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MONEY MARKET AND CAPITAL MARKET
MONEY MARKET AND CAPITAL MARKET
a) Money market provides outlets to commercial banks, non-banking financial
concerns, business corporations and other investors for their short-term funds. It
enables them to use their excess reserves in profitable investment.
(b) Money market also provides short-term funds to businessmen, industrialists, traders
etc. to meet their day-to-day requirements of working capital. Money market plays a
crucial role in financing both internal as well as international trade.
(c) Money market provides short-term funds not only to private businessmen but also
to government and its agencies.
(d) Money market enables businessmen, with temporary surplus funds, to invest them
for a short period.
(e) Money market serves as a medium through which the central bank of the country
exercises control on the creation of credit.
(f) Money market is also of great help to the government.
The functions of the money market are virtually the same in all the countries of the
world. But the institutions, instruments and modes of operation are different in different
Composition of the Money Market
The money market is composed of several financial agencies that deal with different types
of short-term credit. We may describe the following important components of the money
1. Call Money Market: It is a market for short-period loans. Bill brokers and dealers
in stock exchange require financial accommodation for very short periods. Money
may be lent for periods not exceeding seven days. Sometimes money is lent only
overnight. These loans are called call loans or call money as the banks recall these
loans at very short notice. The banks prefer this kind of investment for two reasons.
Firstly, call loans can be treated almost like cash and they form the second line of
defence for the banks after cash. Secondly unlike cash, the call loans earn some
income, in the form of interest, for the banks. The commercial banks are the lenders
and the bill brokers and dealers in stock exchange are the borrowers in the call money
market. The call money market is an important section of the money market.
2. Collateral Loan Market: When loans are offered against collateral securities like
stocks and bonds, they are called ‘collateral loans’ and the market is known as the
collateral loan market. This market is geographically most diversified.
3. Acceptance Market: It refers to the market for bankers acceptances which arise out
of trade-both inland and foreign. When goods are sold to anyone on credit, the buyer
accepts a bill. Such a bill cannot be discounted anywhere easily. The banker adds
his credit to the bill by accepting it on behalf of his customer who has purchased the
goods. Such bills can be discounted anywhere. In London, there are specialist firms
called acceptance houses which accept bills drawn on them by traders. They are
well known all over the world. In the past, the acceptance market was a prominent
section of London money market. Its importance has declined considerably in recent
years. The function of the acceptance houses is being performed by the commercial
banks is several countries.
4. Bill Market or Discount Market: It refers to the market where short-dated bills
and other paper is discounted. Before the First World War the most important paper
discounted in the London money market was the commercial bill which was used to
finance both inland and foreign trade. During the inter-war period the importance
of the commercial bills declined. This place has been taken by treasury bills. The
treasury bills are promissory note of the government to pay a specified sum after a
specified period, generally 90 days. The treasury bills are purchased by the investors
and when necessary they are discounted in the discount market.
These markets are not water-tight compartments. They are related to one another.
The borrowers in the call money market deal in treasury bills which are discounted
with them. Acceptance houses accept bills which are later discounted in the discount
market. Thus, the various sections of the money market are intimately related to and
are dependent on one another.
Financial Institutions of the Money Market
The money market may also be analysed on the basis of the different institutions engaged in
lending and borrowing short-term funds. The nature of these institutions may differ from
country to country. The same institutions may also function both as borrower and as lender
in the market. The lenders are:
1. The Central Bank: It is the lender of last resort. It lends money to commercial
banks when they approach for financial assistance.
2. Commercial Banks: They form the most important class of lenders in the money
market. They also borrow from the central bank directly or indirectly. The money that
they lend comes from the public in the form of deposits repayable on demand. These
funds are invested in various forms of assets. These assets which are considered the
secondary reserve for the bank are closely linked with the money market.
3. Institutional Investors: They include savings banks, insurance companies, trust
companies and investment trusts. The portion of their funds kept invested in liquid
assets finds its way into the money market.
4. Private Individuals, Partnerships and Companies: Normally this group may
not be interested in short-term funds. If the interest rates become attractive, they
may divert a portion of their surplus funds to the money market.
The borrowers in the money market must satisfy certain conditions regarding
the paper they offer for discounting. “The paper must be absolutely liquid, easily
realisable and short of maturity.” These conditions are satisfied by bill brokers and
dealers in stock exchange.
Characteristics of a Developed Money Market
Professor S.N. Sen has described the characteristics of a developed money market in his
well-known study Central Banking in Undeveloped Money Markets. The absence of one or
more of these conditions will make a particular money market an undeveloped one. In every
country of the world, some type of money market exists. While some of these are very highly
developed, a good many are still undeveloped. There are many basic requisites which are
necessary for the evolution of a developed money market:
(a) Highly Organised Commercial Banking System: A fully developed money
market is characterised by the presence of a highly organised commercial banking
system while in an undeveloped money market the banking system is undeveloped.
The commercial banks are the most important suppliers of short-term funds and,
therefore, any policy they follow regarding loans and advances and investments will
have repercussions on the entire money market.
(b) Presence of a Central Bank: The second essential feature of the organisation of
a developed money market is the presence of a central bank. Just as a State cannot
exist and function properly without a head, so also a money market cannot function
properly without a central bank. The central bank keeps the cash reserves of all
commercial banks and comes to their rescue and the money market as a whole in
times of difficulties by rediscounting eligible securities. In times of emergency and
crisis, the central bank enables the money market to convert near-money into cash.
Besides, it performs a valuable service through open-market operations when it
absorbs surplus cash during off-seasons and provides additional liquidity in times
of financial stringency. Thus the central bank is the leader of the money market,
as well as its controller and guide. Without an efficient central bank, a developed
money market cannot exist. In an undeveloped money market, either the central
bank does not exist or is in its infancy without adequate capacity to influence and
control the money market.
(c) Availability of Proper Credit Instruments: An effective money market will
require a continuous supply of highly acceptable and, therefore, negotiable securities
such as bills of exchange, treasury bills, short-term government bonds, etc. At the
same time, there should be a number of dealers in the money market who should buy
and sell these securities. Without their presence, there cannot be any competition
or “life” in the money market. Thus the availability of adequate short-term assets
and the presence of dealers and brokers to deal in them are essential conditions for
the evolution of an organised and developed money market. An undeveloped money
market, on the other hand, is characterised by the absence of sufficient short-term
credit instruments as well as dealers and brokers to deal in them.
(d) Existence of a Number of Sub-markets: The fourth essential condition for the
evolution of a developed money market is the organisation of the money market into
a number of sub-markets, each specialising in particular type of short-term assets.
Each type of short-term asset-depending upon the nature of the asset and period
of maturity involved-is dealt within a separate market. While a developed money
Money Market and Capital Market 87
market consists of a number of sub-markets each specialising in a particular type
of short-term asset, an undeveloped market does not possess all the important and
essential sub-markets particularly the bill market. Besides, there is no coordination
between the different sections of the money market in an undeveloped money
(e) Availability of Ample Resources: The fifth essential condition for a developed
money market is the availability of ample resources to finance the dealings in the
various sub-markets. These resources generally come from within the country
but it is also possible that foreign funds may also be attracted. While developed
money markets, like London and New York, attract funds from all over the world,
undeveloped money markets do not attract foreign funds mainly because of political
instability and absence of stable exchange rates.
Apart from these above important factors which are responsible for the evolution
of a developed money market over a number of years, there should be many other
contributory factors also, such as a large volume of international trade leading to
the system of bills of exchange, industrial development leading to the emergence of
a stock market, stable political conditions, absence of discrimination against foreign
concerns, and so on.
It is difficult to come across many developed money markets. London money
market is the best example of such a market, for all the characteristics of a developed
money market are to be found there. The Indian money market is a good example of
an undeveloped money market.
Usefulness of a Developed Money Market
The money market is an important institution in a modern economy and it has influenced
profoundly industrial and commercial developments:
(a) In Financing Industry and Commerce: In the first place, the money market is
of very great help in financing industry and commerce. Industries are helped in
their working capital requirements through the system of finance bills, commercial
paper, and so on. It has played a very important part in the financing of trade and
commerce. Both internal as well as international trade is normally financed through
the system of bills of exchange which are discounted by the bill market.
(b) Investment of Short-term Funds: The money market plays a very important role
in providing necessary assets for the investment of short-term funds of commercial
banks. Commercial banks find such assets in the call money market as well as in the
bill market. Thus, the money market offers the commercial banks a very good means
of temporarily employing their funds in liquid or near-money investments.
(c) Help to the Central Bank: The money market is of great help to the central bank of
the country. For one thing, the money market and short-term rates of interest which
prevail there serve as a good barometer of monetary and banking conditions in the
country and thus provide a valuable guide to the determination of central banking
policy. For another, the developed money market being a highly integrated structure
enables the central bank to deal with the most sensitive of the sub-markets so that
the influence of the operation of the central bank may spread to other sections also.
d) Help to the Government: Lastly, the money market helps the government. The money
market supplies the government with necessary short-term funds through the treasury
Thus, a developed money market is of great assistance to industry and commerce, to the
commercial banking system, to the central bank of the country and to the government.
Structure of the Money Market
The Indian money market is composed of two categories of financial agencies: (1) Organised,
and (2) Unorganised. The organised sector contains, well established, scientifically managed
financial institutions comprises: (a) The Reserve Bank of India, (b) The State Bank of
India and its associate banks, (c) Joint-stock commercial banks, (d) Exchange banks,
(e) Co-operative banks, (f) Development banks. The Reserve Bank of India is the supreme
monetary and banking authority in the country. It has the responsibility to control the
banking system in the country. It keeps the reserve of all commercial banks and hence is
known as the “Reserve Bank.” There are joint-stock commercial banks. 91% of the banking
institutions are in the public sector. There are foreign exchange banks in the country. There
are cooperative banks. There are also post office savings banks which mobilises the savings
of small holders. Thus, the organised sector of money market is well developed.
The unorganised sector contains agencies which have diverse policies, lack of uniformity
and consistency in the lending business. The unorganised sector includes indigenous
bankers, money lenders, nidhis and chitfunds. Money-lenders and indigenous bankers
provide about 50 percent of rural finance. There are thousands of chitfunds operating on a
big or small scale in many places in India. This sector is unorganised because its activities
are not controlled and co-ordinated by the Reserve Bank of India.
Characteristics of Indian Money Market
The Indian money market is an under-developed money market. It is loosely organised
and suffers from many weaknesses. It is divided into two parts, namely, organised and
unorganised sectors. The following are the important characteristics of Indian market:
(a) The Indian money market does not possess a highly organised banking system,
necessary for the successful working of a money market.
(b) It does not possess an adequate and continuous supply of short-term assets, such as
the bills of exchange, treasury bills or short-term government bonds etc.
(c) There are no dealers in short-term assets in India, who may act as intermediaries
between the government and the banking system.
(d) The Indian money market does not contain the very essential sub-markets such as
the acceptance market, commercial bill market etc. A well developed call money
market, however, exists in India. But acceptance houses and discount houses are not
in existence in India.
(e) There is no proper co-ordination between the different sections of the money market.
This is so because the inter-connection between the different sections of the money
market is often loose and un-co-ordinated. Thus, the money market structure is
unorganised and un-co-ordinated.
(f) There is no uniformity in the interest rates which vary considerably, among the
different financial institutions as well as centres. Money-lenders especially charge
exorbitant rates of interest.
(g) The Indian money market does not attract foreign funds as the London money
market does. Thus, the Indian money market lacks international status.
(h) The Reserve Bank does not possess adequate capacity and power to influence and
control the entire money market. It has no adequate control over the policies and
functioning of the unorganised part of the money market.
Thus, the Indian money market lacks most of the characteristics of a well-developed
market. It is very much undeveloped and cannot be compared with advanced money markets
in the world. The London money market is regarded as the most developed money market
as it possess all the characteristics of a well-developed money market. The Indian money
market is inadequate to meet the financial needs of the country. It is a “money market
of a sort where banks and other financial institutions lend or borrow for short-periods.”
Thus, the Indian money market is not a perfect one. It is unbalanced and loose. It is a
restricted market. It is narrow-based with limited number of participants. It is disintegrated,
ill-developed, ill-liquid, shallow and repressed.
Defects of Indian Money Market
The money market provides funds to finance production and distribution. It helps to
promote economic growth of the country. A well-developed money market is a necessary precondition
for the effective implementation of monetary policy. The central bank controls and
regulates the money supply in the country through the money market. But, unfortunately,
the Indian money market is inadequately developed, loosely organised and suffers from
many weaknesses. The following are the major defects of the Indian money market:
1. Loose and Disjointed Structure: The Indian money market consists of an
organised sector and an unorganised sector. The organised sector consists of modern
well-organised and scientifically operating financial institutions. The unorganised
sector lacks scientific organisation. It is stagnant and ill-organised. The existence of
unorganised money market is an important weakness of the Indian money market.
The unorganised sector consists of indigenous bankers, money-lenders, nidhis,
chitfunds etc., This unorganised sector acts independently. It carries on business
on traditional lines. It follows its own rules of banking and finance. It does not
submit to the control and regulation of the Reserve Bank. There is little contract,
co-ordination and co-operation between the unorganised sector and the organised
sector. Thus, the Indian money market is unbalanced and loose. In such conditions,
it is difficult for the Reserve Bank to ensure uniform and effective implementation
of its monetary policy in both the sectors.
2. Wasteful Competition: Wasteful competition exists not only between the organised
and unorganised sectors, but also among the members of the two sectors. The
relations between the various members of the money market are not cordial. They
are loosely connected with each other and generally, follow separatist tendencies.
For example, even today, the State Bank of India and other commercial banks looks
down upon each other as rivals. Similarly, competition exists between the Indian
commercial banks and foreign exchange banks.
3. Absence of All-India Money Market: Indian money market has not been
organised into a single integrated all-India money market. It is divided into small
segments mostly catering to the local financial needs. For example, there is little
contact between the money markets in the bigger cities like Mumbai, Chennai and
Kolkata, and those in smaller cities.
4. Shortage of Capital: Indian money market, generally, suffers from the shortage of
capital funds. The availability of capital in the money market is insufficient to meet
the needs of trade and industry in the country.
5. Inadequate Banking Facilities: Indian money market is inadequate to meet the
financial needs of the economy. Although there has been rapid expansion of bank
branches in recent years, yet vast rural areas still exist without banking facilities. As
compared to the size and population of the country, the banking institutions are not
6. Seasonal Shortage of Funds: India is primarily an agricultural country. There are
two seasons in agriculture namely, busy season and slack season. During the busy
season, from November to June, there will be excess demand for credit or funds for
carrying on the harvesting and marketing operations in agriculture. But there will
be scarcity of funds. As a result, the interest rates will rise in this period. But during
Money Market and Capital Market 91
the slack season, from July to October, the demand for credit will be less. As a result,
the interest rates will sharply decline. Thus, there will be wide fluctuations in the
interest rates from one period of the year to another.
7. Disparity in Interest rates in Different Centres: There is clear disparity in money
rates of interest from place to place and from institution to institution. Different interest
rates exist at the same time. Close relationship does not exist between the money market
rates and the bank rates. There is also difference in the interest rates of the two principal
financial centres, namely, Mumbai and Kolkata. There are several rates of interest and
they do not react to a change in Bank Rate. This is due to the fact that funds do not move
from one financial centre to another. Disparities in the interest rates adversely affect the
smooth and effective functioning of the money market.
8. Undeveloped Bill Market: The existence of a well-organised and well-developed
bill market is essential for the proper and efficient working of money market.
Unfortunately, inspite of the serious efforts made by the Reserve Bank, the bill
market in India has not yet been fully developed. As a result, the short-term bills
form a smaller proportion of the bank finance in India. Besides, the absence of
developed bill market has reduced the liquidity of the Indian money market.
9. Inelasticity and Instability: The Indian money market is inelastic as well as
unstable. It is a restricted market. It is narrow-based with a limited number of
participants. They are not in a position to effectively mobilise funds. The supply of
funds do not increase in proportion to the demand.
10. Absence of Sub-Markets: Sub-markets like discount houses, acceptance houses,
bill brokers etc., do not exist in the Indian money market. Eventhough a call market
exists, it is restricted mainly to inter bank borrowing, and it is not well-developed.
11. Insensitive to International Influences: Institutions that carry on foreign
exchange business are few in number in our money market. The Indian money
market, due to certain limitations, does not attract foreign funds. It has little contacts
with foreign money markets. But in recent years, the Indian financial sector has
become more global. The flow of foreign exchange has increased. The Indian money
market has become more sensitive to international influences.
Measures for Improvement of the Money Market
The Reserve Bank occupies the highest place in the money market. It is the financial or
monetary authority and is regarded as an apex institution. The Reserve Bank of India, from
time to time, has taken various measures to remove or correct some of the existing defects
and to develop a sound money market in the country. The following are the important
measures or steps taken by the Reserve Bank of India:
1. A number of measures have been taken to improve the functioning of the indigenous
banks. These measures include: (a) their registration, (b) keeping and auditing of
accounts, and (c) providing financial accommodation through banks.
2. The Reserve Bank has taken several steps to remove the differences which existed
between the different sections of the money market. All banks in the country have
been given equal treatment by the Reserve Bank as regards licensing, opening of
branches, the types of loans to be given etc. The discrimination between foreign and
Indian banks does not exist now.
3. In order to develop a sound money market, the Reserve Bank has taken measures to
amalgamate and merge banks into a few strong banks. Encouragement is also given
to the expansion of banking facilities in the country.
4. To develop the bill culture in the money market, the Reserve Bank introduced two
schemes: (a) The Bill Market Scheme, 1952 and (b) The New Bill Market Scheme, 1970.
5. The Reserve Bank introduced a “Lead Banking Scheme” in 1969 to eliminate
banking deficiencies in rural areas.
6. Steps have been taken to establish relations between indigenous bankers and
7. The Reserve Bank has taken steps to reduce considerably the differences in the
interest rates between different sections of the money market as well as different
centres of the money market and at different times. The interest rates are deregulated
and banking and financial institutions have the freedom to determine and adopt
market-related interest rates.
8. Reserve Bank has been able to reduce considerably monetary shortages through
open market operations.
9. Steps have been taken to implement the recommendations of working group under
the chairmanship of Mr. N. Vaghul and Chakravarty committee.
(a) Several new money market instruments were introduced to provide suitable
instruments to the investors. 182 days and 364 days Treasury Bills were introduced
to widening the scope of the short-term money market. In 1992-93, Certificate of
Deposits, commercial paper were introduced. Certificate of deposits provide and
avenue for investment at better rates in the banking sector. Commercial paper
introduced in 1989 is a short-term negotiable money market instrument. Reserve
Bank introduced two more Treasury Bills in 1997, (i) 14-day Intermediate Treasury
Bills, and (ii) a new category of 14-day Treasury bills.
(b) In April 1988, the Discount and Financial House of India Limited was
established with a view to provide liquidity to money market instruments.
Discount and Finance House of India is now the apex body in the Indian
money market. It has developed a secondary market in government securities
by buying and selling them.
10. In 1991, the commercial banks and public sector financial institutions were permitted
to set up “Money Market Mutual Funds” (MMMF). The shares or units of money
market mutual funds are to be sold only to individuals unlike the other mutual
funds. The purpose of this fund is to bring money market instruments, like treasury
bills, within the reach of individuals. In 1995, the Reserve Bank permitted private
sector institutions to set up Money Market Mutual Funds.
Money Market and Capital Market 93
11. The scheme of Inter-Bank Participation (IBP) has been introduced by the Reserve
Bank in 1988.
12. Access to bill rediscounting market has been increased by selectively increasing the
number of participants in the market.
As a result of various measures taken by the Reserve Bank of India, the Indian money
market has shown signs of notable development in many ways. It has become more vibrant
and advanced. The present position of the money market is stated below:
1. It is becoming more and more organised and diversified.
2. The government trading in various instruments like 364-Day Treasury Bills,
commercial bills and commercial paper has increased.
3. The volume of inter-bank call money, short notice money and term money
transactions has grown significantly.
4. At present Discount and Finance House of India is also participating in the money
market, both as a lender and borrower of short-term funds.
5. Banks and non-banking financial institutions are providing “factoring services.”
Suggestions to Remove Defects in the Indian Money Market
In view of the various defects in the Indian money market, the following suggestions have
been made for its proper development:
1. The activities of the money-lenders, indigenous bankers, and chit funds should be
brought under the effective control of the Reserve Bank of India.
2. Hundies used in the money market should be standardised and written in the
uniform manner in order to develop an all-India money market.
3. Banking facilities should be expanded, especially in the unbanked and neglected
4. Discounting and rediscounting facilities should be expanded in a big way to develop
the bill market in the country.
5. For raising the efficiency of the money market, the number of clearing houses in the
country should be increased and their working improved.
6. Adequate and easy remittance facilities should be provided to the businessmen to
increase the mobility of capital.
7. As per recommendation of the Narasimham Committee, well-managed non-banking
financial institutions, like leasing and Hire-purchase companies, Merchant Banks,
Venture capital companies should be allowed to operate in the money market.
8. The Reserve Bank should encourage to open Discount and Acceptance Houses.
9. Harmony between sub-markets and co-ordination of their activities must be
10. More participants should be allowed into the money market and more instruments
should be evolved and introduced in the money market. This will develop the
In recent years, the Indian money market has started becoming more deep and wide owing
to a number of innovative measures undertaken by the authorities towards its structural
reforms and the financial liberalisation. We require a well-developed money market to make
our plans a success. A well organised and developed market can help to achieve economic
growth and stability.
Recent Innovations in the Money Market: Since a long time the Indian money market
has been characterised as disintegrated, ill-developed, ill-liquid, shallow and repressed. The
Seventh Plan period, however, witnessed a remarkable improvement in the whole situation
and working of the money market in the country. The authorities positively accepted certain
major recommendations of the Chakravarty Committee and Vaghul Committee in this
context and enthusiastically acted upon in due course of time. In fact, the celebrated reports
of these two committees blew the air of financial liberalisation and innovation in the Indian
monetary system. Consequently, during the last 3-4 years, the Indian money market has
started becoming more deep and wide owing to a number of innovative measures undertaken
by the authorities towards its structural reforms and the financial liberalisation.
14-day Intermediate Treasury Bills: With the discontinuance of tap treasury bills,
the central government introduced the scheme of 14 day treasury bills to provide the State
governments, foreign central banks and specified bodies with an alternative arrangement to
invest their surplus funds. The salient features of the scheme are: (i) treasury bills would be sold
only to the State governments, foreign central banks and other specified bodies with whom the
RBI has an agreement for investing their temporary surplus funds; (ii) these treasury bills would
be sold on a non-transferable basis for a minimum amount of Rs. 1,00,000 and in multiples of
Rs. 1,00,000; (iii) these treasury bills would be repaid / renewed at par on the expiration of 14
days from the date of their issue, and (iv) the discount rate would be set at quarterly interval such
that the effective yield of this instrument would be equivalent to the interest rate on the Ways
and Means advances chargeable to the Central government. The total bills outstanding at end-
March 2000 was Rs. 2,383 crore of which the share of State governments was 96.18 per cent.
14-Day Auction Treasury Bills: The RBI introduced 14-day auction treasury bills on a
weekly basis with effect from June 6, 1997. The dual purpose of introducing these treasury
bills is to facilitate the cash management requirements of various segments of the economy
and to help in forming a complete yield curve for aiding in the pricing of debt instruments.
The 14-day auction treasury bills do not devolve on the RBI unlike the 91-day treasury bills.
The total issues of 14 day auction treasury bills during 1999-2000 amounted to Rs. 16,453
crore of which non-competitive bids aggregated Rs. 11,253 crore, representing 68 per cent of
the total issues. The subscriptions of the RBI aggregated Rs. 1,134 crore.
91-Day Treasury Bills: Earlier there were two types of 91-day treasury bills–ordinary and ad
hoc. With effect from April 1, 1997 ad hoc treasury bills were discontinued. On this day 91 day ad
hoc treasury bills amounting to Rs. 38,130 crore were converted into special securities without
any specific maturity. The interest on these securities was fixed at 4.6 per cent per annum.
Money Market and Capital Market 95
In 1992-93 a scheme for the issue of 91-day treasury bills with the RBI participation was
introduced. The cut off yields on these treasury bills were higher than the fixed discount rate
of 4.6 per cent per annum on 91-day treasury bills sold on tap.
A gross amount of Rs. 8,155 crore was raised during 1999-2000 in respect of 91-day
treasury bills as against Rs. 16,697 crore in the previous year. Out of the total gross amount,
non-competitive bids aggregated to Rs. 2,995 crore accounting for about 36 per cent of the
value of the total issues.
182-Day Treasury Bills: 182-day treasury bills were reintroduced with effect from May
26, 1999. As per the calender, notified amount for 182-day treasury bills remained constant
at Rs. 100 at the fortnightly auctions held on Wednesdays preceding the non-reporting
Fridays. The cut-off yield has varied within the range of 8.53 - 9.97 per cent.
364-Day Treasury Bills: 364-day treasury bills were introduced in April 1992.
Since then these treasury bills are auctioned on a fortnightly basis in a regular manner.
These treasury bills are not rediscountable with the RBI. However, they offer short-term
investment opportunities to banks and other financial institutions. Since 364-day treasury
bills constitute a safe avenue for investment, the auctions of these treasury bills have evoked
good response. Gross mobilisation through issuance of 364-day treasury bills was Rs. 13,000
crore in 1999-2000 as against Rs. 10,200 crore in 1998-99. The subscription by the RBI was
Rs. 2,267 crore or 17.44 per cent of the value of the total issues.
In 1999-2000, there was a relative stability in the yield on both 91-day treasury bills
and 364-day treasury bills. The yield spread between these bills was rather small during the
The Repo Market
Repo is a money market instrument which helps in collateralised short-term borrowing and
lending through sale/purchase operations in debt instruments. Under a repo transaction,
securities are sold by their holder to an investor with an agreement to repurchase them at a
predetermined rate and date. Under reverse repo transaction, securities are purchased with
a simultaneous commitment to resell at a predetermined rate and date.
Initially repos were allowed in the Central government treasury bills and dated securities
created by converting some of the treasury bills. In order to make the repos market an
equilibrating force between the money market and the government securities market, the
RBI gradually allowed repo transactions in all government securities and treasury bills of
all maturities. Lately State government securities, public sector undertakings’ bonds and
private corporate securities have been made eligible for repos to broaden the repos market.
Explaining the usefulness of repos Report on Currency and Finance 1999-2000 notes
that “repos help to manage liquidity conditions at the short-end of the market spectrum.
Repos have been used to provide banks an avenue to part funds generated by capital inflows
to provide a floor to the call money market. During times of foreign exchange volatility,
repos have been used to prevent speculative activity as the funds tend to flow from the
money market to the foreign exchange market.”
The Commercial Bill Market
The commercial bill market is the sub-market in which the trade bills or the commercial
bills are handled. The commercial bill is a bill drawn by one merchant firm on the other.
Generally, commercial bills arise out of domestic transactions. The legitimate purpose of
a commercial bill is to reimburse the seller while the buyer delays payment. In India, the
commercial bill market is highly undeveloped. The two major factors which have arrested
the growth of a bill market are: (i) popularity of cash credit system in bank lending, and
(ii) the unwillingness of the larger buyer to bind himself to payment discipline associated
with the commercial bill. Among other factors which have prevented growth of genuine bill
market are lack of uniformity in drawing bills, high stamp duty on usance or time bills and
the practice of sales on credit without specified time limit.
Commercial bills as instruments of credit are useful to both business firms and banks.
In addition, since the drawees of the bill generally manage to recover the cost of goods from
their resale or processing and sale during the time it matures, the bill acquires a self liquidating
character. Finally, it is easier for the central bank to regulate bill finance. Keeping in view these
considerations the RBI has made efforts to develop a bill market in this country and popularise
the use of bills. Its two specific bill market schemes, however, had limited success. The old bill
market scheme introduced in January 1952 was not correctly designed to develop a bill market.
It merely provided for further accommodation to banks in addition to facilities they had already
enjoyed. The scheme had, in fact, provided for obtaining loans on the security of bills rather than
for their rediscount. In order to encourage use of bills the RBI offered loans at a concessional rate
of interest and met half the cost of stamp duty incurred by banks on converting demand bills into
usance bills. This scheme, however, failed to make any impact.
Not satisfied with the old scheme the RBI introduced a new bill market scheme in
November 1970. It has been modified from time to time. The two noteworthy features of
the new scheme are: (i) The bills covered under the scheme are genuine trade bills; and
(ii) the scheme provides for their rediscounting. Even this scheme which really aimed at
developing a bill market in the country has not been very successful. The major obstacle
to the development of bill finance in this country is the dominant cash credit system of
credit delivery where the bonus of cash management rests with banks. Absence of an active
secondary market further prevented growth of the market for bills finance.
The success of the bills discounting scheme depends largely upon financial discipline on
the part of borrowers. In the absence of such restraints, the RBI, in July 1992, restricted the
banks to finance bills to the extent of working capital needs based on credit norms. However,
in order to encourage ‘bills’ culture, the RBI advised banks in October 1997 that at least 25
Money Market and Capital Market 97
per cent of inland credit purchases of borrowers should be through bills. Nonetheless, the
outstanding amount of commercial bills rediscounted by the banks with various financial
institutions was only Rs. 235 crore at end-May 2000.
The Certificate of Deposit (CD) Market
A Certificate of Deposit (CD) is a certificate issued by a bank to depositors of funds that
remain on deposit at the bank for a specified period. Thus CDs are similar to the traditional
term deposits but are negotiable and tradeable in the short-term money markets. In the mideighties,
the short-term banks deposit rates were much lower than other comparable interest
rates. The Vaghul Committee thus felt that the CD as a money market instrument could
not be developed in this country until the situation remained unchanged. The Committee
stressed that it was necessary for the introduction of the CD that the short-term bank deposit
rates were aligned with the other interest rates. In 1988-89, the RBI, as a corrective measure
revised upwards the rate of interest on term deposits of 46 to 90 days. Once this was done
in March 1989, the RBI introduced CDs with the objective of widening the range of money
market instruments and to provide investors greater flexibility in the deployment of their
short-term surplus funds. The CDs could initially be issued only by scheduled commercial
banks in multiples of Rs. 25 lakh (later lowered to Rs. 10 lakh) subject to the minimum size
of an issue being Rs. 1 crore. Their maturity varied between three months and one year.
In 1993 six financial institutions, viz., Industrial Development Bank of India, Industrial
Credit and Investment Corporation of India, Industrial Finance Corporation of India, The
Industrial Reconstruction Bank of India, Small Industries Development Bank of India
and Export-Import Bank of India were permitted to issue CDs with a maturity period of
more than one year and upto three years. CDs are issued at discount to face value and the
discount rate is market determined. They are further freely transferable by endorsement
and delivery. Banks pay a high interest rate on CDs. Hence holders of CDs prefer to hold
them till maturity and thus secondary activity in CDs has been non-existent. There was also
a lack of interest among banks in issuing fresh CDs in 1993-94. The stringent conditions in
the money market in 1995-96, however, induced banks to mobilise resources on a large scale
through CDs. The outstanding amount of CDs issued by the banks rose from Rs. 8,017 crore
as at end-March 1995 to Rs. 21,503 crore as on June 7, 1996 but declined to Rs. 14,296 crore
as on March 27, 1998. Thereafter there was a steep fall in outstanding amount of CDs and
it was as low as Rs. 872 crore as on May 5, 2000. Due to the tight money market conditions,
the discount rates on CDs increased sharply during 1995-96. However, since July 1996 the
average discount rate on CDs has steadily declined. On June 2, 2000 effective discount rate
range was 8.00–11.16 per cent per annum. To bring CDs at par with other instruments such
as CPs and term deposits, the minimum maturity of this instrument was reduced to 15 days
in April 2000 from 3 months earlier.
The Commercial Paper Market
The Commercial Paper (CP) is a short-term instrument of raising funds by corporates.
It is essentially a sort of unsecured promissory note sold by the issuer to a banker or a
security house. The issuance of CP is not related to any underlying self-liquidating trade.
Therefore, maturity of this instrument is flexible. Usually borrowers and lenders adopt the
maturity of a CP to their needs. Highly rated corporates which can obtain funds at a cost
lower than the cost of borrowing from banks are particularly interested in issuing CPs.
Institutional investors also find CPs as an attractive outlet for their short-term funds. The
Vaghul Committee had strongly recommended the introduction of CPs in the Indian money
market. In its observations on this instrument, the Committee had stated, “the issue of
commercial paper imparts a degree of financial stability to the system as the issuing company
has an incentive to remain financially strong. The possibility of raising short-term finance
at relatively cheaper cost would provide an adequate incentive for the corporate clients to
improve the financial position and in the process the financial health of the corporate sector
should show visible improvement.”
Following the recommendations of the Vaghul Committee, the CP was introduced in the
Indian money market in January 1990. The CP can be issued by a listed company which has
a working capital of not less than Rs. 5 crore. With maturity ranging from three months to
six months they would be issued in multiples of Rs. 25 lakh (later reduced to Rs. 25 lakh)
subject to the minimum size of an issue being Rs. 1 crore (later reduced to Rs. 25 lakh).
The company wanting to issue CP would have to obtain every six months a specified rating
from an agency approved by the RBI. CPs would be freely transferable by endorsement
and delivery. According to the RBI’s guidelines for the issue of CP, a company will have
to obtain P2 rating from Credit Rating Information Services of India Ltd. (CRISIL) or A2
rating from Investment Information and Credit Rating Agency of India Ltd. (ICRA). It has
also to maintain the current ratio of 1.33:1 to be eligible to issue CP. Maturity period of CP
so far ranged from 3 months to 6 months and the effective interest rates were in the range
of 9.35 to 20.9 per cent per annum. Easy liquidity conditions gave fillip to the issue of CPs
during 1996-97 and the outstanding stocks of CPs rose from a historical low level of Rs. 71
crore in April 1996 to Rs. 7,127 crore as on July 15, 2000 with the typical effective discount
rate range being 9.35–11.65 per cent annum.
Money Market Mutual Funds
A scheme of Money Market Mutual Funds (MMMFs) was introduced by the RBI in April
1992. The objective of the scheme was to provide an additional short-term avenue to the
individual investors. As the initial guidelines were not attractive, the scheme did not receive
a favourable response. Hence, with a view to making the scheme more flexible, the RBI
permitted certain relaxations in November 1995. The new guidelines allow banks, public
financial institutions and also the institutions in the private sector to set up MMMFs. The
ceiling of Rs. 50 crore on the size of MMMFs stipulated earlier, has been withdrawn. The
prescription of limits on investments in individual instruments by MMMF has been generally
Money Market and Capital Market 99
deregulated. Since April 1996, MMMFs are allowed to issue units to corporate enterprises
and others. During 1996-97 the scheme of MMMFs was made more flexible by bringing
it on par with all other mutual funds by allowing investment by corporates and others.
The scheme was later on made more attractive to investors by reducing the lock-in period
from 46 days to 15 days. The scheme was further liberalised in 1997-98 and the MMMFs
were permitted to make investments in rated corporate bonds and debentures with residual
maturity of upto one year. Resources mobilised by the MMMFs could earlier be invested
exclusively in call/notice money, treasury bills, CDs, CPs, commercial bills arising out of
genuine trade/commercial transactions and government securities having an unexpired
maturity upto one year. The prudential measure that the exposure of MMMFs to CPs issued
by an individual company should not exceed 3 per cent of the resources of the MMMF has
The term “Capital Market” is used to describe the institutional arrangements for facilitating
the borrowing and lending of long-term funds. Usually, stress is laid on the markets for longterm
debt and equity claims, government securities, bonds, mortgages, and other instruments
of long-term debts. Thus, the capital market embraces the system through which the public
takes up long-term securities, either directly or through intermediaries. It consists of a series
of channels through which the savings of the community are mobilised and made available
to the entrepreneurs for undertaking investment activities.
Conventionally, short-term credit contracts are usually classified as money market
instruments, while long-term debt contracts and equities are regarded as capital market
instruments. In practice, however, there is a thin line of demarcation between the money
market and the capital market, because quite often, the same institutions participate in the
activities of both the markets, and there is flow of funds between the two markets.
Classification of Indian Capital Market
The Indian capital market is divided into the gilt-edged market and the industrial securities
market. The gilt-edged market refers to the market for government and semi-government
securities, backed by the Reserve Bank of India. The securities traded in this market are of
stable value. They are mostly demanded by banks and other institutions.
The industrial securities market refers to the market for shares and debentures of old
and new companies. This market is further divided into the new issue market and the old
market, meaning the stock exchange. The “new issue market” refers to the raising of new
capital in the form of shares and debentures. The old capital market deals with securities
already issued. Both markets are equally important.
The capital market is also classified into primary capital market and secondary capital
market. The primary market refers to the new issue market. The secondary capital market
refers to the market for old or already issued securities. The secondary capital market is
composed of industrial security market or the stock exchange.
Importance of Capital Market
An efficient capital market is an essential pre-requisite for industrial and commercial
development of a country. An organised and well-developed market operating in a free
market economy ensures the best possible co-ordination and balance between the flow of
savings on the one hand and the flow of investment leading to capital formation on the
other. It also directs the flow of savings into most profitable channels and thereby ensures
optimum utilisation of financial resources. The importance of capital market in the process
of economic development of a country can be described as below:
1. Mobilising Savings: The capital market plays a vital role in mobilising savings to
put it in productive investment, so that the development of trade, commerce and
industry could be facilitated. In this process the capital market helps in the process
of capital formation and hence the economic development. The capital market acts
as a bridge, between savers and investors.
2. Stability in Value: In case of a developed capital market, the experts in banking
and non-banking intermediaries put in every effort in stabilising the values of stocks
and securities. This process is facilitated by providing capital to the needy at a lower
rate of interest and by cutting down the speculative and unproductive activities.
3. Encouragement to Economic Growth: The process of economic growth is made
easier through the capital market. The various institutions of the capital market give
quantitative and qualitative direction to the flow of funds. The proper flow of funds
leads to the development of commerce, trade and industry.
4. Inducement to Savings: Savings are the backbone of any nation’s economic
development. If capital markets are developed in less developed areas, people will
get induced to save more because savings are facilitated by banking and non-banking
Thus, it is clear that the capital market is the life-blood of economic development
of a country. If the capital market is not developed, it will lead to misuse of financial
resources. The capital market plays a significant role in diverting the wrongful use
of resources to their rightful use.
Functions of Capital Market
The major functions performed by a capital market are as follows:
(a) Mobilisation of financial resources on a nation-wide scale.
(b) Securing the foreign capital and know how to fill up the deficit in the required
resources for economic growth at a faster rate.
(c) Effective allocation of the mobilised financial resources by directing the same to
projects yielding highest yield or to the projects needed to promote balanced economic
Money Market and Capital Market 101
Structure of Indian Capital Market
The capital market in India may be classified into two sectors (a) organised, and
(b) unorganised sector. In the organised sector of the capital market demand for long-term
capital comes from corporate enterprises, public sector enterprises, government and semigovernment
institutions. The sources of supply of funds comprise individual investors,
corporate and institutional investors, investment intermediaries, financial institutions,
commercial banks and government. In India, even the organised sector of capital market
was ill-developed till recently because of the following reasons:
(a) Agriculture was the main occupation which did not lend itself to the floatation of
(b) The foreign business houses hampered the growth of securities market.
(c) Various restrictions have been imposed on the investment pattern of various financial
(d) The investment habit of individuals has been very low.
The unorganised sector of the capital market consists of indigenous bankers and private
money-lenders. The main demand in the unorganised capital market comes from the
agriculturists, private individuals for consumption rather than production and even small
traders. The supply of money-capital comes, usually from own resources of money-lenders
and falls short of the requirements.
Components of Indian Capital Market
The following are the main components of the Indian capital market:
1. New Issues Market.
2. Stock Market.
3. Financial Institutions.
1. New Issues Market: The new issues market represents the primary market where
new shares or bonds are offered. Both the new companies and the existing ones can
raise capital on the new issue market. The prime function of the new issues market
is to facilitate the transfer of funds from the willing investors to the entrepreneurs
setting up new corporate enterprises, going in for expansion, diversification, growth or
modernisation. Besides, helping the corporate enterprises in securing their funds, the
new issues market channelises the savings of individuals and others into investments.
The availability of financial resources for corporate enterprises, to a great extent,
depends upon the status of the new issues market of the country. Successful issues of
new securities is a highly specialised activity and requires both experience and skill.
There are a number of methods of marketing new issues of securities.
2. Secondary Market or Stock Market: Stock market represents the secondary
market where existing shares and debentures are traded. Stock exchange provides
an organised mechanism of purchase and sale of existing securities. The stock
exchanges enable free purchase and sale of existing securities. The stock-exchanges
enable free purchase and sale of securities as commodity exchange allow trading in
3. Financial Institutions: Special financial institutions are the most active
constituents of the Indian capital market. Such organisations provide medium
and long-term loans repayable on easy instalments to big business houses. Such
institutions help in promoting new companies, expansion and development of
existing companies and meeting the financial requirements of companies during
economic depression. After independence, a number of financial institutions
have been set up at all India and regional levels for accelerating the growth of
industries by providing financial and other assistance. The following are the
main financial institutions that are most active constituents of the Indian capital
(a) The Industrial Finance Corporation of India Ltd.
(b) The Industrial Credit and Investment Corporation of India.
(c) State Financial Corporations.
(d) The Industrial Development Bank of India.
(e) National Industrial Development Corporations.
(f) Unit Trust of India.
(g) Life Insurance Corporation of India.
(h) Nationalised Commercial Banks.
(i) Merchant Banking Institutions.
(j) The Credit Guarantee Corporation of India.
Recent Trends in the Capital Market
Capital market is the market for long-term funds, just as the money market is the market
for short-term funds. It refers to all the facilities and the institutional arrangements for
borrowing and lending medium-term and long-term funds. It does not deal in capital goods
but is concerned with the raising of money capital for purpose of investment. A welldeveloped
capital market is necessary for the economic development of a country. The Indian
Capital Market was not properly developed before independence. But since independence
the Indian capital market has been broadening significantly and the volume of saving and
investment has shown steady improvement. Many institutional innovations have been made,
liberalisation has been accepted and private sector entered all avenues of trade, commerce
and industry. Capital issues control has been abolished. Stock Exchange Board of India has
taken the challenge of regulating the capital market. New financial instruments and players
entered the market. Leasing companies, hire-purchase companies, venture capital companies
were set up in the country.
The recent trends in the capital market can be discussed under the following heads:
1. Growth of the Capital Market.
Money Market and Capital Market 103
2. New Financial Instruments.
3. New Specialised Financial Institutions.
4. Financial Services.
5. Regulation of Capital Market.
1. Growth of the Capital Market: Since independence and particularly after 1951,
the Indian capital market has grown in size. The volume of saving and investment
in the country has shown steady improvement. All types of encouragement and tax
relief exist in the country to promote savings. Besides, many steps have been taken
to protect the interests of investors. The primary market and secondary market
have grown. A very important indicator of the growth of the capital market is the
growth of joint-stock companies. In 1951, there were about 28,500 companies, both
public and private limited companies, with a paid-up capital of Rs. 775 crores. But
in 1997, there were about 64,000 companies, with a paid-up capital of Rs. 1,00,000
crores. In the last two decades, the capital market in India has witnessed significant
developments. The volume of capital market transactions have increased sharply and
its functioning has been diversified. The number of shareholders runs into several
millions, indicating the growth of the cult of equity.
2. New Financial Instruments: The corporate sector has devised new instruments
for raising funds from the market. New instruments include zero interest bonds,
equity warrant, secured premium note, deep discount bond and partly convertible
debentures. Joint-stock companies could raise more and more finance by the issue
of new instruments. These new instruments widened the capital market. The
Government of India has introduced into the market (1) 14-day Intermediate
Treasury Bills in April 1997, (2) A new category of 14-day Treasury Bills in 1977,
(3) Commercial Paper, (4) Dated Government Securities.
3. New Specialised Financial Institutions: The Government of India has set up a
series of financial institutions to provide funds to the large industrial sector. The
important financial institutions established are the Industrial Finance Corporation
of India, the Industrial Investment and Credit Corporation of India, the Industrial
Development Bank of India. The specialised financial institutions are called
development banks. They have been underwriting the shares and debentures issued
by companies. They have been subscribing to the share capital of companies.
Besides development banks, non-banking finance companies have come into
existence all over the country and have been making rapid progress. They advance
loans to wholesale and retail traders, small-scale industries and self employed
persons. Hire-purchase companies, venture capital companies, finance corporations
are all non-banking finance companies.
Holding Corporation of India, Infrastructure Leasing and Financial Services Ltd.,
The Credit Rating Information Services of India, Housing Development Corporation
of India have been set up in the country.
4. Financial Services: The entry of service sector in the capital market is adding new
dimension in the market. The financial services offered are:
(1) Venture Capital, (2) Factoring Services, (3) Leasing, (4) Merchant Banking,
(5) Mutual Funds.
5. Regulation of Capital Market: Stock Exchange Board of India has been set up in
1988 to lay guidelines, and supervise and regulate the working of capital market.
SEBI in consultation with the Government has taken a number of steps to introduce
improved practices and greater transperancy in the capital markets in the interest of
the investing public and the healthy development of the capital markets. SEBI has the
power to control and regulate the new issue market as well as the old issues market.
Since 1992, the Government has allowed Indian companies access to international
markets through Euro-equity shares.
Comparison of Money Market and Capital Market
There are important similarities and differences between money market and capital
Similarities: The money market and capital market have certain similarities and inter
relations. They are:
1. Complementary: The money market and the capital market are complementary to
each other and are not competitive. The difference between the two is only of degree
rather than of kind.
2. Same Institutions: Certain institutions operate in money as well as capital markets.
For example, commercial banks operate in money market as well as in capital market.
They have started giving long-term loans also in recent years.
3. Interdependence: Money market and capital market are interdependent. The
activities and policies of one market have their impact on those of the other. For
example, the increased demand for funds in the capital market also raises the
demand and interest rates in the money market. Similarly, the monetary policy also
influences the activities of the capital market.
Differences: Money market is distinguished from capital on the basis of the maturity
period, credit instruments and the institutions.
1. Maturity Period: The money market deals in the lending and borrowing of shortterm
finance. But the capital market deals in lending and borrowing of long-term
2. Credit Instruments: The main credit instruments of the money market are trade
bills, promissory notes and Government papers or bills. On the other hand, the main
instruments used in the capital market are stocks, shares, debentures, bonds and
securities of the Government.
3. Nature of Credit Instruments: The credit instruments dealt within the capital
market are more heterogeneous than those in money market.
Money Market and Capital Market 105
4. Institutions: Important institutions operating in the money market are central
bank, commercial banks, acceptance houses, non-banking financial institutions,
bill brokers etc. Important institutions in the stock market are stock exchanges,
commercial banks, development banks and non-banking financial institutions such
as insurance companies, mortgage banks and building societies.
5. Purpose of Loans: The money market meets the short-term credit needs of business.
It provides working capital to the industrialists. The capital market, on the other
hand, meets the long-term needs of the industrialists and provides fixed capital to
buy land, machinery etc.
6. Risk: The degree of risk is small in the money market. The risk is much greater in
7. Relation with Central Bank: The money market is closely and directly linked with
the central bank of the country. The capital market feels central bank’s influence,
but mainly indirectly and through the money market.
8. Market Regulation: In the money market, commercial banks are closely regulated.
In the capital market, the institutions are not much regulated.
9. Basic Role: The basic role of money market is that of liquidity adjustment. The
basic role of capital market is that of putting capital to work preferably to long-term
and productive employment.
From the above discussion, it is clear that the money and capital markets of a country play
an important part, as they control the flow of short-term and long-term funds in the country.
The money market determines the volume of working capital available to business and
industrial units and also the price level. Likewise, the capital market determines the supply
of long-term capital for the industrial units.