Money Market: Meaning, Working and Functions

In this article we will discuss about:- 1. Meaning and Features of Money Market 2. Institutions of the Money Market 3. Instruments 4. Working 5. Functions 6. Characteristics of an Undeveloped Money Market 7. Characteristics of an Developed Money Market.

Contents:

1. Meaning and Features of Money Market
2. Institutions of the Money Market
3. Instruments of Money Market
4. Working of Money Market
5. Functions of Money Market
6. Characteristics of an Undeveloped Money Market
7. Characteristics of an Developed Money Market

1. Meaning and Features of Money Market:

The money market is a market for short-term instruments that are close substitutes for money. The short term instruments are highly liquid, easily marketable, with little change of loss. It provides for the quick and dependable transfer of short term debt instruments maturing in one year or less, which are used to finance the needs of consumers, business agriculture and the government.

The money market is not one market but is “a collective name given to the various form and institutions that deal with the various grades of near- money.” In other words, “it is a network of market that are grouped together because they deal in financial instruments that have a similar function in the economy and are to some degree substitutes from the point of view of holders.” Thus the money market consists of call and notice market, commercial bills market, commercial paper market, treasury bills market, inter-bank market and certificates of deposit market. All these markets are closely interrelated so as to make the money market. It is a wholesale market where large number of financial assets or instruments are traded.

The money market is divided into direct, negotiated, or customers’ money market and the open or impersonal money market. In the former, banks and financial firms supply funds to local customers and also to larger centres such as London for direct lending. In the open money market, idle funds drawn from all-over the country are transferred through intermediaries to the New York City market or the London market.

These intermediaries comprise the Federal Reserve Banks in the USA or the Bank of England in England, commercial banks, insurance companies, business corporations, brokerage houses, finance companies, state and local government securities’ dealers. The money market is a dynamic market in which new money market instruments are evolved and traded and more participants are permitted to deal in the money market.

2. Institutions of the Money Market:

The various financial institutions which deal in short term loans in the money market are its members.

They comprise the following types of institutions:

1. Central Bank:

The central bank of the country is the pivot around which the entire money market revolves. It acts as the guardian of the money market and increases or decreases the supply of money and credit in the interest of stability of the economy. It does not itself enter into direct transactions. But controls the money market through variations in the bank rate and open market operations.

2. Commercial Banks:

Commercial banks also deal in short-term loans which they lend to business and trade. They discount bills of exchange and treasury bills, and lend against promissory notes and through advances and overdrafts.

3. Non-bank Financial Intermediaries:

Besides the commercial banks, there are non-bank financial intermediaries which lend short-term funds to borrowers in the money market. Such financial intermediaries are savings banks, investment houses, insurance companies, provident funds, and other financial corporations.

4. Discount Houses and Bill Brokers:

In developed money markets, private companies operate discount houses. The primary function of discount houses is to discount bills on behalf of other. They, in turn, form the commercial banks and acceptance houses. Along with discount houses, there are bill brokers in the money market who act as intermediaries between borrowers and lenders by discounting bills of exchange at a nominal commission. In underdeveloped money markets, only bill brokers operate.

5. Acceptance Houses:

The institution of acceptance houses developed from the merchant bankers who transferred their headquarters to the London Money Market in the 19th and the early 20 the century. They act as agents between exporters and importers and between lender and borrower traders. They accept bills drawn on merchants whose financial standing is not known in order to make the bills negotiable in the London Money Market. By accepting a trade bill they guarantee the payment of bill at maturity.

However, their importance has declined because the commercial banks have undertaken the acceptance business. All these institutions which comprise the money market do not work in isolation but are interdependent and interrelated with each other.

3. Instruments of the Money Market:

The money market operates through a number of instruments.

1. Promissory Note:

The promissory note is the earliest types of bill. It is a written promise on the part of a businessman today to another a certain sum of money at an agreed future data. Usually, a promissory note falls due for payment after 90 days with three days of grace. A promissory note is drawn by the debtor and has to be accepted by the bank in which the debtor has his account, to be valid. The creditor can get it discounted from his bank till the date of recovery. Promissory notes are rarely used in business these days, except in the USA.

2. Bill of Exchange or Commercial Bills:

Another instrument of the money, market is the bill of exchange which is similar to the promissory note, except in that it is drawn by the creditor and is accepted by the bank of the debater. The creditor can discount the bill of exchange either with a broker or a bank.

There is also the foreign bill of exchange which becomes due for payment from the date of acceptance. The rest of the procedure is the same as for the internal bill of exchange. Promissory notes and bills of exchange are known as trade bills.

3. Treasury Bill:

But the major instrument of the money markets is the treasury bill which is issued for varying periods of less than one year. They are issued by the Secretary to the Treasury in England and are payable at the Bank of England. There are also the short-term government securities in the USA which are traded by commercial banks and dealers in securities.

In India, the treasury bills are issued by the Government of India at a discount generally between 91 days and 364 days. There are three types of treasury bills in India— 91 days, 182 days and 364 days.

4. Call and Notice Money:

There is the call money market in which funds are borrowed and lent for one day. In the notice market, they are borrowed and lent up to 14 days without any collateral security. But deposit receipt is issued to the lender by the borrower who repays the borrowed amount with interest on call.

In India, commercial banks and cooperative banks borrow and lend funds in this market but mutual funds and all-India financial institutions participate only as lenders of funds.

5. Inter-bank Term Market:

This market is exclusively for commercial and cooperative banks in India, which borrow and lend funds for a period of over 14 days and up to 90 days without any collateral security at market-determined rates.

6. Certificates of Deposits (CD):

Certificates of deposits are issued by commercial banks at a discount on face value. The discount rate is determined by the market. In India the minimum size of the issue is Rs.25 lakhs with the minimum subscription of Rs.5 lakhs. The maturity period is between 3 months and 12 months.

7. Commercial Paper (CP):

Commercial papers are issued by highly rate companies to raise short-term working capital requirements directly from the market instead of borrowing from the banks. CP is a promise by the borrowing company to repay the load at a specified date, normally for a period of 3 months to 6 months. This instrument is very popular in the USA, UK, Japan, Australia and a number of other countries. It has been introduced in India in January 1990.

4. Working of the Money Market:

The money market consisting of commercial banks, discount houses, bill brokers, acceptance houses, non-bank financial houses and the central bank operates through the bills, securities, treasury bills, government securities and call loans of various types. As the money market consists of varied types of institutions dealing in different types of instruments, it operates through a number of sub-markets.

First, the money market operates through the call loan market. It has been defined as “a market for marginal funds, for temporarily unemployed or unemployable funds.” In this market the commercial banks use their unused funds to lend for very short periods to bill brokers and dealers in stock exchange.

In developed countries, even big corporations lend their dividends before distribution to earn interest for a very short period. The central bank also lends to commercial bank is for very short periods. Such loans are mostly for a week even for a day or a night and can be recalled at a very short notice.

That is why a short period loan is known as call loan or call money market. Bill brokers and stock brokers who borrow such funds use them to discount or purchase bills or stocks. Such funds are borrowed at the “call rate” which is generally one per cent below the bank rate.

But this rate varies with the volume of funds lent by the bank. If the brokers are asked to pay off loans immediately, then they are forced to get funds from large corporations and even from the central bank at high interest rate.

Second, the money market also operates through the bill market. The bill market is the short-period loan market. In this market, loans are made available to businessmen and the government by the commercial banks, discount houses and brokers. The instruments of credit are the promissory notes. Internal bills of exchange and treasury bills.

The commercial banks discount bills of exchange, lend against promissory notes or through advances or overdrafts to the business community. Similarly, the discount houses and bills brokers lend to businessmen by discounting their bills of exchange before they mature within 90 days. On the other hand, government borrows through the treasury bills from the commercial banks and non-bank financial institutions.

Third, the money market operator through the collateral loan market for a short period. The commercial banks lend to brokers and discount houses against collateral bonds, stock, securities, etc. In case of need, commercial banks themselves borrower from the large banks and the central bank on the basis of collateral securities.

Finally, the other important sub-market through which the money market operates is the acceptance market. The merchant bankers accept bills drawn on domestic and foreign traders whose financial standing is not known. When they accept a domestic or foreign trade bill, they guarantee its payment at maturity. In recent years, the commercial banks have also stared the acceptance business.

5. Functions of a Money Market:

A money market performs a number of functions in an economy.

1. Provides Funds:

It provides short-term funds to the public and private institutions needing such financing for their working capital requirements. It is done by discounting trade bills through commercial banks, discount houses, brokers and acceptance houses. Thus the money market helps the development of commerce, industry and trade within and outside the country.

2. Use of Surplus Funds:

It provides and opportunity to banks and other institutions to use their surplus funds profitably for a short period. These institutions include not only commercial banks and other financial institutions but also large non-financial business corporations, states and local governments.

3. No Need to Borrow from Banks:

The existence of a developed money market removes the necessity of borrowing by the commercial banks from the central bank. If the former find their reserves short of cash requirements they can call in some of their loans from the money market. The commercial banks prefer to recall their loans rather than borrow from the central banks at a higher rate of interests.

4. Helps Government:

The money market helps the government in borrowing short-term funds at low interest rates on the basis of treasury bills. On the other hand, if the government were to issue paper money or borrow from the central bank. It would lead to inflationary pressures in the economy.

5. Helps in Monetary Policy:

A well-developed money market helps in the successful implementation of the monetary policies of the central bank. It is through the money market that the central banks is in a position to control the banking system and thereby influence commerce and industry.

6. Helps in Financial Mobility:

By facilitating the transfer for funds from one sector to another, the money market helps in financial mobility. Mobility in the flow of funds is essential for the development of commerce and industry in an economy.

7. Promotes Liquidity and Safety:

One of the important functions of the money market is that it promotes liquidity and safety of financial assets. It thus encourages savings and investments.

8. Equilibrium between Demand and Supply of Funds:

The money market brings equilibrium between the demand and supply of loanable funds. This it does by allocating saving into investment channels. In this way, it also helps in rational allocation of resources.

9. Economy in Use of Cash:

As the money market deals in near-money assets and not money proper, it helps in economising the use of cash. It thus provides a convenient and safe way of transferring funds from one place to another, thereby immensely helping commerce and industry.

6. Characteristics of an Undeveloped Money Market:

The money markets in the majority of underdeveloped countries are mostly undeveloped or unorganised. In fact, they are dualistics, both developed and undeveloped money markets exist side by side. The developed money market consists of the central bank, the commercial banks, bill broker; discount houses, acceptance houses, etc.

On the other hand, the undeveloped money market consists of the moneylenders, the indigenous bankers, traders, merchants, landlords, pawnbrokers, etc. Since the majority of the people in underdeveloped countries live in rural areas and are poor, the undeveloped market controls a major portion of the money market.

The main characteristics of such a market are:

1. Personal Touch:

The lenders have a personal touch with the borrowers. The lender knows every borrower personally in the village because the latter sides there.

2. Flexibility in Loans:

There is no rigidity in loan transactions. The borrower can have more or less amount of loan according to his requirements depending upon the nature of security or his goodwill with the moneylender.

3. Multiplicity of Lending Activities:

Mostly people do not specialise is moneylending alone. They combine moneylending with other economic activities. A merchant may supply goods on loan instead or money in cash.

4. Varied Interest Rates:

There is multiplicity of interest rates. Interest rates are much higher than rates in the developed sector of the money market. The interest rate are not even uniform. The rate depends on the need of the borrower, the amount of loan, the time for which it is required and the nature of security. The greater the urgency, the higher will be the interest rate.

5. Defective System of Accounting:

In the unorganised sector of the money market, the system of maintaining accounts is highly defecate. Proper accounts are never maintained. Formal receipts are not issued for interest and the principal repaid by the borrowers. Besides, there is utmost secrecy in maintaining accounts and lending procedures in the undeveloped money market. The accounts of the moneylenders are not liable to checking by any higher authority.

6. Absence of Link with the Developed Money Market:

The undeveloped sector is not linked with the developed sector of the money market in such countries. The former works independently of the latter and is also not under the control of the developed market. This has the effect of reducing the volume of monetary transactions and savings, and prevent their use in productive investments.

7. Characteristics of a Developed Money Market:

The developed money market is a well organised market which has the following main features:

1. A Central Bank:

A developed money market has a central banks at the top which is the most powerful authority in monetary and banking matter. I controls, regulates and guides the entire money market. It provides liquidity to the money market, as it is the lender of the last resort to the various constituents of the money market.

2. Organised Banking System:

An organised and integrated banking system is the second feature of a developed money market. In fact, it is the pivot around which the whole money market revolves. It is the commercial banks which supply short-term loans, and discount bills of exchange. They form an important link between the borrowers, brokers, discount houses and acceptance houses and the central bank in the money market.

3. Specialised Sub-Markets:

A developed money market consists of a number of specialised sub-markets dealing in various types of credit instruments. There is the call loan market, the bill market, the treasury bill market, the collateral loan market and the acceptance market, and the foreign exchange market.

The larger the number of sub-markets, the more developed is the money market. But the mere number of sub-markets is not enough. What is required is that the various sub-markets should have a number of dealers in each market and the sub-markets should be properly integrated with each other.

4. Existence of Large Near-Money Assets:

A developed money market has a large number of near-money assets of various types such a bills of exchange, promissory notes, treasury bills, securities, bonds, etc. The larger the number of near-money assets, the more developed is the money market.

5. Integrated Interest-Rate Structure:

Another important characteristic of a developed money market is that it has an integrated interest-rate structure. The interest rates prevailing in the various sub-markets are integrated to each other. A change in the bank rate leads to proportional changes in the interest rate prevailing in the sub-markets.

6. Adequate Financial Resources:

A developed money market has easy access to financial sources from both within and outside the country. In fact, such a market attracts adequate funds from both sources, as is the case with the London Money Market.

7. Remittance Facilities:

A developed money market provides cash and cheap emittance facilities for transferring funds from one market to the other. The London Money Market provides such remittance facilities throughout the world.

8. Miscellaneous Factors:

Besides the above noted features, a developed money market is highly influenced by such factors as restrictions on international transactions, crisis, boom, depression, war, political instability, etc.