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[Economy 4 Newbie] Money market, Repo Rate & Call Money

Mrunal update October-18-2012: This is Old and outdated article. don’t pay muchattention, I’ll refine and rewrite it later.

What is money market· In simple terms, if I borrow money from you for less than 1 year = the placewhere we do this deal is Money market

· For long term loans = Capital market.

See this diagram

Technical definition· market refers to the market for short-term funds, i.e., up to one-year maturity.

· money market is the place where lending and borrowing is done through

instruments having an original maturity of up to one year.

Use of money market· money market provides a mechanism to balance the demand for and supply of

short-term funds.

· the opportunity for players to invest their short-term surplus funds and to borrowshort-term funds in case of deficit.

· Its interlinked with Foreign Exchange market (read my article on currency

devaluation for more on this)

Call/ Notice/Term Money Market

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· It is the market for borrowing and lending for short-term periods (usually upto 14

days, but at times more than that)

· The deals mostly by commercial banks.

· It is a telephonic market, i.e., deals are struck over telephone and reported to

RBI. (that’s why its ‘call’ market)

· Commercial banks often face temporary shortages of funds (e.g., to meet CRRand SLR requirements, or sudden outgo of funds) or temporary surpluses.

· When a bank is in shortage of funds, it telephones & borrows from another bank

which is in surplus.

3 types of deals in Call Market

Call Money

· If borrowing (or lending) is made for one day (overnight), it is known as “CallMoney”.

· This segment is also called overnight money market.

Notice Money

· If the maturity of borrowing (or lending) is more than 1 day but up to 14 days,then it is known as “Notice Money”.

Term Money

· “Term Money” refers to money borrowed (or lent) for more than 14 days but

less than one year. In Indian money market, most of the transactions are of call money and notice money.

Players in Call Market



· commercial banks and primary dealers can both borrow and lend,

· LIC, UTI, GIC, IDBI, NABARD, ICICI & Mutual Fund managers can lendmoney in this market (but they’re not allowed to borrow from this market)

· RBI, as regulator, routinely participates in the market to inject liquidity (lend) or

to mop up liquidity (borrow).

Repos/Reverse Repos· repo (also known as ready forward contract) transaction,

Example

· Suppose I write on a piece of paper “anyone who gives me 100 Rs. I’ll give him120 Rs. After 1 year”

· this piece of paper is security.

· Now I give that paper to you and collect 100 Rs. And tell you that I’ll buy(repurchase) that paper after 6 months and give you 110 Rs.

· This is called repo-contract

· And this period (6 months) is repo period.Now remember the ‘mirror’ – in the mirror my left hand will show as my right hand.Same is for ‘Reverse Repo Rate’

· When you buy a security and sign contract that you’ll sell it after 6 months = thisis reverse repo contract.

· one party borrows funds for a specific period (known as repo period) against thecollateral of specific securities at pre-determined rate (known as repo rate)

for buyer its reverse repo rate (RRR) and for seller its repo rate.(RR)



And whether the transection is RRR or RR is classified by who initiated the deal?

If the buyer initiated the deal– then its RRRIf the seller initiated the deal then its RR To prevent the topic getting confusing and complicated. Lets take an example First the easy example-I’m the RBI manager.

· When I give you security (paper) & take money from you – this is Repo.

· When I buy the security (paper) from you and give you money- this is reverseRepo.

Now the more correct exampleI’m the RBI manager.

· When I give you security (paper) & take money from you & promise you that I’llbuy the same paper back from you after few months – this is Repo.

· When I buy the security (paper) from you and give you money & you promiseme that you’ll buy back that paper from me after few months- this is reverse Repo.

The players in Repo / Reverse Repo Rate

· RBI, Scheduled banks & Primary dealers can borrow and lend

· Non-Bank participants (Finacial institutions) + companies listed in stock market can only lend , they can’t borrow.

Lets rewind the liquidity tape

1. Liquidity = How much money in the market? = if money is plenty= easy to get loans @cheaper interest rate = this is called cheap / easy money.

2. When there is less liquidity =hard to get loans and the interest rate will be higher = this isDear money.

3. Where there is too much money= inflation4. When there is too less money= bad to business as you can’t get loans easily to run your

works.5. So RBI’s work is to fine tune the liquidity (money supply.) = tuning the dear money /



easy money policy based on the situation.

See this diagram

RBI & Repo· absorption of short-term liquidity, RBI carries out overnight (one day) repo

auction at a fixed rate.

· Currently, fixed-rate repo and reverse repo auctions are conducted by the RBIon a daily basis (excluding Saturdays, Sundays and other public holidays) for 1 day

(overnight) tenor.

· This means, RBI is ready to sell as much securities as is demanded by the

participants at the fixed rate.

· This rate is fixed in the sense that it does not change on a daily basis dependingupon the supply-demand condition of short-term liquidity

· Changes in the fixed repo rate are usually made in the Annual Monetary andCredit Policy or in the Mid-Term Review of the Monetary and Credit Policy.

RBI & Reverse Repo· In order to inject liquidity into the system, RBI conducts fixed rate auctions ofreverse repo at a rate higher than the repo rate.

· The reverse repo rate is linked to the repo rate in the sense that it is set at specificpercentage point above the repo rate.

Definition difference from international market.· Keep in mind, the terms repo and reverse repo have been defined above, is just

opposite to the international practice.

· That is, what is repo in Indian terminology is reverse repo in internationalparlance, and what is reverse repo in India is internationally known as repo.

· In a fast globalising environment, this may create confusion.

· Consequently, RBI has changed the definitions of repo and reverse repo to bringthem in line with international practice with effect from 27th October 2004.

· However, in this article, we have throughout followed the older (Indian)definition.



Money market topic doesn’t stop here, there are other remaining items like Commercialpapers, Treasury bills, Certificate of Deposits etc which will be dealt in some other article.

URL to article: http://mrunal.org/2010/02/economy-4-newbie-money-market-repo-rate.html

Posted By On 01/02/2010 @ 14:48 In the category Economy

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