There are two kinds of markets where borrowing and lending of money takes place between fund scarce and fund surplus individuals and groups. The markets which cater to the need of short term funds are called Money Markets while the markets that cater to the need of long term funds are called Capital Markets.
Thus, money markets is that segment of financial markets where borrowing and lending of the short-term funds takes place. The maturity of the money market instruments is one day to one year. In our country, Money Markets are regulated by both RBI and SEBI. Money markets are also sometimes called discount markets.
How Money markets are different from capital markets?
While money markets are markets for short term fund needs; capital markets are markets for long term funds, debts, equity, shares etc.
- Call Money, Notice Money and Term Money Markets
- Bill market
- Treasury Bills
- Certificate Of Deposits (CDs)
- Who can Issue a Certificate of Deposit?
- What is Minimum amount for Certificate of Deposit?
- What is maturity tenure of Certificates of Deposits?
- What is Return on Certificates of Deposits?
- How CDs can be transferred from one person to other?
- What is the lock in period for certificates of deposits
- What are conditions before banks when they issue Certificates of Deposit?
- Commercial Paper (CP)
- Money Market Mutual Funds (MMMFs)
- Repo and Reverse Repo auctions
- Discount And Finance House of India (DFHI)
- Various problems of Money Markets in India
- Salient features of Indian Money Market
- Main functions of Money Markets
- Monetary Aggregates
Segments of money markets in India
Money Market in India is divided into unorganized sector and organized sector. The Unorganized market is old Indigenous market which includes indigenous bankers, money lenders etc. Organized market includes Governments (Central and State), Discount and Finance House of India (DFHI), Mutual Funds, Corporate, Commercial / Cooperative Banks, Public Sector Undertakings (PSUs), Insurance Companies and Financial Institutions and Non-Banking Financial Companies (NBFCs). Organized Money Market is regulated by RBI as well as SEBI.
Various instruments of Money Markets
The organized money market in India is not a single market but is a conglomeration of markets of various instruments, which are called Sub-markets of Money Market. These include Call Money / Notice Money / Term Money Market, Treasury Bills, Commercial Bills, Certificates of Deposits, Commercial Bills, Commercial Papers, Money Market Mutual Funds and Repo / Reverse Repo. The most active segment of the money market is “Overnight Call market” or repo.
Call Money, Notice Money and Term Money Markets
Call Money, Notice Money and Term Money markets are sub-markets of the Indian Money Market. These refer to the markets for very short term funds. Call Money refers to the borrowing or lending of funds for 1 day. Notice Money refers to the borrowing and lending of funds for 2-14 days. Term money refers to borrowing and lending of funds for a period of more than 14 days.
Why the call / notice money market is called Inter-Bank Market?
In India, 80% demand comes from the public sector banks and rest 20% comes from foreign and private sector banks. Then, around 80% of short term funds are supplied by Financial Institutions such as IDBI and Insurance giants such as LIC. Rest 20% of the short term funds come from the banks. In this way, major players in call / notice money markets are banks and financial institutions, which are both lenders and borrowers. Due to this, the call / notice money market is also called Inter-Bank Market.
Interest rates in call / notice money markets
Call Money / Notice Money market is most liquid money market and is indicator of the day to day interest rates. If the call money rates fall, this means there is a rise in the liquidity and vice versa. Interest Rates in Call / Notice Money Markets are market determined i.e. by the demand and supply of short term funds. The intervention of RBI is prominent in the short term funds money market in India and it can influence the rates prominently.
MIBOR refers to Mumbai Interbank Offer Rate. It is the standard reference of interest rates in call / notice money markets in India. It is the average of the call money rates offered by a set of specific banks on a given day. MIBOR is calculated by the NSE (National Stock Exchange) after taking quotes from a specific set of Banks. MIBOR serves as a benchmark to which various entities in the market benchmark their short term interest rates.
Where do you find the call / notice money market in India?
The short term fund market in India is located only in big commercial centres such as Mumbai, Delhi, Chennai and Kolkata.
Bill is a generic term which can mean a bank note, an invoice, a bill of exchange, bill of lading (in export-import business), waybill (in shipments) etc. In case of money market; bills are short term money market instruments. The bill market is a sub-market of the money market in India. There are two types of bills viz. Treasury Bills and commercial bills. While Treasury Bills or T-Bills are issued by the Central Government; Commercial Bills are issued by companies/ financial institutions.
Treasury means government treasury. The Treasury Bills or T-Bills are short term money market instruments which are released by Central Government of India to meet its need short term funds. They were introduced in 1917 for the first time.
Kindly note, State Governments don’t issue Treasury Bills. The maturity of Treasury Bills in India is less than 365 days. At present, the active T-Bills are 91-days T-Bills, 182-day T-Bills and 364-days T-Bills. In 1997, the Government had also introduced the 14-day intermediate treasury bills. Auctions of T-Bills are conducted by RBI.
How the lenders earn interest on T-Bills?
Central Government issues the T-Bills on a discount to face value, however, the lender / investor gets the face value on maturity. The return on T-Bills is the difference between the issue price and face value. This return o depends upon auctions. When the liquidity position in the economy is tight, returns are higher and vice versa. Interest on the treasury bills is determined by market forces.
Who can purchase T-Bills?
Individuals, Firms, Trusts, Institutions and banks can purchase T-Bills. The commercial and cooperative banks can use T-Bills for fulfilling their SLR requirements, because they are government securities. Treasury bills are available for a minimum amount of Rs. 25,000 and in multiples of Rs. 25,000.
What are advantages of T-Bills to Government and Investors?
Objective of issuing T-Bills is to fulfill the short term money borrowing needs of the government. For investors, T-bills have an advantage over the other instruments such as:
- Zero Risk weightage associated with them, because they are issued by government.
- High liquidity because 91 days and 364 days are short term maturity.
- Thesecondary market of T-Bills is very active so they have a higher degree of tradability.
Commercial bills market is basically a market of instruments similar to Bill of Exchange. The participants of commercial bill market in India are banks and financial institutions but this market is not yet developed.
Certificate Of Deposits (CDs)
Certificate of Deposit (CD) is yet another money market instrument, which is negotiable and equivalent to a promissory note. It is either issued in demat form or in the form of a usance promissory note. This instruments is issue in lieu of the funds deposited at a bank for a specified time period.
Who can Issue a Certificate of Deposit?
A Certificate of Deposit in India can be issue by:
- All scheduled commercial banks excluding Regional Rural Banks (RRBs) and Local Area Banks (LABs)
- Select All India Financial Institutions permitted by RBI
A commercial bank can issue Certificate of Deposit as per its own requirements. A financial institution can issue Certificate of Deposit within a limit prescribed by RBI. A thumb rule for FI is that CD together with other instruments, viz. term money, term deposits, commercial papers and inter-corporate deposits should not exceed 100 per cent of its net-owned funds, as per the latest audited balance sheet.
Certificate of Deposit can be issued to individuals, corporations, companies, trusts, funds, associations etc. The No resident Indians are also eligible for CDs provided they don’t repatriate the funds.
What is Minimum amount for Certificate of Deposit?
- Minimum amount for Certificate of Deposit in India has been fixed at Rs. 1 Lakh, to be accepted from a single subscriber
- Larger amounts have to be in the multiples of Rs. 1 Lakh.
What is maturity tenure of Certificates of Deposits?
Certificates of Deposit are money market instruments and their maturity period is between seven days to one year for commercial banks. For Financial Institutions, the maturity is not less than a year and not more than three years.
What is Return on Certificates of Deposits?
The CDs are issued at a discount on face value. Return on them is difference between the issue value and face value.
How CDs can be transferred from one person to other?
If CD has been issued in physical form (as usance promissory notes), they can be freely transferred by endorsement and delivery. If they have been released in Demat form, they can be transferred as per the procedure applicable to other demat securities.
What is the lock in period for certificates of deposits
There is no lock-in period for certificates of deposit
What are conditions before banks when they issue Certificates of Deposit?
Banks/FIs cannot grant loans against CDs. They cannot buy back their own CDs before maturity. Banks need to maintain cash reserve ratio (CRR) and statutory liquidity ratio (SLR), on the issue price of the CDs.
Commercial Paper (CP)
Commercial Paper (CP) is yet another money market instrument, which was first introduced in 1990 to enable the highly rated corporates to diversify their resources for short term fund requirements. They are issued either in the form of a promissory note or in a dematerialized form through any of the depositories approved by and registered with SEBI. They are essentially unsecured debt instruments.
Who is eligible to issue commercial papers?
Corporate, Primary Dealers and All India Financial Institutions are eligible to issue CP. To be eligible to issue Commercial Paper, the Corporate need to have a tangible net worth of minimum Rs. 4 Crore. Further,
- the company must have been sanctioned working capital limit by banks or all-India financial institutions
- The borrower account of the company should be high rated i.e. it should be classified as Standard Asset by the Financial Institutions.
Also, the Corporate, Primary Dealers as well as Financial Institutions must obtain the credit rating for issuance of Commercial Paper either from Credit Rating Information Services of India Ltd. (CRISIL) or the Investment Information and Credit Rating Agency of India Ltd. (ICRA) or the Credit Analysis and Research Ltd. (CARE) or the FITCH Ratings India Pvt. Ltd. or such other credit rating agency (CRA) as may be specified by the Reserve Bank of India from time to time, for the purpose.
What are Denominations and Maturity of Commercial Paper?
Maturity of Commercial Paper is minimum of 7 days and a maximum of up to one year from the date of issue. CP can be issued in denominations of Rs.5 lakh or multiples thereof.
Who can Invest in CP?
Individuals, banking companies, other corporate bodies (registered or incorporated in India) and unincorporated bodies, Non-Resident Indians (NRIs) and Foreign Institutional Investors (FIIs) etc. can invest in CPs. However, investment by FIIs would be within the limits set for them by Securities and Exchange Board of India (SEBI) from time-to-time.
What is return on CP?
CP is issued at a discount to face value as may be determined by the issuer. The difference between issue price and face value is return. Further, CPs are traded in the OTC markets.
What is difference between Commercial Paper and Certificates of Deposits?
- CD is issued by the Commercial banks and Finance Institutions, while commercial papers are issued by corporates, primary dealers (PDs) and the All-India Financial Institutions (FIs).
- CD is issued for Rs. 1 Lakh or its multiples while CP is issued in denominations of Rs.5 lakh or multiples thereof.
Money Market Mutual Funds (MMMFs)
Money Market Mutual Funds (MMMFs) were introduced by RBI in 1992 but since 2000, they are brought under the purview of the SEBI. They provide additional short-term avenue to individual investors.
Repo and Reverse Repo auctions
Repo (repurchase agreement ) was introduced in December 1992. Repo means selling a security under an agreement to repurchase it at a predetermined date and rate. Repo transactions are affected between banks and financial institutions and among bank themselves, RBI also undertake Repo. IN 1996, Reverse Repo was introduced. Reverse Repo means buying a security on a spot basis with a commitment to resell on a forward basis. Reverse Repo transactions are affected with scheduled commercial banks and primary dealers.
Discount And Finance House of India (DFHI)
Discount and Finance House of India was established in 1988 by RBI and is jointly owned by RBI, public sector banks and all India financial institutions, which have contributed to its paid up capital. DFHI plays important role in developing an active secondary market in Money Market Instruments. From 1996, it has been assigned status of a Primary Dealer (PD). It deals in treasury bills, commercial bills, CDs, CPs, short term deposits, call money market and government securities.
Various problems of Money Markets in India
Indian money market is relatively underdeveloped when compared with advanced markets like New York and London Money Markets. Various problems of money markets in India include Dichotomy, Lack of Coordination & Integration, Diversity in the Interest Rates, Seasonality in the markets, shortage of funds, absence of a developed Bill market, Inefficient management etc.
Overall, India’s money markets are relatively less developed and have yet to acquire sufficient depth and width.
Salient features of Indian Money Market
Salient features of Indian Money Market includes:
- Presence of large unorganized market
- Less developed and less popular in comparison to developed countries.
- Seasonal interest rates. Too much difference in interest rates in busy season and slack season.
- The busiest season is November to May-June, funds are required to move the crops and this busy season causes lack of liquidity and hike in the interest rates.
- Highly volatile call / notice money market.
Main functions of Money Markets
Due to short maturity term, the instruments of money market are liquid and can be converted to cash easily and thus are able to address the need of the short term surplus fund of the lenders and short term borrowing requirements of the borrowers. Thus, the major function of the money markets is to cater to the short term financial needs of the economy. The other functions are as follows:
- Money Markets help in effective implementation of the RBI’s monetary policy
- Money markets help to maintain demand and supply equilibrium with regard to short term funds
- They cater to the short term fund requirement of the governments
- They help in maintaining liquidity in the economy
Money supply & Total Stock of Money
All the money held with public, RBI as well as government is called Total Stock of Money. Money Supply is that part of this Total Stock of Money which is with public. By public we refer to the households, firms, local authorities, companies etc. Thus, public money does not include the money held by the government and the money held as CRR with RBI and SLR with themselves by commercial banks. The reason of excluding the above two categories from money supply is that this money held by the Government and RBI is out of circulation. Thus, we can conclude that the money in circulation is the money supply. This money may be in the following forms:
- Currency Notes and Coins
- Demand Deposits such as Saving Banks Deposits ,
- Other Deposits such as Time Deposits / Term Deposits / Fixed Deposits
- Post Office Saving Accounts
- Cash in Hand (Except SLR) and Deposits of Banks in other Banks / RBI (except CRR)
In other way, this money has two components viz. Currency Component and Deposit Component. Currency Component consist of all the coins and notes in the circulation, while Deposit component is the money of the general public with the banks, which can be withdrawn by them using cheques, withdrawals and ATMs. Deposit can be either Demand Deposit or Time Deposit.
The Reserve bank of India calculates the four concepts of Money supply in India. They are called Monetary Aggregates or Money Stock Measures. These monetary aggregates are: M1 (aka Narrow Money; M2, M3 (aka Broad Money) and M4. Further, there is one more concept called M0 or Reserve Money.
Narrow Money (M1)
At any point of time, the money held with the public has two most liquid components
- Currency Component: This consists of all the coins and notes in the circulation
- Demand Deposit Component: Demand Deposit component is the money of the general public with the banks, which can be withdrawn by them using cheques, withdrawals and ATMs.
The above two components i.e. currency component and demand deposit component of the public money is called Narrow Money and is denoted by the RBI as M1. Thus,
M1 = Currency with the public + Demand Deposits of public in Banks
When a third component viz. Post office Savings Deposits is also added to M1, it becomes M2.
M2 = M1 + Post Office Savings.
Narrow money is the most liquid part of the money supply because the demand deposits can be withdrawn anytime during the banking hours. Time deposits on the other hand have a fixed maturity period and hence cannot be withdrawn before expiry of this period. When we add the time despots into the narrow money, we get the broad money, which is denoted by M3.
M3 = Narrow money + Time Deposits of public with banks
We note here that the Broad money does not include the interbank deposits such as deposits of banks with RBI or other banks. At the same time, time deposits of public with all banks including the cooperative banks are included in the Broad Money.
Now, we understand that the major distinction between the M1 and M3 is “Treatment of deposits with the banks”. If we go a little deep, the M3 is the treatment of “Time Deposits” of the public, since demand deposits are available against cheques and ATMs.
When you add the Post Office Savings money also into the M3, it becomes M4.
Why M2 and M4 are irrelevant in monetary aggregates?
Both M2 and M4 which include the Post office Savings with narrow money and broad money respectively are now a days irrelevant. Post Office savings was once a prominent figure when the banks had not expanded in India as we see them today all around. The RBI releases the data at times regarding the money supply in India and Post Office Savings Deposits have not been updated frequently. There is NOT much change in the money of people deposited with the Post office and RBI did not care to update this money. Further, there was a time when the Reserve Bank used broad money (M3) as the policy target. However, with the weakened relationship between money, output and prices, it replaced M3 as a policy target with a multiple indicators approach. RBI started using the Multiple Indicator Approach since 1998
Currently, Narrow Money (M1) and Broad Money (M3) are relevant indicators of money supply in India. The RBI in all its policy documents, monthly Bulletins and other documents shows these aggregates.
Reserve Money (M0)
The other name of the Reserve Money is “High Powered Money” and also “Monetary Base”. Reserve Money is all the Cash in the economy and denoted by M0. This has the following components:
- Currency with the Public
- Other Deposits with the RBI
- Cash Reserves of the banks held with themselves
- Cash Reserves of the Banks held with RBI
Here we should know that Cash Reserves are also of two types viz. Required Reserves (RR) and Excess Reserves (ER). RR are those reserves which the banks are statutorily required to keep with the RBI. At present the Banks are required to keep 4.25% CRR (Cash Reserve Ratio) of their total time and demand liabilities. All reserves excess of RR are called Excess Reserves. ER are held with the Banks while RR is held with RBI. Banks hold the ER to meet their currency drains i.e. withdrawal of currency by depositors.