Money Market Overview – Indian Financial System – Definitions of Different Financial Instruments

Money market is basically the market for short term debt instruments. Short term means those instruments which have maturity period of one year or less. It is a need based market which keeps a balance between demand and supply. It is the main point for RBI for influencing liquidity and interest rates. There are various financial instruments associated with money market. They are Treasury bill (T- bills), Commercial paper, Commercial bills and Certificates of deposit (CD).

Financial Instruments - Currency Symbols of Different Countries

Financial Instruments – Currency Symbols of Different Countries

Treasury Bills (T- Bills):

Let’s talk about treasury bills. These are the bills issued by the RBI at a discount and repaid at face value. These bills can be purchased by anyone including individuals and has almost zero default risk. The commercial banks buy these bills to maintain their SLR (Statuary Liquidity Ratio). SLR is the ratio of the amount deposited in the bank which the bank has to keep as cash on hand. Currently SLR is 24%. T-bills are highly liquid and negotiable instruments. T-bills are of four types on basis of maturity period- 15 days, 30 days, 60 days and 1 year.

Commercial paper:

These are unsecured short term instrument issued at a discount. ‘Unsecured’ basically means debt which is not mortgaged. That’s why only high credit worthy companies can issue commercial papers. There are some credit rating companies which give them credit like CRISIL, ICRA. These papers have maturity period of 6 months or less and repaid at par on maturity. These papers can be issued to companies, individuals or banks.

Commercial bills:-

These are short term bills and are self liquidating. Trade bills are generally drawn in business by the seller on the buyer that certain goods have been delivered to him and will be paid later. They are also known as Bills of Exchange. When such trade bills are accepted by the banks they become commercial bills and bank can give money to the seller by keeping some margin. The interest of such debt is given by the seller. The maturity period is 30days, 60 days or 90 days.

Certificates of deposit (CDs):-

These short term instruments are issued in demat form (electronic form) i.e. there is no physical location of them and are kept like shares, mutual funds etc. They are unsecured, negotiable and are issued by commercial banks and development financial institutions. The difference between FD’s and CD’s is that CD’s are transferrable by endorsement but FD’s are not. The maturity period is 7days- 1year for banks and 1-3 year for financial institutions.

Certificate of Deposit - Bank of India - Samples

Certificate of Deposit – Bank of India – Samples

Call/Notice Money market:-

Banks lend money for a period between 1-14 days. Banks borrow to adhere to CRR (Cash Reserve Ratio) requirements. CRR is the ratio of the amount deposited in the bank which the bank has to keep to RBI. Currently CRR is 6%. CRR has to be maintained for 1-15 days so bank borrows money from market for 15 days. This is risky as no collateral security is required.

 These are various instruments of the money market i.e. short term market. There is a link between Monetary policy and money market as objectives of monetary policy is to keep price stability and growth of the country and money market helps in doing so by  some direct and indirect instruments like CRR, SLR, repo and reverse repo.

Leave a Reply

Your email address will not be published. Required fields are marked *