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SIGNIFICANCE / FUNCTIONS OF MONEY MARKET

It is the trade, commercial and industrial revolutions which have led to the concept of money market to emerge. In recent times, money market has played a vital role in accelerating the rates of economic development of any economy. It is the money market which has opened up avenues for investment in the short term funds. It has further created a healthy climate for the central bank to regulate the money supply. The development of an economy also depends on the sound and developed money market.

In a country like India, where the money market is underdeveloped, the mobilisation of financial resources is a very difficult job. Indian agriculture is poor because the farmer does not get loans for his short term needs. He has to depend on fraudulent money lenders who squeeze him by charging an exorbitant interest rate and by over-writing the loan amount. It is due to this reason that Darling has aptly remarked that the Indian farmer is born in debt, lives in debt and dies in debt. In the under-developed countries like India the sub-markets are not specialised, organised and integrated. It is one side of the picture. On the other hand, money market has proved to be a boon for the development of the advanced countries. It is through organised money market that they have achieved the objective of economic growth with stability. The importance of the money market that they have achieved the objective of economic growth with stability. The importance of the money market is highlighted as under :

1.Economic development. The money market provides short term funds to both public and private institutions. These institutions need money to finance their capital needs. In other words , the money market assures supply of funds : the financing is done through discounting of the trade bills, commercial banks, acceptance houses, discount houses and brokers .In this way, the money market helps in the economic development by providing financial help to trade, commerce and industry. The businessmen take advantage by investing their cash in highly liquid assets to earn income and also to enjoy liquidity because these assets can be converted into cash without much difficulty.

2. Profitable investment. The commercial banks deal with the deposits of their customers. The banks are required to put their assets into cash form to meet the directions of the central banks on the one hand, while on the other, they have to put their excess reserves into productive channels to earn income on them. The aim of the commercial banks is to maximize profits. The excess reserves of the banks are invested in near money assets. The purpose is to ensure liquidity without foregoing profits completely. The same principle also applies to non-banking financial intermediaries, business corporations, state and local governments.

3. Borrowings by the government. The money market helps the government in borrowing short term funds at very low interest rates. The borrowing is done on the basis of treasury bills. But in case the government resorts to deficit financing or to print more currency or to borrow from the central bank, it will merely raise the money supply over and above the needs of the economy and hence the price level will boost up. Thus it is clear that the money market is very useful for the government since it meets its financial needs.

4.Importance for central bank. If the money market is well-developed, the central bank implements the monetary policy successfully. It is only through the money market that the central bank can control the banking system and thus contribute to the development of trade and commerce. The money market is very sensitive : a change in one sub-market affects the other sub-markets immediately. It means the central bank can affect the whole money market by changing just one sub-market. In this connection S. N. Sen has aptly remarked, "The whole of the money market is, as it were, a single credit pool, in which whenever the central bank flings a stone waves will gradually reach all shores. "

5. Mobilisation of funds. The money market helps in transferring funds from one sector to another. The development of any economy depends on availability of finance. No country can develop its trade, commerce and industry until and unless the financial resources are mobilised.

6.Self-sufficiency of commercial banks. In case of the prevalence of a developed money market, the commercial banks need not borrow from the central bank .In case the commercial banks have scarcity of resources, they can meet their requirements by recalling some of their loans from instead of borrowing from the central bank at a higher rate.

7. Savings and investment. Another point of importance of the money market is that it helps in promoting liquidity and safety of financial assets. By doing so it can help in encouraging savings and investment. The savings and investment equilibrium or equilibrium of demand and supply of loanable funds helps in the allocation of resources.

THE COMPINENTS OR SUB-MARKETS OF MONEY MARKET

The money market is not homogeneous in character. This is a loosely organised institution with a number of divisions and sub-divisions. Each particular division or sub-division deals with a particular type of credit creation. All the sub-markets deal in short term credit. The following are the important constituents or sectors of money market.

1.Call Money Market

Call money market refers to the market for very short period. Bill brokers and dealers in stock exchange usually borrow money at call from the commercial banks. These loans are given for a very short period not exceeding seven days under any circumstances, but more often from day-to-day or for overnight only i.e at a very short notice. It is on account of this reason that these loans are called 'call money' or call loans. Thus, call money market is an important component of the money market.

The investment of funds in the call market meets the need of liquidity but not that of profitability because the rate of interest on call loans is very low and changes several times during the courses of the day.

Call loans are useful to the commercial banks because these can be converted into cash at any time. They are almost like cash. It is a form of secondary cash reserves for the commercial banks from which they earn some income too.

2. Collateral Loan Market.

It is another specialised sector of the money market. The market for loans secured by stocks and market is geographically most diversified and most loosely organised. The loans are generally advanced by the commercial banks to private parties in the market. The collateral loans are backed by the securities, stocks and bonds. The collateral securities may be in the form of some valuable, say government bonds which are easily marketable and do not fluctuate much in prices. The collateral money is returned to the borrower when the loan is repaid. Once the borrower is unable to repay the loan, the collateral becomes the property of the lender. These loans are given for a few months. The borrowers are generally the dealers in stocks and shares. But even smaller commercial banks can borrow collateral loans from the bigger banks.

3.Acceptance Market

Banker's acceptances are very old form of commercial credit. Acceptance market refers to the market for banker's acceptances involve in trade transactions. This market deals with banker's acceptances which may be defined as a draft drawn by a business firm upon a bank and accepted by it. It is required to pay to the order of a particular party or to the bearer a certain specific amount at a specific date in the future. These acceptances emerge out of commercial transactions both within the country and abroad. The market where the banker's acceptances are easily sold and discounted is known as acceptance market. Raymond. P. Kent, in his book 'Money and Banking' has stated that banker's acceptances is "a draft drawn by an individual or firm upon a bank and accepted by the bank whereby it is ordered to pay to the order of a designated party or to bearer a certain sum of money at a specified time in future. " A banker's acceptances is payable at a specified future date whereas a cheque is payable on demand. Banker's acceptances can be easily discounted in the money market because they carry the signature of the bankers.

In case of acceptance houses, no bank frauds are involved. The bank has merely added its guarantee to the draft. But a note-worthy point is that the banker's acceptances are used primarily in international trade. In the London Money Market there are specialised firms known as accepting houses which accept bills drawn on them by traders instead of drawing on the true debtors. In the past the acceptance houses were very important in the London Money Market but now their importance has declined considerably. In the Indian Money Market but now their importance has declined considerably. In the Indian Money Market these have no significance because there is no development of the acceptance market. There are no specialised firms which render acceptance services in India, rather this service is provided by commercial banks on a very small scale.

4.Bill Market

It is a market in which short term papers or bills are brought and sold. The important types of short term papers are :

(a) Bills of exchange (b) Treasury bills.

(a) Bills of exchange. Bills of exchange are commercial papers. A bill of exchange is a written unconditional order which is signed by the drawer requiring the drawee to pay on demand or at a fixed future time, a definite sum of money. Once the buyer signifies his acceptance on the bill itself, it becomes a legal document. Such bills are discounted or rediscounted by commercial banks to lend credit to the bill-holders or to borrow from the central bank.

(b) Treasury bills. The treasury bills are government papers securities for a short period usually of 91 days' duration. The treasury bills are the promissory notes of the government to pay a specified sum after a specified period. These are sold by the Central Bank on behalf of the government . An important aspect of a treasury bill is that there is no fixing of rate of interest beforehand. The treasury offers the bills on the basis competitive bidding, so one who is satisfied with minimum interest would be allotted the bills. Since the treasury bills are government papers, they inspire public confidence in the minds of the investors. As no risk is involved in their purchase, they become good papers for the commercial banks to invest their short term funds. Since discounting is the main process of exchange, so it is called 'discount market's also. A pertinent point is that the market for bonds, government long term loan market or treasury bonds, and the stock exchange, etc. deal with a long period, so they cannot be regarded as constituents of money market.

Thus from the above discussion it is clear that different markets from part of money market. The call money market, for example, refers to the borrowing and lending of call loans and advances. The loans backed by securities, stocks and bonds are called collateral loans. The acceptance market refers to the acceptances of bills which leads to the discounting of bills. The bill market refers to buying and selling of bills. All these four sub-markets form the money market.

BILL MARKET IN INDIA

A well-developed bill market of any country is characterized by the following features:

1. There is a practice of borrowing against commercial bills in that country.

2.There is continuous and quite large supply of bills in such a market.

3. Commercial banks provide credit to their customers on discounting of these bills.

4. The market offers facilities to rediscount these bills.

5.The central bank of the country is willing is rediscount these bills readily throughout the year.

6. Bill market provides facilities for acceptance of bills at a low cost.

7.A large number of brokers and dealers in bills function to help the smooth functioning of the bills market.

On the basis of above criteria, Indian bill market is adjudged as underdeveloped one. A well organised bill market or discount market for short-term bill is essential for establishing an effective link between credit agencies and Reserve Bank of India.

The reasons for the poor development of bill market in India are historical and include-

1. People prefer cash credit to bills financing.

2.Lack of uniform practices with regard to bills.

3.Excessive stamp duty discourages people to use bills.

4.There is no active secondary market for bills.

5. Limited discounting or acceptance services available in India.

6.It is difficult to determine the genuineness of the bills by banks/FIs.

7. Banks prefer to hold the bills till maturity with central bank. This affects the velocity of circulation of bills.

BILL MARKET SCHEME

A developed bill market is essential for the development of money market. It is a market for short term bills. The bills could be trade bills, finance bill of treasury bills. The bill market enables the constituents of the money market to invest short term funds in a profitable way while maintaining liquidity. The importance of a good bill market was recognised by RBI way back in 1952.

The Bill Market Scheme, 1952: The RBI introduced the bill market scheme by undertaking to provide funds to commercial banks against trade bills within prescribed limits. The scheme become popular with commercial banks, especially during busy season. The scheme failed to serve the purpose beyond refinance to commercial banks. The reason was lack of sufficient number of dealers.

The New Bills Market Scheme 1970: A committee headed by M. Narasimham went into the question of developing a genuine bill market. On the recommendations of the committee a new bill market scheme was introduced in 1970. It was essential for making bank rate an effective instrument of monetary control.

The scheme was a major step towards developing a bill market. The trade and industry slowly responded to the measures and the bills market became active. After introduction of the scheme, the RBI has been encouraging use of bills as a source of finance by imposing charges on alternatives methods like cash credit.

Working Group on Cash Credit System (1993) headed by R. Jilani also recommended that steps should be taken to promote bill culture to a greater extent in respect of both purchases and sales. Vigrous efforts should be made to persuade Government departments, public sector undertaking and large industrial units to accept bills drawn on them.

In fact, a developed bill market and money market can reduce the dependence of business units on bank credit. The RBI discourages large use of cash credit. all these efforts have positive effect on the growth of bills market. However, it still provides only a small portion of 6-7 percent of the total bank credit.

THE INSTITUTIONS OF MONEY MARKET

The institutions of money market are those which deal in lending and borrowing of short term funds. The institutions of money market and not the same in all the countries of the world, rather they differ from country to country. The commercial banks, central banks, acceptance houses, non-banking financial intermediaries (NBFI), brokers, etc. are the major institutions of money market.

These are discussed as under:

1.Commercial Banks. Commercial banks are the back bone of the money market. They form one of the major constituents of money market. These banks use their short term deposits for financing trade and commerce for short periods. The commercial banks invest their funds in the discounting of bills of exchange, i. e. both exchange bills or commercial bills and treasury bills or government bills to facilitate trade and commerce by mobilising the flow of money. The commercial banks lend against promissory notes and through advances and overdrafts. The call money loans are also provided by these banks to the bill brokers and dealers in the stock exchange market. The commercial banks put their excess reserves in different forms or channels of investments which satisfy their conflicting principles of liquidity and profitability. The aim is that the funds invested not only remain liquid in form but also earn high interest or yield income on them. A noteworthy point is that in addition to commercial banks there are cooperative bank savings banks, financial companies, etc. also which form part of the money market.

2. Central Bank. The central bank plays a vital role in the money market. It is the monetary authority and is regarded as an apex institution. No money market can exist without the central bank. The central bank is the lender of the last resort and controller and guardian of the money market. The member banks may approach the central bank for loans and advances during emergency. It controls and guides the institutions working in the money market. It raises or reduces the money supply and credit to ensure economic stability in the economy. In other words, it helps in averting the possibilities of inflation and deflation. A pertinent point is that the performance of the central bank depends on the character and composition of the money market. But the central bank does not enter into direct transactions, it controls the money market through changes in the bank rate and open market operations.

3.Acceptance Houses. The acceptance houses and bill brokers are the main institutions dealing in the bill market. The institution of acceptance houses developed in England where merchant bankers transferred their headquarters to London Money Market in the late 19th and the early 20th century. They function as intermediaries between importers and exporters, and between lenders and borrowers in the short period. In the London Money Market the acceptance houses performed a very useful role as merchant bankers. These houses specialised in the acceptance of trade bills/commercial bills. They accepted those bills which were drawn on merchants whose financial standing was not known in order to make the bills negotiable in the London Money Market. In this way, they handled the international transactions without any problem. A noteworthy point is that by accepting a trade bill, they guaranteed the payment of the bill on maturity. For this guarantee, these houses charged a commission. The discounting of such accepted bills was done by another specialised agency known as 'discount houses'. This institution was an important segment of the London Money Market in the past but now it's importance has declined because the commercial banks have undertaken the business of acceptance houses.

4.Non-banking Financial Intermediaries. In addition to commercial banks, there are non-banking financial intermediaries which resort to lending and borrowing of short term funds in the money market. In non-banking financial intermediaries we include savings banks, investment houses, insurance companies, building societies, provident funds and other business corporations like chit funds.

5.Bill Brokers. In the developed money markets like the London Money Market and the New York Money Market, private companies act as discount houses. The main function of these companies is to discount bills on behalf of others. Besides these companies, there are bill-brokers who work as intermediaries between the borrowers and lenders by discounting bills of exchange at a small commission. In a under-developed money market, bill brokers are quite important intermediaries.

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