what is money market instruments? | Reforms in Indian Money Market 2021
what is money market instruments?
What is the Money Market?
- The money market is a type of market where lending and borrowing funds for a short period. The Money market deals in short-term funds and financial instruments for the period of one day to one year or less. In the money market financial instruments are highly liquid and converted into cash within a short period.
- In the money market, various instruments are used for lending and borrowing such as call money, commercial bills, treasury bills, certificates of deposits, commercial papers, etc. It is a wholesale market for a short-term debt instrument.
Different Segments and Instruments of Money Market
Call Money Market / Notice Money Market
The lending and borrowing of money for one day are called call money. normally banks depend on the call money market to raise funds for a day. And lending of money for one day to 14 days is called notice money. In the case of notice money, no specific date is given for repayment of funds but generally, borrowers have to make the payment on the given date. The rate of interest in call money is called the call money rate which is determined by the demand and supply of funds.
Treasury bills are issued by the Reserve Bank of India (RBI) on behalf of the Government of India. It is a short-term and main instrument borrowed by the government. Government issue three types of treasury bills by auction, 91 days, 182 days, and 364 days treasury bills.
The commercial bill is a short-term negotiable instrument drawn by a seller on the buyer for the value of goods delivered by the seller. This is a self-liquidating instrument with low risk. This bill also called trade bills which are accepted by commercial banks are called commercial bills. The maturity period of commercial bills is generally 90 days but if the seller needs urgent funds, he can rediscount the bill from the banks.
Certificate of Deposit
Certificates of Deposits were introduced in India in June 1989. Certificates of Deposits issued by commercial banks and development financial institutions. This helps the commercial banks to raise the funds from the market through CDs. The minimum size of issues for a single investor is Rs. 1 lakh and the maturity period is three months to one year.
Commercial Papers (CPs)
Commercial Papers were introduced in January 1990 in India to provide highly rated corporate borrowers with to diversify short-term borrowing. It is an unsecured money market instrument issued in the form of promissory notes with a fixed maturity. commercial papers are highly liquid and quite safe. The maturity of commercial papers for a minimum of 7 days and a maximum of one year.
Repo rate is the rate at which commercial bank borrows money from the Reserve Bank of India by selling their securities in the case of a shortage of funds to maintain liquidity. The Reserve repo rate is the rate at which the Reserve Bank of India(RBI) borrows money from the banks to flow away liquidity from the system.
Money Market Mutual Funds(MMMFs):
MMMFs were introduced by RBI in April 1992 to enable small investors to participate in the money market. MMMFs mobilize the savings of small investors and invest in short-term debt instruments or money market instruments like Call money, Repos, Treasury bills, CDs, and CPs.
Liquidity Adjustment Facility (LAF)
Reserve Bank of India introduced the Liquidity Adjustment Facility in June 2000. It is a monetary policy that allows banks to borrow money from the RBI by repurchase agreement. LAF consists of the Repo rate and Reserve rate.
Marginal Standing Facility (MSF):
Central Bank of India i.e. RBI introduced MSF in its monetary policy on 3rd many 2011 and is effective from 9th many 2011. Under this scheme, banks allow borrowing money for one day. This Scheme can be used when banks exhaust all borrowing options including LAF.
Marginal Cost of Funds based Lending Rate(MCLR):
MCLR is a new method introduced by RBI on 1st April 2016. It is based on the marginal cost of borrowing and returns on net worth for banks. for example, if one-year deposits are 7.5%, then one-year MCLR will be 7.50% plus CRR, operation cost, and tenor premium.
Limitations of the Indian Money market
- Existence two-sector: In the Indian money market there are two sectors organized and unorganized. organized is a regulated market and unorganized is not regulated. unorganized does not distinguish between short-term finance and long-term finance, and also the purpose of finance. Therefore it limits the RBI’s control over the money market.
- Lack of Integration: There is a lack of integration in the Indian money market due to the existence of an organized sector and an unorganized sector with different features such as interest rate and effective control of RBI in the organized sector and no effective control over the unorganized sector.
- Multiplicity in Interest rates: There are different interest rate exits in the Indian money market like the borrowing rate of government, deposits and lending rate of cooperative commercial banks, lending rate of financial institutions, etc.
- Inadequate Funds: Due to inadequate banking facilities, low savings, lack of banking exitance, etc. are the factors of a shortage of funds in the Indian money market. In recent, there is development in the banking sector such as increasing branches and mobilization funds, etc.
- Seasonal Stringency of Money: The seasonal strictness of money and the high-interest rate in the busy season (November to June) is a striking feature of the Indian money market. There are wide fluctuations in the interest rates from one season to another. RBI plays a major role to control the fluctuation in the money market.
- Absence of Well-Organized 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 like the practice of bank widespread practice of using cash credit, high stamp duty on usance bills, etc.
- Inadequate Credit Instrument: The RBI has introduced new credit instruments like treasury bills, CDs, and CPs. These instruments are still in an underdeveloped state in India and do not meet the requirement of providing sufficient liquidity in India’s money market.
Reforms in the Indian Money Market
- Deregulation of Interest Rates: The restriction on the interest rate on the call money, and inter-bank short-term deposits were removed and rates were permitted according to market forces.
- New Money Market Instrument: Introduction of New money market instruments by the RBI like treasury bills, CDs, and CPs. Through these instruments governments, banks, the financial institutes can raise the funds from the Indian money market.
- Repurchase Agreement (Repos): In December 992 RBI introduced Repos in government securities and reserve repos in November 1996. Repos and Reserve Repos help to maintain liquidity and avoid fluctuation in the money market.
- Regulation of NBFCs: The RBI Act was amended in 1997 to provide for comprehensive regulation for the NBFC sector. According to the amendment no Non-Banking Financial Corporation(NBFCs) can carry on any business of a financial institution, including acceptance of public deposit, without obtaining a Certificate of Registration(CoR)
- Discount and Finance House of India(DFHI): DFHI was set up in 1988 jointly by RBI, public sector banks, and financial institutions. It facilitates liquidity to money market instruments and the development of the secondary markets in such instruments.
- Money Market Mutual Funds(MMMF): In April 1992 RBI introduced MMMFs to enable the individual investor to participate in the money market. To make the scheme flexible and attractive RBI makes many modifications.
- Clearing Corporation of India Limited(CCIL): The CCIL clears all transection in government securities and repos reposted on the Negotiated Dealing System(NDS) of RBI and also rupee/Us $ foreign exchange spot and forward deals. The CCIL was registered under the companies act 1956 on 30 April 2001, with the State Bank of India as the chief promoter.
- There are many reforms such as Liquidity Adjustment Facility, Marginal standing facility, and development of inter-bank call and Notice Money Market
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References: Manan Prakashan, Smart Notes,
Imaduddin Khan (MA in Business Economics, Mcom, BMS)