Money Market : Full Explained

The money market is a market for financial assets that are close substitutes for money. It is a market for overnight to short-term funds and instruments having a maturity period of one or less than one year. It is not a physical location (like the stock market), but an activity that is conducted over the telephone. The money market constitutes a very important segment of
the Indian financial system.

The characteristics of the money market are as follows.

• It is not a single market but a collection of markets for several instruments.
• It is a wholesale market of short-term debt instruments.
• Its principal feature is honour where the creditworthiness of the participants is important.
• The main players are: the Reserve Bank of India (RBI), the Discount and Finance House of India (DFHI), mutual funds, insurance companies banks, corporate investors, non-banking finance companies (NBFCs), state governments, provident funds, primary dealers, the Securities Trading Corporation of India (STCI), public sector undertakings (PSUs), and non-resident Indians.
• It is a need-based market wherein the demand and supply of money shape the market.

Functions of the Money Market

A money market is generally expected to perform three broad functions.
• Provide a balancing mechanism to even out the demand for and supply of short-term funds.
• Provide a focal point for central bank intervention for influencing liquidity and general level of interest rates in the economy.
• Provide reasonable access to suppliers and users of short-term funds to fulfill their borrowings and investment requirements at an efficient market clearing price.
Besides the above functions, a well-functioning money market facilitates the development of a market for longer-term securities. The interest rates for extremely short-term use of money serve as a benchmark for longer-term financial instruments.

Benefits of an Efficient Money Market

An efficient money market benefits a number of players. It provides a stable source of funds to banks in addition to deposits, allowing alternative financing structures and competition. It allows banks to manage risks arising from interest rate fluctuations and to manage the maturity structure of their assets and liabilities.

A developed inter-bank market provides the basis for growth and liquidity in the money market including the secondary market for commercial paper and treasury bills.

An efficient money market encourages the development of non-bank intermediaries thus increasing the competition for funds. Savers get a wide array of savings instruments to choose from and invest their savings.

A liquid money market provides an effective source of long-term finance to borrowers. Large borrowers can lower the cost of raising funds and manage short-term funding or surplus efficiently.
A liquid and vibrant money market is necessary for the development of a capital market, foreign exchange market, and market in derivative instruments. The money market supports the long-term debt market by increasing the liquidity of securities. The existence of an efficient money market is a precondition for the development of a government securities market and a forward foreign exchange market.
Trading in forwards, swaps, and futures is also supported by a liquid money market as the certainty of prompt cash settlement is essential for such transactions. The government can achieve better pricing on its debt as it provides access to a wide range of buyers. It facilitates the government market borrowing programme.
Monetary control through indirect methods (repos and open market operations) is more effective if the money market is liquid. In such a market, the market response to the central bank’s policy actions are
both faster and less subject to distortion.

The Indian Money Market

The average turnover of the money market in India is over Rs. 1,00,000 crore daily. This is more than 3 percent let out to the system. This implies that 2 per cent of the annual GDP of India gets traded in the money market in just one day. Even though the money market is many times larger than the capital market, it is not even a fraction of the daily trading in developed markets.

Role of the Reserve Bank of India in the Money Market

The Reserve Bank of India is the most important constituent of the money market. The market comes within the direct purview of the Reserve Bank regulations.
The aims of the Reserve Bank’s operations in the money market are
• to ensure that liquidity and short-term interest rates are maintained at levels consistent with the monetary policy objectives of maintaining price stability;
• to ensure an adequate flow of credit to the productive sectors of the economy; and
• to bring about order in the foreign exchange market.

The Reserve Bank influences liquidity and interest rates through a number of operating instruments—
cash reserve requirement (CRR) of banks, conduct of open market operations (OMOs), repos, change in bank rates, and, at times, foreign exchange swap operations.

Money Market Centres

There are money market centres in India at Mumbai, Delhi, and Kolkata. Mumbai is the only active money market centre in India with money flowing in from all parts of the country getting transacted there.


The instruments traded in the Indian money market are

  1. Treasury bills (T-bills);
  1. Call/notice money market—Call (overnight) and short notice (up to 14 days);
  1. Commercial Papers (CPs)
  1. Certificates of Deposits (CDs)
  1. Commercial Bills (CBs)
  1. Collateralised Borrowing and Lending Obligation (CBLO)

Call/notice money market and treasury bills form the most important segments of the Indian money market. Treasury bills, call money market, and certifi cates of deposit provide liquidity for government and banks while commercial paper and commercial bills provide liquidity for the commercial sector and intermediaries.