Characteristics of the money market

by Sree Rama Rao on November 9, 2008

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

The characteristics of the money market are:

1. It is not a single market but a collection of markets for several instruments
2. It is wholesale market of short term debt instruments
3. Its principal feature is honor where the creditworthiness of the participants is important.
4. The main players are: Reserve bank of India (RBI), Discount and Finance House of India (DFHI), mutual funds, banks, corporate investor, non-banking finance companies (NBFCs), state governments, provident funds, Primary dealers. Securities Trading Corporation of India (STCI), public sector undertaking (PSUs), non-resident Indians and overseas corporate bodies.
5. 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:

1. Provide a balancing mechanism to even out the demand for and supply of short term funds
2. Provide a focal point for central bank intervention for influencing liquidity and general level of interest rates in the economy.
3. 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 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.

Monetary control through indirect methods (repos and open market operations) is more effective if the money market is liquid. In such a 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 40,000 crore daily. This is more than 3 per cent of the total money supply in the Indian economy and 6 percent of the total funds that commercial banks have 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.





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