Money Market2

7/28/2019 Money Market2

1/42

Financial System of any country consists of financial markets,financial intermediation and financial instruments or financial

products

Suppliers of funds

(Mainly households)

Flow of financial services

Incomes , and financial

claims

Seekers of funds

(Mainly business firms

and government)

Flow of funds (savings)


2/42

Organized Indian FinancialSystem

Money MarketInstrument

Capital MarketInstrument

Forex

Market

Capital

Market

Money

Market

Credit

Market

Primary Market

FinancialInstruments FinancialMarkets

FinancialIntermediaries

Secondary Market

Regulators


3/42

A market for short-term lending and borrowing.

Money market provides a platform for providers and user of

short term funds to fulfill their borrowing and investment

requirements at an efficient market clearing price.

It recognizes cost of holding excessive cash even for shortduration.

Money market instruments have the characteristics of

liquidity, minimum transaction cost and no loss in value

Money market performs the crucial role of providing anequilibrating mechanism to even out short-term liquidity and

in the process, facilitating the conduct of monetary policy.


4/42


5/42

It provides a stable source of fund to banks in addition to

deposits ,allowing alternative financing structure.

A liquid money market provides an effective source of long

term finance to borrower

A liquid and vibrant money market is necessary for thedevelopment of a capital market, foreign exchange market and

market in derivative instruments.

Helps in pricing different floating interest products.


6/42

It was a highly regulated and segmented market.

Participants were very limited

Limited number of money market instrument

Interest are also not market determined

Lack of proper secondary market for the money market

instrument.


7/42

The RBI has given the highest priority to the development of a

vibrant money market in India since it is the vital link in the

implementation of monetary policy to ensure a broad based

growth of the countries economy, and initiated following

reform:

Set up the Discount and Finance House of India Ltd in April

1988 as a money market institution to provide a secondary

market for money instruments and create liquidity in these

instrument. Completely withdrew interest rate ceiling for all operation in

call/notice money market and also rediscounting of

commercial bill in may 1989.


8/42

In may 1990 ,allowed GIC,IDBI and NABARD to enter the call moneymarket as lenders.

Allowed certain non-banking institutions to lend in call money market

through DFHI in 1991

Issued Primary dealer (PD) license to DFHI and STCI(State Trading

Corporation of India) for orderly development of secondary market by

1996.

Clearing Corporation of India Limited(CCIL) was set up to institutionalize

the settlement mechanism in debt, forex and money market

A unique product CBLO(Collateralized Borrowing and Lending

Obligation)


9/42

Treasury Bills

Certificate of deposit

Commercial paper

Call/notice Money Term money

Repo

CBLO


10/42

T-bills are short-term instrument issued by RBI on behalf of the govt. totide over short-term liquidity shortfalls. This instrument is issued by the

govt. to raise shortterm funds to bridge seasonal or temporary gap

between its receipt(revenue & capital) and expenditure. T-bills are repaid

at par on maturity. The difference between the amount paid by the tenderer

at the time of purchases (which is less than the face value) and the amountreceived on maturity represent the interest amount on T-bills and is known

as the discount.

Feature of T-bills.

They are negotiable securities.

They are highly liquid as they are of shorter tenure and there is a

possibilities of inter-bank repos in them.

There is an absence of default risk.


11/42

They have an assured yield ,low transaction cost and are eligible forinclusion in the securities for SLR purposes

They are not issued in scrip form. The purchases and sales are effected

through the subsidiary General Ledger (SGL) account

At present ,there are 91-day ,182-day and 364-day T-bills in vogue.

The 91-day T-bills are auctioned by RBI every Friday and 363- day T-

bill every alternate Wednesday i.e. the Wednesday preceding the

reporting Friday

T-bills are available for a minimum amount of Rs 25000 and in multiples

theirof.


12/42

The sale of T-bill is conducted through an auction.

Type of auction

Multipleprice auction

Uniform price auctionBidding process:

Competitive bid

Participants: primary dealers, banks, corporate, mutual fund etc.

Non-competitive bid

Participants: state government provident fund, government provident fund,pension fund


13/42

The call money market is a market for very short-term fundsrepayable on demand and with maturity period varying

between one day to a fortnight. When money is lent for a day

,it is known as call(overnight) money. Intervening holidays

and /or Sundays are excluded for this purpose. When money isis borrowed or lent for more than a day and up to 14 days, It is

known as notice money.

It is highly liquid market and extremely volatile .

No collateral security is required to cover these transaction.


14/42

The call money market is pre-dominantly an inter-bank till1971 when UTI and LIC were allowed as to operate aslenders.

In the 1990s the participation was gradually widened toinclude DFHI,STCI,GIC,NABARD, IDBI, money marketmutual fund, corporate as lenders in this market.

In 1996-97,the RBI permitted Primary Dealer to participate inthis market as both lenders and borrowers. Those entities thatcould provide evidence of surplus fund were permitted to

route their lending through PD. The call money market is now a purely inter-bank money

market with effect from Aug 6,2005.


15/42

The RBI intervenes in the call money indirectly in two ways-

By providing lines of finance/additional funding to the DFHI

and other call money dealers

By conducting repo auction

Additional funding is provided through REPO auctions which

increase liquidity in the market and bring down call money

rates.

RBIs reverse repo auction absorb excess liquidity in the

economy and push up the call rates.


16/42

There is inverse relation between call rates and short-term money marketinstrument such as certificate of deposit and commercial paper.

When call rates peak to high level ,bank raise more funds through CD.

When call rates are lower ,many bank fund CP by borrowing from call

money and earn profits through arbitrage between money market segment.

A large issue of Govt.securities also affect call money rates. when banks

subscribe to large issue of G-sec, liquidity is sucked out from banking

system. This increases the demand for fund in call money market which

pushes up call money rates.

Increase in CRR also increases call money rates.

Call money market and foreign exchange market are related. When call

rates rise , bank borrow dollars from their overseas branches, swap them

for rupees and lend them in the call money market.


17/42

At the same ,they buy dollars forward in anticipation of their repaymentliability. This pushes forward the premia on the rupee-dollar exchange rate.

It happens many a times that bank fund foreign currency positions by

withdrawing from the call money market, causing upsurge in call rate.


18/42

Certificate of deposit( CD) are unsecured, negotiable, short-terminstrument issued by commercial banks and development financial

institutions.

CD are issued by banks during periods of tight liquidity ,at relatively high

interest rates.

They represent a high cost liability.

Bank resort to this source when the deposit growth is sluggish but credit

demand is high.

Minimum amount of CD should be Rs 1lakh i.e. the minimum deposit that

could be accepted from a single subscriber should not be less than Rs 1lakh

and in the multiple of Rs 1lakh thereafter.


19/42

Eligibility: CD can b issued by bank, select financialinstitution.

Maturity: 7day to 1year.

Discount: CD can b issued by at a discount on face value. The

issuing bank is free to determine the discount /coupon rate. Transferability: It is freely transferable .


20/42

Commercial paper is an unsecured short-term promissory note ,negotiableand transferable by endorsement and delivery with fixed maturity period.

It is generally issued at a discount by leading creditworthy and highly rated

corporate to meet their working capital requirements

A CP is usually privately placed ,either through merchant banker or

banks. A specified credit rating of P2 of CRISIL or its equivalent is to beobtained from credit rating agency.

CP is issued as an unsecured promissory note or in dematerialized form at a

discount .The discount rate is freely determined by market forces. The

paper is usually priced between the lending rate of scheduled commercial

bank and a representative money market rate.

Corporates are allowed to issue CPs up to 100% of their fund- based

working capital limits.


21/42

Repo is useful money market instrument enabling the smooth adjustmentof short-term liquidity among varied market participant such as bank and

financial institutions.

Repo refers to a transaction in which a participant acquires immediate

funds by selling securities and simultaneously agrees to repurchase of the

same or similar securities after a specified time at a specified rate.It is also referred as ready forward transaction

REVERSE REPO is exactly the opposite of Repo- a party buy a security

from another party with a commitment to sell it back to latter at a specified

time and price.

In otherworld ,while for one party the transaction is repo , for another party

it is reverse repo.


22/42

Collateralized Borrowing and Lending Obligation (CBLO)", a money marketinstrument as approved by RBI, is a product developed by CCIL for the benefit of

the entities who have either been phased out from inter bank call money market or

have been given restricted participation in terms of ceiling on call borrowing and

lending transactions and who do not have access to the call money market. CBLO

is a discounted instrument available in electronic book entry form for the maturity

period ranging from one day to ninety Days (can be made available up to one year

as per RBI guidelines). In order to enable the market participants to borrow and

lend funds, CCIL provides the Dealing System through:

- Indian Financial Network (INFINET), a closed user group to the Members of

the Negotiated Dealing System (NDS) who maintain Current account with RBI.

- Internet gateway for other entities who do not maintain Current account with

RBI.


23/42

Membership to CBLO segment is extended to entities who are RBI- NDSmembers viz. Nationalized Banks, Private Banks, Foreign Banks, Co-

operative Banks, Financial Institutions, Insurance Companies, Mutual

Funds, Primary Dealers etc.

Associate Membership to CBLO segment is extended to entities who arenot members of RBI- NDS viz. Co-operative Banks, Mutual Funds,

Insurance companies, NBFC's, Corporate, Provident/ Pension Funds etc.


24/42


25/42

RBI and Monetary Policy in India


26/42

The term monetary policy refers to actions taken by central banks to affect

monetary magnitudes or other financial conditions.

Monetary Policy operates on monetary magnitudes or variables such as

money supply, interest rates and availability of credit.

Monetary Policy ultimately operates through its influence on expenditure

flows in the economy.

In other words affects liquidity and by affecting liquidity, and thus credit, it

affects total demand in the economy.


27/42

MP is a part of general economic policy of the govt.

Thus MP contributes to the achievement of the goals of economic policy.

Objective of MP may be:

Full employment

Stable exchange rate

Healthy BoP

Economic growth

Reasonable Price Stability

Greater equality in distribution of income & wealth

Financial stability


28/42

There is convergence of views in developed and developingeconomies, that price stability is the dominant objective of

monetary policy.

Price stability does not mean complete year-to-year price

stability which is difficult to attain. Price stability refers to the long run average stability of prices.

Price stability involves avoidance of both inflationary anddeflationary pressures.


29/42

Price Stability contributes improvements in the standard of living of

people.

It promotes saving in the economy while discouraging unproductive

investment.

Stable prices enable exports to compete in international markets and

contribute to the strengthening of BoP.

Price stability leads to interest rate stability, and exchange rate stability (via

export import stability).

It contributes to the overall financial stability of the economy.


30/42


31/42

InflationA sustained rise in the prices of commodities that leads to a fall inthe purchasing power of a nation is called inflation. Although

inflation is part of the normal economic phenomena of any country,

any increase in inflation above a predetermined level is a cause of

concern.

Types of inflation

Demand pull inflation

Supply shock inflation (cost push) Built in inflation


32/42

Types of money in the Indian system

Reserve Money (M0): Currency in circulation + Bankers deposits with the RBI + Other

deposits with the RBI = Net RBI credit to the Government + RBI credit to the commercialsector + RBIs claims on banks + RBIs net foreign assets + Governments currency

liabilities to the publicRBIs net non-monetary liabilities.

M1: Currency with the public + Deposit money of the public (Demand deposits with the

banking system + Other deposits with the RBI).

M2: M1 + Savings deposits with Post office savings banks.

M3: M2+Time deposits with the banking system. = Net bank credit to the Government +

Bank credit to the commercial sector + Net foreign exchange assets of the banking sector

+ Governments currency liabilities to the public Net non-monetary liabilities of the

banking sector (Other than Time Deposits).

M4: M3 + All deposits with post office savings banks (excluding National Savings

Certificates).

As defined by the Reserve Bank of India (RBI.)


33/42


34/42

Instruments

1. Discount Rate

(Bank Rate)

2.Reserve Ratios

3. Open Market

Operations

OperatingTarget

Monetary Base

Bank Credit

Interest Rates

IntermediateTarget

Monetary

Aggregates(M3)

Long terminterest rates

Ultimate

Goals

Total Spending

Price Stability

Etc.


35/42

Variations in Reserve Ratios

Discount Rate (Bank Rate)

(also called rediscount rate), Repo rate, reverse repo rate

Open Market Operations (OMOs)

Other Instruments


36/42

Banks are required to maintain a certain percentage of their

deposits in the form of reserves or balances with the RBI

It is called Cash Reserve Ratio or CRR

Since reserves are high-powered money or base money, by

varying CRR, RBI can reduce or add to the banks required

reserves and thus affect banks ability to lend.


37/42

Discount rate is the rate of interest charged by the central bank for

providing funds or loans to the banking system.

Funds are provided either through lending directly or rediscounting or

buying commercial bills and treasury bills.

Raising Bank Rate raises cost of borrowing by commercial banks, causing

reduction in credit volume to the banks, and decline in money supply.

Variation in Bank Rate has an effect on the domestic interest rate,

especially the short term rates.

Market regards the increase in Bank rate as the official signal for beginning

of a tight money situation.


38/42

It is introduced through which RBI can add to liquidity in thebanking system. Through repo system RBI buys securities

from the bank and there by provide funds to them.

Repo refers to agreement for a transaction between RBI andbanks through which RBI supplies funds immediately against

government securities and simultaneously agree to repurchase

the same or similar securities after a specified time which maybe one day to 14 days.


39/42

Repo Rate:Repo rate is the rate at which banks borrow funds from RBI to meet the

gap between the demand they are facing for money (loans) and how much

they have on hand to lend. It is a short-term measure.

Reverse repo rate:

Bank rate:

This is the rate at which RBI lends money to other banks. It is

uncollateralized lending.


40/42

A tool used in monetary policy that allows banks to borrow money throughrepurchase agreements. This arrangement allows banks to respond to

liquidity pressures and is used by governments to assure basic stability in

the financial markets.

Liquidity adjustment facilities are used to aid banks in resolving any short-termcash shortages during periods of economic instability or from any other form

of stress caused by forces beyond their control. Various banks will use

eligible securities as collateral through a repo agreement and will use the funds to

alleviate their short-term requirements, thus remaining stable.


41/42

OMOs involve buying (outright or temporary) and selling of govt securities

by the central bank, from or to the public and banks.

RBI when purchases securities, pays the amount of money by crediting the

reserve deposit account of the sellers bank, which in turn credits thesellers deposit account in that bank.


42/42

Documents

Money Market2