Money Market: Features, Components, Instruments, Importance

  • Post last modified:21/02/2022
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What is Money Market?

A money market is a mechanism which makes it possible for borrowers and lenders to come together. Essentially it refers to a market for short-term funds. It meets the short-term requirements of the borrowers and provides liquidity of cash to the lenders.

Money market is the market in which short term funds are borrowed and lent. The money market does not deal in cash or money but in trade bills, promissory notes and government papers which are drawn for short periods. These short term bills are known as near money.

It does not refer to a particular place where short term funds are dealt with. It includes all individuals, institutions and intermediaries dealing with short term funds. It meets the short term requirements of the borrowers and provides liquidity or cash to lenders.


Money Market Definition

A money market is a mechanism through which short term funds are loaned and borrowed and through which a large part of the financial transaction of a particular country or of the world are cleared.” The Reserve Bank of India defines the money market as, The centre for dealing, mainly of short term character, in monetary assets, it meets the short term requirements of borrowers and provides liquidity or cash to the lenders.” – Madden and Nadler


Features of Money Market

Following are features of money market discuss in details:

  1. Existence of Unorganized Money Market
  2. Lack of Integration
  3. Multiplicity in Interest Rates
  4. Inadequate Funds
  5. Seasonal Stringency of Money
  6. Absence of Bill Market
  7. Inadequate Credit Instruments

Existence of Unorganized Money Market

This is one of the major defects of Indian money market. It does not distinguish between short term and long term finance, and also between the purposes of finance. Since it is outside the control and supervision of RBI, it limits the RBI’s control of over money market.

Lack of Integration

The Indian money market is broadly divided into two sectors, the organized money market and the unorganized market. The organized market constitutes several institutions such as RBI, State Bank of India, commercial banks, cooperative banks and financial institutions.

RBI as an apex body regulates their working. The unregulated sector is not homogenous in itself. It constitutes indigenous bankers, loan companies, money lenders, etc. There is no uniformity in their practices and there is multiplicity of functionaries.

Multiplicity in Interest Rates

There exists too many rates of interest in the Indian money market such as the borrowing rate of government, deposits and lending rates of cooperative and commercial banks, lending rates of financial institutions, etc.

This is due to lack of mobility of funds from one section of the money market to another. The rates differ for funds of same durations lent by different institutions.

Inadequate Funds

Generally there is shortage of funds in Indian money market on account of various factors like inadequate banking facilities, low savings, lack of banking habits, existence of parallel economy, etc. However, the banking development particularly branch expansion, has improved the mobilization of funds to some extent in the recent years.

Seasonal Stringency of Money

The seasonal stringency of money and high rate of interest during the busy season (November to June) is a striking feature of Indian money market. There are wide fluctuations in the interest rates from one season to another.

RBI has been taking various measures to avoid such fluctuations in the money market by adding money into the money market during the busy season and withdrawing the funds during the slack season.

Absence of Bill Market

A well organized bill market is necessary for linking up various credit agencies effectively to RBI. The bill market is not yet developed on account of many factors such as the practice of banks keeping a large amount of cash for liquidity purposes, preference for borrowing rather than discounting bills, dependence of indigenous bankers on one another, widespread practice of using cash credit, high stamp duty on usance bill, etc.

Inadequate Credit Instruments

The Indian money market did not have adequate short term paper instruments till 1985-86. There were only call money and bill markets. Moreover there were no specialist dealers and brokers dealing in the money market. After 1985-86, RBI has introduced new credit instruments such as 182-day treasury bills, 364-day treasury bills, CDs and CPs.

These instruments are still in an underdeveloped state in India. The above defects of Indian money market clearly indicate that it is relatively less developed and has yet to acquire sufficient depth and width. Thus, it cannot be compared with developed money markets such as London and New York money markets.


Importance of Money Market

  • Dealing in bills of exchange and commercial papers

  • Acting as an outlet for the excess short term funds of commercial banks

  • Dealing in treasury bills and short dated government securities

  • Guiding central banking policies

  • Making central banking policies effective

  • Reduction of disparities in interest rates

  • Influencing the capital market

Components of Indian Money Market

The money market provides a mechanism for evening out short-term liquidity imbalances within an economy. The development of the money market is thus, a prerequisite for the growth and development of the economy of a country.

The main components of Indian money market are:

  1. Organized Money Market
  2. Unorganized Money Market
  3. Sub Market

Organized Money Market

These markets have standardized and systematic rules, regulations and procedures to govern the financial dealings .Organized money market are governed and regulated by Government and Reserve Bank of India.

It consists of Reserve Bank of India and other banks, financial institutions, specialized financial institutions, non-banking financial institutions, quasi government bodies and government bodies who supply funds through money market.

Unorganized Money Market

Unorganized market consists of indigenous bankers and money lenders. They collect deposits and lend money. A part from them there are certain private finance companies or non-banking companies, chit funds etc.

Reserve Bank of India has taken a number of steps to regulate such type of institutions and bring them in the organized sector. One of such step is issuing of non-banking Financial Companies Act, 1998.

Sub Market

It consists of call money market and bill market. Bill market consists of commercial bill market and Treasury bills market, certificates of deposits, and commercial papers.


Structure of Money Market

The main components of Indian money market are unorganized banking sector, organized banking sector with several sub markets which deals with borrowing and lending of short-term credits:

  1. Unorganized Banking Sector
  2. Organized Banking Sector

Unorganized Banking Sector

The economy, on one hand, performs through organized sector and on other hand in rural areas there is a continuance of unorganized, informal and indigenous sector. The unorganized money market mostly finances the short-term financial needs of farmers and small businessmen. The main constituents of an unorganized money market are

Indigenous Bankers (IBs)

Indigenous bankers are individuals or private firms who receive deposits and give loans and thereby operate as banks. IBs accept deposits as well as lend money. They mostly operate in urban areas, especially in western and southern regions of the country.

The volume of their credit operations is however not known. Further their lending operations are completely unsupervised and unregulated. Over the years, the significance of IBs has declined due to the growing organized banking sector.

Money Lenders (MLs)

Money lenders constitute one of the components of the organized money market of our country. Money lenders are those persons who do not accept deposits from public, but merely lend their own funds. They lend money mainly for consumption and other domestic purposes.

They are mainly two categories of money lenders.

  1. Non-professional money lenders: these are those persons who combine money lending with other activities.
  2. Professional money lenders: they are those persons whose main business is to lend money. It may be of two types.
    1. Resident money lenders : Maharaja, Sahukars, Seths or Banias.
    2. Itinerant money lenders: Pathans, Kabulis and Qustwalas.

Non Banking Financial Companies (NBFCs)

NBFC’s consist of the following:

Chit Funds

Chit funds are savings institutions. It has regular members who make periodic subscriptions to the fund. The beneficiary may be selected by drawing of lots. Chit fund is more popular in Kerala and Tamilnadu. RBI has no control over the lending activities of chit funds.

Nidhis

Nidhis operate as a kind of mutual benefit for their members only. The loans are given to members at a reasonable rate of interest. Nidhis operate particularly in South India.

Loan or Finance Companies

Loan companies are found in all parts of the country. Their total capital consists of borrowings, deposits and owned funds. They give loans to retailers, wholesalers, artisans and self-employed persons. They offer a high rate of interest along with other incentives to attract deposits. They charge high rate of interest varying from 36% to 48% p.a.

Finance Brokers

They are found in all major urban markets especially in cloth, grain and commodity markets. They act as middlemen between lenders and borrowers. They charge commission for their services.

Organized Banking Sector

It consists of the Reserve Bank of India, the State Bank of India and its seven subsidiaries, 19 nationalized banks, the other joint-stock banks including commercial banks, cooperative banks, Regional Rural Banks, special institutions like LIC, UTI, IDBI, SFCs, NABARD, Exim bank etc.

DFHI, non-banking companies and quasi Government bodies and large companies which supply funds in the money market through banks. Reserve Bank of India (RBI) is the central bank and monitory authority of our country. So RBI is the leader of Indian money market.


Types of Money Market Instruments

The present organisation of the money market in India covers the many segments such as:

  1. Reserve Bank of India (RBI)
  2. Treasury Bills Market (T-Bills)
  3. Commercial Bills Market
  4. Commercial Papers Market (CPs)
  5. Call Money Market
  6. Certificate of Deposits Market (CDs)
  7. Primary Dealers
  8. Money Market Mutual Funds

Reserve Bank of India (RBI)

The RBI is like a brain behind the money market and the main regulator of the banking system. The functions/roles of the RBI comprise of note issuing authority (issue of currency), Government banker, bankers’ bank, supervisory authority, promoter of the financial system and regulator of money and credit (monetary authority).

Treasury Bills Market (T-Bills)

A T-bill is an instrument of short-term borrowing by the Government of India. It is a particular kind of finance bill (i.e. a bill that does not arise from any genuine transaction in goods) or a promissory note issued by the RBI on behalf of the Government. T-bills are issued to raise short-term funds to bridge seasonal/temporary gaps between receipts (revenue and capital) and expenditure of the Government of India.

The main features of T-bills are:

  1. These are negotiable securities.

  2. Theseare issued at discount and are repaid at par on maturity. The difference (discount) between the price at which they are sold and their redemption value is the effective return on T-bills.

  3. Absence of default risk due to Government guarantee and RBI’s willingness to always purchase/discount them, negligible capital depreciation.

  4. Assured yield.

  5. Low transaction cost.

  6. Eligibility for inclusion in SLR.

  7. Purchases/sales effected through the SGL (Subsidiary General Ledger) Account with the RBI.

Commercial Bills Market

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

The seller (drawer) draws bills of exchange on the buyer (drawee) for the value of the goods delivered by him. Such bills are called trade bills. Commercial banks can be inland or foreign. Inland bills are drawn/payable in India or drawn upon any person resident in India. Foreign bills are (i) drawn/payable outside India, (ii) drawn on a party/payable in India or drawn in India/payable outside India.

A related classification is export and import bills. While export bills are drawn by exporters in any country outside India, import bills are drawn on importers in India by overseas exporters. When trade bills are accepted by commercial banks, they are called commercial bills. If the seller gives some time for payment, the bill is payable at a future date (usance bill).

During the currency of the bill, if the seller is in need of funds, he may approach his bank for discounting the bill (discounted bill). One of the methods used by banks for providing credit to customers is by discounting commercial bills at a negotiated discount rate.

The bank receives the maturity proceeds (face value) of discounted bills from the drawee. Meanwhile, if the bank is in need of funds, it can rediscount the bills already discounted in the Commercial Bill Discount Market.

Commercial Papers Market (CPs)

Following the recommendations of the Vaghul Committee in March 1989, the RBI permitted the issue of CPs within the framework of its guidelines, which were modified from time to time to enhance their suitability as money market instruments.

The CP is a short-term unsecured negotiable instrument consisting of usance primary notes with a fixed maturity, thus, indicating the short-term obligation of an issuer. It is generally issued by companies as a means of raising short-term debt and, by a process of securitization, inter- mediation of the bank is eliminated. The PDs and all-India financial institutions can also issue CPs.

It is issued on a discount to face value basis but it can also be issued in interest-bearing form. The issuer promises the buyer a fixed amount at a future date but pledges no assets. His liquidity and earning power are the only guarantee. In other words, the CP is not tied to any specific self-liquidating trade transaction in contrast to the commercial bills that arise out of specific trade/commercial transactions.

A CP can be issued by a company directly to the investor or through bank/merchant banks (dealers). When the companies directly deal with the investors, rather than use a securities dealer as an intermediary, the CP is called a direct paper. Such companies/borrowers announce the current rates of CPs of various maturities.

Investors can then select those maturities that closely approximate their holding period and acquire the security/ paper directly from the issuer. When CPs are issued by security dealer/dealers on behalf of their corporate customers, they are called dealer papers. They buy at a price less the commission and sell at the highest possible level.

It is generally backed by a revolving underwriting facility from banks to ensure continuous availability of funds on each roll-over of the CP. Moreover, unlike commercial bills, maturities within the range can be tailored to specific requirements.

Call Money Market

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

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 regulators has prescribed limits on the banks and primary dealer’s operation in the call/notice money market.

Call markets represent the most active segment of the debt markets. Though the demand for funds in the call market is mainly governed by the banks’ need for resources to meet their statutory reserve requirements, it also offers to some participants a regular funding source for building up short-term assets. However, the demand for funds for reserve requirements dominates any other demand in the market.

Certificate of Deposits Market (CDs)

A Certificate of Deposits Market is a document of title to a time deposit and can be distinguished from a conventional time deposit in respect of its free negotiability and, hence, marketability. In other words, CDs are a marketable receipt of funds deposited in a bank for a fixed period at a specified rate of interest. They are bearer documents/instruments and are readily negotiable.

They are attractive to the bankers and the investors in the sense that the former is not required to encash the deposit prematurely, while the latter can sell the CDs in the secondary market before its maturity and thereby the instrument has liquidity/ready marketability.

Based on the recommendations of the Vaghul Committee, the RBI formulated a scheme in June 1989 for the issue of CDs by scheduled banks (excluding RRBs). The RBI guidelines pro- vide the framework for its operations. In order to broad base the primary market, and also to develop an active secondary market, modifications have been introduced from time to time in the limit for issue of CDs, minimum size, denomination and so on.

Primary Dealers

In accordance with the announcement of the monetary policy, on May 14, 1994 to introduce a system of Primary Dealers (PDs):

  1. To strengthen the infrastructure in the Government securities market, including the money market, in order to make it vibrant, liquid and broad based.

  2. To ensure the development of underwriting and market capabilities for Government securities outside the RBI so that the latter will gradually shed these functions.

  3. To improve the secondary market trading system, which would contribute to price discovery, enhance liquidity and turnover and encourage voluntary holding of Government securities amongst a wider investor base.

  4. To make PDs an effective conduit for conducting open market operations (OMOs). The following classes of institutions are eligible to apply for primary dealership.

  5. Subsidiaries of scheduled commercial bank(s) and all-India financial institution(s) dedicated predominantly to the securities business and in particular to the Government securities market.

  6. Companies incorporated under the Companies Act, 1956 and engaged predominantly in the securities business and in particular to the Government securities market.

  7. Subsidiaries/joint ventures set up by entities incorporated abroad under the approval of the Foreign Investment Promotion Board (FIPB).

The applicant should have owned funds (NOFs) of a minimum of `50 crore, consisting of paid- up equity capital, free reserves, balance in share premium account and capital reserves representing a surplus arising out of sale proceeds of assets but not reserves created by the revaluation of assets, less accumulated loss balance, deferred revenue expenditure and other intangible assets.

The decision to enlist PDs would be taken by the RBI based on its perception of market needs, suitability of the applicant and the likely value addition to the system.

Money Market Mutual Funds

The sophistication and versatility of the money market is reflected in the diversity of money market instruments to suit the varied needs of market participants. The money market instruments outlined earlier in the chapter deals with wholesale transactions involving large amount and are suitable for large corporate and institutional investors.

To enable small investors to participate in the money market, a money market mutual fund (MMMF) works as a conduit through which they can earn the market related yield. In April 1991, the RBI outlined a broad framework for setting up these institutions.

As a follow-up, in September 1991, a Task Force was appointed to work out the operating guidelines for the setting up of MMMFs. Following the recommendations of the Task Force, in April 1992, the RBI announced detailed guidelines in this regard.

Despite the lapse of three years since the guidelines were issued, MMMFs continued to be consciously absent in the money market in India. View a view to imparting greater liquidity and depth to the money market and in order to make the scheme more flexible and attractive to banks and financial institutions, certain modifications to the existing scheme were introduced in December 1995.

In its credit policy, announced on October 29, 1999, the RBI stipulated that from the angle of consistent policy, with regard to investor protection, MMMFs would be brought under the umbrella of the SEBI regulations like other mutual funds. Once the SEBI regulatory framework for MMMFs was in place, the RBI would withdraw its guidelines.

However, banks/FIs desirous of setting up MMMFs would have to take necessary clearance from the RBI before approaching the SEBI for registration. The SEBI Mutual Fund Regulations (discussed in a subsequent chapter) are since 2000 applicable to money market mutual funds also.

However, the growth in MMMFs has been less than expected. The size of the MMMF schemes floated by three sponsors is rather small. The MMMFs would hopefully grow when the Indian money market would grow in volume and acquire depth.


Defects of Indian Money Market

The Indian money market is relatively underdeveloped when compared with advanced markets like New York and London Money Markets. It’s main deficiencies/defects are as follows:

Dichotomy

A major feature of Indian Money Market is the existence of dichotomy i.e. existence of two markets: Organized Money Market and Unorganized Money Market.

Organized Sector consists of RBI, Commercial Banks, Financial Institutions etc. The Unorganized Sector consist of IBs, MLs, Chit Funds, Nidhis etc. It is difficult for RBI to integrate the Organized and Unorganized Money Markets. Several segments are loosely connected with each other. Thus there is a dichotomy in the Indian Money Market.

Lack of Co-ordination and Integration

It is difficult for RBI to integrate the organized and unorganized sectors of the money market. RBT is fully effective in organized sector but unorganized market is out of RBI’s control. Thus there is lack of integration between various sub-markets as well as various institutions and agencies. There is less coordination between cooperative and commercial banks as well as State and Foreign banks. The indigenous bankers have their own ways of doing business.

Diversity in Interest Rates

There are different rates of interest existing in different segments of money market. In rural unorganized sectors, the rate of interest are high and they differ with the purpose and borrower. There are differences in the interest rates within the organized sector also. Although wide differences have been narrowed down, yet the existing differences do hamper the efficiency of the money market.

Seasonality of Money

Market Indian agriculture is busy during the period November to June resulting in heavy demand for funds. During this period money market suffers from a Monetary Shortage resulting in a high rate of interest. During slack season rate of interest falls &s there are plenty of funds available. RBI has taken steps to reduce the seasonal fluctuations, but still, the variations exist.

Shortage of Funds

In Indian Money Market demand for funds exceeds the supply. There is a shortage of funds in the Indian Money Market on account of various factors like inadequate banking facilities, low savings, lack of banking habits, existence of parallel economy etc. There is also vast amount of black money in the country which has caused a shortage of funds. However, in recent years development of banking has improved the mobilization of funds to some extent.

Absence of Organized Bill Market

A bill market refers to a mechanism where bills of exchange are purchased and discounted by banks in India. A bill market provides short-term funds to businessmen. The bill market in India is not popular due to overdependence of cash transactions, high discounting rates, the problem of dishonour of bills etc.

Inadequate Banking Facilities

Though commercial banks have been opened on a large scale, yet banking facilities are inadequate in our country. The rural areas are not covered due to poverty. Their savings are very small and mobilization of small savings is difficult. The involvement of the banking system in different scams and the failure of RBI to prevent these abuses of the banking system shows that the Indian banking system is not yet a well-organized sector.

Inefficient and Corrupt Management

One of the major problems of the Indian Money Market is its inefficient and corrupt management. Inefficiency is due to faulty selection, lack of training, poor performance appraisal, faulty promotions etc. For the growth and success of the money market, there is need for a well-trained and dedicated workforce in banks. However, in India some of the bank officials are inefficient and corrupt.

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