UNIT 3 FINANCIAL MARKETS 30 MARKS

 The financial system of an economy provides the way to collect

money from the people who have it and distribute it to those
who can use it best.

 So, the efficient allocation of economic resources is achieved

by a financial system that distributes money to those people
and for those purposes that will yield the best returns.

 The financial system is composed of the products and services

provided by financial institutions,
 which includes banks, insurance companies, pension funds,
organized exchanges, and the many other companies that
serve to facilitate economic transactions.
 Virtually all economic transactions are effected by one or more
of these financial institutions.
 They create financial instruments, such as stocks and bonds,
pay interest on deposits, lend money to creditworthy borrowers,
and create and maintain the payment systems of modern
economies
 MEANING AND IMPORTANCE OF FINANCIAL
MARKETS
 Financial market acts as an intermediary
between individuals and institutions with
surplus resources and those who are in need of
these funds.
 They provide firms, government , individuals
access to capital which they can use for
investment and productive activities.
 Besides providing borrowers funds they also
provide an avenue to people to invest their
savings in profitable returns.
COMPONENTS OF FINANCIAL MARKETS

RBI

Capital market
Money market

Organised
Unorganised
Call
Money lenders
Bill
Indigenous bankers
Collateral
landlords Organised unorganised
Money market mutual funds
primary and Secondary
 Money market is a market for short term
securities and capital markets are a market for
long term securities i.e whose maturity is one
year or more.
 MONEY MARKETS
 Definition:
 Money Market can be understood as the market
for short term funds, wherein lending and
borrowing of funds varies from overnight to a
year.
 It is an important part of the financial system
that helps in fulfilling the short term and very
short term requirements of the companies,
banks, financial institution, government agencies
and so forth.

 Financial instruments – high liquidity, short term maturity .
 Money funds are borrowed and lent against different types
of near money instruments like treasury bills, bills of
exchange, short term securities .
 It provides for the quick and dependable transfer of short
term debt instruments maturing in one year or less, which
are used to finance the needs of consumers, business
agriculture and the government.
 Geoffrey Crowther – ‘ collective name given to various
firms and institutions that deal in various grades of near-
money.’
 RBI- ‘centre for dealings in monetary assets of a short term
nature where short term surplus investible funds with
individuals and financial institutions are bid by borrowers
like firms , government etc.
 SALIENT FEATURES OF MONEY MARKET
 It is a wholesale market, as the transaction volume
is large.
 Trading takes place over the telephone, after which
written confirmation is done by way of e-mails.
 Participants include banks, mutual funds,
investment institutions and Central Banks.
 There is an impersonal relationship between the
participants in the money market, and so, pure
competition exists.
 Money market operations focus on a particular area,
which serves a region or an area. On the basis of the
market size and needs, the area may differ.
 SALIENT FEATURES OF MONEY MARKET
 Short term monetary transactions.

 Money market in India – divided into – organised

(developed)and unorganised(under developed).
Organised- large number of brokers, sub-
markets , adequate funds and effective control
of central bank – monetary policy.
 Unorganised –lesser number of dealers, smaller
number of sub-markets, shortage of funds.
 Funds against near money – money is
borrowed against different types of securities –
close substitutes of money- treasury bills, bills
of exchange, CDs, CPs etc.
 No specific location or place except in case of
London and New York money market.
 Participants –suppliers- central bank,
commercial banks, other financial institutions,
individuals.
 Demanders- commercial banks, government,
traders, stock brokers, businessmen etc.
 ORGANISED SECTOR OF INDIAN MONEY
MARKET:
 The organised segments of the Indian money
market is composed of
 the Reserve Bank of India (RBI),

 the State Bank of India, Commercial banks, Co-

operative banks, foreign banks,
 finance corporations and the Discount Finance
House of India Limited.
 The segment of Indian money market is quite
integrated and well organised.
 Mumbai, Kolkata, Chennai, Delhi, Bangalore
and Ahmedabad are the leading centres of the
organised money market.
 The Mumbai money market is a well organised,
having head offices of the RBI and different
commercial banks, two leading well developed
stock exchanges, the bullion exchange and
fairly organised market for Government
securities.
 All these have placed the Mumbai money
market at par with New York money market of
USA and London money market of England.
THE MAIN CONSTITUENTS OF THE ORGANISED
SECTOR OF INDIAN MONEY MARKET INCLUDE:

 (i) The Call Money Market,

 (ii) The Treasury Bill Market,

 (iii) The Commercial Bill Market,

 (iv) The Certificates of Deposits Market,

 (v) Money Market for Mutual Funds and

 (vi) The Commercial Paper Market.

 (i) Call Money Market:
 a most common form of developed money market.
 It is a most sensitive segment of the financial system
which reflects clearly any change in it.
 The call money market in India is centred at Mumbai,
Chennai and Kolkata and out of which the Mumbai is the
most important one.
 In such market, lending and borrowing operations are
carried out for one day.
 The call money market in also termed as inter-bank call
money market.
 Normally, scheduled commercial banks, Cooperative
banks and the Discount and Finance House of India (DFHI)
operate in this market and
 in a special situation; the LIC, UTI, the GIC, the IDBI and
the NABARD are permitted to operate as lenders in this
call money market.
 In this market, brokers usually play an important role.
THE MAIN FEATURES OF INDIAN CALL MONEY
MARKET ARE AS FOLLOWS
 (i)The banks with temporary deficit of funds form
the demand side and the banks with temporary
excess of funds form the supply side of the call
money market.
 (ii) Mainly the banks participate in the call money
market. The State Bank of India is always on the
lenders’ side of the market.
 (iii) The call money market operates through
brokers who always keep in touch with banks and
establish a link between the borrowing and
lending banks.
 (iv) The call money market is highly sensitive and
competitive market. As such, it acts as the best
indicator of the liquidity position of the organised
money market.
 (v) The rate of interest in the call money market is
highly unstable (6 to 30 percent). It quickly rises
under the pressures of excess demand for funds
and quickly falls under the pressures of excess
supply of funds.
 (vi) The call money market plays a vital role in
removing the day-to-day fluctuations in the reserve
position of the individual banks and improving the
functioning of the banking system in the country.
2. TREASURY BILL MARKET:
 The treasury bill market deals in treasury bills which
are the short-term (i.e., 91, 182 and 364 days)
liability of the Government of India.
 Theoretically these bills are issued to meet the short-
term financial requirements of the government.
 But, in reality, they have become a permanent source
of funds to the government. Every year, a portion of
treasury bills are converted into long-term bonds.
Treasury bills are of two types: ad hoc and regular.
 Ad hoc treasury bills are issued to the state
governments, semi- government departments and
foreign central banks. They are not sold to the banks
and the general public, and are not marketable.
 The regular treasury bills are sold to the banks
and public and are freely marketable.
 Both types of ad hoc and regular treasury bills
are sold by Reserve Bank of India on behalf of
the Central Government.
 The treasury bill market in India is
underdeveloped as compared to the treasury
bill markets in the U.S.A. and the U.K.
 In the U.S.A. and the U.K., the treasury bills are
the most important money market instrument:
 Treasury bills provide a risk-free, profitable and
highly liquid investment outlet for short-term,
surpluses of various financial institutions;
 (b) Treasury bills from an important source of
raising fund for the government; and
 (c) For the central bank the treasury bills are
the main instrument of open market
operations.
 the Indian Treasury bill market has no dealers
expect the Reserve Bank of India. Besides the
Reserve Bank, some treasury bills are held by
commercial banks, state government and semi-
government bodies.
 Commercial Bill Market:
 Commercial bill market deals in commercial bills issued
by the firms engaged in business.
 These bills are generally of three months maturity. A
commercial bill is a promise to pay a specified amount
in a specified period by the buyer of goods to the seller
of the goods. The seller, who has sold his goods on
credit draws the bill and sends it to the buyer for
acceptance. After the buyer or his bank writes the word
‘accepted’ on the bill, it becomes a marketable
instrument and is sent to the seller.
 The seller can now sell the bill (i.e., get it discounted) to
his bank for cash.
 In times of financial crisis, the bank can sell the bills to
other banks or get them rediscounted from the
Reserved Bank.
 In India, the bill market is undeveloped as compared to
the same in advanced countries like the U.K.
 There is absence of specialised institutions like
acceptance houses and discount houses, particularly
dealing in acceptance and discounting business.
CERTIFICATE OF DEPOSIT AND COMMERCIAL
PAPER MARKETS:

 Certificate of Deposit (CD) and Commercial

Paper (CP) markets deal with certificates of
deposit and commercial papers. These two
instruments (CD and CP) were introduced by
Reserve Bank of India in March 1989 in order
to widen the range of money market
instruments and give investors greater flexibility
in the deployment of their short-term surplus
funds.
COLLATERAL LOAN MARKET:

 Collateral loan market deals with collateral

loans i.e., loans backed by security. In the
Indian collateral loan market, the commercial
banks provide short- term loans against
government securities, shares and debentures
of the government, etc.
DISCOUNT HOUSES/ACCEPTANCE HOUSES

 Mostly in developed money markets.

 A discount house is a firm that buys, sells,
discounts bills of exchange, government bonds
and treasury bills.
 Discounts bills of exchange , making available
funds to those who are in need.
 In India RBI and DFHI ltd do the discounting of
bills
PARTICIPANTS
 1. Central Government:
 Central Government is a borrower in the money
market through the issue of Treasury Bills (T-Bills).
The T-Bills are issued through the RBI. The T-Bills
represent zero risk instruments. They are issued
with tenure of 91 days (3 months), 182 days (6
months) and 364 days (1 year). Due to its risk free
nature, banks, corporates and many such
institutions buy the T-Bills and lend to the
government as a part of it short- term borrowing
programme.
 2. Public Sector Undertakings:
 Many government companies have their shares listed on stock
exchanges. As listed companies, they can issue commercial paper in
order to obtain its working capital finance. The PSUs are only
borrowers in the money market. They seldom lend their surplus due
to the bureaucratic mindset. The treasury operations of the PSUs are
very inefficient with huge cash surplus remaining idle for a long
period of time.
 3. Insurance Companies:
 Both general and life insurance companies are usual lenders in the
money market. Being cash surplus entities, they do not borrow in the
money market. With the introduction of CBLO (Collateralized
Borrowing and Lending Obligations), they have become big investors.
In between capital market instruments and money market
instruments, insurance companies in
 4.Banks:
 Scheduled commercial banks are very big borrowers and lenders
in the money market. They borrow and lend in call money market,
short-notice market, repo and reverse repo market. They borrow
in rediscounting market from the RBI and IDBI. They lend in
commercial paper market by way of buying the commercial
papers issued by corporates and listed public sector units. They
also borrow through issue of Certificate of Deposits to the
corporates.

 5. Corporates:
 Corporates borrow by issuing commercial papers which are
nothing but short-term promissory notes. They are issued by
listed companies after obtaining the necessary credit rating for
the CP. They also lend in the CBLO market their temporary
surplus, when the interest rate rules very high in the market. They
are the lender to the banks when they buy the Certificate of
Deposit issued by the banks. In addition, they are the lenders
through purchase of Treasury bills.
 There are many other small players like non-banking finance
companies, primary dealers, provident funds and pension funds.
They mainly invest and borrow in the CBLO market in a small way.
 MONEY MARKET INSTRUMENTS

 Money market deals are not carried out in money

/ cash, but other instruments like trade bills,
government papers, promissory notes, etc.
 Also, money market transactions cannot be done
via brokers but have to be carried out via
mediums like formal documentation, oral or
written communication.
 As the name suggests, Money Market Instruments
are simply the instruments or tools which can help
one operate in the money market.
 These instruments allow borrowers meet their
short-term requirements and also provide easy
liquidity to lenders.
 Some of the common money market instruments
include Banker’s Acceptance, Treasury Bills,
Repurchase Agreements, Certificate of Deposits
and Commercial Papers, Money market mutual
funds.
 TYPES OF MONEY MARKET INSTRUMENTS
 1. Treasury Bills (T-Bills)
 Issued by the Central Government, Treasury Bills are known to
be one of the safest money market instruments available.
 However, treasury bills carry zero risk. I.e. are zero risk
instruments. Therefore, the returns one gets on them are not
attractive.
 Treasury bills come with different maturity periods like 3-month,
6-month and 1 year and are circulated by primary and
secondary markets.
 Treasury bills are issued by the Central government at a lesser
price than their face value. The interest earned by the buyer will
be the difference of the maturity value of the instrument and
the buying price of the bill.
 Currently, there are 3 types of treasury bills issued by the
Government of India via auctions, which are 91-day, 182-day
and 364-day treasury bills.
 2. Certificate of Deposits (CDs)
 A Certificate of Deposit or CD, functions as a deposit receipt for money
which is deposited with a financial organization or bank.
 However, a Certificate of Deposit is different from a Fixed Deposit
Receipt in two aspects.
 The first aspect of difference is that a CD is only issued for a larger sum
of money.
 Secondly, a Certificate of Deposit is freely negotiable.
 First announced in 1989 by RBI, Certificate of Deposits have become a
preferred investment choice for organizations in terms of short-term
surplus investment as they carry low risk while providing interest rates
higher than those on Treasury bills and term deposits.
 Certificate of Deposits are also relatively liquid, which is an added
advantage, especially for issuing banks.
 Like treasury bills, CDs are also issued at a discounted price and their
tenor ranges between a span of 7 days up to 1 year.
 However, banks issue Certificates of Deposits for durations ranging
from 3 months, 6 months and 12 months.
 Issued at a minimum amount of one lakh and its multiples of it
 They can be issued to individuals (except minors), trusts, companies,
corporations, associations, funds, NRIs
 Commercial Papers (CPs)
 Commercial Papers are can be compared to an unsecured
short-term promissory note which is issued by highly rated
companies to meet their raising working capital
requirements directly from the market.
 CPs usually feature a fixed maturity period which can
range anywhere from 1 day up to 270 days.
 Highly popular in countries like Japan, UK, USA, Australia
and many others,
 Commercial Papers promise higher returns as compared
to treasury bills and are automatically not as secure in
comparison. Commercial papers are actively traded in
secondary market.
 Before going for CPs the borrowing Company must
obtain credit rating from CRISIL, CARE etc credit
rating agencies authorized by RBI.
 CP issued in denomination of rupees 5 lakhs and
in multiples thereof.
 Banks, individuals, other corporate bodies, NRIs,
and FIIs approved by SEBI are allowed to
invest/lend through CP
 Banker's Acceptance (BA)
 Banker's Acceptance or BA is basically a document
promising future payment which is guaranteed by
a commercial bank.
 Similar to a treasury bill, Banker’s Acceptance is
often used in money market funds and specifies
the details of the repayment like the amount to be
repaid, date of repayment and the details of the
individual to which the repayment is due. Banker’s
Acceptance features maturity periods ranging
between 30 days up to 180 days.
 Repurchase Agreements (Repo)
 Repurchase Agreements, also known as Reverse Repo
or simply as Repo, loans of a short duration which are
agreed upon by buyers and sellers for the purpose of
selling and repurchasing.
 These transactions can only be carried out between RBI
approved parties.
 Repo / Reverse Repo transactions can be done only
between the parties approved by RBI. Transactions are
only permitted between securities approved by the RBI
like treasury bills, central or state government
securities, corporate bonds and PSU bonds.
 Banker's Acceptance (BA)
 Money market mutual funds
 It is a professionally managed Mutual fund.
 RBI started these funds in April 1991 to enable small
investors get access to the money market .
 RBI allowed banks and their subsidiaries to set up
MMMFs.
 MMMFs are short dated liquid investments which invest
in high quality money market instruments
 Fund managers invest public money in treasury bills, CPs,
CDs, Repos etc.
 Funds are invested in securities of upto 1 year.
 Corporates, retail investors with surplus cash invest in
them but returns from MMMFs attracts Short term capital
gains tax.
 Investment in these funds maybe less risky but returns are
also low on them compared to those on equities.
COMPONENTS OF THE UNORGANIZED MONEY
MARKET IN INDIA

 Main feature – out of effective control of RBI.

 Participants

 Money lenders,

 Indigenous bankers,

 Nidhis,

 Chit Funds,
 MONEY LENDERS.
 Small scale operation.
 Operate with own funds

 Audit of their accounts is not mandatory

 Rate of interest is fixed by money lender- high

 Non-professional- no security needed always

 Only credit .

 Borrowing is risky.

 Provide credit for productive and non- productive

purposes.
INDIGENOUS BANKERS
 Communities – banking business.
 Known as Sarafs, Mahajans,

 Large scale operations.

 Lend borrowed funds.

 Have audit of accounts.

 Charge lower interest rate.

 Give only secured loans.

 Professional

 Relatively risky.

 Loans given for productive purposes.

 NIDHIS
 Means a fund- promote savings and deposit habit
among lower income groups. Popular in South India.
Tamil Nadu
 A type of NBFC – does not require RBI license.
 It is recognised as a non-banking finance company
under Companies Act 2013.
 Core business- lending and borrowing money
among their members.
 Known by other names like Benefit Funds, Mutual
Benefit Funds, Mutual benefit company,
 Regulated by Ministry of Corporate Affairs.
 RBI can issue directives - related to Deposits
 CHIT FUNDS

 Type of rotating savings and credit association in

India.
 Organised by Financial institutions or

 Informally among friends, relatives, industrial

workers, who put a regular amount of money
monthly and through draws of lots pick up the
winner of the fund money.
 Micro finance organisations– regulated under
Chit Funds Act 1982.
 ROLE OF CENTRAL BANK IN MONEY MARKET
 Money market is a very important part of the
financial system.
 Short term funds and liquidity of the economy is
managed in this market.
 The central bank of the country plays a vital role
in the money market.
 Controls, monitors, regulates short term funds in
this market.
 Central bank is the primary source of money
supply .
 It issues currency notes in different
denominations – ₹10, 20, 50, 100, 200, 500,
2000
 RBI under the Minimum Reserves System can
can issue unlimited currency
 Central bank is banker to banks and the govt.
 Serves as a lender of last resort for banks.
 One of the most important functions of the central
bank is to regulate credit , money supply and
interest rates in the economy.
 For this it uses quantitative and qualitative
instruments of credit control.
 For eg.OMOs enable the central bank to manage
its liquidity
 Under Open market Operations Purchase or
discounting of treasury Bills by RBI will increase
liquidity , and sale of T- bills by RBI will decrease
the liquidity in the economy.
 Repo rate- called the bench mark interest rate is
the rate at which the RBI lends money to banks
for a very short term.
 If RBI wants to make it expensive for banks to
borrow from it, it will hike the repo rate and vice
versa.
 On 9th August 2019 RBI cut the repo rate To
5.30%.
 Similarly CRR and SLR can be changed regulate
the money supply and credit in the economy.
 DEFECTS OF INDIAN MONEY MARKET:

 Major defects are discussed below:

 I. Dichotomy between Organised and
Unorganised Sectors:
 The division into two sectors- (a) the organised
sector and (b) the unorganised sector.
 There is little contact, coordination and
cooperation between the two sectors. It is
difficult for the Reserve Bank to ensure uniform
and effective implementations of its monetary
policy in both the sectors.
 II. Predominance of Unorganised Sector:

 The indigenous bankers dominate the money- lending business in the

rural areas.
 no clear-cut distinction is made between short- term and long-term and
between the purposes of loans.
 These indigenous bankers, constitute a large portion of the money
market, remain outside the organised sector.
 Therefore, they seriously restrict the Reserve Bank’s control over the
money market.

 III. Wasteful Competition:

 Wasteful competition exists not only between the organised and
unorganised sectors, but also among the members of the two sectors.
 The relation between various segments of the money market is not
cordial; they are loosely connected with each other and generally follow
separatist tendencies.
 For example, even today, the State Bank of India and other commercial
banks look down upon each other as rivals.
competition exists between the Indian commercial banks and foreign
banks.
 IV. Absence of All-India Money Market:
 Indian money market has not been organised into a single
integrated all-Indian market.
 It is divided into small segments mostly catering to the
local financial needs. For example, there is little contact
between the money markets in the bigger cities, like
Mumbai, Kolkata, Surat and those in smaller towns.
 V. Inadequate Banking Facilities:
 Indian money market is inadequate to meet the financial
need of the economy.
 Although there has been rapid expansion of bank branches
in recent years particularly after the nationalisation of
banks, yet in vast parts of rural, hilly, tribal and forest areas
still banking facilities are not present. As compared to the
size and population of the country, the banking services are
lower.
 VI. Seasonal Shortage of Funds:
 due to the seasonal stringency of credit there is
higher interest rate during a part of the year.
 Such a shortage appears during the busy months
from November to June when there is excess
demand for credit for carrying on the harvesting and
marketing operations in agriculture. As a result, the
interest rates rise in this period.
 On the contrary, during the slack season, from July
to October, the demand for credit and the rate of
interest decline sharply.
 Disparities in the interest rates adversely affect the
smooth and effective functioning of the money
market
 VII. Absence of Bill Market:
 The existence of a well-organised bill market is
essential for the proper and efficient working of
money market. Unfortunately, in spite of the
serious efforts made by the Reserve Bank of
India, the bill market in India has not yet been
fully developed.
REFORMS IN THE INDIAN MONEY MARKET
 A. Measures of RBI to improve Indian money market
 (i) The difference between various sections of the money
market has been reduced. With the enactment of the
Banking Regulation Act, 1949, all banks in the country
have been given equal treatment by the Reserve Bank as
regards licensing, opening of branches, share capital, the
type of loans to be given, etc.
 (ii) the RBI has amalgamated and merged weak banks with
a few strong banks and helped in the expansion of banking
facilities in the country,
 (iii) The RBI has been able to reduce considerably the
differences in the interest rates between different sections
as well as different centres of the money market.
 (iv)Now the interest rate structure of the country is
deregulated much more sensitive to changes in the repo
rate.
 B. The Reserve Bank of India has taken the following
measures to develop the Bill Market:
 (i) With a view to make bill financing attractive to the
borrowers, from April 1987, the effective interest rate on bill
discounting has been fixed at a rate lower than the maximum
lending rate.
 (ii) In order to attract additional funds into rediscount market,
the ceiling on the bill rediscounting rate has been raised from
11.5% to 12:5%
 (iii) Access to bill rediscounting market has been increased by
increasing the number of participants in the market.

 (iv) 182 Day Treasury Bills have been introduced in 1987. 364
Day Treasury Bills were introduced in 1992-93. Like 182-Day
Treasury bills, 364 Day Bills can be held by commercial banks
for meeting their SLR requirements.
 (V)Stamp duty on Bills has been removed by RBI in 1989.
 (vi) The Discount Finance House of India (DFHI) was set up in
March 1988
 DFHI participates in all transactions of money
market
 borrows lends in call market

 Buys, sells T bills sold at auctions, CDs, CPs etc.

 RBI normally does not discount TREASURY BILLS

before maturity so DFHI does it if any bank wants
to discount T bills.
 Quotes its daily bid (buying) and offer (selling)
rates for money market instruments to develop
an active secondary money market and increase
the liquidity of money market instruments.
 C. Some More Measures introduced by RBI

 In March 1989, Reserve Bank of India decided to introduced

Certificates of Deposit (CDs) and Commercial Paper (CP) in order to
widen the range of money market instruments and give investors
greater flexibility in the deployment of their short-term surplus funds

 Since July 1987, the Credit Authorisation Scheme (CAS) has been
liberalised to allow for greater access to credit to meet genuine demand
in production sectors without the prior sanction of the Reserve Bank.

 In 1991, the scheduled commercial banks and their subsidiaries were

permitted to set up Money Market Mutual Fund (MMMF) which would
provide additional short-term avenue to investors and bring money
market instruments within the reach of individuals and small bodies.

 Today FIIs are also allowed to invest in money market instruments in

India.
 As a result of various measures taken by the RBI, the Indian
money market has shown signs of notable development in
many ways:
 (i) more organised and diversified.
 (ii) The government trading in various instruments, like 364
Day treasury Bills, commercial bills and commercial paper,
has increased considerably.
 (iii) The volume of inter-bank call money, short notice money
and term money transactions have grown significantly.
 (iv) At present, scheduled commercial banks, cooperative
banks, Discount and Finance House of India (DFHI) are
participating in the money market both as lenders and
borrowers of short-term funds,
 (v)while Life Insurance Corporation of India (LIC), Unit Trust
of India (UTI), General Insurance Corporation of India (GIC),
Industrial Development Bank of India (IDBI) and National
Bank for Agriculture and Rural Development (NABARD) are
participating as lenders.
OVER VIEW OF INDIAN MONEY MARKET

 Give structure chart.- Organised and

unorganised
 Organised -Mention Main participants

 Organised - Sub markets- call, Tbill, CD, CP,

MMMFs, Bill market.
 Unorganised – summary

 Main Reforms – 3 to 4 points