MONEY MARKET

Meaning of money market

Money market refers to the market where money and highly liquid marketable securities are
bought and sold having a maturity period of one or less than one year.
Definition of money market
According to the Reserve Bank of India,” money market is the centre for dealing mainly of
short term character, in money assets; it meets the short term requirements of borrowings and
provides liquidity or cash to the lenders”.
Features of money market
1. It is a market purely for short term funds or financial assets called near money.
2. It deals with financial assets having a maturity period up to one year only.
3. It deals with only those assets which can be converted into cash readily without loss or
with minimum transaction cost.
4. Generally transactions takes place through phone that is oral communication.
5. Transactions have to be conducted without the help of brokers.
6. The components of a money market are the central bank commercial banks non-
banking financial companies’ discount houses and acceptance house.
Importance of money market

Financing: The money market is essential for both domestic and international trade.
Traders use bills of exchange to get commercial finance, which can be discounted in the bill
market. Acceptance houses and discount markets also support financing for foreign trade.

Industry Financing:

 Short-Term Loans: The money market helps industries by providing short-term loans
for working capital needs using tools like finance bills and commercial papers.
 Long-Term Impact: Although industries need long-term loans from the capital
market, the money market affects this indirectly. Short-term interest rates in the money
market influence long-term rates in the capital market, helping industries indirectly.

Profitable Investment: The money market allows commercial banks to invest their excess
reserves profitably. Banks use these reserves to invest in highly liquid, near-money assets,
which earn income while maintaining liquidity to meet depositors' cash demands.

Self-Sufficiency of Banks: A well-developed money market helps commercial banks

become self-sufficient. Instead of borrowing from the central bank at high rates during fund
shortages, banks can use the money market to manage their liquidity needs by recalling short-
term loans.
 Support for the Central Bank: A developed money market helps the central bank operate
more efficiently. It provides short-term interest rate indicators, which guide the central bank
in shaping monetary policy. A responsive money market helps the central bank implement its
policies effectively and quickly.

Functions of money market

1. Short-Term Funds for Banks and Private Entities:

o The money market is essential for both banks and private entities as it provides
short-term funding.
o Banks use the money market to manage their reserves, which are necessary to
cover the loans they issue.
2. Short-Term Funds for Governments:
o Governments also rely on the money market to borrow short-term funds.
o Although governments have the ability to create money, doing so can lead to
inflation. Therefore, they use money creation primarily for long-term needs and
prefer short-term borrowing for immediate requirements.
3. Implementing Monetary Policy:
o The money market helps evaluate the effectiveness of monetary policies.
o Governments design monetary policies to control interest rates, focusing on
interbank rates as a key target for achieving their economic objectives.
4. Promoting Liquidity:
o A well-functioning money market ensures liquidity, allowing entities to avoid
holding excessive cash for transactions.
o Without a liquid money market, entities would need to hoard cash, which could
reduce productivity due to disruptions in the smooth flow of funds.
5. Utilizing Funds Across Sectors:
o The money market directs funds towards the most profitable investments, serving
as a channel for efficient capital allocation.
o Various government and private entities participate in the money market to
optimize their investment strategies.
6. Financing International Trade:
o The money market is crucial for financing international trade.
o Many private entities use the money market to obtain short-term funds necessary
for their trade activities, facilitating global commerce.

Structure of Indian money market

 A. Organized money market

The RBI is the apex institution which controls and monitors all the organizations in the
organized sector.

Money Market: Also known as the interbank call market, this is where banks lend
and borrow money from each other for just one day. Banks need these short-term loans to
meet regulatory requirements like the Cash Reserve Ratio (CRR) and Statutory Liquidity
Ratio (SLR). The money is supplied by banks with extra funds and financial institutions such
as IDBI.

Bill Market: This market deals with short-term government securities called
treasury bills. They come in durations of 14, 91, 182, and 364 days. The government issues
these bills to manage temporary financial needs, and they are mostly held by the Reserve Bank
of India (RBI).

Bill Market: In this market, bills of exchange are traded. A seller issues a bill
requiring the buyer to pay a specified amount by a certain date. These bills can be domestic
or international. Commercial banks buy and discount these bills, and they may also be handled
by financial institutions like Exim Bank, SIDBI, and IDBI.

of Deposit Market: the scheme of certificate of deposit Introduced by the RBI

in 1989, Certificates of Deposit (CDs) allow banks to raise funds by issuing time-bound
deposits. This scheme helps banks attract funds from the market.

Paper Market: This market involves unsecured, short-term debt instruments

issued by companies. Businesses use commercial papers to meet immediate financial needs,
such as payroll and inventory purchases.
 Market Mutual Funds: the MMMFs were introduced in 1992, Money Market
Mutual Funds (MMMFs) provide individuals with a safe, short-term investment option. They
invest in short-term financial instruments and offer a way for investors to earn returns on their
money.

B. Unorganized money market

The unorganized money market mostly finances short term financial needs of farmers and
small businessmen. The main components of organized money market are:

Indigenous Bankers: These are individuals or private firms that act like banks by accepting
deposits and giving loans. Unlike moneylenders, they handle both deposits and loans. They
mostly operate in urban areas, particularly in western and southern India, serving small
manufacturers and traders who might not get loans from regular banks due to lack of collateral
or other reasons.

Moneylenders: Moneylenders are key players in the informal money market in India. They
can be professionals or non-professionals and operate in both rural and urban areas. They
typically charge high interest rates, ranging from 15% to 50% per year or more. Their clients
often include poor farmers, artisans, small traders, and manual workers who need short-term
funds and cannot access them from organized banks.

Chit Funds and Nidhis: Chit funds and Nidhis are community-based financial
arrangements. Chit funds collect money from members and lend it to them through a lottery
system. Nidhis also collect money from members but lend it to both members and others,
often for personal or other purposes.

Finance Brokers: Finance brokers act as intermediaries between lenders and borrowers.
They facilitate financial transactions and earn a commission for their services. They are
usually found in urban areas, especially in markets dealing with textiles and commodities.

Finance Companies: Finance companies operate nationwide, accepting deposits and

providing loans. They offer financial services similar to indigenous bankers, helping small
traders and other individuals who need funds.

Instruments of money market

1. Treasury Bills (T-Bills): Treasury bills are short-term debt instruments issued by the
Reserve Bank of India on behalf of the government. They help the government manage
temporary cash shortfalls by raising short-term funds. T-Bills are typically issued for
up to one year and are a key part of the money market. They are a safe way for investors
to park their short-term funds with minimal risk.
2. Commercial Papers (CPs): Commercial papers are unsecured, short-term promissory
notes issued by large banks and corporations to meet immediate financial needs. They
are negotiable and can be transferred by endorsement. There are different types of
 commercial papers, including promissory notes, drafts, checks, and certificates of
deposit.
3. Certificates of Deposit (CDs): Certificates of Deposit are short-term, negotiable
deposits issued by commercial banks and development financial institutions. It was
introduced by the RBI, CDs offer a way for banks to raise funds with interest rates that
are deregulated. They can be issued for periods ranging from three months to one year.
4. Repurchase Agreements (Repos): Repos are short-term borrowing and lending
transactions involving the sale and later repurchase of securities. In a repo, a security is
sold with an agreement to buy it back at a future date and price. Repos are typically
short-term, often not exceeding 14 days, and can use government securities and treasury
bills as collateral.
5. Reverse Repos: A reverse repo is the opposite of a repo. In a reverse repo, an entity
buys securities with an agreement to sell them back at a later date. The reverse repo
helps organizations earn interest on idle cash. The main difference from a repo is who
initiates the transaction; in reverse repos, the securities are bought first with a
commitment to resell.
6. Inter-Corporate Deposits (ICDs): Inter-Corporate Deposits are unsecured loans made
by one corporation to another. Corporations with surplus funds lend to other companies
that need funds, usually at a higher interest rate due to the lack of collateral. The interest
rate depends on the credit rating of the borrowing corporation.

PARTICIPANTS /PLAYERS OF MONEY MARKET

1. Reserve Bank of India (RBI): The RBI is the key player in the Indian money market.
It regulates the market to ensure balanced liquidity and interest rates, supporting
economic growth and price stability. The RBI also acts as a merchant banker for the
government, issuing Treasury Bills and government securities to raise funds.
2. Government: The government is the largest borrower in the money market. It raises
funds to cover budget deficits through Treasury Bills and government securities with
various maturities (91, 182, or 364 days).
3. Commercial Banks: Commercial banks are crucial in the money market, engaging in
short-term lending and borrowing. Their daily operations significantly influence
interest rates and liquidity in the market.
4. Financial Institutions: Financial institutions participate in the money market by
lending and borrowing short-term funds and rediscounting Bills of Exchange. They
handle large transactions, impacting the market significantly.
5. Corporate Firms: Corporations use the money market to get short-term funds for their
working capital needs. They issue commercial papers with maturities ranging from 7
days to 1 year, which are sold at a discount and redeemed at face value. Corporations
use both organized and informal money markets.
 6. Discount Houses and Primary Dealers: These intermediaries play a key role in the
money market. Discount Houses deal with commercial bills and Treasury Bills, while
Primary Dealers, introduced by the RBI, help develop the secondary market for
government securities and underwrite these securities.
7. Money Market Mutual Funds: These funds invest in short-term money market
instruments and are considered a safe investment option. They aim to preserve capital
while providing modest returns. Although they are relatively safe, they are not risk-
free, so it’s important to pay attention to the interest rates they offer.

LIMITATIONS OF MONEY MARKET

1. Lack of Integration: The Indian money market is split into two parts: the organized
sector (including RBI-regulated financial institutions) and the unorganized sector (such
as indigenous bankers and village money lenders). There is a poor connection between
these two segments.
2. Multiple Interest Rates: There are numerous interest rates in the Indian money market
for different purposes, like lending, borrowing, and government activities. This variety
can confuse investors.
3. Insufficient Funds: The Indian economy often faces a shortage of financial resources
due to low income, low savings, and poor banking habits among people.
4. Limited Investment Instruments: The range of investment options, such as Treasury
Bills, Commercial Bills, Certificates of Deposit, and Commercial Papers, is inadequate
compared to the large population and market size.
5. Scarcity of Commercial Bills: Many banks keep large funds in reserve, limiting the
use of commercial bills. Additionally, many transactions are conducted in cash,
reducing the need for commercial bills.
6. Weak Banking System: Despite having a large network of commercial banks, the
Indian banking system struggles with issues like non-performing assets (NPAs),
significant losses, and low efficiency. This weak system affects the overall money
market.
7. Less number of Dealers: There are not enough dealers in short-term assets to act as
intermediaries between the government and the banking system. This shortage slows
down the process of connecting lenders with borrowers.

RECENT TRENDS IN MONEY MARKET

Low Interest Rates: Central banks, including the U.S. Federal Reserve, have kept interest
rates very low to address the effects of the COVID-19 pandemic. This has affected money
market yields and influenced investment choices.
 Digital Payment Systems: Digital payment methods, such as mobile wallets and Unified
Payments Interface (UPI), have changed how transactions are made in the money market.
These systems are popular for their convenience and contactless nature.

Cash Management: With low interest rates, companies and investors are focusing on
improving their cash management to stay liquid while trying to earn higher returns in the
money market.

Demand for Short-Term Instruments: The need for short-term financial tools like
Treasury Bills and commercial paper is affected by factors such as liquidity needs, market
conditions, and investor attitudes.

Government Support: Government stimulus and central bank measures have helped
stabilize the money markets during stressful periods, maintaining stability and preventing
disruptions.

Focus on Safety: Due to pandemic-related uncertainty, investors are prioritizing safety and
liquidity, choosing money market funds and other low-risk investments.

Regulatory Reforms: Regulators are updating rules to improve transparency, stability, and
investor protection in the money market, aiming to avoid issues similar to those during the
2008 financial crisis.

Short-Term Funding: Changes in short-term funding markets, like the repo market, have
implications for liquidity management and overall financial stability.

Economic Recovery: As economies recover from the pandemic, shifts in economic data,
inflation, and central bank policies will affect money market conditions.

Alternative Investments: Investors are looking beyond traditional money market funds
for alternative cash investments that offer higher yields and diversification.

ESG Factors: Environmental, Social, and Governance (ESG) considerations are

increasingly important in investment decisions, including for money market instruments.

Central Bank Digital Currencies (CBDCs): Some central banks are exploring digital
currencies, which could impact the money market and payment systems by introducing new
forms of digital central bank money.