Money market can be defined as a market for short-term funds ranging from overnight to one year and includes financial instruments that are considered to be close substitutes for money. The money market is liquid in nature. The money market is a market for financing the short-term needs of government, corporates and other financial institutions. The money market is regulated by the RBI.
India money market has seen exponential growth just after the globalization initiative in 1992. It has been observed that financial institutions do employ money market instruments for financing short-term monetary requirements of various sectors such as agriculture, finance, and manufacturing. The performance of the India money market has been outstanding in the past 20 years. India has a very active money market, where a number of instruments are traded.
MONEY MARKET INSTRUMENTS
- Call money market
Call money market is also known as inter-bank loan market. It is a market wherein surplus funds (mostly of banks) are traded. Banks lend and borrow money for a short duration of this market. The loans are provided for a very short term ranging from 1 to 14 days. The interest rate on these short-term loans fluctuates on a daily basis.
The main participants in the call money market are commercial banks (excluding RRBs), cooperative banks and primary dealers. Discount and Finance House of India (DFHI), Non-banking financial institutions such as LIC, GIC, UTI, NABARD etc. are allowed to participate in the call money market as lenders.
- Commercial bill market
It is a market which deals in commercial bills or trade bills. When bills are drawn by a seller on the buyer for the value of goods taken on credit it is known as trade bills. When these bills are deposited in the bank for getting them discounted these bills become commercial bills. If the seller gives some time for payment, the bill is payable at a future date (i.e. usance bill). Generally, the maturity period is up to 90 days. During the usance period, if the seller is in need of funds, he may approach his bank for discounting the bill. Commercial banks can provide credit to customers by discounting commercial bills. The banks can rediscount the commercial bills any number of times during the usance period of a bill and get money delivered by him. The commercial bill market is not yet fully developed in India.
- Treasury Bills (T-Bills)
Treasury bills are short-term securities issued by RBI on behalf of Government of India. They are the main instruments of short-term borrowing by the Government. They are useful in managing short-term liquidity. At present, the Government of India issues three types of treasury bills through auctions, namely – 91 days, 182-day and 364-day treasury bills. With the introduction of the auction system, interest rates on all types of TBs are being determined by the market forces.
- Certificate of deposits
Certificate of Deposit is like a promissory note issued by a bank in form of a certificate entitling the bearer to receive interest. It is similar to the bank term deposit account. The certificate bears the maturity date, fixed rate of interest and the value. The certificate of deposits is issued by the commercial banks. They are worth the value of Rs. 25 lakh and in multiples of Rs. 25 lakh. The minimum subscription of CD should be worth Rs. 1 Crore. They are available for a tenure ranging from 3 months to 5 years.
- Commercial Papers
Commercial papers are usually known as promissory notes which are unsecured and are generally issued by companies and financial institutions, at a discounted rate from their face value. The fixed maturity for commercial papers is 1 to 270 days. The purpose for which they are issued is – for the financing of inventories, accounts receivables, and settling short-term liabilities or loans. The return on commercial papers is always higher than that of T-bills.
- Money market mutual funds (MMMFs)
Investing in the money market is difficult for individual investors because of the higher amount of investments. In money market mutual funds savings of a large no. of people are pooled and then the entire fund is invested in the money market.
- Gilt-edged government securities
The gilt-edged market refers to the market for Government and semi-government securities, backed by the Reserve Bank of India(RBI). Government securities are tradable debt instruments issued by the Government for meeting its financial requirements. The term gilt-edged means ‘of the best quality’. This is because the Government securities do not suffer from the risk of default and are highly liquid (as they can be easily sold in the market at their current price). The open market operations of the RBI are also conducted in such securities.
These are issued by governments such as Central Government, State Government, Semi Government authorities, City Corporations, Municipalities, Port trust, State Electricity Board, Housing boards etc.
The Repo or the repurchase agreement is used by the government security holder when he sells the security to a lender and promises to repurchase from him at a specified time. Hence the Repos have terms ranging from 1 night to 30 days. They are very safe due to government backing.
On the other hand in the case of reverse repo transactions, securities are purchased with a commitment to resell at a predetermined rate and date
Major participants of the money market and their Role
- Central Bank: Intermediary
- Central and State Government: Borrowers/Issuers
- Bank: Borrowers/Issuers
- Discount houses: Money markets
- Corporates: Issuers
- Non-banking financial institutions: Borrowers/Issuers
- Mutual funds: Lenders/ Investors
- Primary dealers: intermediaries
- FIIs: investors
Functions of a Money Market
A money market performs a number of functions in an economy.
- Provides Funds:
It provides short-term funds to the public and private institutions needing such financing for their working capital requirements. It is done by discounting trade bills through commercial banks, discount houses, brokers and acceptance houses. Thus the money market helps the development of commerce, industry, and trade within and outside the country.
- Use of Surplus Funds:
It provides an opportunity to banks and other institutions to use their surplus funds profitably for a short period. These institutions include not only commercial banks and other financial institutions but also large non-financial business corporations, states, and local governments.
- No Need to Borrow from Banks:
The existence of a developed money market removes the necessity of borrowing by the commercial banks from the central bank. If the former find their reserves short of cash requirements they can call in some of their loans from the money market. The commercial banks prefer to recall their loans rather than borrow from the central banks at a higher rate of interests.
- Helps Government:
The money market helps the government in borrowing short-term funds at low-interest rates on the basis of treasury bills. On the other hand, if the government were to issue paper money or borrow from the central bank. It would lead to inflationary pressures in the economy
- Helps in Monetary Policy:
A well-developed money market helps in the successful implementation of the monetary policies of the central bank. It is through the money market that the central banks are in a position to control the banking .system and thereby influence commerce and industry.
- Helps in Financial Mobility:
By facilitating the transfer of funds from one sector to another, the money market helps in financial mobility. Mobility in the flow of funds is essential for the development of commerce and industry in an economy.
- Promotes Liquidity and Safety:
One of the important functions of the money market is that it promotes liquidity and safety of financial assets. It thus encourages savings and investments.
Can individual investors invest in the Money market?
Individual investors can invest in money market securities but because of high denominations, individual investors stay away from these. But even if individual investors want to invest in money market they can do so through the money market mutual funds or sometimes a money market bank account. These accounts and mutual funds pool jointly the savings of thousands of individuals and but the money market securities on their behalf. Even though money market instruments like treasury bills may be purchased directly or through other large financial institutions with a straight access to these markets.
Defects in the Indian Money market
- Lack of integration:
The Indian Money Market is divided into two sectors viz, the organized and unorganized money market. But both the markets are completely separate from each other. They are working independently and have little effect on each other. RBI is fully effective in controlling the organized sector. But, it has very less control over the unorganized sector.
- The existence of Unorganised Money Market:
The existence of the unorganized sector in money market still prevails in Indian Money Market. The indigenous banker does not make any distinction between short-term and long-term finance. They have no coordination with each other and have no link with other banking sectors. They do not follow any sound banking regulations. The RBI has no control over these bankers.
- Absence of an organized bill market:
In Indian Money Market, there is an absence of adequate bill market. There is an absence of commercial bill market or a discount for short-term commercial bills. There are many factors responsible for the underdeveloped bill market such as
(i) relying more on a cash transaction,
(ii) cash credit of the commercial bank,
(iii)seller’s limited use of bills,
(iv) imposition of heavy stamp duty,
(v) an absence of acceptance houses etc.
- Shortage of funds in the Money Market:
The lack of banking habit, inadequate banking facility, less saving habit, etc has created a shortage of fund in the money market. On the other hand, the increasing demand for loanable funds in the money market far exceeds its supply.
- Inadequate banking facility:
Nowadays, the commercial banks have opened many new branches of banking facilities. But, it still leaves much scope for further development. In a developing country like India, people live below poverty line and have a less saving habit. Their savings are very small and they do not have much access to banking facilities till now.