Money Markets

Overview of Financial Markets

The Need for Money Markets

• Need for short term funds by Banks.

• Outlet for deploying funds on short term basis
• Need to keep the SLR as prescribed
• Need to keep the CRR as prescribed
• Optimize the yield on temporary surplus funds
• 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
The Definition

• 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 Definition (Cont’d)

• 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.
• Allows the investor institutions to optimize the yield
on temporary surplus funds.
• Instrument of Liquidity adjustment by Central Bank.
The Players

• Reserve Bank of India

• SBI DFHI Ltd (Amalgamation of Discount & Finance
House in India and SBI Gilts in 2004)
• Commercial Banks, Co-operative Banks and Primary
Dealers are allowed to borrow and lend.
• Specified All-India Financial Institutions, Mutual
Funds, and certain specified entities are allowed to
access to Call/Notice money market only as lenders
• Individuals, firms, companies, corporate bodies, trusts
and institutions can purchase the treasury bills, CPs
and CDs.
The Products & Process

• Certificate of Deposit (CD)

• Commercial Paper (C.P)
• Inter Bank Participation Certificates
• Inter Bank term Money
• Treasury Bills
• Call Money
CERTIFICATE OF DEPOSIT
(CD)
Certificate of Deposit

• CDs are short-term borrowings in the form of

Promissory Notes having a maturity of not less than 15
days up to a maximum of one year.
• CD is subject to payment of Stamp Duty under Indian
Stamp Act, 1899 (Central Act)
• They are like bank term deposits accounts. Unlike
traditional time deposits these are freely negotiable
instruments and are often referred to as Negotiable
Certificate of Deposits
 Features of CD
• CDs can be issued by all scheduled commercial banks except
RRBs
• Minimum period 15 days
• Maximum period 1 year
• Minimum Amount Rs 1 lac and in multiples of Rs. 1 lac
• CDs are transferable by endorsement
• Liquidity and marketability as its hallmark
• CDs are issued by banks for attracting large corporate
deposits rather mobilising individual savings
• The introduction of CDs in an economy has usually preceded
the introduction of CPs
CDs in India

• In initial years (1980-1987) feasibility of CDs in India is

subject to various constraints like lack of secondary money
market, administered interest rates, lack of proper regulatory
system

• Introduction of CDs in 1989 : recommendation of RBI

working group on money market (Vaghul working group,
1987)

• Broad objective is to further widen the range of money

market instruments and to give investors greater flexibility in
the deployment of short term surplus funds
1
 contd.

CDs in India
• CDs can be issued by (i) scheduled commercial
banks excluding Regional Rural Banks (RRBs) and
Local Area Banks (LABs); and (ii) An FI may issue
CDs within the overall umbrella limit fixed by RBI
• CDs can be issued to individuals, corporations,
companies, trusts, funds, associations, NRIs (on
non- repatriable basis)
• CDs may be issued at a discount on face value.
• All CDs were subject to cash reserve ratio (CRR)
and statutory liquidity ratio (SLR) requirement , on
the issue price of the CDs.

1
 contd.

CDs in India
• Banks / FIs cannot grant loans against CDs and cannot
buy-back their own CDs before maturity.
• CDs are freely transferable by endorsement and delivery
• RBI Guidelines for Issue of CDs with respect to The
maturity period, Minimum Size of Issue and
Denominations modified from time-to-time
• Mutual funds are allowed to invest in CDs with cretin
limit stipulated by Securities Exchange Board of India
(SEBI)
• Existence of favorable supply and demand factors for
growth of CDs market

1
 contd.

CDs in India

• The maximum interest rates on CDs have been mostly

higher than the maximum interest rates on CPs

• There is an inverse relationship between liquidity in the

economy and the amount of CDs issued.

• Interest rates on CDs and CPs increased between 1993-94

to 1995-96 and declined thereafter till 2006-07

1
COMMERCIAL PAPERS
Commercial Paper
• Commercial Paper (CP) is an unsecured money market
instrument issued in the form of a promissory note.
• Introduced in India in 1990
• Enabling highly rated corporate borrowers/ to diversify their
sources of short-term borrowings and to provide an additional
instrument to investors.
• Primary dealers and satellite dealers were also permitted to
issue CP to enable them to meet their short-term funding
requirements for their operations.
Primary Dealers
• The system of Primary Dealers (PDs) in the Government
Securities Market was introduced by Reserve Bank of India
in 1995 to strengthen the market infrastructure of
Government Securities
• Primary Dealers can also be referred to as Merchant Bankers
to Government of India as only they are allowed to
underwrite primary issues of government securities other
than RBI
Activities of Primary Dealers
1. Dealing and underwriting in Government securities.
2. Dealing in Interest Rate Derivatives.
3. Providing broking services in Government securities.
4. Dealing and underwriting in Corporate / PSU / FI bonds/
debentures.
5. Lending in Call/ Notice/ Term/ Repo/ CBLO market.
6. Investment in Commercial Papers.
7. Investment in Certificates of Deposit.
8. Investment in debt mutual funds where entire corpus is invested
in debt securities.
Who can Issue CPs?

• Corporates, primary dealers (PDs) and the All-India Financial

Institutions (FIs)
• Conditions:
a. the tangible net worth of the company, as per the latest audited
balance sheet, is not less than Rs. 4 crore
b. company has been sanctioned working capital limit by bank/s
or all-India financial institution/s; and
c. the borrowal account of the company is classified as a Standard
Asset by the financing bank/s/ institution/s.
CP as on Jan 15 2011

Parameter Values

Total Amount Outstanding(Rs. Crores) 98913

Fresh Issue In Fortnight(Rs. Crores) 22908

Lowest Interest Rate Band(%) 6.60

High Interest Rate Band(%) 11.95

Mean Rate(%) 9.275

Spread(bps) 535
Rating Requirement
• All eligible participants should obtain the credit rating for
issuance of Commercial Paper
• Credit Rating Information Services of India Ltd. (CRISIL)
• Investment Information and Credit Rating Agency of India Ltd.
(ICRA)
• Credit Analysis and Research Ltd. (CARE)
• Duff & Phelps Credit Rating India Pvt. Ltd. (DCR India)
• The minimum credit rating shall be P-2 of CRISIL or such
equivalent rating by other agencies
Maturity

• CP can be issued for maturities between a

minimum of 15 days and a maximum upto
one year from the date of issue.

• If the maturity date is a holiday, the

company would be liable to make payment
on the immediate preceding working day.
To whom issued

• CP is issued to and held by individuals,

banking companies, other corporate
bodies registered or incorporated in
India and unincorporated bodies, Non-
Resident Indians (NRIs) and Foreign
Institutional Investors (FIIs).
RBI Guidelines for Issue of CPs
a) The tangible net worth of the company, as per the latest
audited balance sheet, is not less than Rs.4 crore
b) CP can be issued in denominations of Rs.5 lakh or multiples
thereof.
c) The fund based working capital of the company should not
be less than 4 crore
d) Every issue of CP, including renewal, should be treated as a
fresh issue.
e) CP can be issued as a "stand alone" product (since October 2000).
f) There is no lock in period for CPs

2
 contd.

RBI Guidelines for Issue of CPs

g) CP can be issued for maturities between a minimum of 7 days and a
maximum up to one year from the date of issue ( since October 2004).

h) CP may be issued to and held by individuals, banking companies,NRIs,

other corporate bodies registered or incorporated in India and
unincorporated bodies,

i) Mandatory credit rating for issuance of Commercial Paper. The

minimum credit rating shall be P-2 of CRISIL and A2 for ICRA.
 The company shall not required to get the issue underwritten or co-
accepted

2
CALL MONEY MARKET
Call Money Market

The call money market is an integral part of

the Indian Money Market, where the day-to-
day surplus funds (mostly of banks) are
traded. The loans are of short-term duration
varying from 1 to 14 days.
The money that is lent for one day in this
market is known as "Call Money", and if it
exceeds one day (but less than 15 days) it is
referred to as "Notice Money".
Call Money Market

Banks borrow in this market for the

following purpose
• To fill the gaps or temporary
mismatches in funds
• To meet the CRR & SLR mandatory
requirements as stipulated by the
Central bank
• To meet sudden demand for funds
arising out of large outflows.
Call Rate Vs. Bank Rate
• Significant Relation for better integration in the money
market
• Call money rates remained stable during the period
2003-04 to first half of the 2004-05 reflecting the
substantial overhang of liquidity in the system
• Call money volatility was higher during 2003-04 to
2006-07
• Reduction of Volatility followed by introduction of
policy measure such as market Repo and CBLO
( Collateralized borrowing and lending obligations)

2
Reasons for Call Rate Volatility

 Requirement for CRR needs create excess demand for liquidity

in call money market
 Over extended credit position of Banks
 Occasional market disruptions
 Heavy withdrawal by Institutional investors
 Liquidity crisis in money market
 Sluggish demand in bank deposit with heavy pressure for non-
food credit in the banking sector crating asset liability mismatch
 Causality in foreign exchange market and call money market
 Structural deficiencies in the Banking Sector

3
Gilt edged securities

The term government securities encompass

all Bonds & T-bills issued by the Central
Government, and state governments. These
securities are normally referred to, as "gilt-
edged" as repayments of principal as well as
interest are totally secured by sovereign
guarantee.
T-Bills
 A Particular type of Finance Bill or Promissory note put
out by the Govt. of the country to meet the needs of
supplementary short-term Finance

Characteristics:

 High Liquidity Money Market Instrument

 Absence of Risk of Default
 Ready availability on Tap
 Assured Yield
 Low transaction Cost
 Eligibility for Inclusion in SLR
 Negligible Capital Depreciation
3
 contd.
 Issued by RBI on behalf of the Govt. and is the
predominant buyer/holder of TBs (77-97%)

 Major market players: RBI, Commercial Banks, State

Govts. Foreign Central Banks, NBFCs, State Pension
Funds and Eligible Provident Funds

 Treasury Bill rate is the rate of interest at which treasury

bills are sold by RBI
(Effective Return= Sales Price – Redemption Value)

 Volume of Treasury Bills Variation can undermine

Monetary Policy depending on the extent of
Importance as a Part of Liquidity Ratio
3
 contd.
 Minimum amount for bidding is Rs.25000 or in multiple
of that
 Major Policy Reform in TBs Market: Chakravarty &
Vaghul Committee Report

 Types of Treasury Bills:

 Ordinary
 Ad-hoc (Discontinued since 1994 with WMA system)
 91-days (Money Market Reference Rate with auction system)
 182-days (Ceased to be issued since 1992)
 364-days (Introduced Since 1992)
 14-day (Introduced Since 1997 with high frequency of
auctions)
3
Recent development in TBs market
 Sterilization purposes: Market Stabilization Scheme
(MSS)

 Throughout the period the yield on 364-day TBs has

been higher than the yield on 91-day TBs.

 The 364-day TBs market has been more volatile than

91-day TBs market during the liberalization period
1993-94 to 2006-07

 The relative share of 364- day TBs are higher than

91-day and 182- day TBs 3