Understanding the Money Market

The Reserve Bank of India defines the money market as the center for dealing mainly in short-term monetary assets. It fulfills the short-term requirements of borrowers and provides liquidity or cash to the lenders.

It is a place where short-term surplus investible funds at the disposal of financial and other institutions and individuals are bid by borrowers. These borrowers include institutions, individuals, and the government.

Functions of the Money Market

• Maintaining the balance between the demand and supply for money in short-term monetary transactions (monetary equilibrium).
• Promoting economic growth by making funds available to various units in the economy such as agriculture, small scale industries, etc.
• Assisting Trade and Industry by providing adequate finance. It also provides the facility of discounting bills of exchange for trade and industry.
• Helping in the implementation of Monetary Policy by providing a mechanism for its effective execution.
• Assisting in Capital Formation by making investment avenues available for the short-term period. It aids in generating savings and investments in the economy.

Features of the Money Market

The money market provides non-inflationary sources of finance to the government by issuing treasury bills to raise short loans. However, this does not lead to increases in prices.

The Money Market comprises all organizations and institutions that deal or facilitate dealings in short-term debt instruments. These institutions include RBI, commercial banks, cooperative banks, non-banking financial companies like LIC, GIG, UTI, and special institutions like Discount and Finance House of India (DFHI). The significant money market instruments or securities (financial assets) include the following.

Delving into the Capital Market

The capital market is the market for medium and long-term funds. It encompasses all the financial institutions, organizations, and instruments which deal with lending and borrowing transactions of over one-year maturity.

Varieties of Capital Market

Comparing the Money Market and the Capital Market

Key Terms in the Financial Market

Treasury Bills : Treasury bills are promissory notes issued by the RBI on behalf of the government as a short-term liability. They are sold to banks and the public. The maturity period of these bills ranges from 14 to 364 days. They are negotiable instruments, meaning they are freely transferable. No interest is paid on such bills, but they are issued at a discount on their face value. You can read more about Treasury Bill – Definition, Types & Its Use on the provided page link.

Commercial Bills : Also known as Trade Bills or Bills of Exchange, commercial bills are drawn by one business firm to another in lieu of credit transactions. It is a written acknowledgment of the debt by the maker directing to pay a specified sum of money to a particular person. They are short-term instruments generally issued for 90 days. These are freely marketable. Banks provide working capital finance to firms by purchasing the commercial bills at a discount; this is called ‘discounting of bills’.

Commercial Paper (CP) : Introduced in 1990 on the recommendation of the Vaghul Committee, a commercial paper is an unsecured promissory note issued by a corporate with a net worth of at least Rs 5 crore to the banks for short-term loans. These are issued at a discount on face value for a period of 14 days to 12 months. These are issued in multiples of Rs 1 lakh subject to a minimum of Rs 25 lakh. For more information on Commercial Paper (CP) , check the linked page.

Certificate of Deposit (CD) : Introduced in 1989 on the recommendation of the Vaghul Committee, these are issued by banks against deposits kept by individuals and institutions for a period of 15 days to 3 years. These are similar to Fixed Deposits but are negotiable and tradable. These are issued in multiples of Rs. 1 lakh subject to a minimum of Rs 25 lakh.

Discount and Finance House of India Ltd. : DFHI was set up as a subsidiary of RBI in 1988 on the recommendation of the Vaghul Committee. Its objective is to stimulate activity in the money market by providing liquidity to the money market instrument. It buys bills and short-term securities from banks and financial institutions thereby developing a secondary market in them.

Know more about the Difference between Primary market and Secondary Market on the linked page.

Exploring the Gilt-Edged Market

The Gilt-edged market refers to the market for government and semi-government securities, backed by the RBI. The term 'gilt-edged' implies 'of the best quality'. It is known so because the government securities do not suffer from the risk of default and are highly liquid. The RBI is the sole supplier of such securities. These are demanded by commercial banks, insurance companies, provident funds, and mutual funds.

The gilt-edged market can be divided into two parts- the Treasury bill market and the government bond market. Treasury bills are issued to meet short-term needs for funds of the government, while government bonds are issued to finance long-term developmental expenditure.

It is essential for UPSC aspirants to understand the types of markets while preparing for GS-III of the UPSC Exam.