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MONEY
Learning outcomes
INTRODUCTION:
Money is something which sounds interesting to each and everyone. Money is not only
needed to buy something but it is also needed to various other purpose.
Meaning of Money Market. A money market is a market for short-term loans.
The dealers in the money market comprise various institutions. The borrowers (or
buyers) include government and private institutions. The lenders include various
financial and other institutions and individuals. The commodities traded in this market
are various types of monetary assets, like the bills, government bonds, hundis, etc.
The Reserve Bank defines money market as “The center for dealings, mainly of
short-term character, in monetary assets; it meets the short-term requirements of
borrowers and provides liquidity or cash to the lenders. It is the place where short-term
surplus invisible funds at the disposal of financial and other institutions are bid by
borrowers, again comprising institutions and individuals and also by the government.”
Thus, the major function of the market is to provide finance for short term to various
public and private institutions.
The money market deals in various kinds of loans. Each may be said to
constitute a market by itself, like call money market, bill market, collateral loan market,
etc. The money market is a broad term for all these markets put together.
Money Market and Capital Market, While operations of money market are
limited to short-term loans, a capital market is the market for long-term loans. Such loans
are demanded by business houses, governments, and consumers wanting to purchase
durable consumer goods. Some of these borrowings are done directly by the borrowers
from the general public by the issue of various instruments. But a substantial part of the
loans in a capital market is supplied by the financial intermediaries that form part of the
capital market. These intermediaries get their funds primarily from the savings of
households to be available for long-term financing of investment and consume goods
expenditure.
Constituents of the Indian Money Market. The Major constituents of the
Indian money market can be classified into three groups, viz. (i) organised sector, (ii)
unorganized sector, and (iii) co-operative sector.
(i) The main constituents of the organized sector are the Reserve Bank, the State
Bank and the various commercial banks. Quasi-government bodies and large-sized
commercial firms also operate in this market as lenders and financial intermediaries,
such as loan brokers and general finance and stock brokers take part in the
transactions.
(ii) The unorganised market on the indigenous market comprises the
indigenous bankers and moneylenders, working both in rural and urban areas. In this
market, there is no clear demarcation between short-term and long-term finance, nor
even between the purposes of finances, inasmuch a there is usually nothing on a hundi
(which is indigenous bill of exchange) to indicate whether it is for financing trade, or for
providing financial accommodation; in other words, whether it is a genuine trade bill or a
financial paper. By and large, these bills are accommodation bills.
(iii) A somewhat intermediate position between the organized and
unorganized sectors of the money market is occupied by the co-operative credit
institutions. These institutions were set up mainly with a view to supplanting the
indigenous sources of rural credit, particularly the moneylenders, since the credit
provided by the moneylenders was subject to many drawbacks, especially high interest
rates. While considerable progress has been made in fulfilling this objective in the last
few years, the total credit requirements of the rural sector have also increased
considerably. The Reserve Bank has stepped up substantially the credit assistance to
this sector and to supplement the efforts of the co-operative sector, regional rural banks
and commercial banks are also entering the rural economy in a big way. With the
notable increase in the number of commercial bank branches in the rural areas in the
last decade, closer link have been forged between the co-operative credit system and
the organized money market, particularly with the State Bank of India.
Composition of the Organised Market The organized money market consume
of (i) call money market, (ii) bill market, and (iii) collateral loan market.
(i) Call money market comprises dealings primarily among banks. It is the most
sensitive section of the money market. The rates of interest in this market vary from
time to time according to the volume of transactions, being higher in the busy season
than in the slack season.
(ii) Bill market comprises dealings in short-term bills of exchange, including
hundis of the indigenous bankers. Bill market in India has developed quite late—it had
its real beginning only after the introduction by the Reserve Bank of its New Bill Market
Scheme in 1970. Since then, although this market is developing, it is as yet not a very
prominent feature of the Indian money market.
(iii) Collateral loan market forms, by and large, the largest and the best
developed section of the money market. It this market, loans are given against the
security of government bonds, shares of first class companies, agriculture and
manufactured commodities, and bullion and jewellery.
A. Quantitative Controls
In considering the quantitative credit controls, viz., the bank rate, open market
operations and variable reserve requirements, it is important to stress that these are
closely inter-related and have to be operated in coordination. All of them affect the level
of bank reserves. The use of one instrument rather than another at any point of time is
determined by the nature of the situation and the range of influence it is desired by wield
as well as the rapidity with which the change is required to be brought about.
(b) Bank Rate and Cost of Credit. As regards the cost of credit made
available by the Reserve Bank an increase in the Bank rate implies that commercial
banks can borrow only at higher rates: correspondingly, they will charge higher rates of
interest from their borrowers. Similarly, a fall in the Bank rate would be accompanied by
a fall in the market rates of interest also.
(c) Deposit Mobilisation. Lending rates of commercial banks have been
getting adjusted more or less automatically to the variation in the Bank rate. The
Reserve Bank has also been fixing the deposit rates of commercial banks so as to
mobilize savings in to the banking sector or to regulate the volume of investments.
Bank Rate Policy during Planning Era. The Reserve Bank has been participating
more actively in the development process initiated under the five-year plans.
Consequently, changes in the Bank rate have been more frequent and more meaningful,
as would be seen from Table 21.1.
It would be seen that the raising of the Bank rate by Reserve Bank has now become an
important tool in squeezing bank credit and containing inflationary pressures. The Bank
rate policy of the Reserve Bank has been supplemented by a number of other measures
like the system of differential interest rates, reserve ratio system, etc. We will talk about
these systems in detail separately.
Evaluation of Bank Rate Policy. Although the Reserve Bank has been relying heavily
on the Bank rate as an instrument of credit control, its effectiveness has been limited by
a number of institutional and other constraints.
First, a large portion of the credit in the market is made available by non-banking
institutions. Rate of interest being charged by non-banking institutions does not bear
any direct relation with the Bank rate. The effectiveness of the Bank rate changes thus
gets reduced.
Secondly, in the developing economy of India, speculative dealings carry large
premium in the form of large margin of profits. A small change in the rate of interest only
insignificantly affects the profit margin of the dealer. Therefore, as long as finance is
made available to them, they are willing to bear higher costs.
Thirdly, in an inflationary situation, as has been witnessed in India for the last
three and a half decades, higher costs of credit are more than offset by higher prices of
final products. Higher interest rates, therefore, hardly deter the entrepreneurs from
borrowing.
Fourthly, a large part of the bank credit is being advanced to the priority sectors
of the economy at concessional rates of interest. It is almost immune to the effect of the
changes in Bank rate.
First, one of the factors facilitating the central bank in undertaking open market
operations is the increase in the volume of Government securities, consequent on the
growth of public debt. In India, also, there has been a large expansion in the volume of
Government debt, consequent on the floatation of a large number of loans by the
Government. This factor should be of help in the open market policy of the Reserve
Bank.
Secondly, there are fairly well-organised markets dealing with securities in cities
like Bombay, Calcutta and Madras. This is an important factor favourable for carrying on
open market operations.
Thirdly, commercial banks are now subject to a greater degree of control at the
hands of the Reserve Bank. They are obliged to keep a stable cash ratio to their total
deposit liabilities. This is another factor that should help open market operations.
In this situation, it should be expected that the Reserve Bank will depend more
on open market operations to influence the flow of credit in the economy.
(i) Cash reserve ratio refers to that portion of total deposits of a commercial bank which
it has to keep with the Reserve Bank in the form of cash reserves. Originally, under the
Reserve Bank of India Act, scheduled banks were required to maintain with the Reserve
Bank at the close of business on any day a minimum cash reserve of 5 per cent of their
demand liabilities and 2 per cent of their time liabilities in India. The Amendment Act of
1956 empowered the Bank to vary the minimum reserve required to be maintained with
it by scheduled banks between 5 and 20 per cent in respect of the demand liabilities and
2 and 8 per cent in respect of their time liabilities in India. Incidently, since 1956, the
minimum reserve requirement is related to the average daily balance of banks with the
Reserve Bank, i.e., the average of the balances held at the close of business or each
day of the week, Saturday to Friday. In 1962, the Act was further amended under which
the reserve requirements were fixed at 3 per cent of the aggregate demand and time
liabilities of each bank, thus removing the distinction between demand and time liabilities
for the purpose of reserve requirements. The Reserve Bank was also empowered to
vary the cash ratio between 3 per cent and 15 per cent of the total demand and time
liabilities.
To facilitate the flexible operation of this system, the Reserve Bank has also been vested,
since 1956, with the power to require scheduled banks to maintain the additional cash reserves,
computed with reference to the excess of their total demand and time liabilities over the level of
such liabilities on a base date to be notified by the Reserve Bank. This provision is designed to
ensure equity in the operation of additional reserve requirements when the acquisition of fresh
deposits by banks is highly uneven.
The Reserve Bank, of late, has been frequently changing this reserve requirement.
During 1973, the requirement was changed twice, as form of credit squeeze. It was raised from 3
per cent to 5 per cent in June 1973 and to 7 per cent in September 1973. Later, the Reserve
Bank reduced it to 4 per cent of the total deposit liabilities. It was again raised to 6 per cent in
November 1976, and presently stands at 14 per cent. A rise in this ratio should be taken as a
positive indicator of the tight credit policy being pursued by the Reserve Bank.
(ii) Statutory Liquidity Requirements refer to that portion of total deposits of a
commercial bank which it has to keep with itself in the form of cash reserves. Statutory liquidity
requirements supplement the statutory cash reserves and are so designed as to prevent
commercial banks from offsetting the impact of statutory cash reserves by liquidating their
Government security holdings. Originally, under he Banking Regulation Act, banks had to
maintain liquid assets in cash, gold or unencumbered approved securities amounting to not less
than 20 per cent of the total demand and time deposits. This enabled banks to liquidate their
Government security holdings when the cash reserve requirements were raised and thus
minimize the impact of this instrument. This Act was, therefore, amended in 1962 requiring all
banks to maintain a minimum amount of liquid assets equal to not less than 25 per cent of their
demand and time liabilities in India exclusive of the balances maintained with the Reserve Bank
under statutory cash reserve requirements. This amendment ensured that with every increase in
the cash reserve requirements, the overall liquidity obligations were correspondingly raised. The
Reserve Bank has also been authorized to change the statutory liquidity requirements.
These were raised from 25 per cent of demand and time liabilities to 30 per cent in
November 1972, to 32 per cent in 1973, 33 per cent in 1974, 34 per cent in December 1978 and
subsequently to 38.5 per cent. Since then the SLR on incremental net demand and time liabilities
over April 3, 1992, level has been reduced to 30 per cent from 38.5 per cent. This exercise has
been done to improve bank’s profitability and also to make larger resources available with banks
for lending purposes. In the next three to five years, it will be brought down to 25 per cent.
Moral Suasion
In addition to the above-mentioned methods of credit control, both quantitative and
qualitative, it may be noted that use also has been made in this country of moral suasion.
Periodically, letters are issued to banks urging them to exercise control voer credit in general or
advances against particular commodities or unsecured advances. Discussions are also held with
bankers for the same purpose. Such discussions between the Reserve Bank and the commercial
banks have been frequent in the last thirty years. The Reserve Bank has been able to build up
over the years good informal relations with commercial banks. Moral suasion, backed as it is by
the Reserve Bank’s vast power of direct regulation, has proved quite useful. The use of this
instrument is facilitated by the concentration of banking business in a few big banks.
REFERENCES.
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Capital market
MEANING:
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A capital market is the market for
long-term loans ___________________________________
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2. Analyse the progress of the traditional methods of credit control pursued by the
Reserve Bank of India.
4. What are the different constituents of the Indian Money Market? Also discuss the
limitations of Indian Money Market.
6.Differentiate between dear money and cheap money policy. How would you account
for dear money policy in India?
7. What do you mean by selective credit controls? Examine the factors responsible for increasing
reliance on selective credit controls in the underdeveloped economies.
9. What are the quantitative and qualitative methods of credit control? Explain the
working of the bank rate policy in India.