Money Market

The money market is an organized exchange marketplace where participants can borrow or lend money. It enables the trading of short-term, high-quality debt instruments with an average maturity of a year or less. Banking and finance aspirants should have a clear understanding of the money market to prepare for Banking Awareness.

Key Points

• The money market facilitates the trading of short-term debt investments at wholesale and retail levels.
• At the wholesale level, it involves large volume trades between traders and institutions. At the retail level, it includes money market mutual funds purchased by individual investors and bank customers who open money market accounts.
• The money market comprises negotiable instruments such as certificates of deposits, commercial papers, treasury bills, etc.
• It is considered a safe haven for investment due to its highly liquid securities.

Overview

According to the Reserve Bank of India (RBI), the money market is a market where short-term financial assets are traded. These assets have a maturity period of one year or less and serve as a close substitute for money, enabling money exchange in the primary and secondary markets.

• The money market is a systemized framework that allows for the borrowing and lending of instruments with a maturity of less than a year.
• Within the financial market, there are two categories: the money market and the capital market.
• The money market is characterized by high liquidity and short maturity. Its components include non-banking finance corporations (NBFCs), acceptance houses, and commercial banks.
• Dealings in the money market involve instruments such as promissory notes, government papers, and trade bills, rather than money or cash.
• Transactions in the money market are not conducted through brokers but rather through oral or written communication or formal documentation.

Central Bank Policies:

• The central bank is responsible for guiding the country’s monetary policies and ensuring the proper functioning of the financial system.
• The money market enables the central bank to effectively implement its policy-making functions.

Enabling Industrial Growth:

• The money market provides businesses with an accessible framework to obtain short-term loans for their working capital needs.
• While the money market does not directly offer long-term loans, it can facilitate businesses in securing long-term financing, contributing to industrial growth.

Self-Sufficiency for Commercial Banks:

• The money market offers commercial banks a ready platform to invest their excess funds and earn interest while maintaining liquidity.
• Short-term investments, such as bills of exchange, can be easily converted into cash to meet customer withdrawal demands.

Types of Money Market

The Money Market in India is not an integrated unit and has two segments:

1. Unorganized Money Market
2. Organized Money Market

Let’s explore these two segments in more detail:

Unorganized Money Market**

Non-Banking Financial Intermediaries

Unregulated non-banking financial intermediaries operate as chit funds, nidhis, and loan companies. Indigenous bankers accept deposits and lend money to individuals and private firms. There are four types of indigenous bankers in India:

• Gujarati Shroffs
• Multani or Shikarpuri Shroffs
• Chettiars
• Marwari Kayas

Money Lenders

There are two types of money lenders:

1. Professional money lenders: These individuals lend their own money as a profession to earn interest income.
2. Non-professional money lenders: These individuals may be businessmen who lend their money to earn interest income as a secondary business.

Organized Money Market

The organized money market in India includes the following instruments:

• Treasury bills
• Cash management bills (CMBs)
• Certificates of Deposits (CDs)
• Commercial Papers (CPs)
• Commercial bills
• Money market mutual funds (SEBI)
• Repo/ Reverse Repo Market
• Discount & Finance House of India (DFHI)

With the exception of mutual funds, the Reserve Bank of India (RBI) regulates most money market instruments. The Securities and Exchange Board of India (SEBI) regulates mutual funds.

Classification of Money Market

Based on tenures within a year, the money market is classified into three categories:

1. Overnight or call market: Transactions have a tenure of one working day.
2. Notice money market: Transactions have a tenure ranging from 2 days to 14 days.
3. Term money market: Transactions have a tenure ranging from 15 days to one year.

Types of Money Market Instruments in India

The following are the different types of money market instruments available in India:

Treasury Bills (TBs)

• Treasury bills, also known as TBs, are considered one of the safest money market instruments.
• They are issued by the central government.

Treasury Bills

• Treasury bills are low-risk investments with modest returns.
• They have varying maturity periods, such as 3 months, 6 months, and 1 year.
• Treasury bills are traded in both primary and secondary markets.
• The interest earned is the difference between the maturity value and the purchase price, determined through auctions.

Commercial Papers

• Commercial papers resemble bills of exchange.
• Businesses issue them to meet short-term financial needs.
• They offer high liquidity, allowing easy transfer between individuals for immediate cash requirements.
• Commercial papers typically have a validity of 7 days to one year from issuance.
• They are issued at a discount, with the difference between the face value and the purchase price generating profit for the investor.

Certificate of Deposits (CDs)

• CDs are negotiable instruments known as term deposits, accepted by commercial banks.
• They are usually issued through promissory notes.
• CDs can be issued to trusts, individuals, corporations, etc., and can be discounted by scheduled commercial banks.
• The duration of CDs varies from 1 year to 3 months, but when issued by financial institutions, they can range from 1 year to 3 years.

Cash Management Bills

• Introduced in August 2009 by the Indian government and RBI, cash management bills are short-term instruments.
• They aim to address temporary cash flow mismatches faced by the government.
• Cash management bills are non-standard, discounted instruments with maturities less than 91 days.
• They share characteristics with treasury bills, are tradable, and qualify for ready forward facility.
• Banks consider investments in cash management bills as eligible investments in government securities for Statutory Liquidity Ratio (SLR) purposes.

Banker’s Acceptance (BA)

• A banker’s acceptance is a document guaranteeing future payment by a commercial bank.
• It is used in money market funds and specifies details such as the amount to be paid, repayment date, and recipient.
• The maturity period of a banker’s acceptance ranges from 30 days to 180 days.

Repurchase Agreements (Repo)

• Also known as Reverse Repo or simply Repo, these are short-term loans agreed upon by buyers and sellers for buying and repurchasing.
• Repo transactions are conducted only between parties approved by the Reserve Bank of India (RBI).

Money Market FAQs

What is a money market?

• A highly liquid, safe, and short-term market for debt securities.
• Often seen as cash equivalents that can be traded for money with a maturity of a year or less.

Examples of the money market:

• Treasury bills
• Repurchase agreements
• Commercial papers

Are the money markets safe?

• Considered relatively safer as they are insured by the Federal Deposit Insurance Corporation (FDIC).

Functions of the money market:

• Providing short-term funds
• Growth of investments
• Opportunity for commercial banks to operate in the economy

Segments of the money market:

• Organized money market
• Unorganized money market