What is the Money Market?

The money market is a part of the financial market where short-term funds (≤ 1 year) are borrowed and lent. It helps governments, banks, and companies manage their immediate cash needs.

💡 Example:

The Indian Government sells Treasury Bills (91 days) to raise funds.
Infosys issues Commercial Paper (180 days) to pay suppliers.

Key Features of Money Market

(How it differs from stock/capital markets)

Short-Term Focus

Money market deals in instruments that mature within one year, unlike the stock or capital markets which focus on long-term securities like shares and bonds.

Example: A 91-day Treasury Bill is a typical money market instrument.

Highly Liquid

Instruments can be quickly converted into cash, making it easier for banks and companies to manage day-to-day needs.

Example: Mutual funds often park surplus money in Commercial Papers (CPs) or T-Bills because they can easily sell them.

Low Risk

Most issuers are the government or financially strong corporates, which makes the chance of default low.

Example: Government-issued Treasury Bills are considered “risk-free.”

Wholesale Market

Unlike the stock market (where individuals invest freely), the money market is dominated by large players such as banks, mutual funds, and corporates.

Example: Reliance or Infosys might issue CPs worth hundreds of crores, something small investors cannot easily access.

Unsecured

Many instruments don’t require physical collateral; lending is based on reputation and credit ratings.

Example: A top-rated company like Tata Steel can issue Commercial Paper without pledging assets.

Regulated by RBI

The Reserve Bank of India supervises money markets to ensure transparency, safety, and stability.

Example: RBI controls interest rates through repo and reverse repo operations.

Functions of Money Market

(Why is it useful?)

Manages Liquidity

Banks use money market instruments to meet RBI’s reserve requirements (CRR/SLR) and short-term mismatches.

Example: SBI borrowing in the call money market overnight to meet CRR needs.

Short-Term Funding

Companies borrow to cover immediate expenses like wages, raw material purchases, or seasonal demands.

Example: Maruti Suzuki issuing CPs to finance higher production before Diwali sales.

Monetary Policy Tool

RBI uses instruments like repo, reverse repo, and LAF to control inflation or inject liquidity.

Example: During high inflation, RBI increases repo rates to make borrowing costlier.

Interest Rate Benchmark

Money market rates like MIBOR (Mumbai Interbank Offer Rate) act as benchmarks for loans and pricing of other financial products.

Example: Banks may set lending rates linked to MIBOR.

Supports Trade

Instruments like bills of exchange and banker’s acceptances help in financing imports and exports.

Example: An exporter of cotton to the US may discount export bills in the money market for instant cash.

Importance of Money Market

Stabilizes Economy

Acts as a “safety valve” in financial stress. During crises, RBI can quickly inject liquidity.

Example: During COVID-19, RBI provided liquidity through LTROs to support banks and NBFCs.

Supports Growth

By ensuring short-term funding, industries continue production without disruption.

Example: FMCG companies like Hindustan Unilever rely on CPs for working capital.

Efficient Use of Funds

Idle money from banks or mutual funds is redirected to borrowers in need, ensuring funds are not wasted.

Example: Mutual funds invest surplus into T-Bills instead of letting money sit unused.

Helps RBI Control Inflation

By adjusting repo and reverse repo rates, RBI can reduce or increase money supply quickly.

Example: Raising repo rates makes borrowing expensive, reducing inflationary pressure.

Cheaper Financing

Corporates can borrow through CPs at lower rates compared to traditional bank loans.

Example: Infosys may issue CPs at 6% interest instead of taking a bank loan at 8%.

Key Money Market Instruments in India

Key Players in the Indian Money Market

The money market in India has different participants who either borrow or lend short-term funds (≤ 1 year).

1. Reserve Bank of India (RBI)

Acts as the regulator and controller.
Uses repo, reverse repo, CRR, SLR, LAF to manage liquidity and inflation.
Issues Treasury Bills and manages govt. borrowing.

2. Commercial Banks

Largest participants – both borrowers and lenders.
Manage day-to-day liquidity needs (e.g., through call money, repos).
Issue Certificates of Deposit (CDs) to raise funds.

3. Non-Banking Financial Companies (NBFCs)

Raise short-term funds via Commercial Papers (CPs).
Depend on the money market when banks restrict lending.

4. Mutual Funds / Money Market Mutual Funds (MMMFs)

Invest surplus funds of retail and institutional investors.
Provide liquidity to banks and corporates by buying T-Bills, CPs, CDs.

5. Corporates

Issue Commercial Paper to meet working capital needs.
Borrow short-term instead of taking expensive bank loans.

6. Primary Dealers (PDs)

Specialized institutions approved by RBI.
Play a key role in government securities (T-Bills, bonds) auctions.

7. Other Participants

Insurance companies, cooperative banks, provident funds.
Unorganized players: moneylenders, chit funds, indigenous bankers (important in rural areas).

Role of Dealers in the Money Market

“Dealers” are financial intermediaries who facilitate trading in money market instruments.

Their Roles:

Market Making → Provide continuous quotes (buy/sell rates) in instruments like T-Bills, CPs, CDs.
Liquidity Provider → Ensure that banks, corporates, and funds can quickly borrow or invest money.
Auction Participation → Dealers (esp. Primary Dealers) bid in government auctions and distribute securities to investors.
Price Discovery → Help determine short-term interest rates through their trades.
Risk Management → Take positions in the market and use repos/derivatives to hedge risks.

👉 Example: A Primary Dealer like SBI DFHI Ltd. participates in RBI’s weekly T-Bill auction, buys ₹1,000 crore worth of bills, and later sells parts of it to banks and mutual funds.

✅ Student Takeaway:

Key players = RBI (regulator) + Banks (largest users) + Corporates (issuers of CP) + Mutual Funds (investors) + NBFCs + Primary Dealers.
Dealers act like “wholesalers” who connect issuers and investors, keep the market liquid, and help in price discovery.

Key Primary Dealers in India

As of the most recent RBI data (April 1, 2020), here are some notable Standalone Primary Dealers and Bank Primary Dealers:

Standalone Primary Dealers

ICICI Securities Primary Dealership Limited
Bank of America, N.A.
Morgan Stanley India Primary Dealer Pvt. Ltd.
Nomura Fixed Income Securities Pvt. Ltd.
PNB Gilts Ltd.
STCI Primary Dealer Limited

Bank Primary Dealers

Bank of Baroda
Canara Bank
Citibank N.A.
SBI DFHI Ltd.
Union Bank of India
HDFC Bank Ltd.
Goldman Sachs (India) Capital Markets Pvt. Ltd.
HSBC (Hongkong and Shanghai Banking Corporation Ltd.)
J.P. Morgan Chase Bank N.A. (Mumbai Branch)
Kotak Mahindra Bank Ltd.
Standard Chartered Bank
Axis Bank Ltd.
IDBI Bank Limited
Deutsche Bank AG
Yes Bank Limited Reserve Bank of India+1

What Are Standalone vs. Bank PDs?

Standalone Primary Dealers (SPDs):
Typically NBFCs or subsidiaries (including JV setups). They operate primarily in the securities business and must comply with RBI NBFC licensing and capital norms.
Banking SchoolForumIAS
Bank Primary Dealers:
Established banks that run PD operations within their organizational structure. They don’t form a separate NBFC but function under the bank’s banner.
Banking School

Money Market Instruments: Commercial Paper

Commercial Paper (CP) is an unsecured, short-term debt instrument issued by companies, financial institutions, or primary dealers to meet their working capital needs.

It is issued in the form of a promissory note.
Maturity: 7 days to 1 year.
Only companies with a strong credit rating (usually from CRISIL, ICRA, etc.) can issue CP.

Features of Commercial Paper

Short-Term Instrument – Usually issued for 7 days to 1 year.
Unsecured – No collateral required; issued purely based on creditworthiness.
Large Denomination – Generally issued in multiples of ₹5 lakh or more, so mostly wholesale.
Tradable – Can be bought and sold in the secondary market before maturity.
Issued at Discount – CP is usually issued at a discount to face value and redeemed at par.
- Example: A CP with a face value of ₹1,00,000 may be issued at ₹95,000.
Eligibility – Only companies with strong financials and high credit ratings are allowed to issue.
Regulated by RBI – RBI sets guidelines for issue, maturity, and investors.

Advantages of Commercial Paper

For Companies (Issuers):

Lower Cost of Funds – Cheaper than taking bank loans.
Flexibility – Can raise funds quickly for short-term needs like working capital.
Diversification of Borrowing Sources – Reduces dependence on banks.

For Investors:

Higher Returns – Offers better returns than savings accounts or short-term deposits.
Safety – Issued by top-rated corporates, reducing default risk.
Liquidity – Can be traded in the secondary market before maturity.

Corporate Examples

Reliance Industries Ltd. – Frequently issues CPs to manage its short-term financing requirements.
Tata Motors – Issues CPs to finance seasonal inventory build up before peak sales.
Infosys – Uses CPs to cover short-term working capital gaps at a lower cost than bank borrowing.
HDFC Ltd. – Raises short-term funds through CPs to manage liquidity for housing finance operations.

👉 In simple terms: Commercial Paper is like a short-term IOU issued by top companies to raise money quickly and cheaply, and bought by banks, mutual funds, or corporates looking for safe short-term returns.

Certificates of Deposit (CDs)

A Certificate of Deposit (CD) is a negotiable, short-term money market instrument issued by commercial banks and financial institutions to raise funds from investors.

It is like a time deposit, but in a tradable form.
Issued in dematerialized form or as a promissory note.
Maturity: 7 days to 1 year (banks), and up to 3 years (FIs).

Features of Certificates of Deposit

Issued by Banks & FIs – Scheduled commercial banks (except RRBs & cooperative banks) and some financial institutions issue CDs.
- Example: SBI, HDFC Bank, ICICI Bank issue CDs.
Short-Term Instrument – Banks issue CDs typically between 7 days to 1 year; FIs can go up to 3 years.
Large Denominations – Minimum value is ₹5 lakh, issued in multiples of ₹1 lakh.
Negotiable / Tradable – Unlike fixed deposits, CDs can be traded in the secondary market before maturity.
Issued at Discount – Like Commercial Papers, CDs are usually issued at a discount and redeemed at face value.
Unsecured – No collateral is provided; repayment depends on the issuing bank’s credibility.
RBI Regulation – The issue and trading of CDs are governed by RBI guidelines.

Difference Between Bank Deposits and Certificates of Deposit

Treasury Bills (T-Bills) Market

Definition

The Treasury Bills Market refers to the market where the Government of India issues short-term debt instruments called Treasury Bills (T-Bills) to meet its short-term funding needs.

These are zero-coupon instruments (no interest payments).
They are issued at a discount and redeemed at face value.
Maturity: less than 1 year.
Regulated by the RBI.

👉 Example: If you buy a ₹100 T-Bill at ₹95, the govt. pays you ₹100 on maturity. Your earning = ₹5.

Classification of Treasury Bills Market

The Treasury Bills in India are classified mainly by maturity period:

91-Day T-Bills
- Maturity: 3 months
- Issued weekly (every Friday)
- Used for short-term liquidity adjustment.
- Investors: Banks, Mutual Funds, Corporates.
- Example: SBI or ICICI Bank may park surplus funds here for quick liquidity.
182-Day T-Bills
- Maturity: ~6 months
- Issued every alternate week.
- Suitable for investors seeking medium-term safe investment.
- Example: Insurance companies like LIC use these to balance cash flows.
364-Day T-Bills
- Maturity: ~1 year
- Issued weekly.
- Popular among institutional investors for slightly higher returns than 91-day or 182-day T-Bills.
- Example: Mutual funds and corporate treasuries invest here for better yield.

Importance of Treasury Bills Market

Provides safe investment avenue (backed by Govt. of India).
Helps RBI in monetary policy operations (e.g., controlling liquidity via auctions).
Provides a benchmark rate for short-term interest rates.
Ensures liquidity management for banks and institutions.

👉 In simple terms: The T-Bill Market is where the Govt. borrows for the short term by issuing safe, discount-based securities of 91, 182, and 364 days.

The Reserve Bank of India (RBI) and the Money Market

The Reserve Bank of India (RBI) serves as the central bank of India, holding a pivotal role in maintaining the country's economic and financial stability. It is the apex monetary institution, entrusted with the responsibility of managing the nation's currency, controlling credit, and overseeing the banking system. The RBI's actions and policies are crucial for steering economic growth and managing inflation.

📝 Functions of the RBI

The RBI performs several critical functions that are vital for the smooth operation of the Indian economy.

Monetary Authority: As the monetary authority, the RBI's primary objective is to maintain price stability while ensuring adequate credit flow to support economic growth. It formulates and implements the country's monetary policy, using tools like interest rates and reserve requirements to manage the money supply. This function is central to controlling inflation and influencing overall economic activity.
Issuer of Currency: The RBI is the sole authority for issuing currency notes (except for the one-rupee note and coins, which are issued by the Government of India). It is responsible for the design, printing, and circulation of currency, as well as the withdrawal of old or damaged notes. This ensures uniformity and public confidence in the currency.
Banker to the Government: The RBI acts as a banker to both the central and state governments. It manages their banking accounts, handles their receipts and payments, and provides short-term loans. This role is crucial for the government's financial management and for facilitating smooth treasury operations.
Banker's Bank and Supervisor: The RBI is the ultimate source of liquidity for the banking system. All scheduled commercial banks maintain a current account with the RBI. This enables inter-bank transactions and provides a mechanism for the RBI to lend money to banks in times of need (acting as the "lender of last resort"). The RBI also supervises and regulates commercial banks to ensure the stability and integrity of the financial system.
Manager of Foreign Exchange: The RBI manages India's foreign exchange reserves and oversees the foreign exchange market. It intervenes in the market to stabilize the value of the Indian Rupee against foreign currencies, which is essential for facilitating international trade and managing the balance of payments.

💰 The RBI's Role in the Money Market

The Money Market is a segment of the financial market where financial instruments with high liquidity and very short maturities are traded. The RBI plays a critical role in regulating and stabilizing this market by managing the liquidity (the amount of money available for lending) in the banking system.

Liquidity Adjustment Facility (LAF)

The Liquidity Adjustment Facility (LAF) is a key tool used by the RBI to manage daily liquidity mismatches of banks. It consists of two components: the Repo Rate and the Reverse Repo Rate.

Repo Rate (Repurchase Agreement Rate): This is the interest rate at which commercial banks borrow money from the RBI by selling government securities with an agreement to repurchase them at a future date. The RBI uses the repo rate to inject liquidity into the banking system.
- Impact: When the RBI wants to curb inflation, it increases the repo rate. A higher repo rate makes borrowing more expensive for banks, which in turn reduces their lending to the public. This decreases the money supply in the economy, helping to bring down prices.
- Impact: Conversely, during an economic slowdown, the RBI decreases the repo rate. This makes borrowing cheaper for banks, encouraging them to lend more, thereby boosting economic activity.
Reverse Repo Rate: This is the interest rate at which the RBI borrows money from commercial banks. Banks lend their surplus funds to the RBI by purchasing government securities from it. The reverse repo rate is used by the RBI to absorb excess liquidity from the banking system.
- Impact: To absorb excess liquidity (e.g., to control inflation), the RBI increases the reverse repo rate. This encourages banks to park their surplus funds with the RBI to earn a higher return, reducing the money available for lending in the market.

Marginal Standing Facility (MSF)

The Marginal Standing Facility (MSF) is a special window for commercial banks to borrow from the RBI in an emergency or in case of an acute shortage of funds. Banks can borrow up to a certain limit against government securities, even if they have exhausted their regular borrowing limits under the LAF. The MSF rate is typically higher than the repo rate, making it a last-resort option for banks to access overnight liquidity.

📈 Monetary Policy Committee (MPC)

The Monetary Policy Committee (MPC) is a six-member committee responsible for setting the benchmark interest rate (the Repo Rate) in India to achieve the inflation target set by the government. Its formation in 2016 marked a significant shift from the RBI Governor having sole authority on interest rate decisions to a more collective, transparent, and accountable process.

Structure of the MPC

The committee is composed of six members:

The Governor of the RBI, who serves as the ex-officio Chairperson.
A Deputy Governor of the RBI in charge of monetary policy.
One officer of the RBI nominated by the Central Board.
Three external members appointed by the Government of India. These members are selected for their expertise in economics, banking, finance, or monetary policy.

Functions of the MPC

Functions of the Monetary Policy Committee (MPC)

The primary function of the MPC is to manage inflation while keeping in mind the objective of economic growth.

Setting the Policy Interest Rate: The most critical function of the MPC is to determine the benchmark interest rate, which is the Repo Rate. This rate influences all other interest rates in the economy.
Achieving the Inflation Target: The Government of India sets a specific inflation target for the RBI. The MPC's main responsibility is to adjust the repo rate to keep inflation within this target. The current inflation target is 4%, with a tolerance band of +/- 2% (so, 2% to 6%).
Conducting Regular Meetings: The MPC is mandated to meet at least four times a year. In these meetings, members review various economic indicators to assess the current and future state of the economy.
Providing Transparency and Accountability: After each meeting, the MPC's decisions and the rationale behind them are made public. The minutes of the meeting, which include each member's vote and their reasoning, are also published. This promotes transparency and holds the committee accountable for its actions.
Maintaining Price Stability: By controlling the repo rate and, consequently, the money supply, the MPC ensures that prices remain stable. This helps in protecting the purchasing power of the currency and maintaining the overall health of the economy.

Open Market Operations (OMOs)

OMOs are a key monetary policy tool used by the Reserve Bank of India (RBI) to manage the money supply in the economy. OMOs involve the buying and selling of government securities in the open market. This allows the RBI to either inject or absorb liquidity, thereby influencing interest rates and credit conditions. 📈

How Open Market Operations Work

The mechanism of OMOs is straightforward and depends on the RBI's objective:

To Inject Liquidity (Expansionary Policy): When the RBI wants to increase the money supply in the economy (e.g., to stimulate economic growth), it buys government securities from commercial banks and other financial institutions. By purchasing these securities, the RBI pays the banks, which in turn increases their cash reserves. With more money available, banks are encouraged to lend more at lower interest rates, boosting credit and investment in the economy.
To Absorb Liquidity (Contractionary Policy): When the RBI wants to decrease the money supply (e.g., to control inflation), it sells government securities to banks. Banks use their cash reserves to buy these securities, which effectively removes money from the banking system. With reduced reserves, banks have less money to lend, leading to higher interest rates and a reduction in credit. This helps to curb inflationary pressures.

Types of OMOs in India

The RBI conducts two main types of OMOs:

Outright Purchase/Sale: This is a permanent type of OMO. The RBI either buys or sells government securities with no intention of reversing the transaction. This is used for making long-term adjustments to the money supply in the economy.
Repurchase Agreements (Repos) and Reverse Repos: These are temporary OMOs. As part of its Liquidity Adjustment Facility (LAF), the RBI uses repos (lending to banks) and reverse repos (borrowing from banks) to manage short-term, day-to-day liquidity in the banking system.

The RBI's use of OMOs is a flexible and effective way to influence the economy without resorting to more drastic measures.

UNIT III: MONEY MARKET