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What is Money Market? – Money Market Definition, Types & Instruments

Author Deepika Khude | Posted November 11, 2021

Money market is a place where financial institutions like banks, private and public sector companies etc. come to raise short-term capital. This involves buying and selling short-term instruments having a maturity period ranging from one day to one year. Some of the most popular money market instruments are: 

  • Treasury Bills 
  • Certificates of Deposits 
  • Commercial Papers 
  • Money Market Mutual Funds
  • Interbank Loans etc.  

The key participants of money markets include – 

  • The Lenders 
  • The Borrowers 

Lenders and borrowers in money market includes banks, non-banking financial companies (NBFCs), insurance companies, pension funds, mutual funds and retail investors. The basic aim of money market is to bridge the gap between the lenders and the borrowers. 

Borrowing companies prefer money market over capital markets and bank loans because money market instruments are cheaper. For example: If a company wants to raise capital via bonds, it will have to pay more than 6% coupon rate to attract investors. If they approach a bank for a loan, the bank may charge as high as 9-10% interest. But if the company raises funds via the money market, it would be at a much lower interest rate (4-5%). This is why borrowing companies prefer the money market. 

Retail investors prefer money market because the duration of the loan is very short-term (between one day to one year). This reduces the default risk to a bare minimum. So, investors get the option to earn better returns than bank term deposits with next to nil default risk. This is why money markets are so popular in India among both lenders and borrowers. 

The two most important segments of the Indian money market are: 

  • Call money market 
  • Notice money market 

Call money market deals with instruments having maturity of one day. This market is dominated by banks as they often borrow overnight funds to meet RBI’s statutory liquidity ratios. Notice money market deals in securities maturing in more than one day but less than a year. 

Types of Money Markets in India 

The money market is a market of short-term debt instruments. They are issued by governments, banks and other large institutions to fund their short-term cash requirements. The Indian money market is divided into two categories: 

  1. Unorganised Money Market: This market does not come under any regulations. The lending and borrowing take place outside the purview of regulatory bodies. Majorly Micro, Small and Medium Enterprises (MSME) forms the unorganised money market in India. These are small enterprises who run small businesses and contribute 29% towards India’s Gross domestic product (GDP). Participants of the unorganised market include:
  • Moneylenders: Any person who is lending money to run a business is a moneylender. For example, you lend some money to your friend to start his pickle factory. He promises to repay you in six months. This is an example of an unorganised money market. 
  • Development bankers: These are banks which provide priority loans to the unorganised sector like farmers. Example: National Bank for Agriculture and Rural Development (NABARD)
  1. Organised sector: The lending and borrowings in the organised money market sector is done under the regulation of the Reserve Bank of India (RBI). Participants of the organised money market include:
  • Banks (excluding NABARD).
  • Central and state government.
  • Corporate bodies.

Importance of Money Market in Our Economy

Money market instruments mature in less than 365 days. Hence, they provide quick supply of short-term funds to the borrowers. Money markets enable smooth functioning of commercial banks. They also facilitate effective implementation of the monetary policy of the central bank. Money market allows a variety of participants to raise funds. On the other hand, it helps investors to park their idle funds for the short term. Thus, leading to the development and growth of the economy.

Types of Money Market Instruments in India

1. Call money market (CMM)

Also known as overnight money, call money can be called by the lender and has to be repaid overnight, that is within a day.  Call money instruments are  generally issued by banks to meet their daily Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) .

For example: Assume that Axis bank needs Rs 10 crores to meet its CRR  requirement. To fulfil this requirement, it will ask HDFC bank to lend money for 24 hours. In return, Axis bank will issue a note and promise HDFC bank to repay the money in a day. This is called interbank lending and borrowing.

There are two types of call money: 

a. Short notice money

Here the borrowed money is loaned for more than one day but less than 14 days. As the period of lending increases, the interest rates also rise. So, if Axis bank would borrow money from HDFC bank in exchange for short notice money then it is obliged to repay it within 14 days.

b. Term notice money

Term notice money is an extension of the short notice moneyHere the money is loaned for more than 14 days. The interest rate charged is more than short notice money. Interest rates on all these securities is decided by demand and supply forces. RBI has also set a benchmark rate known as Mumbai Interbank Offer Rate (MIBOR).

What is MIBOR? 

MIBOR is the benchmark rate at which lending takes place between the biggest banks in the country. It is updated daily. It provides lending interest rates for different time frames from 1 day to 90 days. MIBOR rates are decided by demand and supply forces.

  • High demand and low supply will lead to a high interest rate.
  • Low demand and high supply will lead to a low interest rate.

2. Treasury Bills or T-bills

The treasury bill is a popular instrument issued by the RBI on behalf of the Government of India. It is issued for a period of 14 days to 364 days and is considered as the safest instrument in India. Government issues T-bills to either balance its fiscal deficit or to reduce money circulation in the market. 

Hence, T bills are used as a market stabilization scheme (MSS). It is a method to reduce the money supply in the economy. After the bills are circulated, the availability of money in the economy decreases.  

Treasury bills are a type of zero coupon bonds. It is called zero coupon because they do not pay interest. They are issued at a discount and redeemed at par. For example, the face value of the bill is Rs 100. But you will only pay Rs 95 for it. This Rs 5 is your discount and earned interest. When you redeem the bill, you will be paid Rs 100.

Types of treasury bills

1. Ad hoc treasury bills

These bills do not specify the maturity date. They can be redeemed any time before 365 days by the government. In 1997, these bills were replaced by ways and means advances. It is a facility through which both central and state government borrow from the RBI for a specific period.

2Regular treasury bills

These are time specific bills with low risk issued to balance fiscal deficit or reduce money supply in the economy. T-Bills come with different maturity periods. They can be 91 days, 182 days and 364 days T bills.

3. Commercial Paper

These are unsecured debt instruments. This means that they are not backed by a collateral. They are issued by banks, NBFCs or large corporations to meet short-term liquidity crunch. Commercial papers are issued in multiples of Rs 5 lakhs and matures between seven days to a year. All the commercial papers are rated by a standard rating agency like Credit Rating Information Services of India Limited (CRISIL)Investment Information and Credit Rating Agency (ICRA), etc.

Following are CRISIL ratings:

RatingsRisk
AAALow credit risk and highest degree of safety
AALow credit risk and a high degree of safety
ALow credit risk and adequate degree of safety
BBBModerate credit risk and a moderate degree of safety
BBModerate risk of default
BHigh risk of default
Very high risk of default
DThe security has already defaulted or is expected to be in default soon

3. Certificate of Deposits (CD)

CDs are tradable instruments. They are issued by banks and other financial institutions like corporates and NBFCs in Demat form as a promissory note. It is issued for Rs 1 lakh or in multiples thereof. The returns you earn on CDs is higher than T bills. However, CDs cannot be redeemed before maturity. But you can sell it to another party before maturity. A bank issues a CD for a duration of three months to a year. However, there is an exception for financial institution. They can issue CDs with a duration of three months to three years. 

4. Repurchase agreement (Repo rate)

Repo rate is the rate at which commercial banks borrow money from the RBI. It is used by RBI to control excess liquidity in the economy.  Here, banks keep their securities as a collateral with the RBI and collect cash in exchange. On maturity, these banks repurchase their securities from the RBI. The interest rate on these securities is called the repo rate. 

Reforms in the Indian Money Markets

RBI is the sole regulator of the Indian money markets. To ensure efficient functioning, it has brought various reforms in the Indian money markets. These include: 

  • Abolishment of Ad hoc treasury bills in 1997. 
  • Only treasury bills with a fixed redemption date can be issued. 
  • All the NBFCs were bought under the purview of RBI in 1997.
  • In 1998, RBI restricted participation of NBFC’s in the Indian money market. This was done to improve liquidity and stability of the call and term money markets.
  • Debt recovery tribunals (DRTs) were set up to help banks in the recovery of short-term debt.
  • In 1998, RBI developed the Discount and Finance House of India (DHFI). It helps banks borrow and lend call money, notice money and term money. It also purchases and sells CDs, commercial papers and treasury bills. It has played an important role in stabilizing the money market. 
  • For proper distribution of money market instruments dealers are appointed by RBI. For example, if you want to buy a zero-coupon bond you cannot approach the government directly. Hence, dealers like SBI, Morgan Stanley, etc. are appointed.

Now let’s explore a bit more about how retail investors can buy money market instruments with ease.

How Can a Retail Investor Invest in Money Market Instruments?

Money market instruments are mostly out of reach for retail investors. This is because the minimum investment amount is very high.  But through money market mutual funds, a retail investor can invest in money market instruments with a small amount. Money market mutual funds are a type of debt funds. They pool money and invest in high-quality short-term money market instruments. They provide significantly lower returns but are risk free. 

You can watch the following video to know more about several types of debt mutual funds. 

Money market mutual funds are suitable for investors who are risk averse with an investment horizon of three months to one year. 

Here is a list of some of the money market funds:

FundStar rating1-Year Return3-Year Return5-Year ReturnAUM (in Rs Crores)Expense Ratio
Tata Money Market Fund Regular Plan Growth5 stars3.886.445.027,1260.43%
Invesco India Money Market Fund – Growth 5 stars3.515.626.172,6390.55%
HDFC Money Market Fund- Growth3 stars3.756.356.5115,8270.35%
Kotak Money Market Fund – Growth4 stars3.656.046.4211,4540.3%

*This is simply a list of money market funds. This is not investment advice. **Data as on 10th November 2021.

We understand that directly investing in money markets might not be possible for retail investors. But they can enjoy the risk-free returns of money market instruments with money market mutual funds. They are a great way to add safety and diversification to your investment portfolio. 

However, finding the best money market mutual fund can be overwhelming. But don’t worry as Samco’s RankMF rates and ranks all mutual funds in India and gives the most honest answer to kaunsa mutual fund sahi hai…!

So, open a FREE Samco Demat account and get instant (FREE) access to RankMF and start investing in the best money market mutual funds today!

Happy Investing!

By Deepika Khude

The author is a Certified Financial Planner (CFP) with 5 years experience in Investment Advisory and Financial Planning. Her strength lies in simplifying complex financial concepts with real life stories and analogies. Her goal is to make common retail investors financially smart and independent.

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