Money Market & its Role in

Financial Market Integration

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Initial impact of Indirect
Monetary Policy Instruments
PRIMARY MARKET
Initial sale of T-bills by the
Government’s agent, usually the
CB. Sold by auction or tap issue.
PRIMARY GOVERNMENT BOND
MARKET
Initial sale of government bonds by
Government’s agent, usually the
CB. Sold by auction or tap issue.
INTERBANK MARKET
Funds held immediately prior to final settlement to enable
banks to meet obligations to each other and to the central
bank. Only institutions with accounts at the CB & the CB
participate.
CALL LOAN or REPO MARKET
Market for funds with overnight maturity.
Transactions take place during the day.
Banks and large organizations participate.
FOREIGN
EXCHANGE
TERM MONEY MARKET MARKET
Market for funds with maturities >1 day
and <1 year. Includes secondary market in Liquidity of the Money Market
T-bills & other paper. Banks & large affects the functioning of the
financial organizations participate. Foreign Exchange Market.
Money Market liquidity and
stability affects the liquidity of
the Bond Market.
BOND MARKET
Market for paper of over 1 year remaining
to maturity. Banks and other financial and
institutional investors participate.
3
 1. What are Money Markets?

• A word about repos

– “Buyer” agrees to buy securities from the “seller” for a pre-
specified period of time, with an agreement upfront to resell
them back to the “seller” at the pre-specified future date at a
pre-agreed resale price.

– Difference between initial price and resale price reflects

interest rate paid by “seller” for use of cash received.

– In effect, repos are equivalent to a collateralized loan

– Most transactions conducted under a single legal agreement

between two parties—Master Repurchase Agreement

4
 2. Benefits of Money Markets

• More effective monetary policy

• Promote financial stability & market development

• Reduce cost of government borrowing

5
 2. Benefits of Money Markets

• More effective monetary policy

– Desired liquidity settings can be achieved without distorting

prevailing market prices

– First step of transmission of monetary actions to economy

– Money market interest rates are a useful indicator of market

expectations regarding future monetary actions

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 2. Benefits of Money Markets

• Promote financial stability & market development

– Help financial institutions manage their short-term liquidity
flows

– Facilitate development of well-functioning debt, equity, and

foreign exchange markets

Money markets enable market makers in other markets to

fund their holdings of securities and foreign exchange so
they can trade with other participants

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 2. Benefits of Money Markets

• Reduce cost of government borrowing

– Existence of liquid debt markets

 Reduce risk of auction failure (more certainty in funding)

 Lower borrowing costs (government captures liquidity premia)

8
3. Conditions for Money Market Development

Conditions for developing a well-functioning money market

– Banks and other investors should be commercially motivated to

actively manage risk and maximize profits

– Sound banks and other financial institutions

Repos can help foster trading between institutions because transactions

are fully collateralized

– Shift from direct to indirect monetary policy instruments

– Sound government cash & debt management and coordination with

monetary policy

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 4. Role of Monetary Policy Framework

• Role of exchange rate regime / monetary framework

• Stability oriented monetary policy

• Well-designed monetary policy operating procedures

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 4. Role of Monetary Policy Framework

• Choice of exchange rate regime / monetary framework

can help determine role of central bank in money market
– Exchange rate target & open Capital account

Monetary policy mainly relies on unsterilized FX intervention

– Exchange rate target & Capital controls

Some scope for setting domestic liquidity conditions in money

market

– Floating exchange rate & inflation targeting

Well-functioning money market critical to minimize uncertainty

surrounding monetary operations
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 4. Role of Monetary Policy Framework

• Monetary policy objectives also influence development

of the money market

– Market participants more willing to invest in and trade securities

if they are confident that investment returns will not be eroded
by unexpected inflation

– Important to have a nominal anchor for monetary policy

i.e. transparent exchange rate or inflation target for monetary policy

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 4. Role of Monetary Policy Framework

• Monetary policy operating procedures

– Affect the stability of the money market and
– Provide incentives for banks & other investors to use the
money market to manage risk

Trade-off between

– Encouraging active trading in the money market vs.

– Inducing excessive volatility in short-term interest rates

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 4. Role of Monetary Policy Framework

• Standing facilities

– Penalty rates (i.e. wide corridor between central bank

lending and deposit rates) to provide incentives for money
market trading before accessing central bank facilities

– Collateralized lending by central bank to protect it & ensure

credit extended is used by FIs to manage liquidity rather than
solvency deficiencies

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 4. Role of Monetary Policy Framework

• Repo and outright open market operations

– Foster the development of secondary markets in the
underlying securities

 Central bank bills can be a useful instrument when there is

no working T-bill market or the central bank is perceived more
creditworthy than the government
 But: central bank bills may fragment the money market & can
undermine the financial condition of the central bank

– Foster collateralized money markets (collateralized call

loans,repos, buy/sell backs)

– High frequency operations by the central bank may

discourage money market trading
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 4. Role of Monetary Policy Framework

• Reserve requirements

Trading activity in interbank & overnight markets will be

determined by

– Length of reserve maintenance period

– Averaging provisions for meeting reserve requirements
– Treatment of interbank transactions for reserve purposes
– Penalties for accessing central bank lending and deposit
facilities

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5. Coordinating Monetary Operations with Government
Cash & Debt Management

• Importance of accurate liquidity forecasts

– Monetary operations are based on liquidity forecasts

• Good liquidity forecasts contribute to more accurate monetary policy
settings
• This make it easier for the market to understand signals in monetary
operations

– Items in the “autonomous supply component” that are most

difficult to predict are government cash receipts and payments

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 5. Coordinating Monetary Operations with Government
Cash & Debt Management

• Government cash flows

– can be a major source of uncertainty in central bank
liquidity management

– affects the autonomous component of liquidity supply

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 5. Coordinating Monetary Operations with Government
Cash & Debt Management

• Consequently
– Need sound management of government cash flows and
debt stock

– Important to have good information-sharing between those

responsible for implementing monetary policy & those
managing the government’s cash balances and debt stock

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 6. Pitfalls to Avoid

• Some pitfalls to avoid when developing debt markets

– Lenient monetary policy operating procedures that make
it easy for market participants to deal with central bank
rather than with one another
– Weak controls in market operations, which expose the
central bank to the risk of financial loss
– Poorly designed clearing & settlement systems that are
costly to operate and not sufficiently risk-proofed
– Insufficient consultation with market participants & other
stakeholders when introducing market reforms
– Liberalizing K controls too quickly, leaving the financial
system vulnerable to the ebbs & flows of foreign K flows

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Monetary Policy Transmission
Money Market Structure in India
 The Products & Process
• Instrument Based Market (Buy and Sell):
– Certificate of Deposit (CD)
– Commercial Paper (C.P)
– Treasury Bills
• Funding Market (Lending & Borrowing)
– Call Money
– Repo
– Inter Bank term Money
– CBLO
 Rates (%)

10.00
12.00
16.00

0.00
2.00
4.00
6.00
8.00
14.00
Jan-04
May-04
Sep-04
Jan-05
May-05
Sep-05
Jan-06
May-06
Sep-06

CallR
Jan-07
May-07
Sep-07
Jan-08

RepoR
May-08
Sep-08
Jan-09
May-09

CBLOR
Sep-09
Jan-10
May-10
Sep-10

Rev. Repo
Jan-11
May-11
Sep-11
Monetary Policy Synchronization

Jan-12
May-12
LAF Repo

Sep-12
Jan-13
Money Market Rates

May-13
Sep-13
Jan-14
May-14
Sep-14
Jan-15
May-15
Sep-15
 0
10000
20000
30000
40000
50000
60000
70000
80000
90000
Jan-04
May-04
Sep-04
Jan-05
May-05
Sep-05
Jan-06
May-06
Sep-06
Jan-07
May-07
Sep-07
Jan-08
May-08
Sep-08

CallV
Jan-09
May-09
Sep-09

RepoV
Jan-10
May-10

CBLOV
Sep-10
Jan-11
Money Market Activity

May-11
Sep-11
Jan-12
Money Market

May-12
Sep-12
Jan-13
May-13
Sep-13
Jan-14
May-14
Sep-14
Jan-15
May-15
Sep-15
 Interest Rate Structure
Year CallR RepoR CBLOR Rev. Repo LAF Repo
2004 4.60 4.22 4.22 4.54 6.00
2005 5.11 4.94 4.85 4.96 6.05
2006 6.44 6.12 6.01 5.74 6.78
2007 6.69 5.72 5.44 6.00 7.67
2008 7.73 7.21 6.84 5.94 8.02
2009 3.50 3.09 2.84 3.42 4.92
2010 4.93 4.71 4.54 4.15 5.47
2011 7.61 7.38 7.17 6.48 7.48
2012 8.34 8.20 8.07 7.14 8.14
2013 8.28 8.27 8.08 6.52 7.52
2014 8.13 8.24 8.12 6.98 7.98
2015 7.39 7.48 7.41 6.46 7.46
 Market Switch
Market Distribution in 2004 Market Distribution in 2015

Call
CBLO 11%
16%

Call
50% Repo
27%

CBLO
Repo 62%
34%
 A Typical Bank Balance Sheet
Bank Accounting for SLR/CRR
Capital 10000 Cash and Cash Equivalent 6500
Tier I 4000 Cash 2000
Tier II 6000 Cash in Chest 3000
Deposits 65000 Cash in RBI 1500
Savings 20000 Investment MD 36000
Current 12000 Sov Bonds 6.2 20000 2%
(Risk
Recurring 8000 State Bonds 4.5 3000 2% Tolerance
Fixed 25000 Munis 3.6 4000 2% Limit)
Borrowing 36500 Corporate 4.7 9000 2%
Inter-bank 13000 Loans Risk Wght 69000
Overnight 4500 Govt 5% 4500 0%
Term 8500 States 10% 1500 0%
Notes 23500 Retail 100% 25000 40% Collateral
Short Term 8500 Corporate 100% 38000 30%
Long Term 15000
Total 111500 111500
GROSS REVENUE 5000