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:
1. to ensure that liquidity and short term interest rates maintained at levels consistent with the monetary policy objectives of maintaining price stability;
2. to ensure an adequate flow of credit to the productive sectors of the economy; and
3. 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 requirements (CRR) of banks, conduct of open market operations (OMOs), repos, change in Bank rates and at times, foreign exchange swap operations.
The money market in India is divided into the formal (organized) and informal (unorganized) segments. One of the greatest achievements of the Indian financial system over the last fifty years has been the decline in the relative importance of the informal segment and increasing presence and influence of the formal segment.
Several steps were taken in the 1980s and 1990s to reform and develop the money market. The reforms in the money market were initiated in the latter half of the 1980s.
In the 1980s: A committee it review the working of the monetary system under the chairmanship of Sukhamoy Chakravorty was set up in 1985. It underlined the need to develop money market instruments. As a follow up, he Reserve Bank set up a working group on the money market under the chairmanship of N Vagul which submitted its report in 1987. This committee laid the blueprint for the institution of a money market. Based on its recommendation the Reserve Bank initiated a number of measures:
The Discount and Finance House of India (DFHI) was set up as a money market institution jointly by the Reserve Bank, public sector banks, and financial institutions in 1988 to impart liquidity to money market instruments and help the development of a secondary market in such instruments.
Money market instruments such as the 182-day treasury bill, certificate of deposit, and inter-bank participation certificate were introduced in 1988-89. Commercial paper was introduced in January 1990.
To enable price discovery, the interest rate ceiling on call money was freed in stages from October 1988. As a first step, operations of the DFHI in the call/notice money market were freed from the interest rate ceiling in 1988. Interest rate ceilings on inert-bank term money (10.5 – 11.5 per cent), rediscounting of commercial bills (12.5 per cent), and inter-bank participation without risk (12.5 per cent) were withdrawn effective May 1989. All the money market interest rates are, by and large, determined by market forces. There has been a gradual shift from a regime of administered interest rates to market-based interest rates.
In the 1990s: The government set up a high-level committee in August 1991 under the chairmanship of M Narasimham (Narasimham Committee) to examine all aspects relating to structure , organization, functions, and procedures of the financial system. The committee made several recommendations for the development of the money market. The Reserve Bank accepted many of its recommendations.
The securities Trading Corporation of India was step up in June 1994 to provide an active secondary market on government dated securities and public sectors bonds.
Barriers to entry were gradually eased by selling up the primary dealer system in 1995 a satellite dealer system in 1999 to inject liquidity in the market.
Several financial innovations in instruments and methods were introduced.
Ad hoc and on-tap 91-day treasury bills were discontinued. They were replaced by Ways and Means Advances (WMA) linked to the Bank rate. The introduction of WMA led to the limiting of the almost automatic funding of the government.