by a gradual switch from a cash
based system; the interlinkage
Institutional development was carried out in March 1993 to facilitate
" exchange market;
between the money market and the foreign Treasury
remarkable development was noticed regarding the discontinuation of Ad hoc
"A
funding of the Government. Basically, Ad hoc
Bills for restricting the almost automatic Advances (WMA) at interest rates linked
Treasury bills were replaced by Ways and MeansGovernment securities market took place for
to the bank rate and the development of the monetary policy
Ratio (CRR) as a
permitting a gradual de-emphasis on Cash Reserve
instrument;
development-of a group of indirect monetary controlinstrumentswas made during
" The April 1997. The strategy
1997-2000. For instance, the Bank Rate was re-activated in
market operations in Government
of combining auctions, private placements and open Adjustment Facility (LAF) was
paper-was introduced in 1998-99 and the Liquidity
launched in June 2000;
interest rate risks, the interest
" With the objective of facilitating market participants to hedge
market in 1999;
rate swapswere introduced to further deepen the money
and efficiency in
The electronic dealing system was started in 1999 to impart transparency
money market transactions;
in 2000-01, which
" The RBItook a number of structural and instrument-specific measures,
money markets. The
have contributed to the development and sophistication of Indian 2001 and entrusted with
Clearing Corporation of India Limited (CCIL-set up in April Repos--reported on the
the task of clearing all transactions in Government securities and
of Collateralized
Negotiated Dealing System. Other measures include: (i)the introduction
Borrowing and Lending Obligation (CBLO) through the (CCIL) from January 20, 2003.
funds
and (ii) expansion of Repo market outside the LAF These measures of trading provided
after the conversion of call or money market into a pure inter-bank market-have
more opportunities for growth to bank and non-bank participants;
 Money Markets Operations: An Overview 2771
. In its credit policy-announced on April 29.
reliance on call or notice money market: 2002--the RBI decided to reduce bai
. The minimum matur1ty period of CDs-from April 29. 2005
from 15 to 7days. Non-bank participants have been onwards--has been reduce0
money market with effect from August 6, 2005: completely phased out of the call
The technological infrastructure. in the monev market. was modernized with the
introduction of the Negotiated Dealing Svstem (NDS; the Real-Time Gross Settlement
(RTGS)System; and the Centralized Funds Management System
" An initiative was taken--according to the
(CFMS);:
recommendations of the Committee on
Banking Sector Reforms in 1998, under the Chairmanship of Shri M. Narasimhamtor
transforming the call/notice money market into a pure inter-bank market in August 2005.
The ultimate outcome was the development of a Repo market outside the RBI in which
non-bank participants were allowed to trade their surplus/deficit liquidity:
" The CCIL developed a screen-based negotiated quote-driven system for dealings in call/
notice and term money markets (NDS-CALL) during 2005-06. The objectiveof the
introduction of NDS-CALL--was to make deals transparent; enable better price discovery:
improve the market micro-structure:
" Aremarkable development was the substantial migration of money market activity- -from
the uncollateralized call money segment to the collateralized markets- -in 2005-06. This
was done to primarily restrict the callmarket transactions to banks and primary dealers;
Other important initiatives are: (i) imposing prudential limits for an individual bank's
reliance on call money borrowings: (ü) introduction of 1-day Repos by the RBI:
(iii) withdrawal of the RBI from the primary market in 91-day T-Bills; (iv) access to
foreign institutional investors (Flls) in the T-Bills market: and (v) free access to bill re
discounts for: CPs:CDs: and MMMFs to non-bank parties;
Apart from these, amendments to the Securities Contracts (Regulation) Act. 1956: the
stamp duty reforms: and fioating rate bonds are some other prominent reforms in the
money market in India.
However, a review of the money market development in India and the current efforts for further
development show that a base has been created with avariety of products in the money market.
But the market has not gained the required depth in terms of both volume and liquidity. It is
anticipated that the money market. with the further reforms, should gradually get integrated with
debt and foreign exchange markets.