Money Market meaning, characteristics of money market, features of developed money market, functions of money market
MONEY MARKET
Money market is the market for dealing in monetary assets of short-term nature. Short term funds up to one year and financial assets that are close substitutes for money are dealt in the money market. In other words, it refers to the institutional arrangements facilitating borrowing and lending of short-term funds. The money market brings together the lenders who have surplus short term investible funds and the borrowers who are in need of short-term funds.
The money market is a wholesale debt market for low-risk, highly liquid, short-term instruments. The money market is not a place but an activity, the transactions are carried out by telephone, mail etc. among people who may have never met one another. Thus, the money market represents the country’s pool of short-term investible funds to meet the short-term requirements of the economy.
According to Nadler and Shipman, “A money market is a mechanical device through which short term funds are loaned and borrowed through which a large part of the financial transactions of a particular country or world are degraded. A money market is distinct from but supplementary to the commercial banking system.”
According to the McGraw Hill Dictionary of Modern Economics, “money market is the term designed to include the financial institutions which handle the purchase, sale, and transfers of short-term credit instruments. The money market includes the entire machinery for the channelizing of short-term funds. Concerned primarily with small business needs for working capital, individual’s borrowings, and government short term obligations, it differs from the long term or capital market which devotes its attention to dealings in bonds, corporate stock and mortgage credit.”
According to the Reserve Bank of India, “money market is the centre for dealing. mainly of short-term character, in money assets; it meets the short-term requirements of borrowings and provides liquidity or cash to the lenders. It is the place where short term surplus investible funds at the disposal of financial and other institutions and individuals are bid by borrowers’ agents comprising institutions and individuals and also the government itself.”
According to the Geoffrey, “money market is the collective name given to the various firms and institutions that deal in the various grades of the near money.”
According to the J.M. Culbertson, “money market is a network of markets 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 view of holders. The instruments of the money market are liquid assets, interest bearing debts that mature within a short period of time or callable on demand.”
S.N. Sen, in his book ‘Central Banking in Underdeveloped Money Market’, has aptly stated that the short-term money market is “the place where the strain on the banking system is first felt in periods of pressure, and it is the place where ease in the banking system is first felt in periods of monetary superfluity.”
The money market is thus a reservoir of short-term funds. It is a region where short term funds are bought and sold through telephone or mail. Funds are borrowed in the market for a short period ranging from a day to six months or less than one year. The assets which are used as credit instruments are known as “near money assets.”
GENERAL CHARACTERISTICS OF MONEY MARKET
The money market is a wholesale market. The volumes are very large and generally transactions are settled on daily basis. In an economy, a well-developed money market contributes to an effective implementation of the monetary policy also. On the basis of this, general characteristics of money market are outlined below:
1. Near money assets: Money market does not deal in money, but in short-term financial instruments or near-money assets. These assets are relatively liquid and readily marketable. The assets against which the funds can be borrowed in the money market include short-term government securities, bills of exchange, bankers’ acceptances, etc.
2. Short-term Loans: Money market deals with short-term loans. In a money market, the borrowers can obtain funds for periods varying from a day, a week, a month or three to six months. Thus, it deals with financial assets having a maturity period less than one year only.
3. Physical Contact Not Necessary: Money market does not refer to a specific place where borrowers and lenders meet each other. The transactions are being conducted even over the phone and therefore, there is an essential need for the presence of well-developed communication system. Thus, money market simply relates to the arrangement which establishes direct and indirect contact between the borrowers and lenders.
4. Brokers: Transactions in money market may be conducted with or without the help of brokers. Lenders and borrowers may carry on their negotiations through telephone or mail. Thus, money market simply relates to the arrangement which establishes direct and indirect contact between the borrowers and lenders without the help of brokers.
5. Transaction cost: The short-term financial assets that are dealt in money market are close substitutes for money. Therefore, these financial assets are being converted into money with ease, speed, without loss and with minimum transaction cost.
6. Heterogeneous Market: The money market is not a single homogeneous market but consists of several sub-markets, each market dealing with a specific short-term credit instrument, e.g., call money market, trade bill market, etc. Thus, it is difficult to talk about a general money market.
7. Constituents of Money Market: Like other markets, money market also has three constituents:
(a) It has buyers and sellers in the form of borrowers and lenders,
(b) It has a commodity; it deals with short-maturity credit instruments, like commercial bills, treasury bills, etc.
(c) It has a price in the form of rate of interest which is an item of cost to the borrower and return to the lender.
8. Dealers of Money Market: The financial institutions in the money market meet the short-term needs of the borrowers. The borrowers in the money market are traders, manufactures, speculators, and even government institutions. The lenders in the money market are commercial banks, central banks, non-bank financial intermediaries, etc.
9. Need based market: Money market is a need based market wherein the demand and supply of money shape the market. The price of money lent is determined in the form of interest.
10. Different from Capital Market: Money market is different from capital market on the basis of maturity period. Money market deals with the short-term lending and borrowing of funds, while capital market deals with medium and long-term lending and borrowing of funds. There are constant efforts for introducing new instruments and innovative dealing techniques for widening the scope of money market.
CHARACTERISTICS OF A DEVELOPED MONEY MARKET
A well-developed money market is an essential condition for any developed or developing economy. The development of money markets varies from country to country. Some money markets are developed where as others are less developed. If the essential characteristics of any developed money market do not exist in any economy, it is called an undeveloped money market. A developed money market is one which is comparatively efficient. It means it is responsive to changes in demand for and supply of funds in any of its sub-markets.
The effects in one part quickly spread to others without much loss of time. An example of a developed money market is the United Kingdom and that of less developed money market is the India. Let us now discuss the characteristics of a developed money market. Their non-existence will refer to a less developed money market. The following are the characteristics of developed money markets:
1. A developed commercial banking system: For a developed money market not only the banking system should be well-developed and organised, but the public should also have banking habits. These two things are complementary. The commercial banks are the most important suppliers of short-term funds. So, their policy pertaining to loans, advances and investment would have its impact on the entire money market. S.N. Sen in his book ‘Central Banking in Undeveloped Money Market’ rightly calls them “the nucleolus of the whole money market”.
Thus, for any developed money market, the foremost feature is well coordinated and well-integrated money market. Further, the commercial banks are intimately related to the central bank, so they provide a better link between the central bank and other components of money supply and borrowers, brokers, discount houses and acceptance houses.
In India we have organised and developed commercial banks but their activities are confined to urban areas only. As there are a large number of financial institutions working in their own ways, the interest rates charged differ from institution to institution. In India, there is unorganised money market because of indigenous bankers, say money lenders in rural areas and Marwari and Multani in urban areas. Thus, it is clear that money market is not well- organised or integrated because of less developed commercial banking system.
2. Presence of a central bank: In a developed money market, there is always an apex central bank. It means the central bank is both dejure and defacto the head of money and banking authority. A central bank is the lender of the last resort. It means other member banks can borrow from the central bank during emergency. It is because of this reason that it is called guardian of the money market. According to Prof. Sen, “It provides the ultimate liquidity without which a money market cannot function efficiently.” It is a very powerful bank to control money supply as per needs of the economy.
The central bank is the reservoir of all types of funds short, medium and long term. It can definitely act in a more professional manner as compared to the government. The central bank has a wider look to understand the economy and judging its monetary requirements. As per the needs of the economy, it can follow its monetary policy to suit the pre-designed objectives. It is correctly stated that a strong central bank is as necessary a characteristic of the money market as the heart in the human body. Thus it is clear that a powerful central bank controls, regulates and guides the money market.
On the other hand, if the central bank cannot influence the money market, it means the money market is not developed. In India we find that the presence of indigenous bankers obstructs the adoption of an effective monetary policy or controls.
We know that for a well-developed money market the two conditions discussed above are necessary but not sufficient. Prof. S.N. Sen has pointed out that in Australia, both these conditions exist but Australian money market is not well-developed. It means besides these two characteristics, there are some other characteristics which are as under:
3. Sub-markets: A developed money market has the most developed and sensitive sub markets. The money market is a group of various sub-markets, each dealing in loans of various maturities. There will be markets for call loans, the collateral loans, acceptances, foreign exchange, bills of exchange and commercial and treasury bills. If these sub-markets are non-existent or there is less responsiveness to small changes in the interest and discount rates, it means under no circumstances a money market will be developed. These sub-markets are found in the London Money Market and the New York Money Market. There must be a large number of dealers and bidders in different sub-markets.
According to Professor S.N. Sen, “The larger the number of sub markets, the broader and more developed will be the structure of the money market.”
But besides it, the sub-markets must be integrated with each other. It means if the interest rate is high in one market, the borrowers will move to sub-markets where the interest rate is low. The lenders in this case will move to those sub-markets which can provide them higher interest rate. Thus, it will facilitate the mobilisation of resources from one market to another.
In under-developed countries like India various sub-markets are either non-existent or not integrated. There is lack of co-ordination and integration among different sub-markets. The interest rates in different sub-markets in India vary considerably. The undeveloped money market does not possess all the important and essential sub-markets, particularly the bill market. However, in recent years greater integration in various markets have been observed.
4. Near money-assets: In a developed money market, there is a large quantity and variety of financial instruments such as bills of exchange, treasury bills, promissory notes, short dated government bonds, etc. If the number of near money assets are more, the money market will be more developed. The bills are drawn in a standard form and are accepted and discounted. The money market should have the regular supply of these assets. There should also be a large number of people desirous of buying and selling these credit instruments.
If the near-money assets or credit instruments are not available in sufficient number, the money market cannot be developed. It is the dealers in near money assets who actually infuse life into the money market.
5. Availability of ample resources: Another feature of a developed money market is the availability of ample resources. A developed money market has easy access to financial resources from both within and without the country. The London Money Market attracts adequate funds from both sources, i.e. internal and external. Persons in the foreign countries think it safe and profitable to invest money in highly liquid assets in the developed countries. It is the availability of cheap facilities for the remittance of funds from one place to another, which has resulted in raising the resources. Availability of ample funds is essential for the smooth and efficient working of the money market. So all the money markets aim at raising their resources.
Under-developed money markets do not attract foreign funds because of political instability and absence of stable exchange rates. A pertinent point is that it is not a pre- requisite of a developed money market. A money market may be developed even if it can-not attracts short term funds from foreign countries.
6. Integrated interest-rate structure: Another feature of developed money market is that it has an integrated interest rate structure. The interest rates which prevail in the different sub-markets are integrated with each other. To clarify it, a change in the bank rate results in equi-proportionate change in the interest rates which exist in case of different sub-markets. It is due to this structure of interest rates that the central bank can exercise control on the functioning of the money market.
7. Other factors: There are many other factors which are responsible for the money market to be a developed one. The contributory factors are volume of international trade, bills of exchange, great industrial development, stable political condition, economic crisis, boom, depression, war, absence of discrimination, etc.
Thus, from the above discussion it is clear that keeping in view the characteristics of a developed money market, it is only the London Money Market which can be called as the most developed money market. Skyes in his book “The London Money Market’ compares it to a cart wheel, “whose axle is the bank of England and the hub of the wheel is represented by the joint stock banks, the spokes by the other types of banks and the rim by the discount houses.”
The central bank must keep close relationship with other parts of money market for an efficient working. Any characteristic missing from the above would be regarded as symbol of a less developed money market. Once these characteristics are found absent in toto, we can say that money market is undeveloped. The features of an undeveloped money market hence can be stated as an unorganised commercial banking system, weak central bank, lack of credit instruments, non-existence of specialised sub-markets, diversified interest rates, etc. An undeveloped money market is a stumbling block in the way of monetary authority.
FUNCTIONS OF MONEY MARKET
Money market is an important part of the economy. It plays very significant functions. As mentioned above it is basically a market for short term monetary transactions. Thus it has to provide facility for adjusting liquidity to the banks, business corporations, non-banking financial institutions (NBFS) and other financial institutions along with investors.
Though, historically, money market has developed as a result of industrial and commercial progress, it also has important role to play in the process of industrialization and economic development of a country. Functions of developed money market are discussed below:
1. Financing Trade: Money Market plays crucial role in financing both internal as well as international trade. Commercial finance is made available to the traders through bills of exchange, which are discounted by the bill market. The acceptance houses and discount markets help in financing foreign trade.
2. Financing Industry: Money market contributes to the growth of industries in two ways:
(a) Money market helps the industries in securing short-term loans to meet their working capital requirements through the system of finance bills, commercial papers, etc.
(b) Industries generally need long-term loans, which are provided in the capital market. However, capital market depends upon the nature of and the conditions in the money market. The short-term interest rates of the money market influence the long-term interest rates of the capital market. Thus, money market indirectly helps the industries through its link with and influence on long-term capital market.
3. Liquidity of Investment: Stock exchanges provide liquidity of investment to the investors. Investors can sell out any of their investments in securities at any time during trading days and trading hours on stock exchanges. Thus Stock exchanges provide liquidity of investment. The on-line trading and online settlement of demat securities facilitates the investors to sell out their investment and realize the proceeds within a day or two. Even investors can switch over their investment from one security to another according to the changing scenario of capital market.
4. Investment Priorities: Stock exchanges facilitate the investors to decide his investment priorities by providing him the basket of different kinds of securities of different industries and companies. Investor can sell stock of one company and buy a stock of another company through stock exchange whenever he wants. He can manage his investment portfolio to maximize his wealth.
5. Profitable Investment: Money market enables the commercial banks to use their excess reserves in profitable investment. The main objective of the commercial banks is to earn income from its reserves as well as maintain liquidity to meet the uncertain cash demand of the depositors. In the money market, the excess reserves of the commercial banks are invested in near-money assets (e.g. short-term bills of exchange) which are highly liquid and can be easily converted into cash. Thus, the commercial banks earn profits without losing liquidity.
6. Self-Sufficiency of Commercial Bank: Developed money market helps the commercial banks to become self-sufficient. In the situation of emergency, when the commercial banks have scarcity of funds, they need not approach the central bank and borrow at a higher interest rate. On the other hand, they can meet their requirements by recalling their old short-run loans from the money market.
7. Investment Safety: Stock exchanges through their by-laws given by Securities and Exchange Board of India (SEBI). Transparent procedures try to provide safety to the investment in industrial securities. Government has established the National stock Exchange (NSE) and over the counter Exchange of India (OTCEI) or investor’s safety. Exchange authorities try to curb speculative practices and minimize the risk for common investor to preserve his confidence.
8. Help to Central Bank: Though the central bank can function and influence the banking system in the absence of a money market, the existence of a developed money market smoothens the functioning and increases the efficiency of the central bank. Money market helps the central bank in two ways:
(a) The short-run interest rates of the money market serve as an indicator of the monetary and banking conditions in the country and, in this way, guide the central bank to adopt an appropriate banking policy,
(b) The sensitive and integrated money market helps the central bank to secure quick and widespread influence on the sub-markets, and thus achieve effective implementation of its policy.
9. Indicator of Industrial Development: Stock exchanges are the symbolic indicators of industrial development of a nation (i.e. Productivity, efficiency, economic- status). A prospect of each industry and every unit in an industry is reflected through the price fluctuation of industrial on stock exchanges. Stock exchanges Sensex and price fluctuations of securities of various companies tell the entire story of changes in industrial sector.
10. Barometer of National development of Economy: Stock exchanges are taken as a Barometer of national development of the economy of a country. Each economy is economically symbolized (indicators) by its most significant stock exchange. New York stock Exchange, London stock Exchange, Tokyo stock Exchange and Bombay stock Exchange are considered as barometers of U.S.A, United Kingdom, Japan and India respectively. At both national and international level these stock exchanges represent the progress and conditions of their economies.
11. Borrowings by the government: The money market helps the government in borrowing short term funds at very low interest rates. The borrowing is done on the basis of treasury bills. But in case the government resorts to deficit financing or to print more currency or to borrow from the central bank, it will merely raise the money supply over and above the needs of the economy and hence the price level will boost up. Thus, it is clear that the money market is very useful for the government since it meets its financial needs.
12. Savings and investment: Another point of importance of the money market is that it helps in promoting liquidity and safety of financial assets. By doing so it can help in encouraging savings and investment. The saving and investment equilibrium or equilibrium of demand and supply of loanable funds helps in the allocation of resources.
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