INTRODUCTION TO FINANCIAL

SYSTEM
MONEY MARKETS

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INTRODUCTION TO MONEY MARKET

• Money market basically refers to a section of the financial market where financial instruments with high
liquidity and short-term maturities are traded.
• As short-term securities became a commodity, the money market became a component of the financial
market for assets involved in short-term borrowing, lending, buying and selling with original maturities
of one year or less. Trading in money markets is done over the counter and is wholesale.
• Money market funds typically invest in government securities, certificates of deposit, commercial paper
of companies, and other highly liquid, low-risk securities.
• The four most relevant types of money are commodity money, fiat money, fiduciary money (cheques,
banknotes), and commercial bank money.
STRUCTURE OF MONEY MARKET
• The money market in India is dichotomous by nature. It comprises of both, the organized sector as well
as the unorganized sector.
• The organized sector includes the Reserve Bank of India (RBI), commercial banks, co-operative banks,
development financial institutions, investment institutions and the Discount and Finance House of India
(DFHI).
• The unorganized sector on the other hand, comprises of indigenous bankers, money lenders and
unregulated non-bank financial intermediaries.
• Money market centres in India are located at Mumbai, Delhi and Kolkata.
• However, Mumbai is the only active money market centre in India with money flowing in from all parts
of the country.
ORGANIZED SECTOR OF MONEY MARKET

• The organised sector of the money market consists of the Reserve Bank of India, commercial banks, co-
operative banks, regulated financial intermediaries etc. Now we will discuss the organized sector of the
money market in India.

1) RESERVE BANK OF INDIA

• Every country in the world has a Central Bank which is at the apex of the banking system.Reserve Bank
of India is the central bank of our country. It is entrusted with the responsibility of regulating the money
market in the country.
• RBI was nationalized on 1st January, 1949.
• It is the most important constituent of the money market.
FUNCTIONS OF RESERVE BANK OF INDIA
a. Issue of Currency Notes :
• RBI has the sole right to issue currency notes of all denominations, except one rupee note and coins.
• As per the ‘Minimum Reserve System’ of 1957, RBI is required to maintain minimum gold and foreign
exchange reserves of Rupees. 200 crores, out of which at least ` 115 crores should be in gold and the
remaining ` 85 crores should be in terms of foreign currency and government securities.
b. Banker to the Government :
• RBI acts as a banker, agent and advisor to the Government.
• It transacts the business of both, the Central and State Governments.
• It accepts money as well as makes payments on behalf these Governments. It also undertakes the
management of public debt.
c. Banker’s Bank :
• RBI exercises statutory control over the commercial banks.
• All scheduled banks are compulsorily required to maintain a certain minimum of cash reserves with the
RBI against their demand and time liabilities.
• RBI provides financial assistance to banks in the form of discounting of eligible bills. Loans and advances
are also provided against approved securities.
d. Custodian of Foreign Exchange Reserves :
• RBI acts as a custodian of the country’s foreign exchange reserves.
• It has to maintain the official rate of exchange of rupee as well as ensure its stability.
e. Controller of Credit :
• As a supreme banking authority of the country, RBI has the power to influence the volume of credit
created by commercial banks. It also monitors the purpose or use of credit.
• Quantitative methods such as bank rate, open market operations, variable reserve ratios such as Cash
Reserve Ratio(CRR), Statutory Liquid Ratio(SLR) etc. control the volume of credit created.
• Qualitative methods such as fixing margin requirements, credit rationing, moral suasion etc. regulate
the purpose or use of credit
2) COMMERCIAL BANKS
• Commercial banks act as intermediaries in the country’s financial system to bring the savers and
investors together. They are profit seeking financial institutions.
• Acceptance of deposits and granting loans and advances are the primary functions of commercial banks.
• Commercial banks play an important role in mobilizing savings and allocating them to various sectors of
the economy. It includes both scheduled commercial banks and non-scheduled commercial banks.
• In terms of ownership and function, commercial banks in India can be divided into four categories:
1. Public Sector Banks : Example Bank of India, State Bank of India, etc.
2. Private Sector Banks : Example HDFC Bank, ICIC Bank, AXIS Bank, etc.
3. Regional Rural Banks: Example Maharashtra Gramin Bank, Vidarbha Konkan Gramin Bank, etc.
4. Foreign Banks: Example HBSBC, Standard Chartered Bank, etc.
FUNCTIONS OF COMMERCIAL BANK

a. Acceptance of deposits:
• Deposits constitute the main source of funds for commercial banks. Savings lead to the creation of
deposits. Deposits are categorized as (i) Demand deposits and (ii) Time deposits.
(i) Demand Deposits : Deposits that are withdrawable on demand are known as demand deposits
(ii) Time deposits : Deposits that are repayable after a certain period of time are known as time deposits.
b. Ancillary functions :
• Commercial banks also provide a range of ancillary services such as transfer of funds, collection of
money, making periodical payments on behalf of the customer, merchant banking, foreign exchange,
safe deposit lockers, D-mat facility, internet banking, mobile banking etc.
c. Providing loans and advances :
• Commercial banks mobilize savings and lend these funds to institutions and individuals for various
purposes.
• Based on the tenure, loans include call loans, short term, medium term and long term loans.
• Longer the duration of the loans, greater will be the rate of interest.
• Besides this, banks also provide cash credit, overdraft facility as well as discount bills of exchange.
d. Credit Creation :
• Credit creation is an important function of commercial banks. Commercial banks are creators of credit.
• Demand and time deposits constitute the primary deposits of banks.
• After meeting the reserve requirements out of the net demand and time liabilities, the balance amount
is used for giving loans.
• Thus, secondary deposits or ‘derivative deposits’ are created out of the loans given by the banks.
3) CO-OPERATIVE BANKS :
• Co-operative banks came into existence with the enactment of the Co-operative Credit Societies Act of
1904.
• Co-operative banks supplement the efforts of commercial banks by meeting the credit needs of the local
population.
• It fulfills the banking needs of small and medium income groups.
• The co-operative credit sector comprises of co-operative credit institutions such as primary co-operative
credit societies, district central co-operative bank and state co-operative bank.

4) DISCOUNT AND FINANCE HOUSE OF INDIA :

• The Discount and Finance House of India (DFHI) was set up in 1988 as a money market institution based on
the recommendations of the Vaghul Committee.
• It is jointly owned by the RBI, public sector banks and financial institutions to impart liquidity to the money
market instruments.
5) DEVELOPMENT FINANCIAL INSTITUTIONS (DFIs) :
• Development financial institutions are agencies that provide medium and long-term financial assistance.
• They help in the development of industry, agriculture and other key sectors.
• Industrial Finance Corporation of India (IFCI) was the first development financial institution to be
established in 1948.
• Development financial institutions have diversified their operations with the advent of liberalization and
globalization.
• They have set up subsidiaries to offer a wide range of new products and services.
UNORGANIZED SECTOR OF MONEY
MARKET

• The unorganized money market in India comprises of indigenous bankers, money lenders and
unregulated non-bank financial intermediaries.
• The activities of the unorganized money market are largely confined to the rural areas.

1) INDIGENOUS BANKERS :
• They are financial intermediaries that function similar to banks.
• They mostly deal in indigenous short-term credit instruments such as hundi. The rate of interest differs
from one market to another. Indigenous bankers are mostly confined to certain social strata.
• They are an important source of funds in unbanked areas and provide loans directly to agriculture, trade
and industry.
2) MONEY LENDERS :
• They mostly operate in the villages. Money lenders usually charge a high rate of interest.
• The loans provided by money lenders are for both productive and unproductive purpose. At present, the
activities of the money lenders have been restricted by RBI due to their exploitative tendencies.

3) UNREGULATED NON-BANK FINANCIAL

INTERMEDIARIES :
• They include Chit funds, Nidhi, loan companies etc. Under Chit funds, members make regular contribution to
the fund. Bids or draws are made on the basis of a criteria mutually agreed upon by the members.
• Accordingly, the collected fund is given to the chosen member. Chit funds mostly operate in Kerala and Tamil
Nadu. Nidhi is also a type of mutual benefit fund thriving on the contribution of its members.
• Loans are provided to members at reasonable rates of interest.
• They provide loans to traders, small-scale industries and self-employed persons. Being unregulated, they
charge a high rate of interest on loans.
MONEY MARKET INSTRUMENTS
The following instruments are traded in the money market :
1. Call / Notice Money Market : When money is borrowed or lent for a day, it is known as call
(overnight) money. When money is borrowed or lent for more than a day up to 14 days, it is known as
notice money.
2. Treasury Bills (TBs) : They are short term instruments issued by the RBI on behalf of the government
to meet temporary liquidity shortfalls.
3. Commercial Papers (CPs) : It is an unsecured promissory note, negotiable and transferable by
endorsement and delivery with a fixed maturity period.
4.Certificate of Deposits (CDs) : They are unsecured, negotiable instruments in bearer form issued by
commercial banks and development finance institutions.
5. Commercial Bills (CBs) : They are short term, negotiable and self-liquidating instruments with low
risk.
6. Money Market Mutual Funds : A money market mutual fund is a type of mutual fund that invests in
high-quality, short-term debt instruments, cash, and cash equivalents. Though not exactly as safe as cash,
money market funds are considered extremely low risk on the investment spectrum and thus carry close to
the risk-free rate of return.
COMPONENTS OF MONEY MARKET

1.CALL MONEY MARKET :

An interbank call money market is a short-term money market which allows for large financial
institutions to borrow and lend money at interbank rates. The loans in the call money market are very
short, usually lasting no longer than a week.
2. BILL MARKET:
A bill market is an arena where debt transactions occur. In response to extending a loan or an item
based on credit, for instance, a commercial bill may be issued to the borrower. Included in this
document are the details, such as the expiration date for the loan and the total amount due the lender.
3. ACCEPTANCE MARKET:
An acceptance market is a time draft or bill of exchange accepted as payment for goods and
services. The agreement involves two parties—usually an importer and exporter—helps
facilitate trade between two foreign companies or countries.
ROLE OF MONEY MARKET IN INDIA
The following points outline the role of the money market in India :
1) Short-term requirements of borrowers :
• Money market provides reasonable access for meeting the short-term financial needs of the borrowers
at realistic prices.
2) Liquidity Management :
• Money market is a dynamic market.
• It facilitates better management of liquidity and money in the economy by the monetary authorities.
This, in turn, leads to economic stability and development of the country.
3) Financial requirements of the Government :
• Money market helps the Government to fulfil its short term financial requirements on the basis of
Treasury Bills.
4) Portfolio Management :
• Money market deals with different types of financial instruments that are designed to suit the risk and return
preferences of the investors.
• This enables the investors to hold a portfolio of different financial assets which in turn, helps in minimizing risk
and maximizing returns.
5) Equilibrating mechanism :
• Through rational allocation of resources and mobilization of savings into investment channels, money market
helps to establish equilibrium between the demand for and supply of short-term funds.
6) Economizes the use of cash :
• Money market deals with various financial instruments that are close substitutes of money and not actual
money. Thus, it economizes the use of cash.
7) Growth of Commerce, Industry and Trade:
• Money market facilitates discounting bills of exchange to local and international traders who are in urgent need
of short-term funds. It also provides working capital for agriculture and small scale industries.
PROBLEMS OF INDIAN MONEY MARKET
Compared to advanced countries, the Indian money market is less developed in terms of volume and
liquidity. Following points explain the problems of the Indian Money Market :
1) Dual Structure of the Money Market :
• Presence of both, the organized and unorganized sector in the money market leads to disintegration, lack
of transparency and increased volatility.
• The unorganized markets lack co-ordination and do not come under the direct control and supervision of
the RBI.
2) Lack of uniformity in the rates of interest :
• The money market comprises of various entities such as commercial banks, co-operative banks, non-bank
finance companies, development finance institutions, investment companies etc. The category of
borrowers is also different.
3) Shortage of funds :
• Money market faces shortage of funds due to inadequate savings.
• Low per capita income, poor banking habits among the people, indulgence in wasteful consumption,
inadequate banking facilities in the rural areas etc. have also been responsible for the paucity of funds in the
money market.
4) Seasonal fluctuations :
• Demand for funds varies as per the seasons. During the peak season, from October to June, finance is
required on a large scale for various purposes such as trading in agricultural produce, investment inbusiness
activities etc.
• This results in wide fluctuations in the money market.
5) Lack of financial inclusion :
• Banking facilities in the country are still inadequate and inaccessible to the vulnerable groups such as the
weaker sections and the low income groups. This shows lack of financial inclusion.
REFORMS INTRODUCED IN THE MONEY
MARKET

1) Introduction of new instruments such as Treasury bills of varying maturity periods,

Commercial Papers (CPs), Certificate of Deposits (CDs) and Money Market Mutual Mutual Funds
(MMMFs).
2) RBI Repos and Reverse Repos were introduced under the Liquidity Adjustment Facility (LAF).
3) Interest rates to be largely determined by market forces.
4) National Electronic Fund Transfer (NEFT) and Real Time Gross Settlement (RTGS) were
introduced as an improved payment infrastructure.
5) Electronic dealing system was introduced to bring about technological upgradation.