The Great Indian Financial Market is colossal and serves as the backbone of the nation’s growth and development. While many are familiar with capital markets, which are one of its segments, there is another well-functioning arm of the financial market that operates in the background: the money market. Though not widely recognized by retail, it has a profound impact on market participants. For those unfamiliar, the money market is where short-term instruments, ranging from 1 day to 1 year, are traded. In this informative write-up, we will explore this concept in detail and understand its importance, helping you become a more informed investor.
Liquidity is the lifeblood of any business. Manufacturers, in particular, require a steady flow of funds to meet their expenditures. Almost all entities, whether banks, financial institutions, corporations, or even governments, face challenges with liquidity management at some point. The money market addresses this issue by bridging liquidity gaps. Participants engage in short-term borrowing and lending to meet their immediate cash flow needs. It’s often referred to as the short-term market (with maturities of one year or less) because it deals with the short-term capital requirements of businesses and firms. In addition to providing a platform for highly marketable securities, the money market also offers the government a way to finance deficits and implement monetary policy through open market operations. It is regulated by both the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI).
The Indian money market can be broadly divided into two categories: participants and instruments.
A. Participants
Participants in the Indian money market can be grouped into two sectors:
– Organized sector: This includes public and private sector banks, foreign banks, cooperative banks, financial institutions, insurance companies, mutual funds, primary dealers, Non-Banking Financial Companies (NBFCs), corporations, pension funds, payment banks, and small finance banks.
– Unorganized sector: This encompasses indigenous money lenders, nidhis, chit funds, and other informal financial entities.
B. Instruments
The instruments traded in the Indian money market can be further categorized into two segments:
– Borrowing and lending market
– Asset market
The borrowing and lending segment of the money market focuses on short-term financial transactions that ensure liquidity within the system. Key instruments in this segment include Call Money, Notice Money, Term Money, Repo, and TREPS. Each of these instruments serves a distinct purpose in ensuring the efficient movement of short-term funds between financial institutions.
i. Call Money Market
Call money is an overnight loan used by banks to manage their daily liquidity needs. The maturity period is typically one day. Banks that need immediate funds borrow from other banks with surplus cash, ensuring smooth liquidity in the system.
ii. Notice Money Market
An extension of call money, in the notice money market, loans are provided for periods ranging from 2 to 14 days. This type of short-term borrowing is usually done to address temporary cash flow mismatches without resorting to long-term financing.
iii. Term Money Market
Term money refers to loans with maturities exceeding 15 days but usually less than one year. Term money is generally used by banks and financial institutions to manage liquidity for slightly longer periods compared to call or notice money.
iv. Repo Market
Repurchase agreements, commonly known as repos, are short-term borrowing instruments used by banks and financial institutions to raise funds by selling government securities with an agreement to repurchase them at a specified future date. The interest on the borrowing is embedded in the repurchase price, making it an effective tool for liquidity management. The maturity period for repos can range from overnight to up to one year. In contrast, a reverse repo is the exact opposite transaction, where the central bank or a financial institution lends funds, using securities as collateral. Both repos and reverse repos are pivotal in maintaining liquidity in the banking system and are key instruments for the RBI to regulate the money supply and manage systemic liquidity. Repos help maintain liquidity, with typical transactions taking place in ₹1 crore increments.
v. Tri-party Repo
Tri-party Repo is a type of repurchase agreement where a third-party intermediary, known as the Tri-party Agent (TPA), facilitates the transaction between the borrower and lender. The TPA is responsible for crucial aspects of the transaction, including collateral selection, payment and settlement, and custody and management of the collateral throughout the repo period. This arrangement ensures better collateral management and reduces credit and settlement risks.
Financial institutions widely use tri-party repos to manage short-term liquidity needs. These agreements typically range from overnight to one year in duration. A key feature of the tri-party repo is its minimum lot size, which is set at ₹5 lakhs, with borrowing and lending conducted in multiples of this amount. By engaging a TPA, institutions can streamline the repo process, ensuring greater transparency, risk mitigation, and efficiency in collateral management.
vi. Corporate Bond Repo
In a corporate bond repo, a financial institution raises short-term funds by using corporate bonds as collateral. Unlike traditional repos, which typically involve government securities, this type of repo allows for greater flexibility and diversification of collateral. The minimum investment amount in this market typically starts at ₹1 crore, aligning with the larger scale of institutional transactions.
In recent developments, AMC Repo Clearing Limited has been introduced as a key player in enhancing the transparency and efficiency of corporate bond repo transactions. The establishment of this new clearing house facilitates smoother clearing and settlement in the repo market, thus promoting greater stability. AMC Repo Clearing will provide a central counterparty service, reducing settlement risk and ensuring more secure transactions. This development is expected to increase participation in the corporate bond repo market, benefiting both issuers and investors by enhancing liquidity and transparency.
vii. Money Market Funds
Money market funds (MMFs), particularly liquid funds, play an integral role for retail investors and corporations alike. These funds address short-term liquidity needs and provide easy entry and exit options for those with surplus funds. Money Market Funds are debt mutual fund schemes that invest in short-term, high-quality money market instruments, offering a low-risk, highly liquid option for investors, particularly for emergency savings. These funds provide flexibility for temporary parking of excess funds with easy withdrawal options, making them an efficient tool for managing cash flow. For corporations, MMFs also offer a secure solution for handling working capital needs without compromising liquidity.
NDS-CALL (Negotiated Dealing System-Call): An electronic platform for trading in call money, notice money, term money, NDS-CALL enables banks to trade more efficiently, with greater transparency and lower transaction costs.
CROMS (Clearcorp Repo Order Matching System): A platform designed to facilitate repo transactions primarily among institutional participants, such as banks, primary dealers, mutual funds, and insurance companies, offering a robust system that enables real-time matching of repo orders.
F-TRAC (Fixed Income Money Market and Derivatives Association – Trade Reporting and Confirmation System): F-TRAC is an electronic platform designed for reporting and monitoring trades across various money market instruments. It enhances transparency and ensures regulatory compliance by facilitating the reporting of repo transactions, particularly those using corporate bonds as collateral. This system helps streamline the reporting process, making it more efficient for market participants.
When it comes to the asset market, the instruments include Commercial Papers (CPs), Treasury Bills (T-bills), Cash Management Bills (CMBs), and Certificates of Deposit (CDs), all of which are covered in depth individually. You can explore these in the BondUNi section on IndiaBonds.
The RBI leverages the money market to implement its monetary policy by adjusting reserve ratios, conducting open market operations (OMO), and altering policy rates. It manages systemic liquidity by either injecting funds into the banking system or absorbing excess liquidity to maintain the desired interest rate structure. This ensures that sufficient liquidity is available, preventing banks from borrowing at excessively high rates and avoiding situations where banks face liquidity shortages or hold unnecessary excess liquidity. The RBI conducts daily liquidity adjustment facilities to execute its liquidity management strategy through the banking system.
Liquidity Management: Provides a platform for managing short-term liquidity needs efficiently.
Low Risk: Instruments are generally less risky due to their short-term nature.
Flexibility: Entities can quickly adjust their short-term positions based on cash flow needs.
Low Returns: Due to the short-term nature of the instruments, returns tend to be lower compared to long-term investments.
Limited Participation: High minimum investment requirements limit access for retail investors.
The money market is ideal for investors or entities seeking low-risk, short-term investment options with high liquidity. It is particularly suited for institutions needing to park excess funds temporarily, banks managing liquidity, and corporations handling working capital needs.
The Indian money market plays a crucial role in managing liquidity within the economy, supporting financial institutions, corporations, and the government in meeting their short-term funding needs. With the Reserve Bank of India’s active liquidity operations, including repo transactions and Standing Liquidity Facilities (SLF), the market ensures efficient flow of funds and helps maintain economic stability. Platforms like F-TRAC and CROMS further enhance transparency and compliance in trading, making the market more resilient. Understanding the dynamics of this market empowers investors and businesses to make informed decisions, fostering financial stability and growth.
A. The capital market deals with long-term securities with maturities exceeding one year, such as stocks and bonds, while the money market focuses on short-term instruments with maturities of one year or less.
A. The primary objectives of the money market are to provide liquidity to financial institutions, facilitate short-term borrowing and lending, and help the central bank implement monetary policy.
A. RBI regulates and oversees the money market, using it as a tool to manage liquidity in the financial system, adjust interest rates, and transmit its monetary policy effectively.
A. In the call money market, the call rate is the interest rate at which banks borrow and lend overnight to manage liquidity. MIBOR (Mumbai Interbank Offer Rate), on the other hand, is a broader benchmark rate used for various short-term instruments like repos and swaps. While both reflect short-term borrowing costs, the call rate is specific to the call money market, whereas MIBOR is used more widely across the money market.
A. Collateralized Borrowing and Lending Obligation (CBLO) is a secured money market instrument that allows participants to borrow and lend funds using government securities as collateral. It has been replaced by TREPS (Tri-party Repo) for smoother collateral management and transparency.
Disclaimer: Investments in debt securities/ municipal debt securities/ securitised debt instruments are subject to risks including delay and/ or default in payment. Read all the offer related documents carefully.
