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Tuesday, May 25, 2010

MONEY MARKET

MONEY MARKET

Money market is a market for short term loans or financial assets. It is a market for the lending and borrowing of short term funds. As the name implies it does not actually dealing cash or money. But it actually deals with near substitutes for money or near money like trade bills, promissory note and government papers drawn for a short period not exceeding one year. These short term instruments can be converted into cash readily without any loss and at a low transaction cost.

Money market is the center for dealing mainly in short term money assets. It meets the short term requirements of borrowers and provides liquidity or cash to lenders. It is the place where short term surplus funds at the disposal of financial institutions and individuals are borrowed by individuals, institutions and also, government.

Money market does not refer to a particular place where short term funds are dealt with. It includes all individuals, institutions and intermediaries dealing with short term funds. The transaction between borrowers, lenders and middlemen takes place through telephone, telegraph, mail and agents. No personal contact of the two parties is essential for negotiation in a money market. However a geographical name may be given to a money market according to its location.

DEF INITION

According to Geottery Crowther, “The money market is the collective name given to various firms and institutions that deal the various grades of near money”.

The RBI defines “a money market for short term financial substitutes for money, facilitates the exchange of money for new financial clients in the primary market as also for financial clients, already issue in the secondary market.”

Characteristic Features of a Developed Money Market

In order to fulfill the above objectives, the money market should be fully developed and efficient. In every country of the world, some type of money market exists. Some of them are highly developed while others are not well developed. Prof. S.N. Sen has described certain essential features of a developed money market. They are as follows:

(i). Highly Organized Banking System

The commercial banks are the nerve centre of the whole money market. They are the principal suppliers of short-term funds. Their policies regarding loans and advances have impact on the entire money market. The commercial banks serve as vital link between the central bank and the various segments of the money market. Consequently, a well developed money market and a highly organized banking system co-exist. In an underdeveloped money market, the commercial banking system is not fully developed.

(ii). Presence of a Central Bank

The Central Bank acts as the banker’s bank. It keeps their cash reserves and provides them financial accommodation in difficulties by discounting their eligible securities. In other words, it enables the commercial banks and other institutions to convert their assets into cash in times of financial crisis. Through its open market operations, the central bank absorbs surplus cash during off-seasons and provides additional liquidity in the busy seasons. Thus, the central bank is the leader, guide and controller of the money market. In an underdeveloped money market, the central bank is in its infancy and not in a position to influence the money market.

(iii). Availability of Proper Credit Instruments

It is necessary for the existence of developed money market a continuous availability of readily acceptable negotiable securities such a bills of exchange, treasury bills etc. in the market. There should be a number of dealers in the money market to transact in these securities. Availability of negotiable securities and the presence of dealers and brokers in large numbers to transact in these securities are needed for the existence of a developed money market. There is absence of adequate and proper credit instruments as well as dealers to deal in these instruments in an underdeveloped money market.

(iv). Existence of Sub-markets

The number of sub-markets determines the development of a money market. The larger the number of sub-markets, the broader and more developed will be the structure of money market. The several sub-markets together make a coherent money market. In an underdeveloped money market, the various sub-markets, particularly the bill market, are absent. Even if sub-markets exist, there is no co-ordination between them. Consequently, different money rates prevail in the sub-markets and they remain unconnected with one another.

(v). Ample Resources

There must be availability of sufficient funds to finance transactions in the sub-markets. These funds may come from within the country and also from foreign countries. The London, New York and Paris money markets attract funds from all over the world. The underdeveloped money markets are starved of funds.

(vi). Existence of Secondary Market

There should be an active secondary market in these instruments.

(vii). Demand and Supply of Funds

There should be a large demand and supply of short-term funds. It presupposes the existence of a large domestic and foreign trade. Besides, it should have adequate amount of liquidity in the form of large amounts maturing within a short period.

Other Factors

Besides the above, other factors also contribute to the development of a money market. Rapid industrial development leading to the emergence of stock exchanges, large volume of international trade leading to the system of bills of exchange, political stability, favourable conditions for foreign investment, price stabilization etc. are the other factors that facilitate the development of money market in the country.

London Money Market is a highly developed money market because it satisfies all requirements of a developed money market.

If any one or more of these factors are absent, then the money market is called an underdeveloped one.

Functions of Money Market

The money market performs the following functions:

1. Facilitate Liquidity: The basic function of money market is to facilitate adjustment of liquidity position of commercial banks, business corporations & other non-bank financial institutions.

2. Short-Term Surplus Funds: It provides outlets to commercial banks, business corporations, non-bank financial concerns & other investors for their short-term surplus funds.

3. Creation of Credit: The money market constitutes a highly efficient mechanism for credit control. It serves as a medium through which the Central bank of the country exercises control on the creation of credit.

4. Increase Investment: It enables businessmen to invest their temporary surplus for a short-period.

5. Economic Development: It plays a vital role in the flow of funds to the most important uses like capital formation.

COMPOSITION OF MONEY MARKET

As stated earlier, the money market is not a single homogenous market. It consists of a number of sub-markets which collectively constitute the money market. There are other over should be competition within each sub-market as well as between different sub-markets.the following are the main sub-markets of a money market:

1. Call money market

2. Commercial bills market or discount market

3. Acceptance market

4. Treasury bill market

CALL MONEY MARKET

The call money market refers to the market for extremely short period loans; say one day to fourteen days. These loans are repayable on demand at the option of either the lender or the borrower. As stated earlier, these loans are given to brokers and dealers in stock exchange. Similarly with ‘surplus funds’ lend to other banks with ‘deficit funds’ in the call money market. Thus, it provides an equilibrating mechanism for evening out short term surpluses and deficits. Moreover, commercial banks can quickly borrow from the call market to meet their statutory liquidity requirements.

OPERATIONS IN CALL MARKET

Borrowers and lenders in a call market contact each other over telephone. Hence, it is basically over-the-telephone market. After negotiations over the phone, borrowers and lenders arrive at a deal specifying the amount of loan and rate of interest After the deal is over, the lender issues FBL cheque in favour of the borrower. The borrower in turn issues call money borrowing receipt when the loan is repaid with interest, the lender returns the duly discharged receipt.

CALL LOAN MARKET TRANSACTIONS AND

In India, call loans are given for following purposes:

1. To commercial banks to meet large payments, large remittances, to maintain liquidity with RBI and so on

2. To the stock brokers and speculators to deal in stock exchanges and bullion

3. To the bill market for meeting matured bills

4. To the discount and finance house of India and the securities trading corporation of India activate the call market

5.to individuals of very high status purposes to save interest on cash credit

The participants in this market can be classified into two categories

1 Those permitted to act as lenders and borrowers of call loans

2 Those permitted to act only as lenders in the market

The first category includes all commercial banks, co-operative banks, DFHI and STCI. In the second category LIC, UTI, GIC, IDBI, NABARD, specified mutual find etc are included. They can only lend and they cannot borrow in the call market

ADVANTAGES

1. HIGH LIQUIDITY

Money lent in the call market can be called back at any time when needed. So, it is highly liquid. It enables commercial banks to meet large sudden payments and remittances by making a call on the market

2. HIGH PROFITABILITY

Banks can earn high profits by lending their surplus funds to the call market when call rates are high and volatile. It offers a profitable parking place for employing the surplus funds of banks temporarily.

3. MAINTENANCE OF SLR

Call market enables commercial banks to maintain their statutory reserve requirements. Generally banks borrow on a large scale every reporting maintain idle cash to meet reserve requirements. It will tell upon their profitability.

4. SAFE AND CHEAP

Though call loans are not secured, they are safe since the participants have a strong financial standing .It is cheap in the sense brokers have been prohibited from operating in the call market. Hence, banks need not pay brokerage on call money transactions.

5. ASSISTANCE TO CENTRAL BANK OPERATIONS

Call money market is the most sensitive part of any financial system. Changes in demand and supply of funds are quickly reflected in call money rates and it gives indication to the central bank to adopt appropriate monetary policy. Moreover, the existence of an efficient call market helps the central bank to carry out its open market operations effectively and successful.

DRAWBACKS

1. UNEVEN DEVELOPMENT

The call money market in India is confined to only big industrial and commercial centers like Mumbai, Kolkata, Chennai, Delhi, Bangalore and Ahmadabad. Generally call market are associated with stock exchange. Hence the market is not evenly developed.

2. LACK OF INTEGRATION

The call markets in different centers are not fully integrated. Besides, a large number of local call markets exist without any integration

3. VOLATILITY IN CALL MONEY RATES

Another drawback is the volatile nature of the call money rates. Call rates vary to greater extent in different seasons in different ways within a fortnight. The rates vary between 12% and 85%.one cannot believe 85% being changed on call loans.

COMMERCIAL BILLS MARKET OR DISCOUNT MARKET

A commercial bill is one which arises out of a genuine trade transaction, i.e., credit transaction. As soon as goods are sold on credit, the seller draws a bill on the buyer for the amount due. The buyer accepts it immediately agreeing to pay the amount mentioned therein after a certain specified date. Thus, a bill of exchange contains a written order from the creditor to the debtor, to pay a certain sum, to a certain person, after a certain period. A bill of exchange is a ‘self-liquidating’ paper and negotiable. It is drawn always for a short period ranging between 3 months and 6 months.

Definition

Section 5 of the Negotiable Instruments Act defines a bill of exchange as follows:

“An instrument in writing containing a n unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to, or to the order of a certain person or to the bearer of the instrument”.

Types of Bills

Many types of bills are in circulation in a bill market. They can be broadly classified as follows:

1. Demand and usance bills

2. Clean bills and documentary bills

3. Inland and foreign bills

4. Export bills and import bills

5. Indigenous bills

6. Accommodation bills and supply bills.

Demand and Usance Bills

Demand bills are otherwise called sight bills. These bills are payable immediately as soon as they are presented to the drawee. No time of payment is specified and hence they are payable at sight.

Usance bills are called time bills. These bills are payable immediately after the expiry of time period mentioned in the bills. The period varies according to the established trade custom or usage prevailing in the country.

Clean Bills and Documentary Bills

When bills have to be accompanied by documents of title to goods like Railway receipt, Lorry receipt, Bill of Lading etc., the bills are called documentary bills. These bills can be further classified into D/A bills and D/P bills. In the case of D/A bills, the documents accompanying bills have to be delivered to the drawee immediately after his acceptance of the bill.

On the other hand, the documents have to be handed over to the drawee only against payment in the case of D/P bills. The document will be retained by the banker till the payment of such bills. When bills are drawn without accompanying any document they are called clean bills. In such a case, documents will be directly sent to the drawee.

Inland and Foreign Bills

Inland bills are those drawn upon a person resident in India and are payable in India. Foreign bills are drawn outside India and they may be payable either in India or outside India. They must be drawn upon a person resident in India also. Foreign bills have their origin outside India. They also include bills drawn in India but made payable outside India.

Export Bills and Import Bills

Export bills are also drawn by Indian exporters on importers outside India and import bills are drawn on Indian importers in India by exporters outside India.

Indigenous Bills

Indigenous bills are also drawn and accepted according to native custom or usage of trade. These bills are popular among indigenous bankers only. In India, they are called ‘hundis’. The hundis are known by various names such as ‘Shahjog’, ‘Namjog’, ‘Jokhani’, ‘Termainjog’, ‘Darshani’, ‘Dhanijog’ and so on.

Accommodation Bills and Supply Bills

If bills do not arise out of genuine trade transactions, they are called accommodation bills. They are known as ‘kite bills’ or ‘wind bills’. Two parties draw bills on each other purely for the purpose of mutual financial accommodation. These bills are discounted with bankers and the proceeds are shared among themselves. On the due dates, they are paid.

Supply bills are those drawn by suppliers or contractors on the Government departments for the goods supplied by them. These bills are neither accepted by the departments nor accompanied by documents of title to goods. So, they are not considered as negotiable instruments. These bills are useful only for the purpose of getting advances from commercial banks by creating a charge on these bills.

ACCEPTANCE MARKET

The acceptance market refers to the market where short-term genuine trade bills are accepted by financial intermediaries. All trade bills cannot be discounted easily because the parties to the bills may not be financially sound. In case such bills are accepted by financial intermediaries like banks, the bills can earn a good name & reputation & such bills can be readily discounted anywhere.

Advantages or Importance:

In India, commercial banks play a significant role in this market due to the following advantages:

(i). Liquidity

Bills are highly liquid assets. In times of necessity, bills can be converted into cash readily by rediscounting them with the central bank.

(ii). Self-Liquidating & Negotiable Asset

Bills are self-liquidating in character since they have a fixed tenure. Moreover, they are negotiable instruments & hence they can be transferred freely by a mere delivery or by endorsement & delivery.

(iii). Certainty of Payment

Bills are drawn & accepted by business people. Generally, business people are used to keeping their words & the use of bills imposes a strict financial discipline on them. Hence, bills would be honored on the due date.

(iv). Ideal Investment

Bills are for periods not exceeding 6 months. They represent advances for a definite period. This enables financial institutions to invest their surplus funds profitably by selecting bills of different maturities.

(v). Simple Legal Remedy

In case the bills are dishonored, the legal remedy is simple. Such dishonoured bills have to be simply noted and protested and the whole amount should be debited to the customer’s accounts.

(vi). High and Quick Yield

The financial institutions earn a high and quick yield. The discount is deducted at the time of discounting itself whereas in the case of other loans and advances, interest is payable only when it is due.

(vii). Central Bank Control

The central bank can easily influence the money market by manipulating the Bank rate or the rediscounting rate.

Drawbacks

The reasons for the slow growth are the following:

(i). Absence of Bill Culture

Business people in India prefer O.D. and the cash credit to bill financing. Therefore, banks usually accept bills for the conversion of cash credits and overdrafts of their customers.

(ii). Absence of Rediscounting among Banks

There is no practice of re-discounting of bills among banks who need funds and those who have surplus funds. In order to enlarge the rediscounting facility, the RBI has permitted financial institutions like LIC, UTI, GIC and ICICI to rediscount genuine eligible trade bills of commercial banks.

(iii). Stamp Duty

Stamp duty discourages the use of bills. Moreover, stamp papers of required denomination are not available.

(iv). Absence of Secondary Market

There is no active secondary market for bills. Rediscounting facility is available in important centers and that too is restricted to the apex level financial institutions. Hence, the size of the bill market has been curtailed to a large extent.

(v). Difficulty in Ascertaining Genuine Trade Bills

The financial institutions have to verify the bills so as to ascertain whether they are genuine trade bills and not accommodation bills. For this purpose, invoices have to be scrutinized carefully. It involves additional work.

(vi). Limited Foreign Trade

In many developed countries, bill markets have been established mainly for financing foreign trade. Unfortunately, in India, foreign trade as a percentage to national income remains small and it is reflected in the bill market also.

(vii). Absence of Acceptance Services

There are no discount houses or acceptance houses in India. Hence specialized services are not available in the field of discounting or acceptance.

(viii). Attitude of Banks

Banks are shy of rediscounting bills even with the central bank. They have tendency to hold the bills till maturity and hence it affects the velocity of circulation of bills. Again, banks prefer to purchase bill instead of discounting them.

TREASURY BILL MARKET

Just like commercial bills which represents commercial debt, treasury bills represents short-term borrowing of the government. Treasury bill market refers to the market where treasury bills are bought and sold. Treasury bills are very popular and enjoy a higher degree of liquidity since they are issued by the government.

Meaning and features

A treasury bill is nothing but a promissory note issued by the government under discount for a specified period stated therein. The government promises to pay the specified amount mentioned therein to the bearer of the instrument on the due date. The period does not exceed a period of one year. It is a purely a finance bill since it does not arise out of any trade transaction. It does not require any ‘grading’ or ‘endorsement’ or ‘acceptance’ since it is a claim against the government.

Treasury bills are issued only by the RBI on behalf of the government. Treasury bills are issued for meeting temporary government deficits. The treasury bill rate or the rate of discount is fixed by the RBI from time-to-time. It is the lowest one in the entire structure of interest rates in the country because of short-term maturity and high degree of liquidity and security.

Types of treasury bills

In India there are two types of treasury bills viz, (i) ordinary or regular and (ii) ‘ad hoc’ known as ‘ad hocs’. Ordinary treasury bills are issued to the public and other financial institutions for meeting the short-term financial requirements of the central government. These bills are freely marketable and they can be bought and sold at any time and they have secondary market also.

On the other hand ‘ad hocs’ are always issued in favour of the RBI only. They are not sold through tender or auction. They are purchased by the RBI on tap and the RBI is authorized to issue currency notes against them. They are not marketable in India. However, the holders of these bills can always sell them back to the RBI. Ad hocs serve the government in the following ways:

i. They replenish cash balances of the central government. Just like state government get advance (ways and means advances) from the RBI, the central government can raise finance trough these ad hocs.

ii. They also provide an investment medium for investing the temporary surpluses of state governments, Semi-Government departments foreign central banks.

On the basis of periodicity, treasury bills may be classified into three. They are:

i. 91days treasury bills,

ii. 182 days treasury bills, and

iii. 364 days treasury bills.

Ninety one days treasury bills are issued at a fixed discount rate of 4% as well as through auctions. 364 days bills do not carry fixed rate. The discount rate on these bills are quoted in auction by the participants and accepted by the authorities. Such rate is called cut off rate. In the same way, the rate is fixed for 91 days treasury bills sold through auction. 91 days Treasury bills (tap basis) can be rediscounted with the RBI at any time after 14 days of their purchase. Before 14 days a penal rate is charged.

Operations and Participants

The RBI holds 91 days treasury bills (TBs) and they are issued on tap basis throughout the week. However, 364 days TBs are sold through auction which is conducted once in a fortnight. The date of auction and the last date of submission of tenders are noticed by the RBI through a press release. Investors can submit more than one bid also. On the next working day of the date of auction, the accepted bids with the prices are displayed. The successful bidders have to collect letters of acceptance from the RBI and the deposit the same along with a cheque for the amount due on RBI within 24 hours of the announcement of auction results.

Institutional investors like commercial banks, DFHI, STCI, etc., maintain a subsidiary General Ledger (SGL) account with the RBI. Purchase and sales of TBs are automatically recorded in this account. Investors who do not have SGL account can purchase and sell TBs through DFHI. The DFHI does this function on behalf of investors with the help of SGL transfer forms. The DFHI is actively participating in the auctions of TBs. It is playing a significant role in the secondary market also by quoting daily buying and selling rates. It also gives buy-back and sell-back facilities for period up to 14 days at an agreed rate of interest to institutional investors. The establishment of the DFHI has imparted greater liquidity in the TB market.

The participants in this market are the following:

i. RBI and SBI

ii. Commercial banks

iii. State Governments

iv. DFHI

v. STCI

vi. Financial institutions like LIC, GIC, UTI, IDBI, ICICI, IFCI, NABARD, etc.

vii. Corporate customers

viii. Public

Though many participants are there, in actual practice, this market is in the hands of the banking sector. It accounts for nearly 90% of the annual sale of TBs.

Importance or Merits

(i) Safety

Investments in TBs are highly safe since the payment of interest and repayment of principal are assured by the Government. They carry zero default risk since they are issued by the RBI for and on behalf of the Central Government.

(ii) Liquidity

Investments in TBs are also highly liquid because they can be covered into cash at any time at the option of the investors. The DFHI announces daily buying the selling rates for TBs. they can be discounted with the RBI and further refinance facility is available from the RBI against TBs. Hence there is a ready market for TBs.

(iii) Ideal Short-Term Investment

Idle cash can be profitably invested for a very short period in TBs. TBs are available on tap throughout the week at specified rates. Financial institutions can employ their surplus funds on any day. The yield on TBs is also assured.

(iv) Ideal Fund Management

TBs are available on tap as well as through periodical auctions. They are also available in the secondary market. Fund managers of financial institutions build up a portfolio of TBs in such a way that the dates of maturities of TBs may be matched with the dates of payment of their liabilities like deposits of short term maturities. Thus, TBs help financial managers to manage the funds effectively and profitability.

(v) Statutory Liquidity Requirement

As per the RBI directives, commercial banks have to maintain SLR (Statutory Liquidity Ratio) and for measuring this ratio investments in TBs are taken into account. TBs are eligible securities for SLR purposes. Moreover, to maintain CRR (Cash Reserve Ratio). TBs are very helpful. They can be readily converted into cash and thereby CRR can be maintained.

(vi) Source of Short-Term funds

The government can raise short term funds for meetings it temporary budget deficits through the issue of TBs. it is a source of cheap finance to the Government since the discount rates are very low.

(vii) Non-Inflationary Monetary tool

TBs enable the Central Government to support its monetary policy in the economy. For instant excess liquidity, if any, in the economy can be absorbed through the issue of TBs. Moreover, TBs are subscribed by investors other than the RBI. Hence they can not be monetized and their issue does not lead to any inflationary pressure at all.

(viii) Hedging Facility

TBs can be used as a hedge against heavy interest rate fluctuations in the call loan market. When the call rate are very high, money can be raised quickly against TBs and invested in the call money market and vice-versa. TBs can be used in ready forward transactions.

Defects

(i) Poor Yield

The yield from TBs is the lowest. Long term Government securities fetch more interest and hence subscriptions for TBs are on the decline in recent times.

(ii) Absence of Competitive Bids

Though TBs are sold through auction in order to ensure market rates for the investors, in actual practice, competitive bids are conspicuously absent. The RBI is compelled to accept these non-competitive bids. Hence adequate return is not available. It makes TBs unpopular.

(iii) Absence of Active Trading

Generally, the investors hold TBs till maturity and they do not come for circulation. Hence, active trading in TBs is adversely affected.

STRUCTURE OF MONEY MARKET:

Organized sector:

The segment of money market which is under the control of RBI is known as organized market. It includes:

1. Reserve bank of India: the reserve bank of India is the highest institution of the Indian money market. This is the central bank of the country. The reserve bank of India plays a dominant role in controlling the money market.

2. Public sector banks: the public sector banks are those banks whose ownership lies with the government. The government controls them. In India, in1969, 14th and in 1980, 6 banks were nationalized all these banks are in the public sector. Their chief aim is social service. After the merger of the new bank of India with the Punjab national bank in 1993, their number now stands at 19. In addition to this the state bank of India and its subsidiaries are also included in the same category. Their number is 8. In this way, a total number of 27 banks are working in the public sector.

3. Private sector banks: private sector banks are those banks which are owned by private individuals. They run them. Such banks include the Jammu and Kashmir bank ltd. The Punjab bank ltd., etc. an individual has control over the bank to the extent of the shares he holds in it. Their main aim is to earn profit.

4. Co-operative banks: co-operative banks are organized collectively by some individuals. These people alone run these banks. The aim of these banks is to help their own members. They include the state co-operative bank, the central district co-operative bank and primary loan committees.

UNORGANISED SECTOR

The segment of money market which is not under control of RBI is known as the unorganized segment of Indian money market. It consists of:

1. Moneylenders: money lenders are of three types:

Ø Professional moneylenders

Ø Itinerant moneylenders

Ø Non-professional moneylenders.

Professional money lenders are those whose main activity is money lending. Pathans and kabulls are itinerant money lenders charge very high rate of interest; they do not receive deposits from people. Their lending activities are based on their own funds and interest receipts. Mainly economically weaker section of people goes to these moneylenders for consumption and production loans.

2. Indigenous bankers: since commercial banks do not provide unsecured loans, the credit needs of a large section of small traders remain unfulfilled. Indigenous bankers to some extent bridge this gap, since their operation and establishment costs are lower. Although they do some important activity, they do not care about the end use of these loans and they are not regulated by RBI. There are mainly four types of indigenous bankers, viz., Guajarati shroffs, multani or shikarpuri shroffs, south Indian chettiars and Marwari kayas. Indigenous bankers accept deposits and provide loans to individuals or organizations.

3. Unregulated non-bank financial intermediaries: most notable unregulated non-bank financial intermediaries are chit funds and Nidhis. Chit funds have regular members making periodical subscriptions to the funds. Some members of the funds, selected by some previously agreed criteria are then allotted the fund. Nidhis are also like chit funds, as their principal source of capital base is provided by its members and some of its members receive the loan. Both chit funds and Nidhis operate mainly in south India and RBI has no control on them.

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