Short essay on Indian Money Market

In India the money market plays a vital role in the progress of economy. But, it is not well developed when compared to American and London money markets. In this market short-term funds are borrowed and lent among participants permitted by RBI.

Money Market ensures that institutions which have surplus funds earn certain returns on the surplus. Otherwise these funds will be idle with the institutions. Similarly, the money market ensures funds for the needy at reasonable interest. This way liquidity posi­tion is assured by money market operations.

Let us now discuss the various money market instruments in India. In India the Money Market is regulated by RBI. Hence, the instruments traded and the players in the market require to be approved by RBI. The instruments currently traded are as follows:

(i) Call Money:

Call money is a method of borrowing and lending for one day. This is also called overnight money. The rate of interest used to be decided by RBI earlier. After 1989, the interest rate was deregulated and now the liquidity position (availability of funds) determines the rate of interest.

The lender issues a cheque or pay order or its account maintained with RBI in favour of borrower. Accordingly, RBI transfers funds by debit to lender’s account to the borrower’s account.

On repayment, the process is reversed through RBI. In times of tight money, situation or liquidity crunch, the call money interest rate goes up even beyond 50 per cent per annum.

Only permitted organizations like scheduled com­mercial banks, large co-operative banks, DHFI, Primary dealers, NABARD are permitted to borrow funds through call money market. However, funds can be provided or lent even by other entities like LIC, GIC, large corporate, big mutual funds, etc.

(ii) Notice Money / Short-term Money:

Under Notice/Short-term Money Market, funds are borrowed and lent for a maximum period of 14 days. Repayment requires a formal notice or demand from the lender. Interest rate is decided by the market forces. The market is similar to call money market explained above.

(iii) Treasury Bills:

It is the most important money market instrument for the central government. Treasury Bills are short-term promissory notes issued by RBI on behalf of Central Government for raising funds to meet shortfalls in revenue collections, i.e., to meet revenue expenditure.

These are issued at discount to face value. RBI auctions these Trea­sury Bills at regular periodical intervals, i.e., weekly and fortnightly. These days’ five types of Treasury Bills depending upon their maturity are auctioned by RBI.

These are 14-day Treasury Bills; 28-day Treasury Bills, 91-day, 182 day and 364 day Treasury Bills. Any per­son can invest in Treasury Bills. These are very high liquid and safe instruments. Treasury Bills are approved securities for investment by banks under SLR requirement.

(iv) Commercial Bills:

Banks are discounting Commercial Bills drawn by business entities/organisations. Banks can get such discounted bills rediscounted in Money Market. It is not necessary for banks to rediscount each and every discounted bill.

Banks can certify the large number of bills intended to be rediscounted through a single document known as “Derivative Usance Promissory Note” (DUPN). In other words, ‘DUPN’ is a money market instrument backed by genuine commercial bills.

Banks can get the value of DUPN discounted and obtain funds. This way banks can borrow funds without transfer­ring the bills. It is necessary that the original bills in the portfolio of banks should not be drawn for period exceeding 120 days. The maturity of DUPN, however, should not exceed 90 days.

(v) Commercial Paper:

Commercial Paper (C.P.) is a short-term money market instru­ment issued by eligible corporates for raising funds to meet working capital needs. It was introduced in 1989. The C.P. is in nature of negotiable usance promissory notes issued at a discount to face value.

The C.P. should have fixed maturity period of not less than 30 days and not more than one year. Corporates having fund-based working capital facility of Rs. 4 crore or more from banks are only eligible to issue C.Ps. Aggregate value of C.Ps. which can be issued by a corporate is limited to the maximum working capital facility fixed by the banks.

Investors in C.Ps. should have a minimum investment of Rs. 10 lakh and multiples of Rs. 5 lakh thereafter. The RBI decides about the eligibility criteria for corporates to raise funds through C.Ps. on the basis of working capital fund limit (Rs. 4 crore or more); minimum current ratio (1.33); and minimum credit rating (P2 of CRISIL or A2 of ICRA, etc.).

Primary Dealers are also recently permitted to issue C.Ps. Funds raised through C.Ps. should normally be cheaper as compared to bank funds. Hence, corporates raise funds through issue of C.Ps. only when the money market interest rates are fairly low.

(vi) Certificate of Deposits:

It is another form of short-term time deposit. The receipt issued for such a deposit is called Certificate of Deposit. Banks can raise short-term funds, say for 3 or 6 months at rate of interest different from its normal Time Deposit rate through issue of C.Ds. Interest is paid from the date of purchase till maturity.

Banks issue C.Ds. to manage liquidity and to raise funds at marginally varying rate of interest as compared to short-term deposit rates. As per RBI regulations C.Ds. can be issued for a minimum matu­rity of 3 months and a maximum period of 1 year.

Minimum investment should be of Rs.10 lakh and further investments should be in multiple of Rs. 5 lakh. These are issued at dis­count to face value. In India this instrument was first introduced in 1989. Individuals, Corporates, Trusts and any persons can invest in Certificate of Deposits.

(vii) Inter-Bank Participation Certificates:

Inter-Bank Participation Certificates or simply Participation Certificates (PC) are short-term papers issued by scheduled commercial banks to raise funds from other banks against big loan portfolios.

When banks are short of liqui­dity to carry on their immediate operations and need short-term funds, they may approach other banks to share/participate in their lending portfolios. In other words, part of the specified loans and advances of the borrowing bank will be passed on to the lender-bank against cash.

This will have the effect of reducing the exposure of borrower-bank on its particular loan portfolio and increase in the portfolio of lender-bank when the participa­tion is without recourse basis.

Borrower-banks can have access to the facility only, up to certain percentage (currently 40%) of their standard or performing assets, i.e., Loans and Advances which are being serviced without default. PCs. can be issued only for a maxi­mum period of 180 days and not less than a 90-day period.

(viii) Inter-Corporate Deposits:

Inter-Corporate Deposits or ICD is another money mar­ket instrument for corporate to park their temporary surplus funds with other corporate. What a participation certificate for banks is an inter-corporate deposits between corporate.

Under ICD, corporate lend temporary funds generally to their own group companies; otherwise the credit risk will be higher. Any corporate can issue the instrument without there being any prescription about minimum size of such lending and borrowings. This market is not well-regulated for want of adequate information.

(ix) ‘Repo’ Instruments:

‘Repo’ or Repurchase Transactions have been explained in Chap­ter 14. RBI conducts ‘Repo’ transactions to influence short-term interest level in money market. By Repo operation the RBI transmit interest rate signals to the market. When it announces a fixed rate Repo for certain number of days/period it conveys its intention to the market about the desirable level of a short-term interest rate.

Due to greater level of integration among money market, foreign exchange market and Treasury Bill Market, the Repo transactions ensure stability of short-term rates in all the three markets. At the same time Repo transactions of RBI provide an opportunity to banks to part their surplus funds with a minimum rate of return.

You may understand that when RBI conducts ‘repos’, the short-term interest rate in the money market may not go below the RBI repo rate as, if rate of interest is lower in other markets, holders of funds may go for ‘Repos’ with RBI. The RBI also provides liquidity support, i.e., infusion of funds into the market by conducting re­verse Repo transactions with Primary Dealers against Government Securities.