money market2
TRANSCRIPT
-
7/28/2019 Money Market2
1/42
Financial System of any country consists of financial markets,financial intermediation and financial instruments or financial
products
Suppliers of funds
(Mainly households)
Flow of financial services
Incomes , and financial
claims
Seekers of funds
(Mainly business firms
and government)
Flow of funds (savings)
-
7/28/2019 Money Market2
2/42
Organized Indian FinancialSystem
Money MarketInstrument
Capital MarketInstrument
Forex
Market
Capital
Market
Money
Market
Credit
Market
Primary Market
FinancialInstruments FinancialMarkets
FinancialIntermediaries
Secondary Market
Regulators
-
7/28/2019 Money Market2
3/42
A market for short-term lending and borrowing.
Money market provides a platform for providers and user of
short term funds to fulfill their borrowing and investment
requirements at an efficient market clearing price.
It recognizes cost of holding excessive cash even for shortduration.
Money market instruments have the characteristics of
liquidity, minimum transaction cost and no loss in value
Money market performs the crucial role of providing anequilibrating mechanism to even out short-term liquidity and
in the process, facilitating the conduct of monetary policy.
-
7/28/2019 Money Market2
4/42
-
7/28/2019 Money Market2
5/42
It provides a stable source of fund to banks in addition to
deposits ,allowing alternative financing structure.
A liquid money market provides an effective source of long
term finance to borrower
A liquid and vibrant money market is necessary for thedevelopment of a capital market, foreign exchange market and
market in derivative instruments.
Helps in pricing different floating interest products.
-
7/28/2019 Money Market2
6/42
It was a highly regulated and segmented market.
Participants were very limited
Limited number of money market instrument
Interest are also not market determined
Lack of proper secondary market for the money market
instrument.
-
7/28/2019 Money Market2
7/42
The RBI has given the highest priority to the development of a
vibrant money market in India since it is the vital link in the
implementation of monetary policy to ensure a broad based
growth of the countries economy, and initiated following
reform:
Set up the Discount and Finance House of India Ltd in April
1988 as a money market institution to provide a secondary
market for money instruments and create liquidity in these
instrument. Completely withdrew interest rate ceiling for all operation in
call/notice money market and also rediscounting of
commercial bill in may 1989.
-
7/28/2019 Money Market2
8/42
In may 1990 ,allowed GIC,IDBI and NABARD to enter the call moneymarket as lenders.
Allowed certain non-banking institutions to lend in call money market
through DFHI in 1991
Issued Primary dealer (PD) license to DFHI and STCI(State Trading
Corporation of India) for orderly development of secondary market by
1996.
Clearing Corporation of India Limited(CCIL) was set up to institutionalize
the settlement mechanism in debt, forex and money market
A unique product CBLO(Collateralized Borrowing and Lending
Obligation)
-
7/28/2019 Money Market2
9/42
Treasury Bills
Certificate of deposit
Commercial paper
Call/notice Money Term money
Repo
CBLO
-
7/28/2019 Money Market2
10/42
T-bills are short-term instrument issued by RBI on behalf of the govt. totide over short-term liquidity shortfalls. This instrument is issued by the
govt. to raise shortterm funds to bridge seasonal or temporary gap
between its receipt(revenue & capital) and expenditure. T-bills are repaid
at par on maturity. The difference between the amount paid by the tenderer
at the time of purchases (which is less than the face value) and the amountreceived on maturity represent the interest amount on T-bills and is known
as the discount.
Feature of T-bills.
They are negotiable securities.
They are highly liquid as they are of shorter tenure and there is a
possibilities of inter-bank repos in them.
There is an absence of default risk.
-
7/28/2019 Money Market2
11/42
They have an assured yield ,low transaction cost and are eligible forinclusion in the securities for SLR purposes
They are not issued in scrip form. The purchases and sales are effected
through the subsidiary General Ledger (SGL) account
At present ,there are 91-day ,182-day and 364-day T-bills in vogue.
The 91-day T-bills are auctioned by RBI every Friday and 363- day T-
bill every alternate Wednesday i.e. the Wednesday preceding the
reporting Friday
T-bills are available for a minimum amount of Rs 25000 and in multiples
theirof.
-
7/28/2019 Money Market2
12/42
The sale of T-bill is conducted through an auction.
Type of auction
Multipleprice auction
Uniform price auctionBidding process:
Competitive bid
Participants: primary dealers, banks, corporate, mutual fund etc.
Non-competitive bid
Participants: state government provident fund, government provident fund,pension fund
-
7/28/2019 Money Market2
13/42
The call money market is a market for very short-term fundsrepayable on demand and with maturity period varying
between one day to a fortnight. When money is lent for a day
,it is known as call(overnight) money. Intervening holidays
and /or Sundays are excluded for this purpose. When money isis borrowed or lent for more than a day and up to 14 days, It is
known as notice money.
It is highly liquid market and extremely volatile .
No collateral security is required to cover these transaction.
-
7/28/2019 Money Market2
14/42
The call money market is pre-dominantly an inter-bank till1971 when UTI and LIC were allowed as to operate aslenders.
In the 1990s the participation was gradually widened toinclude DFHI,STCI,GIC,NABARD, IDBI, money marketmutual fund, corporate as lenders in this market.
In 1996-97,the RBI permitted Primary Dealer to participate inthis market as both lenders and borrowers. Those entities thatcould provide evidence of surplus fund were permitted to
route their lending through PD. The call money market is now a purely inter-bank money
market with effect from Aug 6,2005.
-
7/28/2019 Money Market2
15/42
The RBI intervenes in the call money indirectly in two ways-
By providing lines of finance/additional funding to the DFHI
and other call money dealers
By conducting repo auction
Additional funding is provided through REPO auctions which
increase liquidity in the market and bring down call money
rates.
RBIs reverse repo auction absorb excess liquidity in the
economy and push up the call rates.
-
7/28/2019 Money Market2
16/42
There is inverse relation between call rates and short-term money marketinstrument such as certificate of deposit and commercial paper.
When call rates peak to high level ,bank raise more funds through CD.
When call rates are lower ,many bank fund CP by borrowing from call
money and earn profits through arbitrage between money market segment.
A large issue of Govt.securities also affect call money rates. when banks
subscribe to large issue of G-sec, liquidity is sucked out from banking
system. This increases the demand for fund in call money market which
pushes up call money rates.
Increase in CRR also increases call money rates.
Call money market and foreign exchange market are related. When call
rates rise , bank borrow dollars from their overseas branches, swap them
for rupees and lend them in the call money market.
-
7/28/2019 Money Market2
17/42
At the same ,they buy dollars forward in anticipation of their repaymentliability. This pushes forward the premia on the rupee-dollar exchange rate.
It happens many a times that bank fund foreign currency positions by
withdrawing from the call money market, causing upsurge in call rate.
-
7/28/2019 Money Market2
18/42
Certificate of deposit( CD) are unsecured, negotiable, short-terminstrument issued by commercial banks and development financial
institutions.
CD are issued by banks during periods of tight liquidity ,at relatively high
interest rates.
They represent a high cost liability.
Bank resort to this source when the deposit growth is sluggish but credit
demand is high.
Minimum amount of CD should be Rs 1lakh i.e. the minimum deposit that
could be accepted from a single subscriber should not be less than Rs 1lakh
and in the multiple of Rs 1lakh thereafter.
-
7/28/2019 Money Market2
19/42
Eligibility: CD can b issued by bank, select financialinstitution.
Maturity: 7day to 1year.
Discount: CD can b issued by at a discount on face value. The
issuing bank is free to determine the discount /coupon rate. Transferability: It is freely transferable .
-
7/28/2019 Money Market2
20/42
Commercial paper is an unsecured short-term promissory note ,negotiableand transferable by endorsement and delivery with fixed maturity period.
It is generally issued at a discount by leading creditworthy and highly rated
corporate to meet their working capital requirements
A CP is usually privately placed ,either through merchant banker or
banks. A specified credit rating of P2 of CRISIL or its equivalent is to beobtained from credit rating agency.
CP is issued as an unsecured promissory note or in dematerialized form at a
discount .The discount rate is freely determined by market forces. The
paper is usually priced between the lending rate of scheduled commercial
bank and a representative money market rate.
Corporates are allowed to issue CPs up to 100% of their fund- based
working capital limits.
-
7/28/2019 Money Market2
21/42
Repo is useful money market instrument enabling the smooth adjustmentof short-term liquidity among varied market participant such as bank and
financial institutions.
Repo refers to a transaction in which a participant acquires immediate
funds by selling securities and simultaneously agrees to repurchase of the
same or similar securities after a specified time at a specified rate.It is also referred as ready forward transaction
REVERSE REPO is exactly the opposite of Repo- a party buy a security
from another party with a commitment to sell it back to latter at a specified
time and price.
In otherworld ,while for one party the transaction is repo , for another party
it is reverse repo.
-
7/28/2019 Money Market2
22/42
Collateralized Borrowing and Lending Obligation (CBLO)", a money marketinstrument as approved by RBI, is a product developed by CCIL for the benefit of
the entities who have either been phased out from inter bank call money market or
have been given restricted participation in terms of ceiling on call borrowing and
lending transactions and who do not have access to the call money market. CBLO
is a discounted instrument available in electronic book entry form for the maturity
period ranging from one day to ninety Days (can be made available up to one year
as per RBI guidelines). In order to enable the market participants to borrow and
lend funds, CCIL provides the Dealing System through:
- Indian Financial Network (INFINET), a closed user group to the Members of
the Negotiated Dealing System (NDS) who maintain Current account with RBI.
- Internet gateway for other entities who do not maintain Current account with
RBI.
-
7/28/2019 Money Market2
23/42
Membership to CBLO segment is extended to entities who are RBI- NDSmembers viz. Nationalized Banks, Private Banks, Foreign Banks, Co-
operative Banks, Financial Institutions, Insurance Companies, Mutual
Funds, Primary Dealers etc.
Associate Membership to CBLO segment is extended to entities who arenot members of RBI- NDS viz. Co-operative Banks, Mutual Funds,
Insurance companies, NBFC's, Corporate, Provident/ Pension Funds etc.
-
7/28/2019 Money Market2
24/42
-
7/28/2019 Money Market2
25/42
RBI and Monetary Policy in India
-
7/28/2019 Money Market2
26/42
The term monetary policy refers to actions taken by central banks to affect
monetary magnitudes or other financial conditions.
Monetary Policy operates on monetary magnitudes or variables such as
money supply, interest rates and availability of credit.
Monetary Policy ultimately operates through its influence on expenditure
flows in the economy.
In other words affects liquidity and by affecting liquidity, and thus credit, it
affects total demand in the economy.
-
7/28/2019 Money Market2
27/42
MP is a part of general economic policy of the govt.
Thus MP contributes to the achievement of the goals of economic policy.
Objective of MP may be:
Full employment
Stable exchange rate
Healthy BoP
Economic growth
Reasonable Price Stability
Greater equality in distribution of income & wealth
Financial stability
-
7/28/2019 Money Market2
28/42
There is convergence of views in developed and developingeconomies, that price stability is the dominant objective of
monetary policy.
Price stability does not mean complete year-to-year price
stability which is difficult to attain. Price stability refers to the long run average stability of prices.
Price stability involves avoidance of both inflationary anddeflationary pressures.
-
7/28/2019 Money Market2
29/42
Price Stability contributes improvements in the standard of living of
people.
It promotes saving in the economy while discouraging unproductive
investment.
Stable prices enable exports to compete in international markets and
contribute to the strengthening of BoP.
Price stability leads to interest rate stability, and exchange rate stability (via
export import stability).
It contributes to the overall financial stability of the economy.
-
7/28/2019 Money Market2
30/42
-
7/28/2019 Money Market2
31/42
InflationA sustained rise in the prices of commodities that leads to a fall inthe purchasing power of a nation is called inflation. Although
inflation is part of the normal economic phenomena of any country,
any increase in inflation above a predetermined level is a cause of
concern.
Types of inflation
Demand pull inflation
Supply shock inflation (cost push) Built in inflation
-
7/28/2019 Money Market2
32/42
Types of money in the Indian system
Reserve Money (M0): Currency in circulation + Bankers deposits with the RBI + Other
deposits with the RBI = Net RBI credit to the Government + RBI credit to the commercialsector + RBIs claims on banks + RBIs net foreign assets + Governments currency
liabilities to the publicRBIs net non-monetary liabilities.
M1: Currency with the public + Deposit money of the public (Demand deposits with the
banking system + Other deposits with the RBI).
M2: M1 + Savings deposits with Post office savings banks.
M3: M2+Time deposits with the banking system. = Net bank credit to the Government +
Bank credit to the commercial sector + Net foreign exchange assets of the banking sector
+ Governments currency liabilities to the public Net non-monetary liabilities of the
banking sector (Other than Time Deposits).
M4: M3 + All deposits with post office savings banks (excluding National Savings
Certificates).
As defined by the Reserve Bank of India (RBI.)
-
7/28/2019 Money Market2
33/42
-
7/28/2019 Money Market2
34/42
Instruments
1. Discount Rate
(Bank Rate)
2.Reserve Ratios
3. Open Market
Operations
OperatingTarget
Monetary Base
Bank Credit
Interest Rates
IntermediateTarget
Monetary
Aggregates(M3)
Long terminterest rates
Ultimate
Goals
Total Spending
Price Stability
Etc.
-
7/28/2019 Money Market2
35/42
Variations in Reserve Ratios
Discount Rate (Bank Rate)
(also called rediscount rate), Repo rate, reverse repo rate
Open Market Operations (OMOs)
Other Instruments
-
7/28/2019 Money Market2
36/42
Banks are required to maintain a certain percentage of their
deposits in the form of reserves or balances with the RBI
It is called Cash Reserve Ratio or CRR
Since reserves are high-powered money or base money, by
varying CRR, RBI can reduce or add to the banks required
reserves and thus affect banks ability to lend.
-
7/28/2019 Money Market2
37/42
Discount rate is the rate of interest charged by the central bank for
providing funds or loans to the banking system.
Funds are provided either through lending directly or rediscounting or
buying commercial bills and treasury bills.
Raising Bank Rate raises cost of borrowing by commercial banks, causing
reduction in credit volume to the banks, and decline in money supply.
Variation in Bank Rate has an effect on the domestic interest rate,
especially the short term rates.
Market regards the increase in Bank rate as the official signal for beginning
of a tight money situation.
-
7/28/2019 Money Market2
38/42
It is introduced through which RBI can add to liquidity in thebanking system. Through repo system RBI buys securities
from the bank and there by provide funds to them.
Repo refers to agreement for a transaction between RBI andbanks through which RBI supplies funds immediately against
government securities and simultaneously agree to repurchase
the same or similar securities after a specified time which maybe one day to 14 days.
-
7/28/2019 Money Market2
39/42
Repo Rate:Repo rate is the rate at which banks borrow funds from RBI to meet the
gap between the demand they are facing for money (loans) and how much
they have on hand to lend. It is a short-term measure.
Reverse repo rate:
Bank rate:
This is the rate at which RBI lends money to other banks. It is
uncollateralized lending.
-
7/28/2019 Money Market2
40/42
A tool used in monetary policy that allows banks to borrow money throughrepurchase agreements. This arrangement allows banks to respond to
liquidity pressures and is used by governments to assure basic stability in
the financial markets.
Liquidity adjustment facilities are used to aid banks in resolving any short-termcash shortages during periods of economic instability or from any other form
of stress caused by forces beyond their control. Various banks will use
eligible securities as collateral through a repo agreement and will use the funds to
alleviate their short-term requirements, thus remaining stable.
-
7/28/2019 Money Market2
41/42
OMOs involve buying (outright or temporary) and selling of govt securities
by the central bank, from or to the public and banks.
RBI when purchases securities, pays the amount of money by crediting the
reserve deposit account of the sellers bank, which in turn credits thesellers deposit account in that bank.
-
7/28/2019 Money Market2
42/42