Organization of Money Market, Defects, Dealers

26th January 2021 0 By indiafreenotes

The money market is an organized exchange market where participants can lend and borrow short-term, high-quality debt securities with average maturities of one year or less. It enables governments, banks, and other large institutions to sell short-term securities to fund their short-term cash flow needs. Money markets also allow individual investors to invest small amounts of money in a low-risk setting.

Structure of Indian Money Markets

  • Organized Sector: This sector comprises of the governments, the RBI, the other commercial banks, rural banks, and even foreign banks. The RBI organizes and controls this sector. Other corporations like the LIC, UTI, etc also participate in this sector but not directly. Other large companies and corporates also participate in this sector through banks.
  • Unorganized Sector: These are the indigenous banks and the local money lenders and hundis etc. Their activities are not controlled by the RBI or any other body, so they are the unorganized sector.

Structure of Indian Money Market:

(i) Broadly speaking, the money market in India comprises two sectors: (a) Organised sector, and (b) Unorganised sector.

(ii) The organised sector consists of the Reserve Bank of India, the State Bank of India with its seven associates, twenty nationalised commercial banks, other scheduled and non-scheduled commercial banks, foreign banks, and Regional Rural Banks. It is called organised because its part is systematically coordinated by the RBI.

(iii) Non-bank financial institutions such as the LIC, the GIC and subsidiaries, the UTI also operate in this market, but only indirectly through banks, and not directly.

(iv) Quasi-government bodies and large companies also make their short-term surplus funds available to the organised market through banks.

(v) Cooperative credit institutions occupy the intermediary position between organised and unorganised parts of the Indian money market. These institutions have a three-tier structure. At the top, there are state cooperative banks. At the local level, there are primary credit societies and urban cooperative banks. Considering the size, methods of operations, and dealings with the RBI and commercial banks, only state and central, cooperative banks should be included in the organised sector. The cooperative societies at the local level are loosely linked with it.

(vi) The unorganised sector consists of indigenous banks and money lenders. It is unorganised because activities of its parts are not systematically coordinated by the RBI.

(vii) The money lenders operate throughout the country, but without any link among themselves.

(viii) Indigenous banks are somewhat better organised because they enjoy rediscount facilities from the commercial banks which, in turn, have link with the RBI. But this type of organisation represents only a loose link with the RBI.

Money market instruments traded in the money market are:

Certificate of Deposit

Lending substantial financial resources to an organization can be done against a certificate of deposit. The operating procedure is similar to that of a fixed deposit, except the higher negotiating capacity, as well as lower liquidity of the former.

Commercial Paper

This type of money market instrument serves as a promissory note generated by a company to raise short term funds. It is unsecured, and thereby can only be used by large-cap companies with renowned market reputation.

The maturity period of these debt instruments lies anywhere between 7 days to one year, and thus, attracts a lower interest rate than equivalent securities sold in the capital market.

Only institutions with a high credit rating can issue commercial paper, and it is therefore considered a safe investment. Individual investors can invest in the commercial paper market indirectly through money market funds. Commercial paper comes with a maturity date between one month and nine months.

Treasury Bills

These are only issued by the central government of a country when it requires funds to meet its short-term obligations.

These securities do not generate interest but allow an investor to make capital gains as it is sold at a discounted rate while the entire face value is paid at the time of maturity.

Treasury bills are an optimal investment tool for novice investors looking for options having minimal risk associated with it. Since treasury bills are backed by the government, the default risk is negligible, thus serving as an optimal investment tool for risk-averse investors.

Repurchase Agreements

Commonly known as Repo, is a short-term borrowing tool where the issuer availing the funds guarantees to repay (repurchase) it in the future.

A repurchase agreement (repo) is a short-term form of borrowing that involves selling a security with an agreement to repurchase it at a higher price at a later date. It commonly used by dealers in government securities who sell Treasury bills to a lender and agree to repurchase them at an agreed price at a later date.

Repurchase agreements generally involve the trading of government securities. They are subject to market interest rates and are backed by the government.

Banker’s Acceptance

One of the most common money market instruments traded in the financial sector, a banker’s acceptance signifies a loan extended to the stipulated bank, with a signed guarantee of repayment in the future.

The holder of the acceptance may decide to sell it on a secondary market, and investors can profit from the short-term investment. The maturity date usually lies between one month and six months from the issuing date.

Since money market instruments are traded wholesale over the counter, it cannot be purchased in standard units by an individual investor.

Supply of Funds:

There are two main sources of supply of short-term funds in the Indian money market:

(a) Unorganised indigenous sector

(b) Organised modern sector

(i) Unorganized Sector:

The unorganised sector comprises numerous indigenous bankers and village money lenders. It is unorganized because its activities are not controlled and coordinated by the Reserve Bank of India.

(ii) Organized Sector:

The organized modern sector of Indian money market comprises:

(a) The Reserve Bank of India;

(b) The State Bank of India and its associate banks;

(c) The Indian joint stock commercial banks (scheduled and non-scheduled) of which 20 scheduled banks have been nationalised;

(d) The exchange banks which mainly finance Indian foreign trade;

(e) Cooperative banks

(f) Other special institutions, such as, Industrial Development Bank of India, State Finance Corporations, National Bank for Agriculture and Rural Development, Export-Import Bank, etc., which operate in the money market indirectly through banks.

(g) Quasi-government bodies and large companies also make their funds available to the money market through banks.

Money Market Defects

Lack of a well Organised Banking System:

Till 1969, the branch expansion was very slow. There was tremendous effort in this direction after nationalisation. A well-developed banking system is essential for money market. Even, at present the lack of branches in rural areas hinders the movement of funds. With emphasis on profitability, there may be some problems on this account.

In totality it can be said that Indian Money Market is relatively under developed. In no case it can be compared with London Money Market or New York Money Market. There are number of factors responsible for it in addition to the above discussed characteristics.

For example, lack of continuous supply of bills, a developed acceptance market, commercial bills market, dealers in short term assets and co-ordination between different sections of the money market.

Lack of Proper Bill Market:

Indian Bill market is an underdeveloped one. A well orgnaised bill market or a discount market for short term bills is essential for establishing an effective link between credit agencies and Reserve Bank of India. The reasons for this situation are historical, like preference for cash to bills etc.

Reserve Bank of India started making efforts in this direction in 1952. However, a new and proper bill market was introduced in 1970. There has been substantial improvement since then.

Seasonal Diversity of Money Market:

A notable characteristic is the seasonal diversity. There are very wide fluctuations in the rates of interest in the money market from one period to another in the year. November to June is the busy period. During this period crops from rural areas are moved to cities and parts. The wide fluctuations create problems in the money market. The Reserve Bank of India attempts to lessen the seasonal fluctuations in money market.

Disparity in Interest Rates:

There have been too many interest rates prevailing in the market at the same time like borrowings rates of government, the lending rates of commercial banks, the rates of co-operative banks and rates of financial institutions.

This was basically due to lack of mobility of funds from one sub- segment to another. However, with changes in financial sector the different rates of interest have been quickly adjusting to changes in the bank rate.

Lack of Integration:

Another important deficiency is the lack of integration of different segments or functionaries. However, with the enactment of the Banking Companies Regulation Act 1949, the position has changed considerably. The RBI is now almost fully effective in this area under various provisions of the RBI Act and the Banking Companies Regulation Act.

Existence of Un-organised Money Market:

The most important defect of the Indian money market is the existence of unorganised segment. In this segment of the market the purpose as well period are not clearly demarcated. In fact, this segment thrives on this characteristic.

This segment undermines the role of the RBI in the money market. Efforts of RBI to bring indigenous bankers within statutory frame work have not yielded much result.