Money Market

Session 7
 What is Money Market?
• Market for financial assets that are close
substitutes for money
• It is a market for overnight to short-term
funds and instruments having a maturity
period of one or less than one year
 Money Market Instruments
- Treasury Bills Market
- Commercial Paper Market (CP)
- Certificate of Deposit Market (CD)
- Repo Market
- Call/Notice Market
- Primary Dealers
- Money Market Mutual Funds came up
 Instruments for Controlling Money Supply
• Bank Rate: the bank rate is the rate at which the central bank
offers refinance to the com banks.
– lending rates and borrowing rates as a mark up over the bank rate
– Consequently, these rates tend to move together
– RBI changes the bank rate to induce medium term movements in
borrowing and lending rates
– Bank rate ?
– 6.5%
• Open Market Operations:
– Outright purchase/sale of Government Securities
– Repurchase Agreement (Repo) and Reverse repo operations
 Liquidity adjustment facility (LAF)
• allows banks to borrow money through repurchase
agreements
• aids banks in adjusting the day to day mismatches in liquidity
• consists of repo and reverse repo operations
• framework of the LAF
• has undergone various tweaks over time as monetary
conditions and operational frameworks have changed
• money market has become deep and diverse with
emergence of several segments like CBLO (collateralized
borrowing and lending obligations)
 Repo Rate
– Rate at which RBI lends short term funds to the com banks against government securities
• Under repo transaction, the contract specifies a date and a price for their resale to
banks
• Reverse repo
– Rate that banks receive when they deposit their excess funds with RBI
– RBI sells financial instruments to banks under a contract with a specified date and price to buy them
back
– The contract period ranges from 1 to 30 days

• It also works as a tool to control money supply

– The RBI decreases repo rate
• It becomes cheaper for com banks to get funds from RBI
• banks swap the government securities for cash
• More liquidity with banks and thus more liquidity in the market
• What will happen to the interest rates charged by banks to lenders?
– The RBI increases repo rate
• ??
 Repo Rates
• Repo: injecting liquidity into the system
• Reverse Repo : absorb liquidity from the system
– Repo rate is 6.25%
– Reverse Repo rate is 6.00%

• Repo transaction does not involve buying or selling strictly

• Short term , collateralized exchange of ownership
• Thus, Repo transactions involve almost no risk
 Call Money Mkt
• inter-bank very short-term money market (usually overnight)

• In India,
– public sector banks generally liquidity surplus

– smaller private banks are in liquidity shortage

– Public sector banks tend to be the lenders

• Call Money Rates can be quite volatile

– LAF was also introduced to reduce and control the volatility in the call money market

– Call money markets are more risky a s they do not involve collaterals

– So they are higher than reverse repo rates

 Repo, Reverse Repo & Call Money

• In normal circumstances,
• Call money
call money rates < repo markets more
rates risky
prevent arbitrage • Do not involve
r Rep
collaterals
• So, call money
o rates > reverse
repo rates.

Ideally, the call

money rate
LAF Corridor should be within
this corridor

Reverse Repo

t
 Marginal Standing Facility (MSF)
• RBI introduced MSF in 2011-12 to regulate short- term asset
liability mismatches more effectively
– Banks can borrow funds from RBI at 1% above the liquidity adjustment

• facility-repo rate
– against pledging government securities

– The MSF rate used to be pegged 100 basis points or a percentage point
above the repo rate
– Currently, 6.50%

• Banks can borrow funds through MSF when there is a

considerable shortfall of liquidity 
 Collateralized Borrowing and Lending Obligation (CBLO)

• borrowing and lending of funds

• market participants: members in CBLO Segment
• Clearcorp Dealing Systems (India) Ltd
• borrowing and / or lending in CBLO is facilitated from
overnight to a year
• The type of entity eligible for CBLO Membership are
– Nationalized Banks, Private Banks, Foreign Banks, Co-
operative Banks, Financial Institutions, Insurance Companies,
Mutual Funds, Primary Dealers, Bank cum Primary Dealers,
NBFC, Corporate, Provident/ Pension Funds etc. 
45.00

Bank Rate, CRR and SLR

40.00
(1991-2016)
35.00

30.00

25.00

Bank Rate
%
20.00 Cash Reserve Ratio
Statutory Liquidity
Ratio
15.00

10.00

5.00

0.00
91 9 3 9 3 94 9 5 9 6 97 9 7 98 98 9 9 00 00 0 1 01 0 3 06 07 0 7 08 08 0 9 10 1 2 12 13 1 3 14 15 16
-19 -19 -19 -19 -19 -19 -19 -19 -19 -19 -19 -20 -20 -20 -20 -20 -20 -20 -20 -20 -20 -20 -20 -20 -20 -20 -20 -20 -20 -20
7 3 9 8 1 7 1 0 3 4 5 4 8 3 2 4 2 3 8 5 0 1 2 2 9 3 0 8 6 4
-0 -0 -0 -0 -1 -0 -0 -1 -0 -0 -0 -0 -0 -0 -1 -0 -1 -0 -0 -0 -1 -0 -0 -0 -0 -0 -1 -0 -0 -0
04 0 6 1 8 06 1 1 0 6 18 2 5 19 29 0 8 08 12 1 0 29 2 9 23 03 0 4 24 11 0 5 27 1 3 22 19 0 7 09 02 05
 T-bills
• T-bill (Treasury Bill)
• Issued by govt.
• Maturity> 14 days to 364 days
– Currently, 2 choices
– 91 day (Dutch auction), 182 days and 364 days
(French auction)
• Issued at discount to face value
• On maturity face value paid to the holder
 Com papers (CPs)
• Promissory notes
• Issued by corporate firms and fin institutions
– High credit rating
• At discount to face value
• Maturity pd=> 1 day to 270 days
• Physical and dematerialized form
 Certificate of Deposit (CD)
• Promissory notes
• Banks
• Certificate form
• Fixed interest rate
• Maturity pd=> 15 days to 365 days
• Both physical and demat form
• Like fixed deposit
• But freely negotiable instruments
 Call, Notice, Term Money
• Call Money=>Borrowed or lent for a day
• Notice Money=> 1 day <x <14 days
• Term Money=> 14days <x<365 days
• Participants
– Commercial banks (excluding RRBs), co-operative banks
(other than Land Development Banks) and Primary
Dealers (PDs)
– PDs are firms that buy government securities directly
from a government, with the intention of reselling them
to others