The Money Market is an important financial market that plays an important role in regulating liquidity and meeting short-term financing needs of banks, governments and corporate entities. Having an understanding about the Money Market can help you get clarity for the functioning of the Indian Financial System. In this article, we are going to cover the Money Market, its definitions, structure, major instruments and significance.
Money Market
The Money Market is a part of the Financial Market where short-term financial instruments are traded. These Money Market instruments have a maturity period of up to one year and are highly liquid in nature. Since the maturity period is short, securities can be quickly converted into cash. This is why these investments are called cash investments.
- The financial Market includes all platforms where buying and selling of financial instruments such as shares, currencies and derivatives take place.
- The Financial Market is divided into two main categories:
- Money Market: Market for short-term instruments with maturity up to 1 year
- Capital Market: Market for medium and long-term instruments with maturity of more than 1 year.
Money Market Structure
The Money Market is divided into two important sectors:
Organised Money Market
- The organised money market sector is regulated, licensed and systematically supervised by market regulators like the RBI.
- The sector works in a structured and coordinated manner under RBI’s control.
- Money Market main participants include RBI, commercial banks, non-banking financial companies, mutual funds and insurance companies.
Unorganised Money Market
- The unorganised money market sector is outside the purview of registration or regulation by the RBI.
- The sector is called unorganised due to the lack of a formal structure and coordination.
- The main participants of the money market includes local moneylenders, chit funds, indigenous bankers etc.
Money Market Major Instruments
The Money Market has different types of financial instruments that help meet the needs of lenders and borrowers. These Money Market instruments include:
Call Money
Call Money is a short-term borrowing and lending among banks and financial institutions for a very small period, ranging from overnight to 14 days.
- It helps banks manage sudden liquidity shortages.
- The interest rate charged in call money market is called the Call Money Rate, which fluctuates frequently, even hourly, depending on demand and supply.
- Call Money Market has two segments:
- Call Market (Overnight Market): Borrowing and lending for one day.
- Short Notice Market: Borrowing and lending for up to 14 days.
Treasury Bills (T-Bills)
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- Treasury Bills are short-term securities issued by the RBI on behalf of the Central Government to raise funds.
- They are part of Government Securities (G-Secs).
- T-Bills: T-Bills have a maturity of less than one year and hence is a money market instrument.
- Government Bonds: Government Bonds have a maturity of more than one year and hence is a capital market instrument.
- Treasury Bills Features:
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- Issued at a discount and redeemed at face value.
Example: A ₹100 bill may be issued at ₹95, but redeemed at ₹100 at maturity. - They are zero-interest or zero-coupon securities.
- They are risk-free and highly liquid, being backed by the Government.
- Only the Central Government issues them; States cannot issue T-Bills.
- Issued via auction to ensure transparency and maximize government revenue.
- Available in multiples of ₹25,000.
- Issued at a discount and redeemed at face value.
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- Treasury Bills Types:
The treasury bills are of three types:
- 91-day T-Bill
- 182-day T-Bill
- 364-day T-Bill
- Treasury Bills uses for Banks:
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- The treasury bills can help maintain Statutory Liquidity Ratio (SLR).
- As collateral with RBI to borrow funds under Repo operations.
Cash Management Bills (CMBs)
- The Cash Management Bills are similar to treasury bills but with maturity of less than 91 days.
- These are issued to cover short-term mismatches in government cash flow.
- CMS bills are Issued at a discount and redeemed at face value through RBI auctions.
- Banks can also use them to meet SLR requirements.
Ways and Means Advances (WMAs)
- WMAs are temporary loans provided by the RBI to both Central and State Governments.
- They were introduced under Section 17(5) of the RBI Act to replace the earlier Ad-hoc T-Bills.
- They are not a permanent source of government finance but are used to cover short-term mismatches between income and expenditure.
- Repayment: If repaid within 90 days the debt is treated as Ways and Means Advances and if repayment exceeds 90 days it is treated as overdraft.
- Interest charged on ways and means advances is that of repo rate and the overdraft charges repo rate +2%.
Certificate of Deposit (CD)
- Certificates of Deposit are issued by Scheduled Commercial Banks and select Financial Institutions permitted by the RBI.
- Cooperative Banks and Regional Rural Banks (RRBs) cannot issue Certificate of Deposits.
- Minimum amount that can be issued is ₹1 lakh, issued in multiples of ₹1 lakh.
- It is issued at discount and redeemed at par.
- The maturity period is more than 7 days, up to 1 year.
- Premature withdrawal of the deposits leads to penalty.
- No loans can be taken against CDs.
Commercial Paper (CP)
- Commercial Papers are unsecured, short-term debt instruments issued by large corporations, financial institutions, and primary dealers.
- These are issued as promissory notes to finance short-term needs like inventory and working capital.
- These are issued privately and not traded on exchanges.
- Denomination: Minimum ₹5 lakh, issued in multiples of ₹5 lakh.
- Maturity: Minimum 7 days, maximum up to 1 year.
Commercial Bill (CB) or Trade Bill
- A commercial bill is a negotiable instrument drawn by the seller or buyer for goods or services supplied.
- The bill helps sellers extend credit to buyers.
- When accepted by a commercial bank, it becomes a Trade Bill.
- Commercial Bills are first discounted by banks and then re-discounted with the RBI.
Money Market Importance
The money market plays an important role in the financial system because:
- It helps banks and financial institutions manage liquidity by balancing short-term surpluses and deficits.
- It provides industries and businesses access to short-term funds without using long-term and expensive resources.
- It supports both domestic and international trade financing.
- It shows the prevailing short-term interest rates, offering insight into the state of the economy.
- Interest rates in the money market serve as benchmarks for pricing loans, mortgages, and credit in broader markets.
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Money Market FAQs
Q1: What is the Capital Market?
Ans: The Capital Market is a financial market for long-term funds where stocks, bonds, and securities are traded.
Q2: What do you mean by Money Market?
Ans: The Money Market is a financial market that deals with short-term borrowing and lending of funds, usually up to one year.
Q3: What is the difference between Money Market and Capital Market?
Ans: The Money Market provides short-term funds (up to one year), while the Capital Market provides long-term funds (more than one year).
Q4: What is a Treasury Bill?
Ans: A Treasury Bill (T-Bill) is a short-term government security issued at a discount and redeemed at face value on maturity.
Q5: What do you mean by Ways and Means Advances?
Ans: Ways and Means Advances (WMA) are temporary loan facilities provided by the RBI to the government to meet short-term cash flow mismatches.