Page 50 - DCOM304_INDIAN_FINANCIAL_SYSTEM

Unit 3: Financial Markets

 Political Risk: Most of the measures adopted to bring economic stability will have a Notes
direct/indirect implication on the money market instruments and operations. This is due
to the fact that the money market activity reflects the money supply position in the
economy, the interest rate and the exchange rate structures, etc. Thus, any policy decisions
adopted by the Central Government will have an impact on the money market. In the
Indian context, it is the policy measure taken by the RBI, and sometimes the Ministry of
Finance (MoF) that have an impact on the money market. For instance, in order to build up
forex reserves, the government may prevent repatriation of investments made by FIIs/
NRIs in the money market. This measure will have a definite impact on the operations of
these players in the money market. Depending on the guidelines issued by the government,
all or few of the instruments will be affected. Though the above mentioned risks that the
money market instruments are exposed to, seem to be similar to the risk profile of other
financial markets, their level of exposure varies. For instance, due to the short-term nature
of the market, reinvestment risk and default risk will be minimal.
Money Market

The money markets provide the funds for market participants with maturity starting from one
day to one year. The RBI, commercial banks, financial institutions and the primary dealers are
prominent players in this market, each operating for a specific purpose. The Call/notice money
market makes available funds for banks with a maturity range of 1 to 14 days. The market with
a maturity of 15 days to one-year is the term money market. Following are some features of the
money market:
1. The working of the money market offsets the demand supply imbalance of short-term
funds.
2. The money market is a hub of activities, which influences the liquidity and general level of
interest rates in the economy.
3. The money markets enable the lending/borrowing activities at fair and competitive rates.
Evolution of Money Markets in India
The Vaghul Committee, a working group on money market, appointed by the RBI under the
Chairmanship of N Vaghul, had suggested measures to develop the money market in India.
The following are some initiatives taken up by the RBI as a follow up of those
recommendations:
1. DFHI (Discount and Finance House of India) was formed in March 1988, to enable liquidity
of the money market instruments.
2. Widening the range of money market instruments; introduction of the new instruments like
CP, CD and interbank participation certificates during 1988-89.
3. Interest rate regulations in call money markets were gradually removed to make it a market
determined one.
The bank rate has become the reference rate in the money market and the minimum limit is set
usually by the call rates and the repo rates and the bank rate act as a ceiling. The other
benchmark instruments are government securities and the Treasury bills.
There is yet another important and rather interesting feature of the money market that explains
the lower level of the default risk. Money market players have to honour obligations as a universally
accepted code of conduct. Irrespective of the volume of transactions in the market, the quantum
involved in such transactions, and the mode in which these transactions take place, this code of
conduct will be strictly adhered to by the participants in the money market. Since defaulting in the
money market virtually expels the player from the market, in spite of being unsecured transactions,
the obligations are definitely met. However, as observed earlier, the money market players are
mostly large institutional players, having a good standing in the market with a good rating. Of the
risks that the money market instruments are exposed to, the volume and the quantum of transactions
generally put the market/interest rate at a higher level.

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