CHAPTER

2 Money Markets

LEARNING OBJECTIVES understand:

should be able to
the chapter you
After studying Markets
What are Financial Markets
Segments of Financial and Money Market
Difference
between Capital Market
Money Market Instruments
MMarket eu B
Shortcomings of Indian Money

Financial Markets the users

funds required by
markets a r e markets
through which the financial
Financial the development of
the savers of funds. With financial surpluses
can be
are supplied by that accrue to units with
real
markets the savings investment outlets.
In this m a n n e r
allocated to preferred purpose of
efficiently those who need them for the
made available to which the
resources are
modern economy, a
system in
capital
formation. In a complex
the accessibility of various sorts of
production technologies, and of financial
demand, o v e r time, a system
dramatically
raw materials can change from financial surplus units to
transter of resources
markets tacilitates
the
the financial system
lies not only in
The efficiency of
financial deficit units. too. The
conversion
transmutation (conversion)
but the to the
transfer of funds securities into indirect securities according
direct the
of securities from of savers as well as
u s e r s help in enhancing

needs and requirementsflows.

financial
magnitude of
functions: fan uus
Financial marketperforms following
in establishing fair prices of securities
Helps
of the financial
assets
Enhancing the liquidity
transaction costs
Minimizing the
Chon
27
'TAXMANN"
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 28 MONEY MARKETS

in KiSk
Helps in Diversification and reduction of the payment
mechan
anism
Facilitates the better mode of operation

Segments of Financial Markets depending on the

two segments,
be divided into
markets can
Financial
traded therein:
financial claims,
maturities of the
1. Capital Markets.
2. Money Markets.

Capital Markets
Market and deals financial
in
market is a vitalsegment of Financial lt is a market for
The Capital m o r e than one
year.
which have, maturities of expected to generate
claims, These a r e typically
shares.
long-term debt and equity
institutional arrangement
is
toinvestors. It investors. It not only represents
an
annualizedreturn
a higher
transfer of funds among
that facilitate the participating to
raise r e s o u r c e s or
which a r e directly
those economic agents who execute the
those participants
resources, but also institutions
those who provide
merchant banks and underwriting
intermediaries like
role of of debt and equity
to encompass the private placements
It is wide enough The two types of capital
markets like stock exchanges.
aswell as organized
markets and secondary markets.
markets are primary

Money Market
be definedmarket for short-term funds with
as a
Money market can
financial
one year and includes
maturities ranging from overnight to
instruments that are considered to be close substitutes of [Link] provides
an equilibrating mechanism for demand
and supply of short-term funds
in
and in the process provides an avenue for central bank intervention
influencing both the quantum and cost of liquidity in the financial system,
consistent with the overall stance of monetary policy. In the process
money market plays a central role in the monetary policy transmission
mechanism by providing a key link in the operations of monetary policy
to financial markets and ultimately, to the real economy. In fact, money
market is the first and the most important stage in the chain of monetary
policy transmission. Typically, the monetary policy instrument, effectively
the price of central bank
view of limited control over
liquidity, is directly set by the central bank. In
a
long-term interest rates, central banks adopt
strategy to exert direct influence on short-term interest rates.
in the short-term
policy rate provide Changes
signals
to financial markets, whereby

TAXMANN®.
 MONEY MARKETS5 29

different segments of the

financial system respond by adjusting their rates
on various instruments, depending sensitivity and the
on their
of return
mechanism. Howquickly and cffectively the
efficacy of the transmission
of market interest rates
actions intluence the spectrum
monetary policy of various segments of financial
depends upon the level of development
the money market.
markets, particularly
market for banks and financial
market is also an important funding
Money Stressed conditions in the
times, even for corporate,
institutions, and at a central
hazard with banks expecting
could increase moral
money markets of first resort.
as the lender
bank to function markets in which
set of related
market reters to a
The term money
traded. money market
In money the or
instruments are
similarfinancial
traded whose maturity period is less
than one year. It
are sector. RBI
its equivalents for industry and banking
meets the needs
for short term funds financial assets
market as "a market
for short-term
defined the money facilitates the exchange
of money for
for money,
that are close substitutes market andalso for the claims,
the new financial
claims in the primary facilitates liquidity
secondary market". Money Market
alreadyissued in the market of short term
a wholesale
the role of
in market and also performs
debt instrument.
because of their short
term

The money markets securities are more liquid borrowers

financial activity, by assuring
nature. Money market encourages
short-term funds (returns)
and lenders the
of
(lenders) of the availability
of the short term funds to
create income. It
also
avenues for deployment information about the
flow of funds in the
the
provides the regulators the monetary adjustments to e n s u r e stability in
which helps in
economy
the economy. insurance
in the money
market include banks,
various participants
The
company, mutual funds and corporate.

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Difference between Capital Market and
eotu Money Market
[Link]. Capital Market Money Market
Capital market is afinancial market Money market is a financial ma
monu and
where the long term
borrowing where the short term markey
lending of funds with maturity | and lending of funds withborrou
m period of more than one year take | period of less than one mat
a

place. year t
place. ke
2.
The debentures, derivatives and | The instruments used in
equity backed securities are used | markets are treasury mone
as Instruments in bill
u capital market. commercial paper, bill rediscountine
and certificates of deposits etc.
To Capital market investments carry Money market
od
Prod'
huge riskss investments are safe
liquid and less risky.
The regulator for
is SEBI
Capital Market The regulator for Money marke
is RBI.
tao Capital market helps to generate Money market facilitates funds for
funds for fi
forfixed capital.
rabinds working capital.
Tr
Features of Money Markets
The following are salient features of money market:
Money market deals with highly liquid and short term
It involves securities which
securities.
are
readily transferable.
Firms buy/sell securities in their
own account and at
The money market is their own risk.
regulated by Reserve Bank of India.
There is no well defined
place where
market. It's a system of transactions business is transacted in money
of short term funds. between borrowers and lenders
It provides trends in liquidity and interest rates.
I t is a
wholesale market and the role of individual is
The maturity period for most of the
insignificant.
overnight to one week. transaction in money market is
Instruments include Certificate of
Govt. Securities & others. Deposit, T-Bills, Commercial Papers,
The risk of investments in money market is
low.

TAXMANN°. wwwwww wwww

[Link]
 MONEY MARKETS 31

Obiectives/Functions of the money market

mechanism for movement of funds from short
1Money Market is
a

units to short term deficit units.

term surplus
infused by the interventions of
market the liquidity is
2. In money
Central bank.
a c c e s s oft short term
funds at a reasonable
3. Money
market enables the
market.
price in the
Market
Need for Money and the major
for day-to-day operations
Business needs
working capital can lead to disruption
of adequate cash
of that is Cash. Lack of funds
component The short term mismatch
activities of a business.
in day-to-day known as short term liquidity
crisis, which
and availability is adds cost to the
requirement
of day-to-day operations and hence
leads to not meeting up yield. Hence Money Market is
cash too does not bring any
firm. Excess of and lenders. Thus
transaction
coordinate between borrowers
required to volumes and is less risky.
in money
market is in high

Constituents of Money Market

market where the financial
institutions provide to
The Money market is a
investors with an opportunity
to borrowers and
the broad range of platform market consist
trade in different forms of short term securities. Money
to
of three segments:
1. Borrowers of Funds
2. Intermediaries

3. Market Makers.

TAXMANN.
 MONEY MARKETS
32

Money Market Participants

Participants in
Money
Markets

Issuers/ Market
BorrowerTS
Intermediary Makers

Govt.
Banks Discount
Financial Houses
Institutions
Central Bank Acceptance
Dealers Houses
Corporate
Houses Mutual
Funds
FlIs

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
Call money market serves the role of
position of the banks.
equilibrating
the short-term liquidity

Money Market Institutions/Organizations

The institutions which deal with the
short term borrowings and lending of
funds are known as Money Market
Institutions. The two sectors in which
money market has been classitied are as
follows:
organized sector and
unorganized sector. The composition and rates of interest of both
markets are difterent from each of these
other.
1. Organised Sector:
The organized sector of
money market is integrated. It
Mutual Funds, Public and
Private sector banks, comprises of RB
Development banks and Financial Institutions Cooperative Societies
& UTI. like IDBI, IFCI, ICCI, LI

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 MONEY MARKETSS 33

2. Unorganised Sector:
market is neither
integrated nor
The unorganized sector of Money
homogeneous. It comprises ofthetollowinginstitutionslike Money Lenders,
non-bank financial
Indigenous banks, Chits, Nidhis and Unregulated
intermediaries.
Chlkunos
Money Market Instruments

Market Instruments have a maturity period of less than one

The Money market instruments

are as followws:
main money
vear. The
of Deposit
1. Certificates
2. Commercial Paper
certificates
Inter-bank participation
3.
4. Inter-bank
term money
5. Treasury Bills

6. Bill rediscounting
7. Call/Notice/Term money

8. CBLO

9. Market Repo

Certificates of Deposits
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 34 MONEY MARKETS

Certificate of Deposits (CDs) arc negotiable money market

and are also known as instrumen
Negotiable Certilicate of Deposits. They are iss.
indematerialized form by commercial banks and linancial
discount to face value for specitied time institutions
a
period. They are like bank ter
deposits accounts.
CDs issued in the form of Usance Promissory Note
are
(UPN) by financi-
institutions and the titles are easily transferable endorsement
CDs were introduced in 1989
by and deliver
by Reserve Bank of India with a maturit
of not less than 7 days and maximum
up to a year. Scheduled banks ca
issue CDs for a
period ranging from 1 year to 3 years.
The issuance of CDs in India is governed
Act, 1881. The issue of CDs attracts
by the Indian Negotiable Instrument
payment of stampduty under the Indiar-
Stamp Act, 1899. There is no lock in period for CDs. They are generall-
issued to individuals,
issued
corporations, trusts, funds
and associations. They are
discount rate to the face value, determined
at a
the repayment of CDs no
by the investors. For
grace period is provided. However if there is a
holiday on the date of maturity, the payment is to be made
by the issuing
bank on the immediate preceding working day. Buy- Back of
CDs is also
allowed.

Commercial Paper

Commercial Paper (CP) is a borrowing by corporate,

money
rm borrowina
short-lerm L.

institutions, primary
irom the
dealers
(Usance market.
P et. lt is an financial
It ial
institu phys990.
the physical
issued inby
form
nce
Promissory unsecured red
instrument
issued
by RBI in RBI enables
It [Link]
l990.

co
It
CorD
corporate Note)
Nole)
demat
or demat
form. It was

the need
initiated

for term
short rowings borrowings at
at
freely competitive
is
bor
borrowers
"pctitivdle
to
Torm
rates
meet

market. CP issued
in physical throus rough the
ement
and delivery.
The credit
rating esinent lnformation and lntormation
c o m p a n i e s

the
India
in I
Investment
n like Cred
Credit Ratin.
Info Rating
of India
Lid(CRISIL),

TAXMANN Credit Servi

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Rating Agency
 MONEY MARKETS 35

f India limited (ICRA), Credit analysis and rescarch Ltd. (CARE) or the
EITCH Rating India private limited provide ratings to the participants for
issuing commercial paper.
CP
1S ISSued as per the guidelines of RBI and
denomination of R 5 lacs and its multiples thercof. The rate
with minimum
is related to the yield on the one ycar government bond.
of interest on CP
the high raled corporate (corporate borrowers,
CP can be issued by linancial institutions) whose
satellite dealers and all-India
Drimary dealers, The investment in CP is as per
net worth is more than 4 crore.
tangible of India can be bought
and
the limits setbySecurities and Exchange Boardbodies registered or
individuals, banking companies, other corporate
by Non-Resident Indians
and unincorporated bodies,
incorporated in India
Institutional Investors (FIls).
(NRIs) and Foreign investments in CP, thus it is a very
requirement against
There is no security of issue ranges between 7 days
to
instrument. The maturity period
risky of issue.
trom the date
one year

Treasury Bills (T-Bills):

Government of India issues
T-Bills
called as T-Bills. The
A treasury bill is also The treasury bills are
for short term borrowing.
to meet the requirement ranges between
discount-to-face value andtheirmaturity period
issued at a for T-bills, the higher the
14 to 364 days. The longer the maturity period
c a n earn.
interest rate on them the investor
State Governments,
T-Bills can be purchased by banks, primary dealers, FIls
institutions, insurance companies, NBFCs,
financial
provident funds, the secondary
and NRIs as an investor through
(as per prescribed norms), issued.
market where it has been previously
has issued the following types of treasury
Presently in India the Government and 364-day. T-Bills can also
through auctions like 91-day, 182-day
bills is fixed through a competitive
be purchased at an auction where price
at a discount and redeemed at par.
For example:
bidding process generally a discount for 90. But at
An investor buys T-Bills of ? 100 face value at
the time of maturity of T-Bills, it is redeemed at F 100. Thus investor gains
10 on the T-bills investments as an interest.
bills.
The State Government does not have an option to issue any treasury
The minimum amount for which treasury bills are available in market is
The issue
25,000. The investments can be in the multiple of R 25,000 only.
price and the discount are to be calculated at each auction. The 91-day T-bills
are auctioned by RBI weekly, whereas the Central Government auctions
basis.
the182-day T-bills and 364-days T-bills on a fortnightly

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36 MONEY MARKETS

CBLO (Collateralized Borrowing and Lending Obligation)

market instruments
electronic
available in

CBLO Is one of the money

A between borrower
and
enders
OOON
Cntry torm. It represents an obligation
maturity period ranges
from one day to

as per the terms of the loans. The this can also be extended uptO One year
ninety days. As per RBI guidelines
RBI and Clearing
Corporation of
are approved and developed by
They where major participants
in 2003. It is an online trading system In case of
ndia(CCIL) and insurance companies.
side mutual funds dealers
in the lender
are
are
nationalized banks, primary
borrowers the major participants
and non financial companies. borrowed at
to repay the money
In the borrower has the obligation
CBLO, The lender has an authority to
receive money
a predetermined future date. security held
date. There is a charge on
lent at the predetermined future
by CCIL.
CCIL has an authority to enable participants
By providing a dealing system, available are:
to borrow and lend funds. The dealing systems
Indian Financial Network (INFINET): This is a closedgroup formed
by the members of the Negotiated Dealing System (NDS), who gen-
erally have an account with RBI.
Internet gateway: This enables the dealing system for those entities
which do not maintain a Current account with RBI.
Entities like banks, financial institutions, primary dealers, mutual funds
ind co-operative banks who are members of NDS can participate in CBLO
transactions. The Non-NDS members like corporates,
co-operative banks,
NBFCs,Pension/ Provident Funds, Trusts [Link], however, participate only
by obtaining the Associate Membership to the CBLO
Segment.
Repos or Repurchase Agreements
Repos are also known as repurchase [Link] is a
where one who sells the
short term borrowing
party security agrees to repurchase it in future.
The securities for Repo transaction are government
like treasury Bills, and Central/State approved securities
Government securities.
Repo
(repurchase agreement) instruments enable
term borrowing through the selling of debt collateralized short
transaction is instruments.
repo as he agrees to repurchase it at a
a For the seller
the
reverse repo as he specified date and
rate. Whereas for the buyer it is a
security now and sells it in future. agrees to the buy
The seller agrees to buyback the securities at a rate
interest charged by the buyer for allowing which includes the
purchasing securities from the
TAXMANN®,
 MONEY MARKETS 37

requires funds so he repurchases the securities by payir

seller. The seller
the buyer.
interest to

Call/Notice/Term Money
constituent of Indian Money Market. It is a
money is an important lent on demand and has aa maturity
on demand
Call
where money
is borrowed or
lent Inter-bank
market and two weeks. It is also known as
between one day Call/Notice market is to facilitate
ranging purpose of
market. The main of shortfall of funds, to
meet
call money
to bridge the gaps
banks and to fulfil the
the commercial of funds out
ot large outflows,
and
the sudden
requirement Cash Reserve Ratio (CRR)
ot RBI such as the
requirements
stipulated Requirements (SLR).
the Statutory Liquidity is in
and term money
notice money
difference among
call money,
b o r r o w e d money.
Call money is
The of the
the period of
maturity and repaid on the
terms of o r lent for a single day
borrowed
o r Sunday in
this case
defined as the money of holiday
There is an exception is defined as
next working day. Notice basis. money
the transaction is only for overnight between two to fourteen
as
o r lent for
a period ranging requirements
the money
borrowed
in these type of
collateral security required
days. There is
no
nature.
are of
short term "Term
as they
than 14 days then it is called as
transacted for m o r e Call/Notice Market
If the funds a r e transaction in
limits for
fixes the prudential Commercial Banks,
Money". RBI from time to time. Scheduled
borrowers in
call/notice
which keeps on changing dealers a r e the
and Primary transact
Co-operative banks not permitted to
are
financial institutions call/notice
market. The non-banking lenders in the
since 2005. Important
call/notice market banks and primary
dealers.
in the commercial banks, cooperative
market are

Features of Call Market: made

market and loans are

1. There is no collateral required in call

available on clean basis.
facilitates the redistribution of surplus day
2. The call money market funds.
funds banks by curbing temporary deficit of
to day among
their cash.
facilitates banks to economize
3. The call market enables
and sensitive market.
4. Call money market is a very competitive
other
the liquidity position of banks and
5.
Callmoney helps to improve
financial institutions.

TAXMANN
 38 MONEY MARKETS

Commercial Bills
in nced of fund
to banks
bills facilitate short term liquidity
ercial ng creditto
This Money market instrument is an important disc
customers by banks by discounting
commercial
bills prescribed discouny
bills at
at prescribed

introduced by RBI
in l1952 and
later
tates. The bill market scheme was I9/0in
was
introduced
new scheme called bills rediscounting
seller are called trad
between the buyer and are called
drawn and accepted commercial banks, they
e bills accepted by the
Dills. When these bills a r e rediscounted in
the commercia
commercial bill can
be
COmmercial bills. The commercial banks
to get money before
market. It helps the c o m m e r c i a l bills whose
bill rediscount RBI, only those
date of rediscounting and
to
the maturity date. According
m o r e than
90 days from sale of
maturity period is
not
commercial
transaction of goods
created out ofa
which have been
can be rediscounted.

a Central Bank
Role of and monitorthe
of a country istocontrol Reserve
The function of the central bank In India, the Bank
system of the country.
banking and financialCentral Bank. The main role of RBl is related to the
of India (RB) is the RBImake changes
banks a r e an instrument help
to
Indian economy, and the
m a c r o e c o n o m i c facets of
the Indian economy.
according to different
There a r e 3 ultimate goals
of a central bank
sustainable
Growth higher
- the better, but should be
1. Economic
bononie ouoth,
2. Controlling Inflation.
mempoy.
3. Reducing Unemployment. Lalatron
in 1949. The RBIplays
The RBI was established in 1935. It was nationalized
in India. The Banking Regulation
role of regulator of the banking system
have given the RBI the power to regulate
Act, 1949 and the RBI Act, 1953
the banking system.
RBI: Controller and Supervisor of Banking Systems
the
The RBI has been assigned the role of controlling and supervising
banking system in India. The RBI is responsible for controlling the overall1
operations of all banks in India. These banks may be:
Public sector banks
Private sector banks
Foreign banks

TAXMANN®. ** **
 MONEY MARKETS 39

Co-operative banks, or
Regional rural banks
The control and supeivisory 1oles of the Rescr ve Bank of India is done
hrough the lollowing:
Issue of Licence: Under the Banking Regulation Act, 1949, the RBI
has been given powers to grant licenses to units to comnence new
banking operations. The RBl also grants licenses toexisting banks tor
opening ew branches. Under the licensing policy, the RBI provides

bankng services in arcas that do not have this facility.

and
Prudential Norms: The RBI issucs guidelines for credit control
Committee on
management. The RBI is a member of the Banking
are responsible for im-
Banking Supervision (BCBS). As such, they
plementation of international standards of capital adequacy norms

and asset classitication.

The RBI has power to control the appoint

Corporate Governance:
directors of banks in India. The RBI has
ment of the chairman and
additional directors in banks as well.
appoint
powers to
and prevent the use of
KYC Norms: To curb money laundering
The RBI has "Know Your
the banking system for financial crimes,
Customer" guidelines. Every bank
has to ensure KYC norms are
to an account.
applied before allowing someone open
means that every bank
has to disclose
Transparency Norms: This and customers have the right to
their charges for providing services
know these charges.
to banks for taking
Risk Management: The RBIprovides guidelines
risk. They do this through
the steps that are necessary to mitigate
risk management in basel norms.
inspection
and is con-
Audit and Inspection: The procedure of audit
trolled by the RBI through off-site and on-site monitoring system.
On-site inspection is done by the RBI on
the basis of "CAMELS".

Capital adequacy; Asset quality; Management;A Earning; Liquidity;

u r s b i notly
System and control.
Baut 5au
Major functions of the RBl are as follows: Sawkes to Gov,

1. Issue of Bank Notes:

Section 22 of the RBI Act gives authority to the RBI to issue currency R
controlcirculation of fake currency.
notes. The RBIalsotakes action to
notes
The Reserve Bank of India has the sole right to issue currency
are issued by the Ministry of
Finance.
except one rupee notes which
TAXMANN®
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40
MONEY MARKETS

urrency notes issued by the Reserve Bank are declared unlimited

egal tender throughout the country. This concentraton or notes

ISSue function with the Reserve Bank has a number of advantages:

t brings uniformity in notes issue; (ü)it makes possible effective
State supervision; (ii) it is easier to control and regulate credit in
it
requirements in the economy;
and (iv) keeps
accordance with the
faith of the public in the paper currency.
2. Banker to Government: As the banker to the government
the Reserve
has to-maintain
Bank manages the banking needs [Link]
and operate the government's deposit accounts. It collects receipts
of funds and makes payments on behalf of the government. It rep.
member of the IMF and the
resents the Government of India as the
World Bank.
3. Custodian of Cash Reserves of Commercial Banks:
The commercial banks hold deposits in the Reserve Bank and the
latter has the custody of the cash reserves of the commercial banks.
4. Custodian of Country's Foreign Currency Reserves:
The Reserve Bank has the custody of the country's reserves of in-
ternational currency, and this enables the Reserve Bank to deal with
crisis connected with adverse balance of payments position.
5.
Foreign Exchange Control: The RBIplays crucial role in foreign
a
exchange transactions. It does due diligence on every foreign trans-
action, including the inflow and outflow of foreign exchange. It takes
steps to stop the fall in value of the Indian Rupee. The RBI also takes
necessary steps to control the current account deficit. RBI
gives
support to promote exports from the country.
6. Lender of Last Resort:
The commercial banks
approach the Reserve Bank of India in times
of emergency to tide over financial
comes to their rescue as a lender
difficulties, and the Central Bank
of last resort.
7. Central Clearance and Accounts
Settlement:
Since commercial banks have their
in the Reserve Bank of India, it is surplus
cash reserves
easier to deal with each deposited
settle the claim of each on the other other and
in the books of the Central Bank. The through book keeping entries
clearing
become an essential function of the Reserve of accounts has now
Bank of India.
8. Controller of Credit:
Credit is controlled by the Reserve Bank in
accordance with the
economic priorities of the gOvernment. RBI has
a Control on bank
TAXMANN®.
 MONEY MARKETS
41
redit through
Cash Reserve
Ratio (SLR) which commercialRatio (CRR) and
banks have to Statutory Liquidity
uidity
RBI is the Regulator of Financial System maintain.
through
The Government intervenes to control the interest Monetary Policy
rates and mone
supply in the economy through Fiscal and Monetary ney
policy.
A number of institutions can atfect the
supply of money but the
greatest impact on the money supply is made by the Reserve Bank
and the commercial banks.
The RBI formulates monetary policy twice a year. It reviews the
policy every quarter as wel., The main objectives of monitoring
monetary policy are to control the Inflation by Monitoring different
key indicators like GDP and inflation.
The RBIundertakes0penmarket
operationsandInterest rate control,
through repo rate, reverse repo rate, and bank rate. A repo transac-
tion is one in which a bank or financial institution sells government
securities or bonds to the RBI, which charges interest on it. Known
as the repo rate, the RBI uses it to infuse liquidity in the system. In
the reverse repo transaction, the RBI sells or releases bonds to drain
out excess liquidity. These transactions are carried out daily as part
of the central bank's liquidity management operations, and are cur-
rently not traded on the exchange.
Another way in which the money supply can be affected by the cen-
tral bank is through its operation of the interest rate. By raising or
loweringinterest rates the demand for money is respectively reduced
or increased.
The RBIregulates the Indian banking and financial systemby issuing
broad guidelines and instructions also. It helps in Maintaining peo-
ple's confidence in the banking and financial system, and Provides
different tools for customers' help, such as acting as the "Banking
Ombudsman." . CARSLR
2, Raks
Monetary Policy 3 Open Mtr pe rahoni
Monetary policy refers to the use of certain regulatory tools under the
control of the RBI in order to regulate the availability, cost and use of
money and credit. There are several direct and indirect tools which RBI
can use to regulate the financial markets and maintain stability. Important
ones are discussed below:
Cash Reserve Ratio (CRR): CRR is the minimum amount of cash that
Commercial banks have tokeep with the RBI at any given point in time. RBI
TAXMANN
42 MONEY MARKETS

uses CRR either to drain excess liquidity from the

economy

cconomy.
or
release
toj

additional funds eeded for the growth of the

CRR from 5% to 4%, means tha
It

ror example, if the RBI reduces the

will now have to keep a lesser
proportion of their deposits with the
Similarly, RBI decide
il
Danks available for business.
KBI making more monev banks gOCs down.
available with the
the CRR, the amount
mcrease
that commercial bank
is the amount
Liquidity Ratio (SLR): SLR government approvei
Statutory form of gold or
in the
are required to
maintain SLR is stated in terme
the c u s t o m e r s .
credit to
Securities before providing bank and is determined
available with the
percentage of
total deposits control the
of a India in order to
the Reserve Bank of
and maintained by commercial banks have
credit. For example,
currently,
expansion of bank securities for a value equal to 23
government approved
to keep gold or

of their total deposits. commercial banks

which
rate at the RBI is willing to lend to
Repo Rate: The Whenever banks have any
shortage of funds they
the Repo Rate. increases the Repo
is called securities. If the RBI
borrow from the RBI, against
can
and vice versa. As a tool to
it makes borrowing expensive for banks
Rate, it m o r e expensive
increases the Repo Rate, making
control inflation, RBI restrict the availability
the RBI with a view to
for the banks to borrow from in a deflationary
of money. Similarly, the RBI will do the exact opposite
environment.
to borrow from
Rate: The rate at which the RBI is willing
Reverse Repo increases the
reverse repo rate. If the RBI
the commercial banks is called
m e a n s that the RBI is willing
to offer lucrative interest
r e v e r s e repo rate, it
with the RBI. This results in a decrease
rates to banks to park their money
banks customers as banks preter to
in the amount of money available for
This naturally
park their money with the RBI as it provides greater safety.
leads to a higher rate of interest which the banks will demand
from ther
customers for lending money to them.
The Repo Rate and the Reverse Repo Rate are important tools with which
the RBI can control the availabilityand thesupply of money in the economy
Over the last decade, there has been substantial development in the Indian
money market in terms of depth, varicty of instruments and etticiency
This has enabled the Reserve Bank to change its monetary operations
from direct quantity based instruments to indirect interest rate baseu
instruments to enhance the elficiency of monetary transmission consisten
with international best practice.

TAXMANN®
 MONEY MARKETS 43

Market in India
Money rcforrms
in India began in the carly 1990s including the
Financial
reforms
the dian money market was
characterized by
arket. Earlier, market micro
money
lack of lepth and distortions in the
in o treasury hills,
of
instruments,
lateralizcd
uncollateralizcd
call market, treas
call
paucity consistedot

mainly
structure. It participation
certificates.

bills and
commercial
Market since the 1990s
Developments
in Money
April 1997
Major treasury
bills in
Abolition of ad hoc
1. 2000.
LAF in June introduced in 2003
2. Full fledged non-bank
participants
and
for corporale 2004
3. CBLO CPs
shortened by October
maturity of PDs to call/notice
4.
Minimum
of banks and
limits on e x p o s u r e
Prudential
5.
in April 2005 2005
market
shortened by April
CDs gradually i n t e r - b a n k market
of
6. Maturity market intoa pure
Transformation
of call money
7. securities
by August 2005 Government
State
collateral base by making 2007
of since April
8. Widening for LAF operations (NDS-CALL)
(SDLs) eligible negotiatedsystem

markets
9.
Operationalisation ofascreen-based
call/notice and
the term money
made
in the such
transactions

for all dealings reporting of all

2006. The 2012. November
in September NDS-CALL in
compulsory through 2010.
in March
bonds allowed market
corporate
10. Repo in for secondary
of a reporting platform
Operationalisation 2010.
11.
CPs and CDs in July
transactions in market;
rate ceilings
in the money
Withdrawal of interest
12. The
bills;
Introduction of auctions in treasury loan-based
13. credit system to
a
from the cash
move away
14. Gradual
also
system.
instruments such CP and CDs w e r e
as
of other existing importantly,
Maturities
wider participation. Most
to encourage stop to
gradually shortened
a
abolished in 1997 thereby putting
treasury bills
were instrument
the ad hoc This enhanced the
monetisation of fiscal deficit.
automatic Bank of India.
independence of the Reserve
ratio of cash to deposits
which they consid
Banks generally have a command for cash is
such that
safe level. If
er to be the minimum

TAXMANN®.
 44 MONEY MARKETS

their reserves fall below this level they will able to borron.
from the central bank at its discount rate. If market
et rates
rates mone
were
banks might
and the discount rate were also 8%, then the banks might ddece
their cash reserves to their minimum ratio knowing that if
exceeds supply they will be able to borrow at 8%. The central
even if, nmay raise its discount rate to a value above the markes
in order to encourage banks not to reduce their cash reservec.e
minimum during excess loans. By raising the discount value to
a level, the commercial banks are given an incentive to hold suc
reserves thus reducing the money multiplier and the
money sun
The central bank may also control the money supply through i
financial base. It may choose to either buy or sell securities in th.
marketplace which will either inject or remove money respectiveh
Thus the monetary base will be affected causing the money
supni
to modify. Pp
This money market is dominated by the Central bank. It facilitate
the exchange of financial assets for money. In India, RBI acts as
watchdog of the monetary system. It occupies strategic position and
influences availability and cost of credit. The pivotal roBle of RBI
that of promotional and development banker in the money marke
RBI intervenes to regulate the liquidity and interest rates throu
its monetary policies like Repo or Reverse Repo rates to achieve the
broad objectives like stability of interest rate and foreign exchange
market. The funds are being sold and purchased at a certain price
by banking, institutions and individuals.

Shortcomings of Indian the Money Market

Indian money market is one of the leading money market among various
developingcountries but it still suffersfrom many drawbacks. The importan!
shortcomings are as follows:
1.
Absence of Integration: Indian money mnarket has been classified
into organized and unorganized sector. Both of them further have o
number of divisions and subdivisions. The organized sector consists
of financial institutions headed by RBI. The unorganized sector co
sist of institutions like indigenous bankers, village
The financial operations of these two
moneylenders et
segments are independent
cach other. There is a lack of coordination and
integration among
various sub-markets.
2. Inadequate banking facility: The major problems of the banking sy
tem in India are huge NPA,
under-developed rural banking netwol
TAXMANN.
 MONIY MAVKET 45
and poor clficieney. Thun thee drawh ks lead tro the prohlerm os
mobilizalion huge aneintof sniall avings in the rural arcas very
dilficult. Thisinadequatc banking facility is major problemfor noney
narket in India.

3. Multiple Interest rates: Most of the legal financial institutions work

in their own way and they charge different interest rates. There is a
huge variation in rates for lending, borrowing, government activities,
etc. Thus the investors get confused in this system
market faces seasonal
4, Shortage of funds or resources: Indian money
demand for funds is much more
shortage of financial resources. The
reasons for shortage of funds
than the supply of funds. The major
lower savings, inadequate banking
in Indian cconomy are poverty,
lower income.
facility and
instruments like
of in vestments instruments: Various
5. Shortage bills and com-
commercial papers, Certificate of Deposits, Treasury is
Indian money market. However, there
mercial bills are used in
the size of the population and the market
an inadequacy among
instruments. Although RBI has taken
several steps for the
for these
instruments but there is still much to be
development of efficient
desired.

Summary
barter system to a money economy
is clearly
from a
The process of evolution in the financial sector
different characteristic patterns observed
confirmed by In the early stages of
of countries atdifferent levels of economic development.
financial sector while financial markets
and non-
development, Banks dominate later stage.
more dominant role at a
banking financial institutions play a
Financial markets can be divided into two segments,
depending on the maturities
Market. The money markets
of the financial claims: Capital Market and Money
term nature. It also provides the
securities are more liquid because of their short
flow of funds in the economy which helps
regulators the information about the in the economy. Money Market is
n the monetary adjustments to ensure stability

to coordinate between borrowers and

lenders. Thus transaction in money
required
market is in high volumes and is less risky.

money markets among various developing

o n e y market is one of the leadingdrawbacks. Over the last decade, there has
countries but it still suffers from many in terms of depth,
Deen a substantial development in the Indian money market
variety of instruments and efficiency.
market is dominated by the Central bank. It facilitates the exchange
ofoney
dnClal assets for money. In India, RBI acts as a watchdog of the monetary

wwe TAXMANN.
 46 MONEY MARKETS

system. It occupies a strategic position and intluences the availability

credit. The pivotal role of RBI is that of promotional and development hanL CS
money market. RBI intervenes to regulate the liquidity and interest
its monetary policies like changing the
rateet
Repo or Reverse Rep0 rates to achi
broad objectives like stability of interest rate and
funds are being sold and
foreign exchange mark
purchased at a certain price by banking, institutio
individuals. jons an

Review Questions
Q.1 Give brief description of Financial
Markets in India.
Q.2 Give an overview of ([Link] Hons, 2014
Indian money market. ([Link] Hons, 201
0.3 Explain the
organisation of money market in India.
Q.4 Differentiate ([Link] Hons, 2014
between money and capital market
Q.5 Explain the
money market instruments.
Q.6 Write short note on
Repo and Reverse Repo
([Link] Hons, 2015
Q.7 What are the various Rate ([Link] Hons, 2015
ways in which the
Q.8 Explain the role financial market can be classified?
of RBI in money market.
Q.9 What is
money market and
dealt in capital market? Explain the
money market and
capital market in India. instrumenls

Tww F e n

COuhuY

Tratrabe