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Money market is the market where the banks raise and deploy (i.e. borrow & lend) short term funds ranging from one. day to one year These may be in the form of :

(a) Inter-bank money market such as Call money, Notice money and Term money, where investment are as per the ceiling imposed by RBI:

(I) Call Money : This is lending or borrowing for one day i.e. overnight Call money transactions reflect the liquidity availability on any particular day. Call money rate is indicated by Mumbai Inter-bank offered Rate (MIBOR).

(2)Notice money : Investment of funds for a period of more than one day but up to 14 days.

(3)Term money : Investment of funds for a period of 15 days or above up to I year.

Prudential Limits fixed by RBI for inter-bank money market

(1)Borrowing : On a fortnightly average basis, borrowing outstanding should not exceed 100 per cent of capital fund_s(i.e., sum of Tier 1 and Tier II capital) of latest audited balance sheet. However, banks are allowed to borrow a maximum of 125 per cent of their capital funds on any day, during a fortnight.

(2)Lending: On a fortnightly average basis, lending outstanding should not exceed 25 per cent of their capital fund_s;however, banks are allowed to lend a maximum of SO per cent of their capital funds on any day, during a fortnight.

(b) Investments in Securities such as treasury bills, commercial paper, certificate of deposit, repo.

(1)Treasury bills : These are issued by Govt. through RBI for maturity of 91 days, 182 days and 364 days, for predetermined amount. The interest is allowed by way of discount which is called implicit yield. The prices are determined by way of Auction by RBI where the banks or primary dealers participate. Investment in Treasury Bills by the Treasury of a bank, is an opportunity to park surplus funds in zero-risk securities that yield low income (but more than call money lending) and is liquid (as these can be sold) in secondary market.

T-Bills are held in electronic form in a SGL account (or constituent SGL account) maintained by banks with RBI. The payment of T-bills is received through Clearing Corpn. of India.

(2)Commercial paper: CP is an unsecured usance promissory note (i.e. negotiable instrument) issued by rated companies or financial institution to raise short term money with a maturity period of 7 days to one year. It can be issued for a minimum amount of Rs.5 lac, in Demat form only, at a discount to face value. For a company to issue CP, it should have credit rating of P2 by CRISIL or equivalent from any other agency. Issuing of CP is regulated by RBI guidelines and market practices prescribed by Fixed Income and Money Market and Derivatives Association of India (FIMMDA).

This instrument carries lower risk due to credit rating. Its sale and purchase can be made through depository participants. Treasury can make investment in CP and earn return better than T-Bills or call money operations. Being negotiable instrument, it also offers liquidity.

(3)Certificate of deposit: CD is an unsecured usance promissory note (i.e. negotiable instrument unlike a fixed deposit) issued by Banks and financial institutions to raise short term sources with a maturity of 7 days to one year. The minimum amount is Rs.1 lac. It is issued at a discount to face value, in demat form only. Treasury can make investment in CD and cam return better than T-Bills or call money operations. Being negotiable instrument, it also offers liquidity. Since it is issued by a bank or FI, it carries relatively lower risk.

(4)Repo : It refers to sale of a security (normally a Govt. security) with a commitment to repurchase of the same security at a later date. Whenever a bank is in need of short term funds_?.it can enter into a repo transaction with other bank or RBI. The difference in the sale price and re-purchase price is similar to interest on cash advance. The effective rate on repo is marginally lower than the corresponding money market rate, as the lending bank has security in hand, till the loan is repaid. In the books of a bank, the transaction appears like a sale and purchase transactions.

Treasury of the respective bank can use the Repo transaction both for investment purpose and for the purpose of raising short term funds.

RBI makes use of Repo extensively as an instrument to control liquidity in the inter-bank market. In case of short term liquidity problem, the banks also make use of repo under Liquidity Adjustment Facility.

Whenever RBI wants to absorb liquidity from the inter-bank market, it resorts to purchase of govt.

securities i.e. a Repo transaction. On the other hand to inject liquidity it makes use of Reverse Repo transaction and resorts to sale of govt. securities. The rate at which these transactions are undertaken is called Repo Rate and Reverse Repo Rate which keeps on changes. However, RBI maintains some spread in these rates.

(5)Bills rediscounting : Bills discounting provides an investment opportunity to the Treasury. These bills are of short term nature with maturity, generally, of 3-6 months which are already discounted by

Compiled by Sanjay Kumar Trivedy , Senior Manager , RSTC, Mumbai 166 | other banks. The rediscounting is done at near market prevailing rates. The borrowing bank is able to maintain liquidity by getting these bills rediscounted. It also is in a position to reduce its capital

requirement for capital adequacy purpose, as these bills are removed from credit portfolio and are added to the inter-bank liability.

Products available in Securities Market

Securities market offers an excellent opportunity for bank Treasury to invest surplus funds in (a) govt.

securities and (b) corporate securities.

Govt. Securities: Major portion of investment in Govt. securities takes the form of investment for SLR purpose (SLR is fixed by RBI without any minimum but subject to Maximum of 40% as per provision of Section 24 of RBI Act).

Govt. securities are issued (in the form of Bonds) by Public Debt Office of RBI on behalf of Govt. of India of State governments. The securities are sold through auctions conducted by RBI. Interest paid is called coupon rate. During these auctions, RBI reaches the cut-off price, based on the bids received from banks or PDs_

Govt securities are actively traded in the secondary market. Hence, the market price of these

securities keeps on changing depending upon demand and also the current interest rates prevailing in the market.

RBI issues bonds with a maturity period ranging from I to 30 years, with step-up coupon rates or coupon rates linked to inflation index or floating rate coupons.

Corporate Securities - Debt paper: These securities referred to as non-SLR investment, include the debenture and long term bends issued by companies and financial institutions. Tier-2 bonds such as Redeemable Cumulative Bonds issued by banks also fall in this category.

Yield on such securities is higher than the Govt. securities. Most of these securities are issued in Deposits, Companies issue these securities after getting them rated from rating agencies. When these securities are issued ie international market, the rating is obtained from international rating agencies.

corporate Securities - Debentures & bonds : These debt instruments are issued by companies as secured instruments by creating charge on their assets including floating charge or at times without any charge also (called unsecured debentures).

Conventionally, in India, the debentures are issued by companies and bonds by Public Sector Undertakings. PSUs may issue these bonds with or without govt. guarantee.

Debentures are governed by provisions of Companies Act and transferable by registration only.

Bonds are negotiable instruments. Companies issues unsecured debentures and bonds have to comply with Companies Acceptance of Deposits Rule* 1975.

Both may be issued with different structures such as (a) structured obligations, with put I call option (b) convertibility options (c) Zero coupon bonds (d) floating rate bonds (e) deep discount bonds.

These can be issued with redemption options in instalments (called period bonds).

The issuer of these securities appoints a Trustee where the bonds or debentures are secured. Such trustee functions in a fiduciary capacity to protect the interest of debenture I bond holders. The role of Trustee is governed by SEBI guidelines.

Corporate Securities - Convertible bonds : These bonds are a mix of debt and equity. In this

arrangement, the bond holders are given an opportunity to convert the debt into equity on a pre-fixed date or during a fixed period. The advantage of such instrument is that the company has no debt repayment obligation and gets additional equity on conversion.

Bank^,. can make investment in the corporate securities within the overall Capital Market Exposure ceiling prescribed by RBI. (Direct exposure 20% of net worth of previous year of a bank and aggregate exposure 40% - as on Mar of previous year).

Domestic & Global Markets-_,Interaction

The securities mentioned above are available both for domestic and 'global market. The interaction between domestic and global markets has offered opportunity for Treasury transactions and this interaction takes place through various instruments ;products, the details of which are given as under:

Foreign Institutional Investment (FII): Foreign currency funds are converted into rupees for

portfolio investment. Later on the rupee funds are converted into foreign currency for repatriation purposes.

ADRs/GDRs by Indian Companies : Indian companies mobilize funds abroad in the form of American Depository Receipts or Global Depository Receipts by issue of equity shares in the

international markets. The holders of these securities have the option to sell their securities in domestic market and receive the proceeds in foreign currency.

External commercial borrowing (ECB): Indian companies borrow in global markets to fund their domestic requirements. Such loans can be repaid by conversion of rupee funds into foreign currency funds.

Foreign currency funds of banks : Bank funds like FCNR deposits, can be invested in overseas or domestic market by banks. Banks can also borrow foreign currency funds from abroad within the ceiling fixed by RBI.