Money Market

Chapter 3
 Money Market is the market for short-term funds,
generally ranging from overnight to a year. It helps in
meeting the short-term and very short-term requirements
of banks, financial institutions, firms, companies and also
the Government. On the other hand, the surplus funds
for short periods, with' the individuals and other savers,
are immobilized through the market and made available
to the Banking System and Money Market aforesaid
entities for utilization by them. Thus, the money market
provides a mechanism for balancing short-term liquidity
imbalances within an economy. The development of the
money market is, thus, a prerequisite for the growth and
development of the economy of a country.
Money Market Instruments
Call /notice/term money
 Is an integral part of the Indian money market where
day-to-day surplus funds (mostly of banks) are traded.
 The loans are of short-term duration (1 to 14 days).
Money lent for one day is called ‘call money’; if it
exceeds 1 day but is less than 15 days it is called ‘notice
money’. Money lent for more than 15 days is ‘term
money’
 The borrowing is exclusively limited to banks, who are
temporarily short of funds.
Cont…..
 Call loans are generally made on a clean basis-
i.e. no collateral is required
 The main function of the call money market is to
redistribute the pool of day-to-day surplus funds
of banks among other banks in temporary deficit
of funds
 The call market helps banks economise their
cash and yet improve their liquidity
 It acts as a good indicator of the liquidity position
 Bill Market : Commercial Bill
Commercial Bill arises from sale transactions.
Banks finance commercial bills . Usually the bills
consist of an invoice drawn on the buyer, the
documents to title to goods and a bill of
exchange. The bills are given to the bank for
advancing money against sale of goods.
Commercial Bill financing is a post sale finance.
 Bill Market : Treasury Bills
Treasury Bill market- Also called the T-Bill
market
 These bills are short-term liabilities (91-day, 182-day,
364-day) of the Government of India
 It is promise by the government to pay the stated
amount after expiry of the stated period from the date
of issue
 They are issued at discount to the face value and at
the end of maturity the face value is paid
 Certificates of Deposit
 CDs are short-term borrowing instruments (in the form of Usance
Promissory Note) issued by all scheduled banks and are freely
transferable by endorsement and delivery.
 Introduced in 1989
 Maturity of not less than 7 days and maximum up to a year. FIs are
allowed to issue CDs for a period between 1 year and up to 3 years
 Subject to payment of stamp duty under the Indian Stamp Act, 1899
 Issued to individuals, corporations, trusts, funds and associations
 They are issued at a discount rate freely determined by the
market/investors
 Commercial Papers
 Short-term borrowings by corporates, financial institutions, primary
dealers from the money market
 Can be issued in the physical form (Usance Promissory Note) or
demat form
 Introduced in 1990
 When issued in physical form are negotiable by endorsement and
delivery and hence, highly flexible
 Issued subject to minimum of Rs. 5 lacs and in the multiple of Rs. 5
lacs after that
 Maturity is 7 days to 1 year
 Unsecured and backed by credit rating of the issuing company
 Issued at discount to the face value
 Repo is a method of borrowing against certain securities
for a short period. The borrower undertakes a
commitment to purchase back (or to take back) the same
securities after the specified period at a pre-determined
price. The difference between the two prices is treated
as interest on the amount borrowed. Thus by repos the
Reserve Bank expands money supply in the system
 Reserve Repo is the opposite practice wherein the
lender lends against the securities with the commitment
to take back the securities from the borrower against
payment at a specified price. Thus by reverse repos the
Reserve Bank contracts liquidity from the system.
 Money Market Mutual Fund
A Money Market Fund (or Money Market Mutual
Fund) is an open ended mutual fund that invests
in short term debt securities. Regulated under
the Investment Company Act of 1940, Money
Market funds are important providers of liquidity
to financial intermediaries.
Money Market Players
 Government: Government is an active money
market player and in most economies, it is the
biggest borrower in this market. The need for
the government to borrow funds arises mainly
when the budgeted expenditure goes beyond
the budgeted revenue. To adjust this deficit,
the government generally issues securities in
the money market and raises funds.
 Central Bank: Central Bank of the country
generally operates in the money market on
behalf of the government. It issues government
securities based on the present and future
requirements of the government and market
condition. In certain cases, it also underwrites
the issues of the government. Apart from acting
as the merchant banker to the government, it
also acts as a regulator of the money market
and issues guidelines to govern the money
market operations.
 Banks: One of the most significant segments of the money market players is
the banking industry. Banks mobilize deposits and utilize the same for credit
accommodation. However, the banks are not allowed to use the entire
amount for extending credit. In order to promote certain prudential norms for
healthy banking practices, banks are required to maintain minimum liquid
and cash reserves. Thus the banks should first ensure that these reserve
requirements are met before deciding their credit plans. If banks fall while
meeting these statutory reserve requirements, they can raise the same from
money market this it is a short term deficit.
 Banks borrow in the money market to:
 Fill the gaps or temporary mismatch of funds
 To meet the CRR and SLR mandatory requirements as stipulated by the central
bank
 To meet sudden demand for funds arising out of large outflows (like advance tax
payments)
 Financial Institutions: Like banks, Financial
Institutions also undertake lending and
borrowing of short term funds in the money
market.
 Corporates: Companies create demand for
funds from the banking system. They raise
short-term funds directly from the money market
by issuing commercial paper. Moreover, they
accept public deposits and also indulge in inter
corporate deposits and investments.
 Mutual Funds: Mutual funds also invest
their surplus funds in various money
market instruments for short periods.
Money Market Mutual Funds have been
set up specifically for the purpose of
mobilization of short-term funds for
investment in money market instruments.
Recent Developments in money
Market
 The money market forms an important part of the financial system by
providing an avenue for equilibrating the surplus funds of lenders and the
requirements of borrowers for short periods. It also provides a focal point
for central bank’s intervention for influencing the liquidity in the financial
system. The primary aim of the Reserve Bank’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. In
recent years, the Reserve Bank’s approach has been to foster balanced
development of different segments of the money market, introduce new
instruments, reduce dependence of participants on uncollateralized
exposures, and upgrade the payment system infrastructure. Accordingly,
the Reserve Bank’s strategy has focused on developing pure call/ notice
money market, instituting full-fledged Liquidity Adjustment Facility(LAF),
developing infrastructure, promoting transparency, and various measures
pertaining to instruments for non-bank participants. On the next slide, are
some of the important developments pertaining to the money market:
 With a view to transforming the call/ notice
money market into a pure inter-bank market
with participation of banks and primary
dealers (PDs) only, a phased exit of non-
banks from the call/notice money market
was started in May 2001. With effect from
August 6, 2005, non-bank participants have
been completely phased out of the call
money market.
 Several new financial instruments have
been introduced. The traditional refinance
support on fixed terms has been replaced
by a full-fledged Liquidity Adjustment
Facility (LAF) was introduced on June 5,
2000 with a view to modulating short-term
liquidity under diverse market conditions.
 Measures have also been taken to make
various other money market instruments
(such as CDs, CPs, etc.) freely accessible
to non-bank participants. These measures
were intended to improve the depth of as
well as the efficiency and transparency of
operations in the money market.
 As part of the development of new
instruments, a major initiative pertains
to Collateralised Borrowing and
Lending Obligation (CBLO), which was
operationalised as a money market
instrument through CCIL on January
20, 2003.
 CBLO:
• Is an RBI approved Money Market instrument;
• Is an instrument backed by Gilts as Collaterals
• Creates an Obligation on the borrower to repay the
money borrowed along with interest on a predetermined
future date;
 • A Right and Authority to the lender to receive money
lent along with interest on a predetermined future date;
• Creates a charge on the Collaterals deposited by the
Borrower with CCIL for the purpose.