Professional Documents
Culture Documents
REPORT
ON
MONEY MARKET
1
INDEX
1 INTRODUCTION 1
2 THE ROLE OF MONEY MARKET 4
3 FINANCIAL SECTOR REFORMS 4
4 WHAT IS MONEY MARKET? 12
5 MONEY MARKET INSTRUMENTS 14
5.1 CALL/NOTICE MONEY 14
5.2 TREASURY BILLS 16
5.3 INTER-BANK TERM MONEY 17
5.4 CERTIFICATE OF DEPOSIT 18
5.5 COMMERCIAL PAPERS 19
5.6 READY FORWARD CONTRACTS 21
5.7 COMMERCIAL BILLS 24
2
(1) INTRODUCTION
There are areas or people with surplus funds and there are those with a
deficit. A financial system or financial sector functions as an intermediary
and facilitates the flow of funds from the areas of surplus to the areas of
deficit. A Financial System is a composition of various institutions,
markets, regulations and laws, practices, money manager, analysts,
transactions and claims and liabilities.
FINANCIAL SYSTEM
The word "system", in the term "financial system", implies a set of complex
and closely connected or interlined institutions, agents, practices, markets,
transactions, claims, and liabilities in the economy. The financial system is
concerned about money, credit and finance-the three terms are intimately
related yet are somewhat different from each other. Indian financial system
consists of financial market, financial instruments and financial
intermediation. These are briefly discussed below;
3
FINANCIAL MARKETS
4
sometime in the future and /or periodic payment in the form of interest or
dividend.
• Money Market
The money market ifs a wholesale debt market for low-risk, highly-liquid,
short-term instrument. Funds are available in this market for periods
ranging from a single day up to a year. This market is dominated mostly by
government, banks and financial institutions.
• Capital Market
• Forex Market
The Forex market deals with the multicurrency requirements, which are met
by the exchange of currencies. Depending on the exchange rate that is
applicable, the transfer of funds takes place in this market. This is one of the
most developed and integrated market across the globe.
• Credit Market
Credit market is a place where banks, FIs and NBFCs purvey short, medium
and long-term loans to corporate and individuals.
5
(2) THE ROLE OF MONEY MARKET IN
OUR NATIONAL ECONOMY
The money market is an integral part of the economy and it plays a vital role
in the development of the economy. This is endorsed by the fact that in the
less developed countries, money market too is undeveloped. Consequently,
in the absence of well-developed money market in these countries great
difficulty is experienced in pooling funds large enough to finance private
enterprise. Up to the latter half of the Eighties money market in India was
lopsided. Reserve bank too the initiative and introduced financial sector
reforms to make the money market broad-based and integrated.
6
• Financial system functioned in an environment of constriction, driven
primarily by fiscal compulsions. It was geared to provide significant
support for Government expenditure.
• The monetary and debt management policy was underlined by
excessive monetization of Central Government's fiscal deficit.
• Money and Govt. Securities market did not display any vibrancy and
had limited significance in the indirect conduct of monetary policy.
• Money Market instruments were few
• Market had a narrow base and limited to a few participants -
commercial banks and six all India Financial Institutions
• Rate of interest on money market instruments was regulated.
• Money market instruments consisted of Treasury Bills (91-days T-
Bills) and term securities of different maturities issued by the Central
and State Governments.
• The average maturity of securities remained fairly long, that is above
20-years, reflecting the preference of more the Issuers than those of
the Investors
• Government borrowings were done at rates, which were far below the
market rates. For example, for 30-year securities the interest rate was
low at 6.5 per cent in 1977-78.
• The Policy led to distortions in the Banking System with high lending
rates on certain segments combined with relatively low interest rates
on deposits.
7
The Report of the Committee to Review the
Working of the Monetary System - 1985 (Sukkmoy
Chakravarthi Committee)
8
Measures taken to encouraging a secondary market in securities:
1. Maximum coupon rate, which was as low as 6.5 per cent in 1977-78,
was raised in stages to 11.5 per cent in 1985-86. Along with this the
maximum maturity period was reduced from 30 years to 20 years.
2. 182 days Treasury bills were introduced in November 1986 for the
first time
3. The Discount and Finance House of India Ltd. was set up in April
1988 as a money market institution jointly by RBI, Public sector
banks and all India financial institutions, to develop a secondary
market for money market instruments and to provide liquidity to these
instruments.
9
entered the market in 1989-90. RBI framed guidelines for the issuance
of these instruments.
10
Since the withdrawal of the ceiling on the call rate, the call money rate has
shown a tendency to fluctuate significantly on occasions. The sharp
imbalances that arise in the demand and supply of money due to
combination of several factors have led to such volatile behavior. The most
important of these has been bunching of banks' needs for short-term funds in
order to meet the CRR compliance.
11
The effect of the above reform measures resulted in expanding the investor
base gradually to non-traditional investors. The auction system contributed
to a new treasury culture and progressive development of bidding and
portfolio management skills.
12
• The Repo market has been activated by allowing repos/reverse repos
transactions in all government securities besides treasury bills of all
maturities.
• Non-bank entities which are holders of account with the RBI have
been allowed to enter reverse repo (but not direct) transactions with
banks/PDs
• With a view to encouraging Mutual Funds to set up gilt funds in
government securities either by way of outright purchase or reverse
repos to the extent of 20 per cent of the outstanding investments.
• Guidelines for satellite dealers in government securities market were
announced in December 1996 And in April 1997 and the RBI granted
approval to 17 entities for registration as satellite dealers in
government securities, to promote/activate retailing in Government
securities
13
(4) WHAT IS MONEY MARKET?
Money market refers to the market for short term assets that are close
substitutes of money, usually with maturities of less than a year. A well
functioning money market provides a relatively safe and steady income-
yielding avenue, for short term investment of funds both for banks and
corporate and allows the investor institutions to optimize the yield on
temporary surplus funds. The RBI is a regular player in the money market
and intervenes to regulate the liquidity and interest rates in the conduct of
monetary policy to achieve the broad objective of price stability, efficient
allocation of credit and a stable foreign exchange market. As per definition
given by RBI the money market is "the centre for dealings, mainly short-
term character, in money assets. It meets the short-term requirements of
borrower and provides liquidity or cash to the lenders. It is the place where
short-term surplus investible funds at the disposal of financial and other
institutions and individuals are bid by borrowers, again comprising
Institutions, individuals and also the Government itself".The main segments
of the money market are the call/notice money, term money, commercial
bills, treasury bills, commercial paper and certificate deposits. Mr.G.
Crowther in his treatise "An Outline of Money defines money market as "the
collective name given to the various firms and institutions that deal in the
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various grades of near-money". The money market is as concrete as any
other market and one could see it in operation in London's Lambard Street
or New York's Wall Street. Typical of any other commodity market, there is
very close relationship between different segments of the money market,
(like bankers' Call Money market, commercial paper, treasury bills) that the
one is affected by the other. In other words different segments of the money-
market are broadly integrated.
15
(5) MONEY MARKET INSTRUMENTS
Call/Notice Money
Treasury Bills
Inter Bank term Money
Certificate of Deposit (CD)
Commercial Paper (C.P)
Commercial Bills
Inter Bank Participation Certificates
The most active segment of the money market has been the call money
market, where the day to day imbalances in the funds position of scheduled
commercial banks are eased out. The call notice money market has
graduated into a broad and vibrant institution.
16
The entry into this field is restricted by RBI. Commercial Banks, Co-
operative Banks and Primary Dealers are allowed to borrow and lend in this
market. Specified All-India Financial Institutions, Mutual Funds, and certain
specified entities are allowed to access to Call/Notice money market only as
lenders. Reserve Bank of India has recently taken steps to make the
call/notice money market completely inter-bank market. Hence the non-bank
entities will not be allowed access to this market beyond December 31,
2000.
From May 1, 1989, the interest rates in the call and the notice money market
are market determined. Interest rates in this market are highly sensitive to
the demand - supply factors. Within one fortnight, rates are known to have
moved from a low of 1 - 2 per cent to dizzy heights of over 140 per cent per
annum. Large intra-day variations are also not uncommon. Hence there is a
high degree of interest rate risk for participants. In view of the short tenure
of such transactions, both the borrowers and the lenders are required to have
current accounts with the Reserve Bank of India. This will facilitate quick
and timely debit and credit operations. The call market enables the banks
and institutions to even out their day to day deficits and surpluses of money.
Banks especially access the call market to borrow/lend money for adjusting
their cash reserve requirements (CRR). The lenders having steady inflow of
funds (e.g. LIC, UTI) look at the call market as an outlet for deploying funds
on short term basis.
17
(5.2) TREASURY BILLS
Treasury Bills are short term (up to one year) borrowing instruments of the
union government. It is an IOU of the Government. It is a promise by the
Government to pay a stated sum after expiry of the stated period from the
date of issue (14/91/182/364 days i.e. less than one year). They are issued at
a discount to the face value, and on maturity the face value is paid to the
holder. The rate of discount and the corresponding issue price are
determined at each auction.
18
• The bills are generally issued in the form of SGL - entries in the books
of Reserve Bank of India. The SGL holdings can be transferred by
issuing a SGL transfer form. For non-SGL account holders, RBI has
been issuing the bills in scrip form.
The market in this segment is presently not very deep. The declining spread
in lending operations, the volatility in the call money market with
accompanying risks in running asset/liability mismatches, the growing desire
for fixed interest rate borrowing by corporate, the move towards fuller
integration between forex and money markets, etc. are all the driving forces
for the development of the term money market. These, coupled with the
proposals for rationalization of reserve requirements and stringent guidelines
by regulators/managements of institutions, in the asset/liability and interest
rate risk management, should stimulate the evolution of term money market
sooner than later. The DFHI (Discount & Finance House of India), as a
major player in the market, is putting in all efforts to activate this market.
19
Certificates of Deposit (CDs) - introduced since June 1989 - are negotiable
term deposit certificates issued by a commercial banks/Financial Institutions
at discount to face value at market rates, with maturity ranging from 15 days
to one year.
DFHI trades in these instruments in the secondary market. The market for
these instruments is not very deep, but quite often CDs are available in the
secondary market. DFHI is always willing to buy these instruments thereby
lending liquidity to the market.
• Salient features:
CDs are issued by Banks, when the deposit growth is sluggish and credit
demand is high and a tightening trend in call rate is evident. CDs are
20
generally considered high cost liabilities and banks have recourse to them
only under tight liquidity conditions.
Commercial Papers are unsecured debts of corporate. They are issued in the
form of promissory notes, redeemable at par to the holder at maturity. Only
corporate who get an investment grade rating can issue CPs, as per RBI
rules. Though CPs is issued by corporate, they could be good investments, if
proper caution is exercised.
The market is generally segmented into the PSU CPs, i.e. those issued by
public sector unit and the private sector CPs. CPs issued by top rated
corporate is considered as sound investments.
DFHI trades in these certificates. It will buy these certificates, subject to its
perception of the instrument and will also be offering them for sale subject
to availability of stock.
Salient Features
21
• CPs is issued by companies in the form of usance promissory note,
redeemable at par to the holder on maturity.
• The tangible net worth of the issuing company should be not less than
Rs.4 crores.
• Working capital (fund based) limit of the company should not be less
than Rs.4 crores.
• Credit rating should be at least equivalent of P2/A2/PP2/Ind.D.2 or
higher from any approved rating agencies and should be more than 2
months old on the date of issue of CP.
• Cooperators are allowed to issue CP up to 100% of their fund based
working capital limits.
• It is issued at a discount to face value.
• CP attracts stamp duty.
• CP can be issued for maturities between 15 days and less than one
year from the date of issue.
• CP may be issued in the multiples of Rs.5 lakh.
• No prior approval of RBI is needed to issue CP and underwriting the
issue is not mandatory.
• All expenses (such as dealers' fees, rating agency fee and charges for
provision of stand-by facilities) for issue of CP are to be borne by the
issuing company,
22
(5.6) READY FORWARD CONTRACTS
(REPOS)
The motivation for the banks and other organizations to enter into a ready
forward transaction is that it can finance the purchase of securities or
otherwise fund its requirements at relatively competitive rates. On account
of this reason the ready forward transaction is purely a money lending
23
operation. Under ready forward deal the seller of the security is the borrower
and the buyer is the lender of funds. Such a transaction offers benefits both
to the seller and the buyer. Seller gets the funds at a specified interest rate
and thus hedges himself against volatile rates without parting with his
security permanently (thereby avoiding any distressed sale) and the buyer
gets the security to meet his SLR requirements. In addition to pure funding
reasons, the ready forward transactions are often also resorted to manage
short term SLR mismatches.
24
The relaxations over the years made by RBI with regard to repo transactions
are:
Apart from inter-bank repos RBI has been using this instrument effectively
for its liquidity management, both for absorbing liquidity and also for
injecting funds into the system. Thus, Repos and Reverse Repo are resorted
to by the RBI as a tool of liquidity control in the system. With a view to
absorbing surplus liquidity from the system in a flexible way and to prevent
25
interest rate arbitraging, RBI introduced a system of daily fixed rate repos
from November 29, 1997.
The major players in the repo and reverse repurchase market tend to be
banks who have substantially huge portfolios of government securities.
Besides these players, primary dealers who often hold large inventories of
tradable government securities are also active players in the repo and reverse
repo market.
26
currency of the bill, if the seller is in need of funds, he may approach his
bank for discounting the bill. One of the methods of providing credit to
customers by bank is by discounting commercial bills at a prescribed
discount rate. The bank will receive the maturity proceeds (face value) of
discounted bill from the drawee. In the meanwhile, if the bank is in need of
funds, it can rediscount the bill already discounted by it in the commercial
bill rediscount market at the market related rediscount rate. (The RBI
introduced the Bill Market Scheme in 1952 and a new scheme called the Bill
Rediscounting Scheme in November 1970).
27
has exempted stamp duty on derivative usance promissory notes. This has
indeed simplified and streamlined the bill rediscounting by Institutions and
made commercial bill an active instrument in the secondary money market.
Rediscounting institutions have also advantages in that the derivative usance
promissory note, being a negotiable instrument issued by a bank, is good
security for investment. It is transferable by endorsement and delivery and
hence is liquid. Thanks to the existence of a secondary market the
rediscounting institution can further discount the bills anytime it wishes
prior to the date of maturity. In the bill rediscounting market, it is possible to
acquire bills having balance maturity period of different days upto 90 days.
Bills thus provide a smooth glide from call/overnight lending to short term
lending with security, liquidity and competitive return on investment. As
some banks were using the facility of rediscounting commercial bills and
derivative usance promissory notes for as short a period as one day merely a
substitute for call money, RBI has since restricted such rediscounting for a
minimum period of 15 days.
28
PRIMARY DEALERS
The full extent of notified amount of the dated government securities were
offered for underwriting and the underwriting fees and amounts to be
allowed to each PD prior to auction of each security. In respect of TBs, the
PDs are required to give minimum holding commitments and fixed
underwriting fees are paid for successful bids. The RBI granted liquidity
support for PDs against their holding in SGL Account.
29
Guidelines for satellite dealers in the government securities market were
announced in December 1996 and in April 1997. Satellite dealers in
government securities are expected to activate retailing of government
securities.
SATELLITE DEALERS
30
(6)Foreign Institutional Investor (FII)
FII means an entity established or incorporated outside India which proposes
to make investment in India. The FIIs have been a major driver in Indian
equities' upward journey in the recent past and resumption of positive
momentum is unlikely before FIIs start purchasing again. One who propose
to invest their proprietary funds or on behalf of "broad based" funds or of
foreign corporate and individuals and belong to any of the under given
categories can be registered for FII.
1. Pension Funds
2. Mutual Funds
3. Investment Trust
4. Insurance or reinsurance companies
5. Endowment Funds
6. University Funds
7. Foundations or Charitable Trusts or Charitable Societies who propose
to invest on their own behalf, and
8. Asset Management Companies
9. Nominee Companies
10. Institutional Portfolio Managers
11. Trustees
12. Power of Attorney Holders
13. Bank
31
As per Regulation 6 of SEBI (FII) Regulations, 1995, Foreign
Institutional Investors are required to fulfill the following
conditions to qualify for grant of registration:
• Applicant should have track record, professional competence,
financial soundness, experience, general reputation of fairness and
integrity;
• The applicant should be regulated by an appropriate foreign
regulatory authority in the same capacity/category where registration
is sought from SEBI. Registration with authorities, which are
responsible for incorporation, is not adequate to qualify as Foreign
Institutional Investor.
• The applicant is required to have the permission under the provisions
of the Foreign Exchange Management Act, 1999 from the Reserve
Bank of India.
• Applicant must be legally permitted to invest in securities outside the
country or its in-corporation / establishment.
• The applicant must be a "fit and proper" person.
• The applicant has to appoint a local custodian and enter into an
agreement with the custodian. Besides it also has to appoint a
designated bank to route its transactions.
• Payment of registration fee of US $ 5,000.00
32
Current scenario of FII
The FII inflow has slowed down considerably in the past few days,
partly due to valuations getting expensive in India, and the overseas
investors have started exploring other markets with better valuations.
So far in 2007, the FIIs have made a net purchase worth over Rs
70,000 crore (more than 17 billion dollars) -- the highest annual
inflow so far.
India funds have seen a net outflow of 792 million dollar so far in
2007, against an inflow of 1,751 million dollar in the same period last
year.
33