Ch 4 Money Market [Bharti Pathak]

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 Market1. 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 MarketThe 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

In the 1980s:A committee to review the working of the monetary system under theChairmanship of Sukhamoy Chakravorty was set up in 1985.

As a follow up, the Reserve Bank set up a working group on the moneyMarket 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 andfinancial institutions in 1988 to impart liquidity to money marketinstruments and help the development of a secondary market in such instruments.

Steps to Develop the Money Market in India

The money market in India is divided into the Formal (organized) and Informal (unorganized) segments.

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 bya. Setting up the primary dealer system in 1995 and satellite dealer

system in 1999 to inject liquidity in the market.

b. Relaxing issuance restrictions and subscription norms in respect of money market instrumentsc. Allowing the determination of yields based on the demand and

supply of such paper.d. Enabling market evaluation of associated risks by withdrawing

regulatory restriction such as bank guarantees in respect of commercial papers.

e. Increasing the no. Of participants by allowing the entry of foreign institutional investors (FIIs), non-bank financial institutions, mutualfunds and so on.

3. Several financial innovations in instruments and methods were introduced. Treasury bills of varying maturities and RBI repos were introduced.

4. 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

• Banker’s 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 fundsTo 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 determined9.00% 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:-

Minimum Rs. 1,00,000 and in Multiple thereof.

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: (100-P)*365*100Y = ------------------       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 BorrowerLiquidity of collateralComparable rates of other Money market instruments

Tenure of Repo:-Overnight RepoTerm RepoOpen RepoFlexible Repo

Instruments Dealt in Repo:-Money Market SecuritiesGovernment Dated SecuritiesEquityCorporate BondsTreasury 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 InstrumentsMutual FundsPrimary 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.