Topic 2 Money Markets

8/7/2019 Topic 2 Money Markets

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Money Markets


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Overview of Financial Markets


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Need for short term funds by Banks.

Outlet for deploying funds on short term basis

Need to keep the SLR as prescribed Need to keep the CRR as prescribed

Optimize the yield on temporary surplus funds

Regulate the liquidity and interest rates in the conductof monetary policy to achieve the broad objective ofprice stability, efficient allocation of credit and a stableforeign exchange market

The Need for Money Markets


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The Definition

Money Market is "the centre for dealings, mainly short-term character, in money assets.

It meets the short-term requirements of borrower and

provides liquidity or cash to the lenders. It is the place where short-term surplus investible funds

at the disposal of financial and other institutions andindividuals are bid by borrowers, again comprising

Institutions, individuals and also the Government itself"


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The Definition (Contd)

Money market refers to the market for short term assetsthat are close substitutes of money, usually withmaturities of less than a year.

A well functioning money market provides a relativelysafe and steady income-yielding avenue.

Allows the investor institutions to optimize the yield ontemporary surplus funds.

Instrument of Liquidity adjustment by Central Bank.


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Reserve Bank of India

SBI DFHI Ltd (Amalgamation of Discount & FinanceHouse in India and SBI Gilts in 2004)

Commercial Banks, Co-operative Banks and PrimaryDealers are allowed to borrow and lend.

Specified All-India Financial Institutions, Mutual Funds,and certain specified entities are allowed to access to

Call/Notice money market only as lenders Individuals, firms, companies, corporate bodies, trusts

and institutions can purchase the treasury bills, CPs andCDs.

The Players


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The Products & Process

Certificate of Deposit (CD)

Commercial Paper (C.P)

Inter Bank Participation Certificates

Inter Bank term Money

Treasury Bills

Call Money


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CERTIFICATE OF DEPOSIT(CD)


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CDs are short-term borrowings in the form ofPromissory Notes having a maturity of not less than 15days up to a maximum of one year.

CD is subject to payment of Stamp Duty under IndianStamp Act, 1899 (Central Act)

They are like bank term deposits accounts. Unliketraditional time deposits these are freely negotiable

instruments and are often referred to as NegotiableCertificate of Deposits

Certificate of Deposit


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Features of CD

CDs can be issued by all scheduled commercial banksexcept RRBs

Minimum period 15 days

Maximum period 1 year Minimum Amount Rs 1 lac and in multiples of Rs. 1 lac

CDs are transferable by endorsement

Liquidity and marketability as its hallmark CDs are issued by banks for attracting large corporatedeposits rather mobilising individual savings

The introduction of CDs in an economy has usually

preceded the introduction of CPs


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In initial years (1980-1987) feasibility of CDs in India issubject to various constraints like lack of secondarymoney market, administered interest rates, lack of proper

regulatory system

Introduction of CDs in 1989 : recommendation of RBIworking group on money market (Vaghul working group,

1987)

Broad objective is to further widen the range of moneymarket instruments and to give investors greater

flexibility in the deployment of short term surplus funds 1

CDs in India


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Banks / FIs cannot grant loans against CDs and cannotbuy-back their own CDs before maturity.

CDs are freely transferable by endorsement and delivery

RBI Guidelines for Issue of CDs with respect to Thematurity period, Minimum Size of Issue and Denominationsmodified from time-to-time

Mutual funds are allowed to invest in CDs with cretin limitstipulated by Securities Exchange Board of India (SEBI)

Existence of favorable supply and demand factors forgrowth of CDs market

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contd.

CDs in India


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The maximum interest rates on CDs have been mostlyhigher than the maximum interest rates on CPs

There is an inverse relationship between liquidity in theeconomy and the amount of CDs issued.

Interest rates on CDs and CPs increased between 1993-94

to 1995-96 and declined thereafter till 2006-07

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contd.

CDs in India


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Commercial Paper

Commercial Paper (CP) is an unsecured money marketinstrument issued in the form of a promissory note.

Introduced in India in 1990

Enabling highly rated corporate borrowers/ to diversify theirsources of short-term borrowings and to provide an additionalinstrument to investors.

Primary dealers and satellite dealers were also permitted to issueCP to enable them to meet their short-term funding

requirements for their operations.


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Primary Dealers

The system of Primary Dealers (PDs) in the GovernmentSecurities Market was introduced by Reserve Bank of India in1995 to strengthen the market infrastructure of GovernmentSecurities

Primary Dealers can also be referred to as Merchant Bankers toGovernment of India as only they are allowed to underwriteprimary issues of government securities other than RBI


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Activities of Primary Dealers

1. Dealing and underwriting in Government securities.

2. Dealing in Interest Rate Derivatives.

3. Providing broking services in Government securities.

4. Dealing and underwriting in Corporate / PSU / FI bonds/debentures.

5. Lending in Call/ Notice/ Term/ Repo/ CBLO market.

6. Investment in Commercial Papers.

7. Investment in Certificates of Deposit.

8. Investment in debt mutual funds where entire corpus is investedin debt securities.


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Who can Issue CPs?

Corporates, primary dealers (PDs) and the All-India Financial

Institutions (FIs)

Conditions:

a. the tangible net worth of the company, as per the latest auditedbalance sheet, is not less than Rs. 4 crore

b. company has been sanctioned working capital limit by bank/s or

all-India financial institution/s; and

c. the borrowal account of the company is classified as a StandardAsset by the financing bank/s/ institution/s.


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CP as on Jan 15 2011

Parameter Values

Total Amount Outstanding(Rs. Crores) 98913

Fresh Issue In Fortnight(Rs. Crores) 22908

Lowest Interest Rate Band(%) 6.60

High Interest Rate Band(%) 11.95

Mean Rate(%) 9.275

Spread(bps) 535


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All eligible participants should obtain the credit rating forissuance of Commercial Paper

Credit Rating Information Services of India Ltd. (CRISIL)

Investment Information and Credit Rating Agency of India Ltd.(ICRA)

Credit Analysis and Research Ltd. (CARE)

Duff & Phelps Credit Rating India Pvt. Ltd. (DCR India)

The minimum credit rating shall be P-2 of CRISIL or such

equivalent rating by other agencies

Rating Requirement


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To whom issued

CP is issued to and held by individuals,banking companies, other corporate

bodies registered or incorporated inIndia and unincorporated bodies, Non-Resident Indians (NRIs) and ForeignInstitutional Investors (FIIs).


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a) The tangible net worth of the company, as per the latestaudited balance sheet, is not less than Rs.4 crore

b) CP can be issued in denominations of Rs.5 lakh or multiples

thereof.c) The fund based working capital of the company should not be

less than 4 crore

d) Every issue of CP, including renewal, should be treated as afresh issue.

e) CP can be issued as a "stand alone" product (since October 2000).

f) There is no lock in period for CPs

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RBI Guidelines for Issue of CPs


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g) CP can be issued f or maturities between a minimum of 7

days and a maximum up to one year from the date of issue( since October 2004).

h) CP may be issued to and held by individuals, banking

companies,NRIs, other cor porate bodies registered or

incorporated in India and unincorporated bodies,

i) Mandatory credit rating for issuance of Commercial Paper.

The minimum credit rating shall be P-2 of CRISIL and A2

for ICRA.

` The company shall not required to get the issue underwritten

or co-accepted 2

contd.

RBI Guidelines for Issue of CPs


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CALL MONEY MARKET


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Call Money Market

The call money market is an integral part ofthe Indian Money Market, where the day-to-day surplus funds (mostly of banks) are

traded. The loans are of short-term durationvarying from 1 to 14 days.

The money that is lent for one day in this

market is known as "Call Money

", and if itexceeds one day (but less than 15 days) it isreferred to as "Notice Money".


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Banks borrow in this market for thefollowing purpose

To fill the gaps or temporarymismatches in funds

To meet the CRR & SLR mandatoryrequirements as stipulated by the

Central bank To meet sudden demand for funds

arising out of large outflows.

Call Money Market


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Significant Relation for better integration in the

money market

Call money rates remained stable during the period

2003-04 to first halfof the 2004-05 reflecting thesubstantial overhangof liquidity in the system

Call money volatility was higherduring 2003-04 to

2006-07

Reduction of Volatility followed by introduction of

policy measure such as market Repo and CBLO

( Collateralized borrowing and lendingobligations)

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Call Rate Vs. BankRate


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Requirement for CRRneeds create excess demand for

liquidity in call money market

Overextended credit position ofBanks

Occasional market disruptions

Heavy withdrawal by Institutional investors

Liquidity crisis in money market

Sluggish demand in bank deposit with heavy pressurefor non-food credit in the banking sector crating asset

liability mismatch

Causality in foreign exchange market and call money

market3

Reasons for Call Rate Volatility


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The term government securities encompassall Bonds & T-bills issued by the CentralGovernment, and state governments. Thesesecurities are normally referred to, as "gilt-edged" as repayments of principal as well asinterest are totally secured by sovereign

guarantee.

Gilt edged securities


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` A Particular type of Finance Bill or Promissory note putout by the Govt. of the country to meet the needs ofsupplementary short-term Finance

`Characteristics:

High Liquidity Money Market Instrument

Absence ofRiskof Default

Ready availability on Tap Assured Yield

Low transaction Cost

Eligibility for Inclusion in SLR

Negligible Capital Depre

ciati

on 3

T-Bills


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` Issued by RBI on behalf of the Govt. and is thepredominant buyer/holder of TBs (77-97%)

`Major market players: RBI, Commercial Banks, StateGovts. Foreign Central Banks, NBFCs, State PensionFunds and Eligible Provident Funds

` Treasury Bill rate is the rate of interest at which treasurybills are sold by RBI

(Effective Return= Sales Price Redemption Value)

`Volume of Treasury Bills Variation can undermineMonetary Policy depending on the extent ofImportance a s a P art of Liquidity Ratio

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contd.


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`Minimum amount f orbidding is Rs.25000 or in multipleof that

`Major Policy Reform in TBs Market: Chakravarty &Vaghul Committee Report

`Types of Treasury Bills:

Ordinary

Ad-hoc (Discontinued since 1994 with WMA system)

91-days (Money Market Reference Rate with auction system)

182-days (Ceased to be issued since 1992)

364-days (Introduced Since 1992)

14-day (Introduced Since 1997 with high frequency ofauctions)

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contd.


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` Sterilization purposes: Market Stabilization Scheme(MSS)

`Th

rough

out the pe

riod the yield

on 364-day T

Bs hasbeen higher than the yield on 91-day TBs.

` The 364-day TBs market has been more volatile than

91-day TBs market during the liberalization period1993-94 to 2006-07

` The relative share of 364- day TBs are higher than

91-day and 182- day TBs

Recent development in TBs market

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Topic 2 Money Markets