Money Market Explained | Objectives, Role of RBI in Money Market

Money Market Explained

Money market is market for short-term borrowing and lending of funds. It is the place to meet demand and supply of short-term funds. The short-term means period of 364 days or less. The function of money market is to meet the liquidity gap. Money market securities are liquid in nature.

Money market is very important segment of Indian Financial System. The money market in India is regulated by Reserve Bank of India (RBI)

Objectives of Money Market

The objectives of money market are:

  • To cater to the requirements of borrowers for short term funds at competitive prices.
  • To overcome short term deficits
  • Helps central bank to regulate liquidity in the economy
  • Helps government to implement monetary policy through open market operation
  • It helps employment of surplus fund, thus provides good investment opportunity.

Money Market Instruments

Money market instruments are those tools or securities which helps in operating in the money market.

Common money market instruments are:

Call Money, Certificate of deposits and Treasury bills are mainly used by government and banks, whereas Commercial papers and Commercial bills are used by corporates and intermediaries to meet their liquidity requirements.

Call Money Market

The call money market deals with borrowing and lending of funds for one day. The participants in this market are mostly banks, therefore it is also called interbank call money market. This market is a purely unsecured market as no collateral is offered for securing the funds and there are no brokers involved

The banks with temporary deficit of funds form the demand side and the banks with temporary excess of funds form the supply side of the call money market. The most prominent use of this market is to help banks in maintaining reserve requirements i.e. CRR

The call money market consists of three important instruments viz. Call Money, Notice Money and Term Money

  1. Call money refers to the unsecured segment of the money market that is designed for management of liquidity for a very short period of time – mostly overnight.
  2. Notice Money: If the period of money lent is more than one day and upto 14 days it is called ‘Notice money’.
  3. Term Money: Money lent for 15 days to 1 year is called ‘Term money’

The following entities shall be eligible to participate in the Call, Notice and Term Money Markets, both as borrowers and lenders:

  • Scheduled Commercial Banks (excluding Local Area Banks);
  • Payment Banks;
  • Small Finance Banks;
  • Regional Rural Banks;
  • State Co-operative Banks, District Central Co-operative Banks and Urban Co-operative Banks (hereinafter Co-operative Banks); and
  • Primary Dealers.

Treasury bills

These bills are issued to meet the short-term funding requirements of the government. Government raises short term funds through T-bills to meet gaps between its revenue receipts and expenditure. Treasury bills are of two types: ad hoc and regular

  • The treasury bills are sold to the banks and public and are freely marketable
  • Treasury bills are sold by Reserve Bank of India.
  • They are presently issued in three tenors, namely, 91 day, 182 day and 364 day. These are zero coupon securities and pay no interest. Instead, they are issued at a discount and redeemed at the face value at maturity.
  • T-bills are available for a minimum amount of Rs. 25,000 and in multiples of Rs. 25,000
  • It is totally risk free as it is backed by government

Commercial Papers

Commercial Paper (CP) is an unsecured money market instrument issued in the form of a promissory note.

  • Corporates, primary dealers (PDs) and the All-India Financial Institutions (FIs) are eligible to issue CP.
  • Individuals, banking companies, other corporate bodies (registered or incorporated in India) and unincorporated bodies, Non-Resident Indians (NRIs) and Foreign Institutional Investors (FIIs) etc. can invest in CPs
  • It can be issued in denominations of Rs.5 lakh or multiples thereof.
  • The maturity period is 7 days to 1 year.
  • It can be issued as promissory note or dematerialized form

Certificates of Deposits

Certificate of Deposit (CD) is a negotiable money market instrument and issued in dematerialised form or as a Usance Promissory Note against funds deposited at a bank or other eligible financial institution for a specified time period

  • 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
  • Minimum amount of a CD should be Rs.1 lakh, i.e., the minimum deposit that could be accepted from a single subscriber should not be less than Rs.1 lakh, and in multiples of Rs. 1 lakh thereafter.
  • CDs can be issued to individuals, corporations, companies (including banks and PDs), trusts, funds, associations, etc. Non-Resident Indians (NRIs) may also subscribe to CDs, but only on non-repatriable basis, which should be clearly stated on the Certificate. Such CDs cannot be endorsed to another NRI in the secondary market.
  • The maturity period of CDs issued by banks should not be less than 7 days and not more than one year, from the date of issue.
  • The FIs can issue CDs for a period not less than 1 year and not exceeding 3 years from the date of issue.

Commercial Bills

Commercial bill is a bill of exchange used by a commercial firm to raise money for short term need. When a seller sold his goods on credit, the buyer of goods becomes liable to make payment on a specified date in future. The seller draws the bill which is accepted by buyer. On acceptance of bill by the buyer, the bill becomes a marketable instrument called Trade bill or Bill of Exchange. If seller need funds before the maturity of date of maturity of bill, he can approach his bank to get the bill discounted. When trade bills are accepted by commercial banks, they are called Commercial Bills. They are negotiable instruments drawn by a seller on the buyer for the value of goods delivered by him.

  • Generally, the maturity period is up to 90 days
  • Commercial banks can provide credit to customers by discounting commercial bills
  • It is issued by the All-India Financial Institutions (AIFIs), Non-Banking Finance Companies (NBFCs), Scheduled Commercial Banks, Merchant Banks, Co-operative Banks and the Mutual Funds

Collateralized Borrowing and Lending Operations (CBLO)

Collateralised borrowing and lending obligation (CBLO) is a money market instrument which enables borrowing and lending of funds to market participants who are admitted as members in CBLO Segment in a collateralized environment

  • It is operated by Clearing Corporation of India Ltd (CCIL)
  • It facilitates borrowing and lending for various tenors, from overnight up to a maximum of one year
  • Eligible securities as collateral are Central Government securities including Treasury Bills
  • Entity eligible for CBLO Membership are Nationalized Banks, Private Banks, Foreign Banks, Co-operative Banks, Financial Institutions, Insurance Companies, Mutual Funds, Primary Dealers, Bank cum Primary Dealers, NBFC, Corporate, Provident/ Pension Funds etc

Repurchase Agreements

Repo is a money market instrument, which enables collateralised short-term borrowing and lending through sale/purchase operations in debt instruments. Under a repo transaction, a holder of securities sells them to an investor with an agreement to repurchase at a predetermined date and rate.

The reverse repo is exactly opposite to repo transaction. In this type of transaction, an investor with temporary surplus cash buys the security and agree to sell it back at a future date at a predetermined price

  • Repo rate is annualised interest rate for the funds transferred by the lender to the borrower.
  • A reverse repo is the mirror image of a repo
  • The securities eligible for repo/reverse repo transaction are specified as the Central and State Government securities including treasury bills.

Role of RBI in Money Market

RBI regularly intervenes in the money market to control the liquidity position in the financial system. It absorbs liquidity when there is excess of liquidity in the system or inject liquidity when there is a shortage of liquidity.

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