importance of money market

7/27/2019 Importance of Money Market

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Introduction on 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. It

is not a place like the stock market but an activity conducted by telephone. The money

market constitutes a very important segment of the Indian financial system.

The highly liquid marketable securities are also called as money market

instruments like treasury bills, government securities, commercial paper, certificates

of deposit, call money, repurchase agreements etc.

The major player in the money market are Reserve Bank of India (RBI), Discount

and Finance House of India (DFHI), banks, financial institutions, mutual funds,

government, big corporate houses. The basic aim of dealing in money market

instruments is to fill the gap of short-term liquidity problems or to deploy the short-

term surplus to gain income on that.


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Definition of Money Market:

According to the McGraw Hill Dictionary of Modern Economics, money

market is the term designed to include the financial institutions which handle the

purchase, sale, and transfers of short term credit instruments. The money market

includes the entire machinery for the channelizing of short-term funds. Concerned

primarily with small business needs for working capital, individuals borrowings, and

government short term obligations, it differs from the long term or capital market

which devotes its attention to dealings in bonds, corporate stock and mortgage

credit.

According to the Reserve Bank of India, money market is the centre for

dealing, inly of short term character, in money assets; it meets the short term

requirements of borrowings and provides liquidity or cash to the lenders. It is the place

where short term surplus investible funds at the disposal of financial and other

institutions and individuals are bid by borrowers agents comprising institutions and

individuals and also the government itself.

According to the Geoffrey,money market is the collective name given to the

various firms and institutions that deal in the various grades of the near money.


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General Characteristics of Money Market:

The general characteristics of money market are outlined below:

Short-term funds are borrowed and lent. No fixed place for conduct of operations, the transactions being conducted even over

the phone and therefore, there is an essential need for the presence of well developed

communications system.

Dealings may be conducted with or without the help the brokers. The short-term financial assets that are dealt in are close substitutes for money,

financial assets being converted into money with ease, speed, without loss and with

minimum transaction cost.

Funds are traded for a maximum period of one year. Presence of a large number of submarkets such as inter-bank call money, bill

rediscounting, and treasury bills, etc.


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The Role of the Reserve Bank of India in the Money Market:

The Reserve Bank of India is the most important constituent of the money market. The

market comes within the direct preview of the Reserve Bank of India regulations.

The aims of the Reserve Banks operations in the money market are:

To ensure that liquidity and short term interest rates are maintained at levelsconsistent with the monetary policy objectives of maintaining price stability.

To ensure an adequate flow of credit to the productive sector of the economy and To bring about order in the foreign exchange market.

The Reserve Bank of India influence liquidity and interest rates through a number

of operating instruments - cash reserve requirement (CRR) of banks, conduct of open

market operations (OMOs), repos, change in bank rates and at times, foreign exchange

swap operations.


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Money Market mutual fund (MMMFS):

A mutual fund is a professionally managed type of collective investment scheme

that pools money from many investors and invests it in stocks, bonds, short- term

money market instruments and other securities. Mutual funds have a fund manager

who invests the money on behalf of the investors by buying / selling stocks, bonds etc.

Money market mutual funds (mmmfs) were introduced in April 1991 to provide

an additional short-term avenue for investment and bring money market investment

within the reach of individuals. These mutual funds would invest exclusively in money

market instruments. Money market mutual funds bridge the gap between small

investors and the money market. It mobilizes saving from small investors and invests

them in short-term debt instruments or money market instruments.

There are various investment avenues available to an investor such as real

estate, bank deposits, post office deposits, shares, debentures, bonds etc. A mutual

fund is one more type of Investment avenue available to investors. There are many

reasons why investors prefer mutual funds. An investors money is invested by the

mutual fund in a variety of shares, bonds and other securities thus diversifying the

investors portfolio across different companies and sectors. This diversification helps

in reducing the overall risk of the portfolio. It is also less expensive to invest in a

mutual fund since the minimum investment amount in mutual fund units is fairly low


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(Rs. 500 or so). With Rs. 500 an investor may be able to buy only a few stocks and not

get the desired diversification. These are some of the reasons why mutual funds have

gained in popularity over the years

An Overview - Money Market Mutual Funds:

Currently, the worldwide value of all mutual funds totals more than $US 26

trillion. The United States leads with the number of mutual fund schemes. There are

more than 8000 mutual fund schemes in the U.S.A. Comparatively, India has around

1000 mutual fund schemes, but this number has grown exponentially in the last few

years. The Total Assets under Management in India of all Mutual funds put together

touched a peak of Rs. 5, 44,535 crs. at the end of August 2008. . As of today there are

41 Mutual Funds in the country. Together they offer over 1000 schemes to the

investor. Many more mutual funds are expected to enter India in the next few years.

Indians have been traditionally savers and invested money in traditional savings

instruments such as bank deposits. Against this background, if we look at

approximately Rs. 5 lakh crores which Indian Mutual Funds are managing, then it is no

mean an achievement. A country traditionally putting money in safe, risk-free

investments like Bank FDs, Post Office and Life Insurance, has started to invest in

stocks, bonds and shares thanks to the mutual fund industry.


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CHARACTERISTIC OF MUTUAL FUND

The ownership is in the hands of the investors who have pooled in their funds.

It is managed by a team of investment professionals and other service providers.

The pool of funds is invested in a portfolio of marketable investments.

The investors share is denominated by units whose value is called as Net Asset Value(NAV) which changes every day and investors subscription is accounted as unit capital.

The investment portfolio is created according to the stated investment objectives ofthe fund.


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ADVANTAGES OF MUTUAL FUNDS TO INVESTORS:

1. Portfolio Diversification purchasing units in a mutual fund instead of buyingindividual stocks or bonds, the investors risk is spread out and minimized up to certain

extent. The idea behind diversification is to invest in a large number of assets so that a

loss in any particular investment is minimized by gain in others.

2. Professional Management The basic advantage of funds is that, they areprofessional managed, by well qualified professional. Investors purchase funds

because they do not have the time or the expertise to manage their own portfolio. A

mutual fund is considered to be relatively less expensive way to make and monitor

their investment.

3. Economies of scale Mutual fund buy and sell large amounts of securities at a time,thus help to reducing transaction costs, and help to bring down the average cost of the

unit for their investors.

4. Liquidity Just like an individual stock, mutual fund also allow investors to liquidatetheir holdings as and when they want.


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5. Simplicity Investments in mutual fund is considered to be easy, compare to otheravailable instruments in the market, and the minimum investment is small. Most AMC

also have automatic purchase plans whereby as little as Rs. 2000, where SIP start with

just Rs. 50 per month basis.

6. Transparency - Investors get regular information on the value of your investment inaddition to disclosure on the specific investments made by your scheme, the

proportion invested in each class of assets and the fund manager's investment

strategy and outlook.

7. Flexibility - Through features such as regular investment plans, regular withdrawalplans and dividend reinvestment plans; you can systematically invest or withdraw

funds according to your needs and convenience

8. Liquidity Just like an individual stock, mutual fund also allow investors to liquidatetheir holdings as and when they want.

9. Simplicity Investments in mutual fund is considered to be easy, compare to otheravailable instruments in the market, and the minimum investment is small. Most AMC


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also have automatic purchase plans whereby as little as Rs. 2000, where SIP start with

just Rs. 50 per month basis.

10.Transparency - Investors get regular information on the value of your investment inaddition to disclosure on the specific investments made by your scheme, the

proportion invested in each class of assets and the fund manager's investment

strategy and outlook.

DISADVANTAGES OF MUTUAL FUNDS TO INVESTORS

1. Professional Management Some funds doesnt perform in neither the market, astheir management is not dynamic enough to explore the available opportunity in the

market, thus many investors debate over whether or not the so-called professional are

any better than mutual fund or investor himself, for picking up stock.

2. Costs The biggest source of AMC income is generally from the entry and exit loadwhich they charge from investors, at the time of purchase. The mutual fund industries

are thus charging extra cost under layers of jargon.


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3. Dilution Because funds have small holdings across different companies, high returnsfrom a few investments often dont make much difference on the overall return.

Dilution is also the result of a successful fund getting to big. When money pours into

funds that have had strong success, the manager often has trouble finding a good

investment for all the new money.

4. TaxesWhen making decision about your money, fund managers dont consider yourpersonal tax situation. For example, when a fund manager sells a security, a capital

gain tax is triggered, which affect how profitable the individual is from the sale. It

might have been more advantageous for the individual to defer the capital gains

liability.

5. Professional Management Some funds doesnt perform in neither the market, astheir management is not dynamic enough to explore the available opportunity in the

market, thus many investors debate over whether or not the so-called professional are

any better than mutual fund or investor himself, for picking up stock.

6. Costs The biggest source of AMC income is generally from the entry and exit loadwhich they charge from investors, at the time of purchase. The mutual fund industries

are thus charging extra cost under layers of jargon.


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7. Taxes When making decision about your money, fund managers dont consider yourpersonal tax situation. For example, when a fund manager sells a security, a capital

gain tax is triggered, which affect how profitable the individual is from the sale. It

might have been more advantageous for the individual to defer the capital gains

liability.

8. Restrictive gains - Diversification helps, if risk minimization is your objective. However,the lack of investment focus also means you gain less than if you had invested directly

in a single security. Assume, Reliance appreciated 50 per cent. A direct investment in

the stock would appreciate by 50 per cent. But your investment in the mutual fund,

which had invested 10 per cent of its corpus in Reliance, will see only a 5 per cent

appreciation.

9. Management risk - Assume, Reliance appreciated 50 per cent. A direct investment inthe stock would appreciate by 50 per cent. But your investment in the mutual fund,

which had invested 10 per cent of its corpus in Reliance, will see only a 5 per cent

appreciation.


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Recommendation on Indian Money Market by RBI:

Financial sector reforms and monetary policy measures the governor announced

certain structural and other policy recommendation to strengthen and rationalise the

functioning of money market.

1) Call/Notice Money Market:

RBI may migrate from OF (Owned Fund) to capital funds (sum of Tier I and Tier II

capital) as the benchmark for fixing prudential limits for call/notice money market for

scheduled commercial banks. RBI may, however, continue with the present norm

associated with co-operative banks (i.e., Aggregate Deposit), PDs (i.e., Net Owned

Fund) and non-banks (i.e., 30 per cent of their average daily lending during 2000-01).

Call/notice money market transactions should be conducted on an electronic

negotiated quote driven platform.

Banks and PDs with appropriate risk management systems in place and balance sheet

structure may be allowed more flexibility to borrow in call/notice money market.

Upon accomplishing the call/notice money market intoa pure inter-bank one, larger

freedom in lending in call/notice market should be afforded to banks and PDs.

2) Repos/CBLO :


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Consequent upon coming into effect of the FRBM Act 2003, there would be a need to

broad-base the pool of securities to act as collateral for repo and CBLO markets.

The possibility of conducting repo transactions on an electronic, anonymous orderdriven trading system may be explored.

3) Term Money:

Reporting of term money transactions on NDS platform may be made compulsory to

improve transparency.

Term money market transactions on an electronic, negotiated quote driven platform

should be introduced.

4) CD

Maturity period of CDs to be reduced to 7 days, in line with that under CP and fixed

deposit.

5) Commercial Paper

Asset-backed CP should be introduced in the Indian market.

Development of a transparent benchmark Presence of a term money market


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Development of policies that provide incentives for banks and financial institutions tomanage risk and maximise profit

Increasing secondary market activity in commercial paper and certificate of deposit. Incase of commercial paper, underwriting should be allowed and revolving underwriting

finance facility and Asset backed commercial paper should be introduced. In case of

Certificate of deposits the tenure of those of the financial institutions certificate of

deposits should be rationalised. Moreover, floating rate certificate of deposits can be

introduced.

Rationalisation of the stamp duty structure. Multiple prescription of stamp duty leadsto in the administrative costs and administrative hassles.

Change in the regulatory mindset of the Reserve Bank by shifting the focus of controlfrom quantity of liquidity to price which can lead to an orderly development of money

market.

Good debt and cash management on the part of the government which will not onlybe complementary to the monetary policy but give greater freedom to the Reserve

Bank in setting its operating procedures.


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GROWTH OF MONEY MARKET IN INDIA

While the need for long term financing is met by the capital or financial

markets, money market is a mechanism which deals with lending and

borrowing of short term funds. Post reforms period in India has witnessed

tremendous growth of the Indian money markets. Banks and other financial

institutions have been able to meet the high expectations of short term

funding of important sectors like the industry, services and agriculture.

Functioning under the regulation and control of the Reserve Bank of India

(RBI), the Indian money markets have also exhibited the required maturity and

resilience over the past about two decades. Decision of the government to

allow the private sector banks to operate has provided much needed healthy

competition in the money markets, resulting in fair amount of improvement in

their functioning. Money market denotes inter-bank market where the banks

borrow and lend among themselves to meet the short term credit and deposit

needs of the economy. Short term generally covers the time period upto one

year. The money market operations help the banks tide over the temporary

mismatch of funds with them. In case a particular bank needs funds for a few

days, it can borrow from another bank by paying the determined interest rate.

The lending bank also gains, as it is able to earn interest on the funds lying idle

with it. In other words, money market provides avenues to the players in the


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market to strike equilibrium between the surplus funds with the lenders and

the requirement of funds for the borrowers. An important function of the

money market is to provide a focal point for interventions of the RBI to

influence the liquidity in the financial system and implement other monetary

policy measures.

Quantum of liquidity in the banking system is of paramount importance, as it is

an important determinant of the inflation rate as well as the creation of credit

by the banks in the economy. Market forces generally indicate the need for

borrowing or liquidity and the money market adjusts itself to such calls. RBI

facilitates such adjustments with monetary policy tools available with it. Heavy

call for funds overnight indicates that the banks are in need of short term

funds and in case of liquidity crunch, the interest rates would go up.

Depending on the economic situation and available market trends, the RBI

intervenes in the money market through a host of interventions. In case of

liquidity crunch, the RBI has the option of either reducing the Cash Reserve

Ratio (CRR) or pumping in more money supply into the system. Recently, to

overcome the liquidity crunch in the Indian money market, the RBI has

released more than Rs 75,000 crore with two back-to-back reductions in the

CRR.


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In addition to the lending by the banks and the financial institutions, various

companies in the corporate sector also issue fixed deposits to the public for

shorter duration and to that extent become part of the money market

mechanism selectively. The maturities of the instruments issued by the money

market as a whole, range from one day to one year. The money market is also

closely linked with the Foreign Market, through the process of covered interest

arbitrage in which the forward premium acts as a bridge between the domestic

and foreign interest rates.

Determination of appropriate interest for deposits or loans by the banks or the

other financial institutions is a complex mechanism in itself. There are several

issues that need to be resolved before the optimum rates are determined.

While the term structure of the interest rate is a very important determinant,

the difference between the existing domestic and international interest rates

also emerges as an important factor. Further, there are several credit

instruments which involve similar maturity but diversely different risk factors.

Such distortions are available only in developing and diverse economies like

the Indian economy and need extra care while handling the issues at the policy

levels.

Diverse Functions


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Money markets are one of the most important mechanisms of any deve-loping

economy. Instead of just ensuring that the money market in India regulates the

flow of credit and credit rates, this mechanism has emerged as one of the

important policy tools with the government and the RBI to control the

monetary policy, money supply, credit creation and control, inflation rate and

overall economic policy of the State. Hence, the first and the foremost function

of the money market mechanism is regulatory in nature. While determining

the total volume of credit plan for the six monthly period, the credit policy also

aims at directing the flow of credit as per the priorities fixed by the

government according to the needs of the economy. Credit policy as an

instrument is important to ensure the availability of the credit in adequate

volumes; it also caters to the credit needs of various sectors of the economy.

The RBI assists the government to implement its policies related to the credit

plans through its statutory control over the banking system of the country.

Monetary policy, on the other hand, has longer term perspective and aims at

correcting the imbalances in the economy. Credit policy and the monetary

policy, both complement each other to achieve the long term goals

determined by the government. It not only maintains complete control over

the credit creation by the banks, but also keeps a close watch over it. The

instruments of monetary policy, including the repo rate, cash reserve ratio and


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bank rate are used by the Central Bank of the country to give the required

direction to the monetary policy.

Inflation is one of the serious economic problems that all the developing

economies have to face every now and then. Cyclical fluctuations do affect the

price level differently, depending upon the demand and supply scenario at the

given point of time. Money market rates play a major role in controlling the

price line. Higher rates in the money markets reduce the liquidity in the

economy and have the effect of reducing the economic activity in the system.

Reduced rates, on the other hand, increase the liquidity in the market and

bring down the cost of capital substantially, thereby increasing the investment.

This function also assists the RBI to control the overall money supply in the

economy. Such operations supplement the efforts of direct infusion of newly

printed notes by the RBI.

Future of Open Markets

Financial openness is said to be a situation under which the residents of one

country are in a position to trade their assets with residents of another

country. A slightly mild definition of openness may be referred to as financial

integration of two or more economies. In recent years, the process of

globalization has made the money market operations and the monetary policy

tools quite important. The idea is not only to regulate the economy and its


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money markets for the overall economic development, but also to attract

more and more foreign capital into the country. Foreign investment results in

increased economic activity, income and employment generation in the

economy. Free and unrestricted flow of foreign capital and growing integration

of the global markets is the hallmark of openness of economies.

Indian experience with open markets has been a mixed one. On the positive side,

the growth rate of the country has soared to new levels and the foreign trade had

been growing at around 20 per cent during the past few years. Foreign exchange

reserves have burgeoned to significantly higher levels and the country has achieved

new heights in the overall socio-economic development. The money market

mechanism has played a significant role in rapid development of the country during

the post-reforms era.

On the flip side, the post-reforms period has witnessed relatively lesser growth of

the social sector. Money market mechanism has kept the markets upbeat, yet the

social sector needs more focused attention. With the base of the economy now

strengthened, the money market mechanism must also focus on ensuring that

proper direction is provided to the credit flows so that the poorest sections of the

society also gain.


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IMPORTANT SEGMENTS OF MONEY MARKET

1) 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 receipt (revenue and capital) and

expenditure. They form the most important segment of the money market not

only in India but all over the world as well.

In other words, T-Bills are short term (up to one year) borrowing instruments

of the Government of India which enable investors to park their short term

surplus funds while reducing their market risk

T-bills are repaid at par on maturity. The difference between the amount paid

by the tenderer at the time of purchase (which is less than the face value) and

the amount received on maturity represents the interest amount on T-bills and is

known as the discount. Tax deducted at source (TDS) is not applicable on T-

bills.

Features of T-bills are:

They are negotiable securities. They are highly liquid as they are of shorter tenure and there is a

possibility of an interbank repos on them.

There is absence of default risk. They have an assured yield, low transaction cost, and are eligible for

inclusion in the securities for SLR purpose.


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They are not issued in scrip form. The purchases and sales are affectedthrough the subsidiary general ledger (SGL) account. T-Bills are issued in

the form of SGL entries in the books of Reserve Bank of India to hold the

securities on behalf of the holder. The SGL holdings can be transferred

by issuing a SGL transfer form

Recently T-Bills are also being issued frequently under the MarketStabilization Scheme (MSS).

Types of Treasury Bills:

Treasury bills (T-bills) offer short-term investment opportunities, generally up

to one year. They are thus useful in managing short-term liquidity. At present,

RBI issues T-Bills for three different maturities : 91 days, 182 days and 364

days. The 91 day T-Bills are issued on weekly auction basis while 182 day T-

Bill auction is held on Wednesday preceding non-reporting Friday and 364 day

T-Bill auction on Wednesday preceding the reporting Friday. There are no

treasury bills issued by State Governments.

Advantages of investing in T-Bills:

No Tax Deducted at Source (TDS) Zero default risk as these are the liabilities of GOI Liquid money Market Instrument Active secondary market thereby enabling holder to meet immediate fund

requirement.

Amount:


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Treasury bills are available for a minimum amount of Rs.25,000 and in

multiples of Rs. 25,000. Treasury bills are issued at a discount and are redeemed

at par. Treasury bills are also issued under the Market Stabilization Scheme

(MSS). They are available in both Primary and Secondary market.

Auctions of Treasury Bills:

While 91-day T-bills are auctioned every week on Wednesdays, 182 days and

364-day T-bills are auctioned every alternate week on Wednesdays. The

Reserve Bank of India issues a quarterly calendar of T-bill auctions which is

shown below (table 1.1). It also announces the exact dates of auction, the

amount to be auctioned and payment dates by issuing press releases prior to

every auction.

Participants in the T-bills market:

The Reserve Bank of India, mutual funds, financial institutions, primary dealers,

satellite dealers, provident funds, corporates, foreign banks, and foreign

institutional investors are all participants in the treasury bill market. The sale

government can invest their surplus funds as non-competitive bidders in T-bills

of all maturities.

Treasury bills are pre-dominantly held by banks. In the recent years, there has

been a growth in the number of non-competitive bids, resulting in significant

holding of T- bills by provident funds, trusts and mutual funds.

2) Commercial Paper:

Commercial paper was introduced into the Indian money market during

the year 1990, on the recommendation of Vaghul Committee. Now it has

become a popular debt instrument of the corporate world.


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A commercial paper is an unsecured short-term instrument issued by the large

banks and corporations in the form of promissory note, negotiable and

transferable by endorsement and delivery with a fixed maturity period to meet

the short-term financial requirement. There are four basic kinds of commercial

paper: promissory notes, drafts, checks, and certificates of deposit.

It is generally issued at a discount by the leading creditworthy and highly

rated corporates. Depending upon the issuing company, a commercial paper is

also known as Financial paper, industrial paper or corporate paper.

Commercial paper was initially meant to be used by the corporates borrowers

having good ranking in the market as established by a credit rating agency to

diversify their sources of short term borrowings at a rate which was usually

lower than the banks working capital lending rate.

Commercial papers can now be issued by primary dealers, satellite dealers, and all-

India financial institutions, apart from corporatist, to access short-term funds. Effective

from 6th September 1996 and 17th June 1998, primary dealers and satellite dealers were

also permitted to issue commercial paper to access greater volume of funds to help

increase their activities in the secondary market. It can be issued to individuals, banks,

companies and other registered Indian corporate bodies and unincorporated bodies. It is

issued at a discount determined by the issuer company. The discount varies with the

credit rating of the issuer company and the demand and the supply position in the

money market. In India, the emergence of commercial paper has added a new

dimension to the money market.

Advantage of commercial paper:

High credit ratings fetch a lower cost of capital.
http://en.wikipedia.org/wiki/Certificates_of_deposithttp://en.wikipedia.org/wiki/Certificates_of_deposit


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Wide range of maturity provide more flexibility. It does not create any lien on asset of the company. Tradability of Commercial Paper provides investors with exit options.

Disadvantages of commercial paper:

Its usage is limited to only blue chip companies. Issuances of Commercial Paper bring down the bank credit limits. A high degree of control is exercised on issue of Commercial Paper. Stand-by-credit may become necessary. Growth in the Commercial Paper Market: Commercial paper was introduced in India in January 1990, in pursuance

of the Vaghul Committees recommendations, in order to enable highly

rated non-bank corporate borrowers to diversify their sources of short

term borrowings and also provide an additional instrument to investors.

commercial paper could carry on an interest rate coupon but is generally

sold at a discount. Since commercial paper is freely transferable, banks,

financial institutions, insurance companies and others are able to invest

their short-term surplus funds in a highly liquid instrument at attractive

rates of return.

A major reform to impart a measure of independence to the commercialpaper market took place when the stand by facility* of the restoration of

the cash credit limit and guaranteeing funds to the issuer on maturity of

the paper was withdrawn in October 1994. As the reduction in cash credit

portion of the MPBF impeded the development of the commercial paper

market, the issuance of commercial paper was delinked from the cash


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credit limit in October 1997. It was converted into a stand alone product

from October 2000 so as to enable the issuers of the service sector to

meet short-term working capital requirements.

Banks are allowed to fix working capital limits after taking into accountthe resource pattern of the companies finances, including commercial

papers. Corporates, PDs and all-India financial institutions (FIs) under

specified stipulations have permitted to raise short-term resources by the

Reserve Bank through the issue of commercial papers. There is no lock in

period for commercial papers. Furthermore, guidelines were issued

permitting investments in commercial papers which has enabled a

reduction in transaction cost.

In order to rationalize the and standardize wherever possible, variousaspects of processing, settlement and documentation of commercial

paper issuance, several measures were undertaken with a view toachieving the settlement on T+1 basis. For further deepening the market,

the Reserve Bank of India issued draft guidelines on securitisation of

standard assets on April 4, 2005.


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3. Certificate of Deposits:

Certicate of deposit are unsecured, negotiable, short-term instruments in

bearer form, issued by commercial banks and development financial

institutions.

The scheme of certificates of Deposits (CDs) was introduced by RBI as a

step towards deregulation of interest rates on deposits. Under this scheme, any

scheduled commercial banks, co-operative banks excluding land development

banks, can issue certificate of deposits for a period of not less than three months

and upto a period of not more than one year. The financial institutions

specifically authorised by the RBI can issue certificate of deposits for a period

not below one year and not above 3 years duration. Certificate of deposits, can

be issued within the period prescribed for any maturity.

Certificates of Deposits (CDs) are short-term borrowings by banks.

Certificates of deposits differ from term deposit because they involve the

creation of paper, and hence have the facility for transfer and multiple

ownerships before maturity. Certificate of deposits rates are usually higher than

the term deposit rates, due to the low transactions costs. Banks use the

certificates of deposits for borrowing during a credit pick-up, to the extent of

shortage in incremental deposits. Most certificates of deposits are held until

maturity, and there is limited secondary market activity.

Certificates of Deposit (CDs) is a negotiable money market instrument

and issued in dematerialised form or as a Usance Promissory Note, for funds

deposited at a bank or other eligible financial institution for a specified time

period. Guidelines for issue of certificate of deposits are presently governed by

various directives issued by the Reserve Bank of India.


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Eligibility for Issue of Certificate of Deposits:

Certificate of deposits can be issued by (i) scheduled commercial banks

excluding Regional Rural Banks (RRBs) and Local Area Banks (LABs); and

(ii) select all-India Financial Institutions that have been permitted by RBI to

raise short -term resources within the umbrella limit fixed by RBI.

Banks have the freedom to issue certificate of deposits depending on

their requirements. An FI may issue certificate of deposits within the overall

umbrella limit fixed by RBI, i.e., issue of certificate of deposits together with

other instruments, viz., term money, term deposits, commercial papers andinter-corporate deposits should not exceed 100 per cent of its net owned funds,

as per the latest audited balance sheet.

Denomination For Certificate Of Deposits:

Minimum amount of a certificate of deposits 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 the multiples of Rs. 1 lakh thereafter.

Certificate of deposits can be issued to individuals, corporations, companies,

trusts, funds, associations, etc. Non-Resident Indians (NRIs) may also

subscribe to certificate of deposits, but only on non-repatriable basis which

should be clearly stated on the Certificate. Such certificate of deposits cannot

be endorsed to another NRI in the secondary market.

Maturity:

The maturity period of certificate of deposits issued by banks should be

not less than 7 days and not more than one year. The FIs can issue certificate of


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deposits for a period not less than 1 year and not exceeding 3 years from the

date of issue.


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4. Call Money Market:

Call and notice money market refers to the market for short -term funds

ranging from overnight funds to funds for a maximum tenor of 14 days. Under

Call money market, funds are transacted on overnight basis and under notice

money market, funds are transacted for the period of 2 days to 14 days.

The call/notice money market is an important segment of the Indian

Money Market. This is because, any change in demand and supply of short-

term funds in the financial system is quickly reflected in call money rates. The

RBI makes use of this market for conducting the open market operationseffectively.

Participants in call/notice money market currently include banks

(excluding RRBs) and Primary dealers both as borrowers and lenders. Non

Bank institutions are not permitted in the call/notice money market with effect

from August 6, 2005. The regulator has prescribed limits on the banks and

primary dealers operation in the call/notice money market.

Call money market is for very short term funds, known as money on call.

The rate at which funds are borrowed in this market is called `Call Money rate'.

The size of the market for these funds in India is between Rs 60,000 million to

Rs 70,000 million, of which public sector banks account for 80% of borrowings

and foreign banks/private sector banks account for the balance 20%. Non-bank

financial institutions like IDBI, LIC, and GIC etc participate only as lenders in

this market. 80% of the requirement of call money funds is met by the non-bank

participants and 20% from the banking system.

In pursuance of the announcement made in the Annual Policy Statement

of April 2006, an electronic screen-based negotiated quote-driven system for

all dealings in call/notice and term money market was operationalised with

effect from September 18, 2006. This system has been developed by Clearing


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Corporation of India Ltd. on behalf of the Reserve Bank of India. The NDS -

CALL system provides an electronic dealing platform with features like Direct

one to one negotiation, real time quote and trade information, preferred

counterparty setup, online exposure limit monitoring, online regulatory limit

monitoring, dealing in call, notice and term money, dealing facilitated for T+0

settlement type for Call Money and dealing facilitated for T+0 and T+1

settlement type for Notice and Term Money. Information on previous dealt

rates, ongoing bids/offers on re al time basis imparts greater transparency and

facilitates better rate discovery in the call money market. The system has also

helped to improve the ease of transactions, increased operational efficiency and

resolve problems associated with asymmetry of information. However,

participation on this platform is optional and currently both the electronic

platform and the telephonic market are co-existing. After the introduction of

NDS-CALL, market participants have increasingly started using this new

system more so during times of high volatility in call rates.

Participants in the Call Money Market:

Participants in call money market include the following:

As lenders and borrowers: Banks and institutions such as commercialbanks, both Indian and foreign, State Bank of India, Cooperative Banks,

Discount and Finance House of India ltd. (DFHL) and Securities Trading

Corporation of India (STCI).

As lenders: Life Insurance Corporation of India (LIC), Unit Trust ofIndia (UTI), General Insurance Corporation (GIC), Industrial

Development Bank of India (IDBI), National Bank for Agriculture and

Rural Development (NABARD), specified institutions already operating

in bills rediscounting market, and entities/corporates/mutual funds.


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The participants in the call markets increased in the 1990s, with a

gradual opening up of the call markets to non-bank entities. Initially DFHI was

the only PD eligible to participate in the call market, with other PDs having to

route their transactions through DFHI, and subsequently STCI. In 1996, PDs

apart from DFHI and STCI were allowed to lend and borrow directly in the call

markets. Presently there are 18 primary dealers participating in the call

markets. Then from 1991 onwards, corporates were allowed to lend in the call

markets, initially through the DFHI, and later through any of the PDs. In order

to be able to lend, corporates had to provide proof of bulk lendable resources to

the RBI and were not suppose to have any outstanding borrowings with the

banking system. The minimum amount corporates had to lend was reduced

from Rs. 20 crore, in a phased manner to Rs. 3 crore in 1998. There were 50

corporates eligible to lend in the call markets, through the primary dealers. The

corporates which were allowed to route their transactions through PDs, were

phased out by end June 2001.

Table 4.2: Number of Participants in Call/Notice Money Market

Category Bank PD FI MF Corporate Total

I. Borrower 154 19 - - - 173

II. Lender 154 19 20 35 50 277

Source: Report of the Technical Group on Phasing Out of Non-banks from

Call/Notice Money Market, March 2001.

Banks and PDs technically can operate on both sides of the call market, though

in reality, only the P Ds borrow and lend in the call markets. The bank

participants are divided into two categories: banks which are pre- dominantly

lenders (mostly the public sector banks) and banks which are pre- dominantly


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the reverse repo rate. Table 4.3 provides data on the behaviour of call rates.

Figure 4.3displays the trend of average monthly call rates.

The behaviour of call rates has historically been influenced by liquidity

conditions in the market. Call rates touched a peak of about 35% in May 1992,

reflecting tight liquidity on account of high levels of statutory pre-emptions and

withdrawal of all refinance facilities, barring export credit refinance. Call rates

again came under pressure in November 1995 when the rates were 35% par.


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5. Commercial bill market:

Commercial bill is a short term, negotiable, and self-liquidating instrument with low

risk. It enhances he liability to make payment in a fixed date when goods are bought on

credit. According to the Indian Negotiable Instruments Act, 1881, bill or exchange is a

written instrument containing an unconditional order, signed by the maker, directing to pay a

certain amount of money only to a particular person, or to the bearer of the instrument. Bills

of exchange are negotiable instruments drawn by the seller (drawer) on the buyer (drawee) or

the value of the goods delivered to him. Such bills are called trade bills. When trade bills are

accepted by commercial banks, they are called commercial bills. The bank discount this bill

by keeping a certain margin and credits the proceeds. Banks, when in need of money, can

also get such bills rediscounted by financial institutions such as LIC, UTI, GIC, ICICI and

IRBI. The maturity period of the bills varies from 30 days, 60 days or 90 days, depending on

the credit extended in the industry.

Types of Commercial Bills:

Commercial bill is an important tool finance credit sales. It may be a demand bil l or a

usance bil l. A demand bill is payable on demand, that is immediately at sight or onpresentation by the drawee. A usance bill is payable after a specified time. If the seller wishes

to give sometime for payment, the bill would be payable at a future date. These bills can

either be clean bills or documentary bills. In a clean bill, documents are enclosed and

delivered against acceptance by drawee, after which it becomes clear. In the case of a

documentary bill, documents are delivered against payment accepted by the drawee and

documents of bill are filed by bankers till the bill is paid.

Commercial bills can be in land bil ls or f oreign bil ls. Inland bills must (1) be drawn

or made in India and must be payable in India: or (2) drawn upon any person resident in

India. Foreign bills, on the other hand, are (1) drawn outside India and may be payable and by

a party outside India, or may be payable in India or drawn on a party in India or (2) it may be

drawn in India and made payable outside India. A related classification of bills is export bills

and import bills. While export bills are drawn by exporters in any country outside India,

import bills are drawn on importers in India by exporters abroad.


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The indigenous variety of bill of exchange for financing the movement of agricultural

produce, called a hundi has a long tradition of use in India. It is vogue among indigenous

bankers for raising money or remitting funds or to finance inland trade. A hundi is an

important instrument in India; so indigenous bankers dominate the bill market. However,

with reforms in the financial system and lack of availability of funds from private sources, the

role of indigenous bankers is declining.

With a view to eliminating movement of papers and facilitating multiple

rediscounting, RBI introduced an innovation instruments known as Derivative Usance

Promissory Notes, backed by such eligible commercial bills for required amounts and

usance period (up to 90 days). Government has exempted stamp duty on derivative usance

promissory notes. This has simplified and streamlined bill rediscounting by institutions and

made the commercial bill an active instrument in the secondary money market. This

instrument, being a negotiable instrument issued by banks, is a sound investment for

rediscounting institutions. Moreover rediscounting institutions can further discount the bills

anytime prior to the date of maturity. Since some banks were using the facility of

rediscounting commercial bills and derivative usance promissory notes of as short a period as

one day, the Reserve Bank restricted such rediscounting to a minimum period of 15 days. The

eligibility criteria prescribed by the Reserve Bank for rediscounting commercial bills are that

the bill should arise out of a genuine commercial transaction showing evidence of sale of

goods and the maturity date of the bill should to exceed 90 days from the date of

rediscounting.

Commercial bills can be traded by offering the bills for rediscounting. Banks provide

credit to their customers by discounting commercial bills. This credit is repayable on maturity

of the bill. In case of need for funds, and can rediscount the bills in the money market and get

ready money. Commercial bills ensure improved quality of lending, liquidity and efficiency

in money management. It is fully secured for investment since it is transferable by

endorsement and delivery and it has high degree of liquidity.

The bills market is highly developed in industrial countries but it is very limited in

India. Commercial bills rediscounted by commercial banks with financial institutions amount

to less than Rs 1,000 crore. In India, the bill market did not develop due to (1) the cash credit

system of credit delivery where the onus of cash management rest with banks and (2) an

absence of an active secondary market.


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Measures to Develop the Bills Market:

One of the objectives of the Reserve Bank in setting up the Discount and finance

House of India was to develop commercial bills market. The bank sanctioned a refinance

limit for the DFHI against collateral of treasury bills and against the holdings of eligible

commercial bills.

With a view to developing the bills market, the interest rate ceiling of 12.5 per cent on

rediscounting of commercial bills was withdrawn from May 1, 1989.

To develop the bills market, the Securities and Exchange Board of India (SEBI) allowed, in

1995-96, 14 mutual funds to participate as lenders in the bills rediscounting market. During

1996-97, seven more mutual funds were permitted to participate in this market as lenders

while another four primary dealers were allowed to participate as both lenders and borrowers.

In order to encourage the bills culture, the Reserve Bank advised banks in October 1997 to

ensure that at least 25 percent of inland credit purchases of borrowers be through bills.

Size of the Commercial Bills Market:

The size of the commercial market is reflected in the outstanding amount of

commercial bills discounted by banks with various financial institutions.

The share of bill finance in the total bank credit increased from 1993-94 to 1995-96

but declined subsequently. This reflects the underdevelopment state of the bills market. The

reasons for the underdevelopment are as follows:

The Reserve Bank made an attempt to promote the development of the bill market byrediscounting facilities with it self till 1974. Then, in the beginning of the 1980s, the

availability of funds from the Reserve Bank under the bill rediscounting scheme was put on a

discretionary basis. It was altogether stopped in 1981. The popularity of the bill of exchange

as a credit instrument depends upon the availability of acceptance sources of the central bank

as it is the ultimate source of cash in times of a shortage of funds. However, it is not so in

India. The Reserve Bank set up the DFHI to deal in this instrument and extends refinance

facility to it. Even then, the business in commercial bills has declined drastically as DFHI

concentrates more on other money market instruments such as call money and treasury bills.


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It is mostly foreign trade that is financed through the bills market. The size of this market is

small because the share of foreign trade in national income is small. Moreover, export and

import bills are still drawn in foreign currency which has restricted their scope of negotiation.

A large part of the bills discounted by banks are not genuine. They are bills created by

converting the cash-credit/overdraft accounts of their customers.

The system of cash-credit and overdraft from banks is cheaper and more convenient than bill

financing as the procedures for discounting and rediscounting are complex and time

consuming.

This market was highly misused in the early 1990s by banks and finance companies which

refinanced it at times when it could to be refinanced. This led to channeling of money into

undesirable uses.

The development of bills discounting as a financial service depends upon the

existence of a full fledged bill market. The Reserve Bank of India (RBI) has constantly

endeavored to develop the commercial bills market. Several committees set up to examine the

system of bank financing, and the money market had strongly recommended a gradual shift

to bills finance and phase out of the cash credit system. The most notable of these were: (1)

Dehejia Committee, 1969, (2) Tandon Committee, 1974, (3) Chore Committee, 1980 and (4)

Vaghul Committee, 1985.This section briefly outlines the efforts made by the RBI in the

direction of the development of a full fledged bill market.


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CONCLUSION

In recent years, the money market is undergoing structural changes

in India. Many steps have been taken to transform the restricted and

narrow market to an active and broad market. There have been a

process of integration of the unorganised with the organised sector.

The RBI has taken initiatives to expand the reach of commercial

banks to rural areas. Setting up of the DFHI has led to widening of

call money market. Recently, Schemes for the development of

secondary market in commercial paper and for trading in CDs and

PCs have been initiated by the RBI. All attempts are being taken to

promote the bill culture and development of Money Market Mutual

Funds (MMMF). Various Credit rating agencies are been set up in the

last decade. RBI set up the Securities Trading Corporation of India

Ltd. (STCI) in 1994 to provide a secondary market in government

securities.

In view of these recent developments, the money market in India can

no longer be called an underdeveloped one.


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WEBLIGRAPHY

http://en.wikipedia.org/wiki/Money_market_in_Indiahttp://economictimes.indiatimes.com/markets/money-market

http://www.rbi.org.in/scripts/bs_viewmmo.aspxhttp://lurnq.com/lesson/Money-Market/section/Conclusion-Along-With-Recent-

Developments/
http://en.wikipedia.org/wiki/Money_market_in_Indiahttp://en.wikipedia.org/wiki/Money_market_in_Indiahttp://en.wikipedia.org/wiki/Money_market_in_Indiahttp://economictimes.indiatimes.com/markets/money-markethttp://economictimes.indiatimes.com/markets/money-markethttp://economictimes.indiatimes.com/markets/money-markethttp://www.rbi.org.in/scripts/bs_viewmmo.aspxhttp://www.rbi.org.in/scripts/bs_viewmmo.aspxhttp://www.rbi.org.in/scripts/bs_viewmmo.aspxhttp://lurnq.com/lesson/Money-Market/section/Conclusion-Along-With-Recent-Developments/http://lurnq.com/lesson/Money-Market/section/Conclusion-Along-With-Recent-Developments/http://lurnq.com/lesson/Money-Market/section/Conclusion-Along-With-Recent-Developments/http://lurnq.com/lesson/Money-Market/section/Conclusion-Along-With-Recent-Developments/http://lurnq.com/lesson/Money-Market/section/Conclusion-Along-With-Recent-Developments/http://lurnq.com/lesson/Money-Market/section/Conclusion-Along-With-Recent-Developments/http://lurnq.com/lesson/Money-Market/section/Conclusion-Along-With-Recent-Developments/http://www.rbi.org.in/scripts/bs_viewmmo.aspxhttp://economictimes.indiatimes.com/markets/money-markethttp://en.wikipedia.org/wiki/Money_market_in_India

importance of money market

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