Money Markets in India

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Money market is one the major segments within financial markets in India that plays a critical role in the development of the economy. This market enables flow of money in large amounts on short-term basis. This market allows flow of money by means of borrowing and lending in the short-term that is reflective of the extent of liquidity in the economy.

The 1990s witnessed major reform initiatives, one of which included deregulation of interest rates on deposit accounts and loans. This implied that banks could freely determine interest rates for savings and investments but based on certain conditions prescribed by the RBI. The deregulation of interest rates led to introduction of various money market instruments (or financial services) that enabled borrowing and lending across individuals and businesses on short-term basis. These instruments aimed at enabling short-term liquidity requirements of the economy in accordance to different interest rates offered for different maturity period in the short-term which can be either for a day or for a year. Thus, the workings of money markets can be realized by understanding three main components that build the structure of money markets – interest rates, participants of money markets and money market instruments.

Interest rate is a rate charged by lenders to borrowers as compensation for using of an asset. The asset can be a house or car for an individual, machinery for a manufacturer or managing the day-to-day operations of a bank branch. Thus, the main influences of different interest rates on different money market instruments for different participants in the money market are[1]

(a)      Allowing efficient transfer of short-term funds between borrowers and lenders (of goods/services)

(b)     Providing good returns on funds for investors or lenders

(c)      Enabling relatively inexpensive and quick acquisition of money (in short-term) to pay off short-term liabilities

(d)     Enabling RBI’s intervention for influencing liquidity and general levels of interest rates in the economy[2]

The main interest rates through which RBI intervenes for controlling liquidity in the economy are – Bank Rate, Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR)

  1. Bank Rate – Bank rate is a benchmark rate, which the RBI uses as an indication for all banks to change their interest rates on savings and loans accordingly. For example, if RBI increases the bank rate, banks all over the country would increase the long-term interest rates on savings and loans and vice versa. Currently, bank rate in India is 6%
  2. Cash Reserve Ratio (CRR) – RBI prescribes a minimum Cash Reserve Ratio (CRR) for scheduled banks where these banks are required to hold a certain proportion of their deposits in form of cash. For example, if a bank’s deposits increases by Rs 100 and if the CRR is 6%, then the banks will have to hold Rs. 6 (6% of Rs. 100) with RBI and the bank will be able to use Rs 94 for investments and providing credit (or loans). Thus, if the CRR is hiked, banks will have fewer amounts of deposits for investments and providing credit (or loans). CRR is a favorable tool for RBI to increase or decrease credit availability in the short-run. Currently, CRR is 6% in India
  3. Statutory Liquidity Ratio (SLR) – Every bank is required to maintain a minimum proportion of Net Demand and Time liabilities as liquid assets in the form of cash, gold and securities. This minimum proportion is known as Statutory Liquidity Ratio (SLR). Demand liabilities are liabilities, which are payable on demand and includes current deposits, demand liabilities portion of savings bank deposits, margins held against letters of credit/guarantees, balances in overdue fixed deposits, cash certificates and cumulative/recurring deposits, outstanding Telegraphic Transfers (TTs), Mail Transfer (MTs), Demand Drafts (DDs), unclaimed deposits, credit balances in the Cash Credit account and deposits held as security for advances which are payable on demand. Time Liabilities are those which are payable otherwise than on demand that include fixed deposits, cash certificates, cumulative and recurring deposits, time liabilities portion of savings bank deposits, staff security deposits, margin held against letters of credit, if not payable on demand, deposits held as securities for advances which are not payable on demand and Gold deposits[3]. Minimum limit for SLR is 20% and maximum limit is 40%. At present, the SLR limit for banks is about 35%.

Based on the bank rate, CRR and SLR, money markets in India can be further divided into three sub-markets – (A) Government Securities Market; (B) Call money market; (C) Repo Market and; (D) Other Instruments

(A) Government Securities (G-Sec) Market

Government securities are tradable instruments issued by central and state governments of India. There are two types of securities issued by the governments, which are – short term securities with maturities less than a year and long-term securities with maturities with maturity period of one year or more. In India, Central Government issues short-term and long-term securities, whereas state governments issue only long-term securities. The main participants of G-Sec market other than central and state governments are SCBs, Primary Dealers (PDs), insurance companies, cooperative banks, RRBs, mutual funds, provident funds, large corporations and Foreign Institutional Investors (FIIs)[4]. These institutions are compulsorily required to maintain a certain minimum of G-Secs under the SLR requirements prescribed by the RBI. These institutions hold G-Secs in a Subsidiary General Ledger (SGL) account maintained by the RBI. The SGL account is like any savings account opened by an individual with a bank though the purpose of SGL is to maintain tradable transactions of G-Secs, which RBI can easily monitor and regulate.

Primary Dealers (PDs) were introduced by RBI in the G-Sec market for undertaking certain PD activities like supporting auctions for issue of short-term and long-term securities, providing adequate physical infrastructure and skilled manpower for efficient participation in primary issues, trading in the secondary market and to advise and educate investors, maintaining internal control system for fair conduct for business, settlement of trades and maintenance of accounts and submitting periodic returns on a timely basis as prescribed by the RBI. PDs were introduced by RBI under the Fiscal Responsibility and Budget Management (FRBM) Act 2003 that aimed at funding government expenditure on fiscal developments of the country through provision of G-Sec market. PDs can be SCBs and other financial institutions that have minimum net owned funds of Rs 1000 crore, Minimum Capital to Risk Weighted Assets Ratio (CRAR)[5] of 9% and Net Non-Performing Assets (NPAs)[6] of less than 3% and a profit making record for last three years.

The instruments in G-Secs market as mentioned above can be short-term securities and long-term securities. These securities are listed below:

  1. Treasury Bills (T-bills): T-bills are short-term instruments that pay no interest rate and are known as zero-coupon bonds. These are issued with maturities as short as 91 days, 182 days and 364 days. Coupon rate is the interest rate (or return) on the bond. However, T-bills have zero coupon rate which implies that there is no interest rate on the bond. Hence, the returns on zero-coupon bond or T-bill are the difference between the face value of the bond and the market price at the time of maturity. For example, a 91 T-bill of face value[7] Rs 100 is issued in the market at a discount value of Rs 98.20. The returns or yield on the T-bill would be [(100-98.20)/98.20] * (365 / 91)*100 which is equal to 7.35%, where 365 is the number of days in a year and 91 is the time of maturity. This also implies that a T-bill purchased at Rs 98.20 will give returns at 7.35% which will be a total of Rs 98.20 plus 7.35% of Rs 98.20 (Rs. 7.22) that equals Rs 105.42 after completion of 91 days. The main feature of zero-coupon bonds is that the returns on the same are based on percentage difference between the face value and the discount value at which the bond is issued. Hence, these bonds are considered the safest in a short-term despite low rate of returns.
  2. Dated Government Securities (G-Sec): Dated G-Secs are long-term bonds with fixed or floating interest (coupon) rates which is usually paid on half-yearly basis. For example – 8.24% GS2018 is a fixed-dated G-Sec that was issued on April 22 2008 for a period of 10 years maturing on April 28, 2018. Interest or coupon will be paid on half-yearly basis at 4.12% (half of 8.24% coupon rate) of the face value on October 22 and April 22 of each year. The features of fixed date G-Sec are that are:-
  • These are issued on face value
  • The rate of interest and tenure of the security is fixed at the time of issuance and does not change till maturity
  • The interest is paid on half-yearly basis
  • On maturity the security is redeemed at face value

Floating rate dated G-Secs have the same characteristics as a fixed dated bonds except that the coupon rate keeps changing and are based on a predefined benchmark rate that can either a bank rate or rate of return on a T-bill. Changes on the interest rates are accordingly announced and displayed after regular intervals (usually every six months or a year)

In summary, G-Sec market can be advantageous especially when a bank holds cash in excess of the day-to-day needs of a bank that do not provide any returns. Accordingly, investment in G-Sec market provide following advantages:

  1. G-Secs offer maximum safety as they are regulated and monitored by RBI that enables commitment for payment of the principal amount and interest rate
  2. G-Secs can be held in the dematerialized form
  3. G-Secs are available in wide range of maturities from 91 days to 30 years
  4. G-Secs can be sold in the secondary markets to meet cash requirements
  5. G-Secs can be used as collateral to borrow funds in the repo market
  6. G-Secs prices are easily available due to liquid and active secondary market and transparent price dissemination mechanism
  7. Banks and other financial institutions are compulsorily required to maintain minimu amount of G-Secs as prescribed by the RBI.

Please Note: There are various other long-term government bonds issued in the G-Sec market such as Cash Management Bills (CMBs), capital indexed bonds, State Development loans (SDL), etc, which will be covered during the course of under-graduate study in banking and insurance.

(B) Call money market

Call or notice money market consists of call money as the instrument (or financial service) offered by the participants at call-money interest rate that are traded for a period between 2 days and 14 days[8]. The participants of the market include SCBs (excluding RRBs), Cooperative Banks and Primary Dealers (PDs) that are involved in borrowing and lending of call money and participants can freely adjust interest rates. The participants borrow and lend in call money market for the following reasons:

  1. To fill gaps of temporary mismatches in funds
  2. To meet the CRR and SLR compulsory requirements of RBI
  3. To meet the sudden demand for funds arising out of large outflows

Before 2005, the call money market included participants like mutual fund companies, insurance companies, RRBs, etc but this was discontinued to make call money rates as pure inter-bank rates. Hence, participation in this market is restricted to SCBs (excluding RRBs), Cooperative Banks and PDs.

(C) Repo market

The instrument in repo market is a repo or ready forward contract for borrowing funds by selling government securities with an agreement to repurchase the said securities on a mutually agreed future date at an agreed price which includes interest for the funds borrowed[9]. Suppose a bank thinks that the price of a particular security will increase in a couple of days but the bank does not have enough money to purchase that security. The bank then borrows the cash from RBI at a repo rate through a repo contract that will end or mature in a couple of days. The securities will be transferred to RBI and will be repurchased by the bank at when the contract matures. If the price of the security increases then the bank can sell the securities to convert into cash profit.

Repos are predominantly undertaken on overnight basis (for one day period). The key participants of repo market are RBI and SCBs (excluding institutions like RRBs, LABs, PDs, all-India FIs, NBFCs, mutual funds, housing finance companies, and insurance companies). The money market is regulated by the Reserve Bank of India. All the above mentioned money market transactions should be reported on the electronic platform called the Negotiated Dealing System (NDS).

(D) Other Instruments’ Market

Other instruments traded in the money markets are 1. Commercial Papers (CPs) market; 2. Certificate of Deposits (CDs) market and; 3. Commercial Bills (CBs) market

1.) Commercial Papers (CPs) market – The instrument in the CP market are unsecured money market promissory notes whose interest rates are lower than the primary rates (like T-bills, Dated G-Secs, etc). Participants include large corporations, PDs and financial institutions who can issue and raise CPs through an Issuing and Paying Agent (IPA), where an IPA is a scheduled bank approved by the RBI. All corporations are not eligible to participate in the CP market unless their tangible net worth is not less than Rs 4 crore, company has been sanctioned a working-capital limit by banks or financial institutions and the borrowal account of a company is classified as a ‘Standard Asset’ by the financing banks/institutions.

Unsecured notes are similar to debentures whose issues are not backed by collateral but issued on the basis of the creditworthiness of the bank. Accordingly, CPs are backed by credit ratings provided by CRISIL, ICRA, FITCH Ratings, etc during its issuance. CPs can be issued for maturities between 15 days and 1 year from the date of issue. CPs can be issued in denominations of Rs 5 lakh or multiples thereof[10]. The purpose of investing in CP market is to:

  1. Enable highly rated corporate borrowers to diversify their sources of short-term borrowing
  2. Provide additional instrument for investment
  3. Meet their short-term funding requirements for their operations
  4. Release pressure on bank funds for small and medium-sized borrowers[11]

2.) Certificate of Deposits (CDs) market – The instruments in the CDs market is a negotiable time deposit (similar to fixed deposits) that is deposited for a short-term with maturities between 7 days and 1 year[12]. The issuers of CDs can be SCBs (excluding RRBs and LABs) and select financial institutions permitted by RBI to raise short-term resources mostly for maintaining CRR and SLR requirements. Investors of CDs include individuals, corporations, companies, trusts, funds, associations etc. The issuers can fix the interest rates freely and can be either fixed or floating, which are informed to the investors. The minimum amount that can be deposited in CDs is Rs 1 lakh or more. The purpose of CD market is to:

  1. Earn steady interest on your deposits in a short time period
  2. Earn interest rates relatively higher than the savings account rate
  3. Maintain appropriate CRR and SLR requirements by banks on the issue price of CDs

3.) Commercial Bills (CBs) – CBs can be traded by offering the bills for rediscounting. Banks provide credit to their customers by discounting commercial bills[13]. This credit is repayable on maturity of the bill. For immediate need for funds, banks can rediscount the bills in the money market and get ready money. Commercial bills ensure improved quality of lending, liquidity and efficiency in money management. It is a fully secured for investment since it is transferable by endorsement and delivery and it has high degree of liquidity. For example, a seller sells products to a buyer at Rs 1000 who pays on credit card (or loan). The money of the sale from the buyer would be received after 1 day but the seller wishes to obtain the sale money immediately. The seller can approach a bank that will pay immediately offer the sales price minus the bank’s commission rate and the bank will collect this money from the buyer. This is known as discounting a bill. Rediscounting occurs when the same bank approaches another bank (because the former bank will have to wait to receive funds from the buyer) that offers the same value minus the other bank’s commission rate andt are capable of managing short-term securities.

The bills market is highly developed in industrial countries but it is very limited in India. Commercial bills rediscounted by commercial banks with financial institutions amount to less than Rs 1,000 crore. In India, the bill market has not developed due to (1) the cash credit system of credit delivery where the onus of cash management rest with banks and (2) an absence of an active secondary market.



[4] FIIs institutions established outside India but manage to raise or collect or borrow funds through an domestic-based asset management company whose account is registered with SEBI

[5] CRAR is the amount of capital relative to a financial institutions loans and other assets

[6] NPAs are debt obligations or loans (interest and principal amount) borrowed by borrowers that has not been to paid to the lender or financial institution for an extended period of time

[7] Face value is the value printed on the face of the bond or bill

[11] Modern Banking: Theory and Practice By Muralidharan