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A project on Money market in India-issues and concerns

Submitted by : Kritika Garg Enroll. Number- 12BSPHH010481

ABSTRACT
A well regulated financial sector is essential in globalize economy. Financial innovation has contributed in the economic development. A financial institution is an institution that provides financial services for its clients or members. Probably the most important financial service provided by financial institutions is acting as financial intermediaries. Most financial institutions are highly regulated by government. The definition of money for money market purposes is not confined to bank notes but includes a range of assets that can be turned into cash at short notice, such as short-term government securities, bills of exchange, and bankers acceptances This paper analyses the real effects of financial markets subsequent to financial liberalization in an economy with risk averse savers and learning by lending. Transition from full financial repression to full financial liberalization might initially slow down the growth process or even induce a recession, whenever the initial level of valuable investments known by the financial intuitions is sufficiently scanty. However, lending activity leads to accumulation of information (learning by lending) regarding valuable investments. The purpose of this paper is to advocate and encourage financial markets in the overall development of the economy.

INTRODUCTION
Financial openness is often regarded as providing important potential benefits. Access to money markets expands investors opportunities for a potential for achieving higher risk-adjusted rates of return. It also allows countries to borrow to smooth consumption in the face of adverse shocks, the potential growth and welfare gains resulting from such international risk sharing can be large. It has also been argued that by increasing the rewards of good policies and the penalties for bad policies, free flow of capital across borders may induce countries to follow more disciplined macroeconomic policies that translate into greater macroeconomic stability. An increasingly common argument in favor of financial openness is that it may increase the depth and breadth of domestic financial markets and lead to an increase in financial intermediation process by lowering costs and excessive profits associated with monopolistic or cartelized markets, thereby lowering the cost of investment and improving resource allocation. Organized financial markets have existed in India for more than a century. Today, markets of varying maturity exist in equity, debt, commodities and foreign exchange. There are 25 stock markets all over the country, the most important of which, are the Bombay Stock Exchange and the National Stock Exchange. The rupee has been convertible on the current account since 1992. India Financial Market helps in promoting the savings of the economy - helping to adopt an effective channel to transmit various financial policies. The Indian financial sector is welldeveloped, competitive, efficient and integrated to face all shocks. In the India financial market there are various types of financial products whose prices are determined by the numerous buyers and sellers in the market. The other determinant factor of the prices of the financial products is the market forces of demand and supply.

The India money market is a monetary system that involves the lending and borrowing of shortterm funds. India money market has seen exponential growth just after the globalization initiative in 1992. It has been observed that financial institutions do employ money market instruments for financing short-term monetary requirements of various sectors such as agriculture, finance and manufacturing. The performance of the India money market has been outstanding in the past 20 years. Central bank of the country - the Reserve Bank of India (RBI) has always been playing the major role in regulating and controlling the India money market. The intervention of RBI is varied -

curbing crisis situations by reducing the cash reserve ratio (CRR) or infusing more money in the economy.

Player Central Bank Government Bank Discount Houses FIs MFs FIIs Dealers Corporates

Role Intermediary Barrowers/Issuers Barrowers/Issuers Market markets Barrowers/Issuers Lenders/Investors Investors Intermediaries Issuers MAJOR PLAYERS IN MONEY MAKRET The major players and their role in money market is listed below:

INDIAN MONEY MARKET FEATURES:


Every money is unique in nature. The money market in developed and developing countries differ markedly from each other in many senses. Indian money market is not an exception for this. Though it is not a developed money market, it is a leading money market among the developing countries. Indian Money Market has the following major features or characteristics:-

DICHOTOMIC STRUCTURE:

It is a significant aspect of the Indian money market. It has a simultaneous existence of both the organized money market as well as unorganized money markets. The organized money market consists of RBI, all scheduled commercial banks and other recognized financial institutions. However, the unorganized part of the money market comprises domestic money lenders, indigenous bankers, trader, etc. The organized money market is in full control of the RBI. However, unorganized money market remains outside the RBI control. Thus both the organized and unorganized money market exists simultaneously. SEASONALITY:

The demand for money in Indian money market is of a seasonal nature. India being an agriculture predominant economy, the demand for money is generated from the agricultural operations. During the busy season i.e. between October and April more agricultural activities takes place leading to a higher demand for money. MULTIPLICITY OF INTEREST RATES:

In Indian money market, we have many levels of interest rates. They differ from bank to bank from period to period and even from borrower to borrower. Again in both organized and unorganized segment the interest rates differ. Thus there is an existence of many rates of interest in the Indian money market. LACK OF ORGANIZED BILL MARKET:

In the Indian money market, the organized bill market is not prevalent. Though the RBI tried to introduce the Bill Market Scheme (1952) and then New Bill Market Scheme in 1970, still there is no properly organized bill market in India.

ABSENCE OF INTEGRATION:

This is a very important feature of the Indian money market. At the same time it is divided among several segments or sections which are loosely connected with each other. There is a lack of coordination among these different components of the money market. RBI has full control over the components in the organized segment but it cannot control the components in the unorganized segment. HIGH VOLATILITY IN CALL MONEY MARKET:

The call money market is a market for very short term money. Here money is demanded at the call rate. Basically the demand for call money comes from the commercial banks. Institutions such as the GIC, LIC, etc suffer huge fluctuations and thus it has remained highly volatile. LIMITED INSTRUMENTS

It is in fact a defect of the Indian money market. In our money market the supply of various instruments such as the Treasury Bills, Commercial Bills, Certificate of Deposits, Commercial Papers, etc. is very limited. In order to meet the varied requirements of borrowers and lenders, It is necessary to develop numerous instruments

BENEFITS & FEATURES


1. Interest Rate Being collateralized loans, repos help reduce counter party risk & therefore, fetch a low interest rate. 2. Contract The Repo contract provides the seller bank to get money by partying with its security and the buyer bank in turn to get the security by parting with its money. It becomes a Reserve Repo deal for the purchaser of the security. Securities are sold first to a buyer bank and simultaneously another contract is entered in to with buyer to repurchase them at a predetermine date and price in future. The price of the sale and repurchase of securities is determined before entering into deal. 3. Safety Repo is an almost risk free instrument used to even out liquidity changes in the system. Repos offer short-term outlet for temporary excess cash at close to the market interest rate.

4. Hedge tool As purchaser of the repo requires title to the securities for the term of agreement and as the repurchase price is locked in at a time of sale itself. It is possible to use repos as an effective hedge-tool to arrange the others repos or to sell them outright or to deliver them to another party to fulfill the delivery commitment in respect of a forward or future contract or a short sale or a maturing reverse repo. 5. Period The minimum period for Ready Forward Transaction Bill will be 3 day. However, RBI withdraws this restriction for the minimum period with the effect from October 30, 1998. 6. Liquidity Control The RBI uses Repo as a tool of liquidity control for absorbing surplus liquidity from the banking system in a flexible way and thereby preventing interest rate arbitraging. All Repo transaction are to be effected at Mumbai only and the deals are to be necessary put through the subsidiary General Ledger (SGL) account with the Reserve Bank of India. 7. Cash Management Tool The Repo arrangement essential serves as a short term cash management tool as the bank receive cash from the buyer of the securities in return for the securities. This helps the banker meet temporary cash requirement. This also makes the repo a pure money lending operation. On the maturity of the repos the security is purchased back by the seller bank from the buyer-bank by returning the money to the buyer

FUNCTIONS OF MONEY MARKEET


INVESTMENT FUNCTION The money market provides an ideal source for investment of the funds for a short period of time for commercial banks, non banking financial concerns, business corporations and other investors. It enables businessmen, with temporary surplus funds, to invest them for a short period. FINANCING FUNCTION

Money market provides an ideal source for short-term financing for businessmen, industrialists, traders, etc to meet their day-to-day requirements of working capital. Funds are available for borrowing by the government and its agencies also. FACILITATING FUNCTION

Money market provides an ideal play ground for the central monetary authority of the country to carry out various regulatory operations relating to the banking and financial system of the country. The sensitive nature of the money market helps the central bank to make it an ideal arena for the execution of various credit control measures.

STRUCTURE MARKET

OF

INDIAN

MONEY

The entire money market in India can be divided into two parts. They are organized money market and the unorganized money market. The unorganized money market can also be known as an unauthorized money market. Both of these components comprise several constituents. The following chart will help you in understanding the organizational structure of the Indian money market.

Components, Submarkets of Indian Money Market


After studying above organizational chart of the Indian money market it is necessary to understand various components or sub markets within it. They are explained below

CALL MONEY MARKET: It an important sub market of the Indian money market. It is also known as money at call and money at short notice. It is also called inter bank loan market. In this market money is demanded for extremely short period. The duration of such transactions is from few hours to 14 days. It is basically located in the industrial and commercial locations such as Mumbai, Delhi, Calcutta, etc. These transactions help stock brokers and dealers to fulfill their financial requirements. The rate at which money is made available is called as a call rate. Thus rate is fixed by the market forces such as the demand for and supply of money. Commercial banks, both Indian and foreign, co-operative banks, Discount and Finance House of India Ltd.(DFHI), Securities trading corporation of India (STCI) participate as both lenders and borrowers and Life Insurance Corporation of India (LIC), Unit Trust of India(UTI), National Bank for Agriculture and Rural Development (NABARD)can participate only as lenders. The interest rate paid on call money loans, known as the call rate, is highly volatile. It is the most sensitive section of the money market and the changes in the demand for and supply of call loans are promptly reflected in call rates. There are now two call rates in India: the Interbank call rate and the lending rate of DFHI. The ceilings on the call rate and inter-bank term money rate were dropped, with effect from May 1, 1989. The Indian call money market has been transformed into a pure inter-bank market during 200607. [3] The major call money markets are in Mumbai, Kolkata, Delhi, Chennai, and Ahmadabad. COMMERCIAL BILL MARKET: It is a market for the short term, self liquidating and negotiable money market instrument. Commercial bills are used to finance the movement and storage of agriculture and industrial

goods in domestic and foreign markets. The commercial bill market in India is still underdeveloped. TREASURY BILL MARKET: Treasury bills are instrument of short-term borrowing by the Government of India, issued as promissory notes under discount. The interest received on them is the discount which is the difference between the price at which they are issued and their redemption value. They have assured yield and negligible risk of default. Under one classification, treasury bills are categorized as ad hoc, tap and auction bills and under another classification it is classified on the maturity period like 91-days TBs, 182-days TBs, 364-days TBs and two types of 14-days TBs. In the recent times (200203, 200304), the Reserve Bank of India has been issuing only 91-day and 364-day treasury bills. The auction format of 91-day treasury bill has changed from uniform price to multiple price to encourage more responsible bidding from the market players.[4] the bills are two kinds- Adhoc and regular. The adhoc bills are issued for investment by the state governments, semi government departments and foreign central banks for temporary investment. They are not sold to banks and general public. The treasury bills sold to the public and banks are called regular treasury bills. They are freely marketable. Commercial bank buy entire quantity of such bills issued on tender . they are bought and sold on discount basis. Ad-hoc bills were abolished in April 1997. MAKRET FOR CERTIFICATE OF DEPOSITS: It is again an important segment of the Indian money market. The certificate of deposits is issued by the commercial banks. They are worth the value of Rs. 25 lakh and in multiple of Rs. 25 lakh. The minimum subscription of CD should be worth Rs. 1 Crore. The maturity period of CD is as low as 3 months and as high as 1 year. These are the transferable investment instrument in a money market. The government initiated a market of CDs in order to widen the range of instruments in the money market and to provide a higher flexibility to investors for investing their short term money. MARKET FOR COMMERCIAL PAPERS: It is the market where the commercial papers are traded. Commercial paper (CP) is an investment instrument which can be issued by a listed company having working capital more than or equal to Rs. 5 cr. The CPs can be issued in multiples of Rs. 25 lakhs. However the minimum subscription should at least be Rs. 1 cr. The maturity period for the CP is minimum of 3 months and maximum 6 months. This was introduced by the government in 1990. Short Term Loan Market : It is a market where the short term loan requirements of corporate are met by the Commercial banks. Banks provide short term loans to corporate in the form of cash credit or in the form of overdraft. Cash credit is given to industrialists and overdraft is given to businessmen.

RECENT REFORMS IN INDIAN MONEY MARKET


The recommendations of the Sukhmoy Chakravarty Committee on the Review of the Working of the Monetary system, and the Narasimham Committee Report on the Working of the Financial System in India, 1991, The Reserve Bank of India has initiated a series of money market reforms basically directed towards the efficient discharge of its objectives. The bank reduced the ceiling rate on bank advances and on inter-bank call and short-notice money. There has been a significant lowering of the minimum lending rate of commercial banks and public sector development financial institutions from 18% in 199091 to 10.5% in 200506.[8] Reforms made in the Indian Money Market are:- Deregulation of the Interest Rate : In recent period the government has adopted an interest rate policy of liberal nature. It lifted the ceiling rates of the call money market, short-term deposits, bills rediscounting, etc. Commercial banks are advised to see the interest rate change that takes place within the limit. There was a further deregulation of interest rates during the economic reforms. Currently interest rates are determined by the working of market forces except for a few regulations. Money Market Mutual Fund (MMMFs) : In order to provide additional short-term investment revenue, the RBI encouraged and established the Money Market Mutual Funds (MMMFs) in April 1992. MMMFs are allowed to sell units to corporate and individuals. The upper limit of 50 crore investments has also been lifted. Financial institutions such as the IDBI and the UTI have set up such funds. Establishment of the DFI : The Discount and Finance House of India (DFHI) was set up in April 1988 to impart liquidity in the money market. It was set up jointly by the RBI, Public sector Banks and Financial Institutions. DFHI has played an important role in stabilizing the Indian money market. Liquidity Adjustment Facility (LAF) : Through the LAF, the RBI remains in the money market on a continue basis through the repo transaction. LAF adjusts liquidity in the market through absorption and or injection of financial resources. Electronic Transactions : In

order to impart transparency and efficiency in the money market transaction the electronic dealing system has been started. It covers all deals in the money market. Similarly it is useful for the RBI to watchdog the money market. Establishment of the CCIL : The Clearing Corporation of India limited (CCIL) was set up in April 2001. The CCIL clears all transactions in government securities, and repose reported on the Negotiated Dealing System. Development of New Market Instruments : The government has consistently tried to introduce new short-term investment instruments. Examples: Treasury Bills of various duration, Commercial papers, Certificates of Deposits, MMMFs, etc. have been introduced in the Indian Money Market.

Reforms made in the Indian Money Market are:DEREGULATION OF THE INTEREST RATE: In recent period the government has adopted an interest rate policy of liberal nature. It lifted the ceiling rates of the call money market, short-term deposits, bills rediscounting, etc. Commercial banks are advised to see the interest rate change that takes place within the limit. There was a further deregulation of interest rates during the economic reforms. Currently interest rates are determined by the working of market forces except for a few regulations. MONEY MARKET MUTUAL FUND: In order to provide additional short-term investment revenue, the RBI encouraged and established the Money Market Mutual Funds (MMMFs) in April 1992. MMMFs are allowed to sell units to corporate and individuals. The upper limit of 50 crore investments has also been lifted. Financial institutions such as the IDBI and the UTI have set up such funds. ESTABLISHMENT OF THE DFI: The Discount and Finance House of India (DFHI) was set up in April 1988 to impart liquidity in the money market. It was set up jointly by the RBI, Public sector Banks and Financial Institutions. DFHI has played an important role in stabilizing the Indian money market. LIQUIDITY ADJUSTMENT FACILITY: Through the LAF, the RBI remains in the money market on a continue basis through the repo transaction. LAF adjusts liquidity in the market through absorption and or injection of financial resources.

ELECTRONIC TRANSACTIONS: In order to impart transparency and efficiency in the money market transaction the electronic dealing system has been started. It covers all deals in the money market. Similarly it is useful for the RBI to watchdog the money market. ESTABLISHMENT OF THE CCIL: The Clearing Corporation of India limited (CCIL) was set up in April 2001. The CCIL clears all transactions in government securities, and repose reported on the Negotiated Dealing System.

DEVELOPMENT INSTRUMENTS:

OF

NEW

MARKET

The government has consistently tried to introduce new short-term investment instruments. Examples: Treasury Bills of various duration, Commercial papers, Certificates of Deposits, MMMFs, etc. have been introduced in the Indian Money Market. These are major reforms undertaken in the money market in India. Apart from these, the stamp duty reforms, floating rate bonds, etc. are some other prominent reforms in the money market in India. Thus, at the end we can conclude that the Indian money market is developing at a good speed.

PROBLEMS IN THE INDIAN MONEY MARKET


1. Absence of Coordination: There is no coordination between organized and unorganized sectors of the money market. At times there is even wasteful competition between them.Such a situation is extremely harmful for the economic progress of the country. 2. Absence of Developed Bill Market: An important shortcoming of Indian Money Market is the absence of a well developed money market. Though both inland and foreign bills are traded in Indian Money Market yet its scope is very limited. In spite of the efforts of Reserve Bank in 1952 and in 1970, only a limited bill market exists in India. Thus, an organized bill market in the real sense of the term has not yet been fully developed in India. The main obstacles in the development of bill market appear to be the following: The lack of uniformity in drawing bills in different parts of the country, The large use of cash credit as the main form of borrowing from commercial banks, (iii) Presence of Inter-call money market and

The pressure of cash transactions. Thus, Bill Market is relatively underdeveloped.

3. Shortage of Funds in Money Market: The Indian money market is characterized by shortage of funds. The funds available in the market are inadequate to meet the requirements of trade and industry. The main reasons responsible for shortage of funds are poverty, low level of income and low savings. Inadequate banking facilities are also one of the main causes of shortage of funds. 4. Seasonal Stringency of Funds: Another defect of Indian Money Market is the stringency of credit in particular seasons of the year. During the harvest time (April to November) there is substantial rise in demand for credit. The supply of credit at such a time does not increase in the same proportion in which demand increases. Consequently, rate of interest shoots up during the busy season. On the other hand, during the slack season, due to fall in demand for credit, the interest rate declines. These wide variations in the supply and demand for money are due to inelastic supply of money. 5. Lack of Uniformity in Interest Rates: In Indian Money Market, there is no uniformity in rates of interest. The lending rates of commercial banks differ from those of the Rural Regional Banks and cooperative banks. There is also wide variation in the rates of interest charged by the banks of organized sector and of indigenous banks. The bill finance rate also differs from hundi rate. 6. Underdeveloped Banking Habits: In spite8 of rapid branches expansion of banks and spread of banking to unbanked and rural centers, the banking habits in India are still underdeveloped whereas in U.S.A. for every 1400 persons there is a branch of a commercial bank, in India there is a branch for every 13,000 people There are several reasons for it. The use of cheques is restricted, The majority of transactions are settled in cash The hoarding habit is widespread.

7. Dominance of Indigenous Bankers: The indigenous banker still dominates the banking scene in India. Even after banking expansion in the rural areas, the money lenders still continue to be the only source to the agriculturists. They exploit their customers by adopting malpractices and charging exorbitant rate of interest The Reserve Bank exercises no control over them.

CONCLUSION
To sum up, the money market is a key component of the financial system as it is the fulcrum of monetary operations conducted by the central bank in its pursuit of monetary policy objectives. It is a market for short-term funds with maturity ranging from overnight to one year and includes financial instruments that are deemed to be close substitutes of money. The money market performs three broad functions. Firstly, it provides an equilibrating mechanism for demand and supply of short-term funds. Secondly, it enables borrowers and lenders of short-term funds to fulfill their borrowing and investment requirements at an efficient market clearing price. Three, it provides an avenue for central bank intervention in influencing both quantum and cost of liquidity in the financial system, thereby transmitting monetary policy impulses to the real economy. the objective of monetary management by the central bank is to align money market rates with the key policy rate. As excessive money market volatility could deliver confusing signals about the stance of monetary policy, it is critical to ensure orderly market behavior, from the point of view of both monetary and financial stability. Thus, efficient functioning of the money market is important for the effectiveness of monetary policy

References:
http://en.wikipedia.org/wiki/Money_market http://www.rbi.org.in/home.aspx http://www.shareyouressays.com http://kalyan-city.blogspot.com http://www.gr8ambitionz.com