FINANCIAL MODULE 2

MARKETS
Meaning of Money Market

1. Money market refers to the market where money and highly

liquid marketable securities are bought and sold having a maturity
period of one or less than one year. It is not a place like the stock
market, but an activity conducted by telephone.
2. The money market constitutes a very important segment of the
Indian financial system. The highly liquid marketable securities are
also called as ‘money market instruments’ like treasury bills,
government securities, commercial paper, certificates of deposit,
call money, repurchase agreements etc.
3. According to the Geoffrey, “money market is the collective name
given to the various firms and institutions that deal in the various
grades of the near money.”
 Money market has no geographical constraints as that of a stock exchange.
The financial institutions dealing in monetary assets may be spread over a
wide geographical area.
Even though there are various centers of money market such as Mumbai,
Calcutta, Chennai, etc., they are not separate independent markets but are
inter-linked and interrelated.

Features of It relates to all dealings in money or monetary assets.

Money It is a market purely for short-term funds.

Market It is not a single homogeneous market. There are various sub-markets such as
Call money market, Bill market, etc.

Money market establishes a link between RBI and banks and provides
information of monetary policy and management.

Transactions can be conducted without the help of brokers.

Variety of instruments are traded in money market.

 To cater to the requirements of borrowers for short
term funds and provide liquidity to the lenders of these
funds.

To provide parking place for temporary employment of

surplus fund.

Objectives of
Money To provide facility to overcome short term deficits.

Market
To enable the central bank to influence and regulate
liquidity in the economy.

To help the government to implement its monetary

policy through open market operation.
Constituents of Indian Money Market
Money market is a center where short-term funds are supplied and demanded. Thus, the main
constituents of money market are the lenders who supply and the borrowers who demand short-
term credit.

I. Supply of Funds II. Demand for Funds:

• There are two main sources of
supply of short-term funds in
the Indian money market:
• (a) Unorganised indigenous
sector, and
• (b) Organised modern sector.
• In the Indian money market, the
main borrowers of short-term
funds are: (a) Central Government,
(b) State Governments, (c) Local
bodies, such as, municipalities,
village panchayats, etc., (d) traders,
industrialists, farmers, exporters
and importers, and (e) general
public.
 • The unorganised sector comprises
numerous indigenous bankers and
Unorganized village money lenders. It is unorganized
Sector because its activities are not controlled
and coordinated by the Reserve Bank
of India.
 The organized modern sector of Indian money market
comprises:
(a) The Reserve Bank of India;
(b) The State Bank of India and its associate banks;
(c) The Indian joint stock commercial banks (scheduled
and non-scheduled) of which 20 scheduled banks have
been nationalised;

Organized (d) The exchange banks which mainly finance Indian

foreign trade;
Sector (e) Cooperative banks;
(f) Other special institutions, such as, Industrial
Development Bank of India, State Finance Corporations,
National Bank for Agriculture and Rural Development,
Export-Import Bank, etc., which operate in the money
market indirectly through banks; and
(g) Quasi-government bodies and large companies also
make their funds available to the money market through
banks.
 Functions of Money Market
1. A money market by providing profitable investment opportunities for short-
term surplus funds helps to enhance the profit of financial insti­tutions.
2. A money market enhances the amount of liquidity available to the entire
country.
3. A well-developed money market helps to avoid wide seasonal fluctuations in
the interest rates.
4. A well-developed money market, through quick transfer of funds from one
place to another, helps to avoid the regional gluts and stringencies of funds.
5. By providing various kinds of credit instru­ments suitable and attractive for
different sections, a money market augments the supply of funds.
6. A well organized money market is essen­tial for the successful operation of the
central bank­ing policies.
Money Market Instruments
• Call money- money borrowed/lent for a day. No collateral
is required.
• Inter-bank term money- Borrowings among banks for a
period of more than 14 days
• Treasury Bills- short term instruments issued by the Union
Govt. to raise money. Issued at a discount to the face
value
• Certificates of Deposit- Issued by banks to raise money.
Minimum value is Rs. 1 lakh, tradable in the market
• CDs can be issued by banks/FIs
Money Market Instruments
• Commercial Paper (CPs) are issued by corporates to raise short term
money
• Issued in multiple of 25 lakhs, can be issued by companies with a net
worth of at least 5 crores
• CP is an unsecured promissory note privately placed with investors at
a discount rate to face value. The maturity of CP is between 3 and 6
months
 Affect generation
Includes institutions
of savings by the community
and mechanisms
Mobilisation of savings
which distribution of savings
Effective

Institutions are banks,

Financial insurance companies,
mutual funds-
Institutions promote/mobilise
savings

Individual investors,
industrial and
trading companies-
borrowers
Financial Markets
Primary Issues Market
Organised (Banks) Stock Market
Unorganised (money lenders, chit funds, etc.) Bond Market

Money Market- for short-term funds (less Capital Market- for long-term funds
than a year)
 Call money market

Organised Bill Market

Money
Market Bank loans (short-term)

Organised money market

comprises RBI, banks
(commercial and co-
operative)
 • It deals with one-day loans (overnight, to be
precise) called call loans or call money
• Participants are mostly banks. Also called inter-
bank call money market.
Call money • The borrowing is exclusively limited to banks,
who are temporarily short of funds.
market • On the lending side, besides banks with excess
cash and as special cases few FIs like LIC, UTI
• All others have to keep their funds in term
deposits of minimum 15 days with banks to
earn interest
 • Call loans are generally made on a clean basis-
i.e. no collateral is required
• The main function of the call money market is
to redistribute the pool of day-to-day surplus
Call money funds of banks among other banks in temporary
deficit of funds
market (contd) • The call market helps banks economise their
cash and yet improve their liquidity
• It is a highly competitive and sensitive market
• It acts as a good indicator of the liquidity
position
 Treasury Bill market- Also called the T-Bill market

●
These bills are short-term liabilities (91-day, 182-day, 364-day) of the Government of India

Bill Market
●
It is an IOU of the government, a promise to pay the stated amount after expiry of the stated
period from the date of issue
●
They are issued at discount to the face value and at the end of maturity the face value is paid
●
The rate of discount and the corresponding issue price are determined at each auction

Commercial Bill market- Not as developed in India as the T-Bill

market
Bank formed Video
• https://www.youtube.com/watch?v=7I_k0tAnQ7U
 Central Bank (Reserve Bank of India)

Commercial banks

Indian
Co-operative banks
Banking
System Banks can be classified as:
●
Scheduled (Second Schedule of RBI Act, 1934)
●
Non-Scheduled

Scheduled banks can be classified as:

●
Public Sector Banks (27)
●
Private Sector Banks (Old and New) (30)
●
Foreign Banks (40)
●
Regional Rural Banks (102)
 Indigenous bankers
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 Methods employed by the
indigenous bankers are traditional
with vernacular system of
accounting.

RBI suggested that bankers give up

their trading and commission
business and switch over to the
western system of accounting.

RBI and It also suggested that these

indigenous bankers should develop the
deposit side of their business
bankers
Ambiguous character of the
hundi should stop

Some of them should play the

role of discount houses (buy
and sell bills of exchange)
 IB should have their accounts
audited by certified chartered
accountants

Submit their accounts to

RBI and RBI periodically

indigenous As against these obligations the RBI

promised to provide them with

bankers
privileges offered to commercial
banks including

(contd) The IB declined to accept

the restrictions as well as
compensation from the RBI

Therefore, the IB remain

out of RBI’s purview
 Development Oriented Banking

• Historically, close association between banks and some traditional industries- cotton
textiles in the west, jute textiles in the east
• Banking has not been mere acceptance of deposits and lending money to include
development banking
• Lead Bank Scheme- opening bank offices in all important localities
• Providing credit for development of the district
• Mobilising savings in the district. ‘Service area approach’
 • Nationalisation of banks in 1969: 14 banks were
nationalised
• Branch expansion: Increased from 8260 in 1969
Progress of to 68500 in 2005
• Population served per branch has come down
banking in from 64000 to 15000
India • A rural branch office serves 15 to 25 villages
within a radius of 16 kms
• However, at present only 32,180 villages out of
5 lakh have been covered
 • Deposit mobilisation:
• 1951-1971 (20 years)- 700% or 7 times
• 1971-1991 (20 years)- 3260% or 32.6 times
• 1991- 2006 (11 years)- 1100% or 11 times
Progress of • Expansion of bank credit: Growing at 20-30%
banking in thanks to rapid growth in industrial and
agricultural output
India (contd) • Development oriented banking: priority sector
lending
 • Diversification in banking: Banking has moved
from deposit and lending to
• Merchant banking and underwriting
Progress of • Mutual funds
• Retail banking
banking in • ATMs
India (contd) • Anywhere banking
• Internet banking
• Venture capital funds
• Factoring-
 Reforms has shifted the focus of banks from being development
oriented to being commercially viable

Profitability ●
Declining interest income

of Banks(1) Increasing cost of operations

●

Prior to reforms banks were not profitable and in fact made

losses for the following reasons:
 Declining interest income was for the following reasons:

Profitability ●
High proportion of deposits impounded for CRR and SLR, earning
relatively low interest rates

of banks () System of directed lending

●

●
Political interference- leading to huge NPAs

Rising costs of operations for banks was because of several

reasons: economic and political
 As per the Narasimham Committee (1991) the reasons for rising
costs of banks were:

Profitability ●
Uneconomic branch expansion

of Banks ●

●
Heavy recruitment of employees
Growing indiscipline and inefficiency of staff due to trade union activities

(contd)
●
Low productivity

Declining interest income and rising cost of operations of banks

led to low profitability in the 90s
 Bank profitability: Suggestions

• Some suggestions made by Narsimham Committee are:

• Set up an Asset Reconstruction Fund to take over doubtful debts
• SLR to be reduced to 25% of total deposits
• CRR to be reduced to 3 to 5% of total deposits
• Banks to get more freedom to set minimum lending rates
• Share of priority sector credit be reduced to 10% from 40%
 Suggestions (cont’d)

• All concessional rates of interest should be removed

• Banks should go for new sources of funds such as Certificates of Deposits
• Branch expansion should be carried out strictly on commercial principles
• Diversification of banking activities
• Almost all suggestions of the Narasimham Committee have been accepted and
implemented in a phased manner since the onset of Reforms
 The Narasimham Committee recommendations were made,
among other things, to reduce the Non-Performing Assets (NPAs)
of banks

NPA To tackle this the government enacted the Securitization and

Reconstruction of Financial Assets and Enforcement of Security
Management Act (SARFAESI) Act, 2002

Enabled banks to realise their dues without intervention of courts

 Enables setting up of Asset Management Companies to acquire
NPAs of any bank or FI (SASF, ARCIL are examples)

NPAs are acquired by issuing debentures, bonds or any other

security

SARFAESI As a second creditor can serve notice to the defaulting borrower

Act to discharge his/her liabilities in 60 days

Failing which the company can take possession of assets, takeover

the management of assets and appoint any person to manage the
secured assets

Borrowers have the right to appeal to the Debts Tribunal after

depositing 75% of the amount claimed by the second creditor
The Indian Capital Market (1)
Gilt-edged market
Industrial securities market (new issues and stock market)

Market for long-term capital. Demand comes from Supply comes from individuals, corporates,
the industrial, service sector and government banks, financial institutions, etc. Can be classified into:
The Indian Capital Market (2)
Industrial Finance Corporation of India (IFCI) Merchant Banks
Mutual Funds
State Finance Corporations (SFCs) Leasing Companies
Industrial Development Finance Corporation (IDFC) Venture Capital Companies

Development Financial Institutions Financial Intermediaries

 Refers to the market for shares and debentures
of old and new companies
Industrial
Securities New Issues Market- also known as the primary market- refers
Market to raising of new capital in the form of shares and debentures

Stock Market- also known as the secondary market.

Deals with securities already issued by companies
 • Mutual Funds- Promote savings and mobilise
funds which are invested in the stock market
and bond market
• Indirect source of finance to companies
Financial • Pool funds of savers and invest in the stock
market/bond market
Intermediaries • Their instruments at saver’s end are called units
• Offer many types of schemes: growth fund,
income fund, balanced fund
• Regulated by SEBI
 • Merchant banking- manage and underwrite
new issues, undertake syndication of credit,
advise corporate clients on fund raising
Financial • Subject to regulation by SEBI and RBI
• SEBI regulates them on issue activity and
Intermediaries portfolio management of their business.
(contd) • RBI supervises those merchant banks which are
subsidiaries or affiliates of commercial banks
• Have to adopt stipulated capital adequacy
norms and abide by a code of conduct
 Conclusion

• There are other financial intermediaries such as NBFCs, Venture

Capital Funds, Hire and Leasing Companies, etc.
• India’s financial system is quite huge and caters to every kind of
demand for funds
• Banks are at the core of our financial system and therefore, there is
greater expectation from them in terms of reaching out to the vast
populace as well as being competitive.