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Transcript of Raja Shekar Reddy
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1.1 INTRODUCTION
The research methodology is the conceptual structure within which the research is
conducted.
1.2 TITLE:
A COMPREHENSIVE STUDY ON MONEY MARKET.
1.3 NEED AND SCOPE OF THE STUDY:
The need for a money market arises because receipts of economic units do not
coincide with their expenditures. These units can hold money balances to insure that planned
expenditures can be maintained independently of cash receipts (that is, transactions balances in
the form of currency, demand deposits, or NOW accounts). There are however, costs in the form
of foregone interest involved, by holding these balances. To enable the economic units to
minimize this cost, they usually seek to hold the minimum money balances required for day-to-
day transactions. They supplement these balances with holdings of money market instruments.
The advantages of money market instruments are: that it can be converted to cash quickly and at
a relatively low cost, and it have low price risk due to their short maturities. Economic units can
also meet their short-term cash demands by maintaining access to the money market and raising
funds there when required.
1.4 OBJECTIVES OF THE STUDY:
To know about the money market To identify how money market is functioning The growth of the money market in India The importance of money market
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SCOPE OF THE STUDY:
The India money market is a monetary system that involves the lending and borrowing of short-
term funds. India money market has seen exponential growth just after the globalization initiative
in 1992. It has been observed that financial institutions do employ money market instruments for
financing short-term monetary requirements of various sectors such as agriculture, finance and
manufacturing. The performance of the India money market has been outstanding in the past 20
years.
1.5 LIMATITATION OF THE STUDY:
It is one time study.
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WHAT DOES FINANCIAL MARKET MEAN?
Broad term describing any marketplace where buyers and sellers participate in the
trade of assets such as equities, bonds, currencies and derivatives. Financial markets are typically
defined by having transparent pricing, basic regulations on trading, costs and fees and marketforces determining the prices of securities that trade.
TYPES OF FINANCIAL MARKETS
A financial market consists of two major segments;
(a) Capital market and
(b) money market
While the money market deals in short-term credit, the capital market handles the
medium term and long-term credit.
Capital Market differs from money market in many ways. Firstly, while money market is Related
to short-term funds, the capital market related to long term funds. Secondly, while Money market
deals in securities like treasury bills, commercial paper, trade bills, deposit Certificates, etc., the
capital market deals in shares, debentures, bonds and government Securities. Thirdly, while the
participants in money market are Reserve Bank of India, Commercial banks, non-banking
financial companies, etc., the participants in capital market.
Are stockbrokers, underwriters, mutual funds, financial institutions, and individual investors.
Fourthly, while the money market is regulated by Reserve Bank of India, the capital market is
regulated by Securities Exchange Board of India (SEBI)
Let us discuss these two types of markets in detail
Capital Market may be defined as a market dealing in medium and long-term funds. It is An
institutional arrangement for borrowing medium and long-term funds and which provides
Facilities for marketing and trading of securities. So it constitutes all long-term borrowings from
banks and financial institutions, borrowings from foreign markets and raising of capital by issue
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various securities such as shares debentures, bonds, etc. In the present chapter let us discuss
about the market for trading of securities.
The market where securities are traded known as Securities market. It consists of two different
segments namely primary and secondary market. The primary market deals with new or freshissue of securities and is, therefore, also known as new issue market; Whereas the secondary
market provides a place for purchase and sale of existing securities and is often termed as stock
market or stock exchange.
PRIMARY MARKET:
The Primary Market consists of arrangements, which facilitate the procurement of long term
funds by companies by making fresh issue of shares and debentures. You know that companies
make fresh issue of shares and/or debentures at their formation stage and, if necessary,
subsequently for the expansion of business. It is usually done through private placement to
friends, relatives and financial institutions or by making public issue.
the companies have to follow a well-established legal procedure and involve a number of
intermediaries such as underwriters, brokers, etc. who form an integral part of the Primary
market. You must have learnt about many initial public offers (IPOs) made recently by a number
of public sector undertakings such as ONGC, GAIL, NTPC and the private Sector companies
like Tata Consultancy Services (TCS), Biocon, Jet-Airways and so on.
SECONDARY MARKET
The secondary market known as stock market or stock exchange plays an equally important role
in mobilizing long-term funds by providing the necessary liquidity to holdings in shares and
debentures. It provides a place where these securities can be encased without any difficulty and
delay. It is an organized market where shares and debentures are traded regularly with high
degree of transparency and security. In fact, an active secondary market facilitates the growth of
primary market as the investors in the primary market are as soured of a continuous market for
liquidity of their holdings. The major players in the primary market are merchant bankers,
mutual funds, financial institutions, and the individual investors; and in the secondary market
you have all these and the stockbrokers who are members of the stock exchange who facilitate
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the trading. After having a brief idea about the primary market and secondary market let see the
difference between them.
The main points of distinction between the primary market and secondary market are as follows:
1. Function:While the main function of primary market is to raise long-term funds through
fresh issue of securities, the main function of secondary market is to provide continuous
and ready market for the existing long-term securities.
2. Participants:While the major players in the primary market are financial institutions, mutual
funds, underwriters and individual investors, the major players in secondary market are
all of these and the stockbrokers who are members of the stock exchange.
3. Listing Requirement:While only those securities can be dealt with in the secondary market, which have
been approved for the purpose (listed), there is no such requirement in case of primary
market.
4. Determination of prices:In case of primary market, the prices are determined by the management with due
compliance with SEBI requirement for new issue of securities. But in case of secondary
market, the price of the securities is determined by forces of demand and supply of the
market and keeps on fluctuating.
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Introduction of Money Market
Whenever a bear market comes along, investors realize (yet again!) that the
stock market is a risky place for their savings. It's a fact we tend to forget while enjoying the
returns of a bull market! Unfortunately, this is part of the risk-return tradeoff. To get higherreturns, you have to take on a higher level of risk. For many investors, a volatile market is too
much to stomach - the money market offers an alternative to these higher-risk investments.
Definition of Money Market:
Market for short-term debt securities, such as banker's acceptances, commercial
paper, repos, negotiable certificates of deposit, and Treasury Bills with a maturity of one year or
less and often 30 days or less. Money market securities are generally very safe
investments which return a relatively low interest rate that is most appropriate for temporary cash
storage or short-term time horizons. Bid and ask spreads are relatively small due to the
large size and high liquidity of the market.
Definition of Capital Market:
A financial market that works as a conduit for demand and supply of debt and equity
capital. It channels the money provided by savers and depository institutions (banks, credit
unions, insurance companies, etc.) to borrowers and investees through a variety of financial
instruments (bonds, notes, shares) called securities.
A capital market is not a compact unit, but a highly decentralized system made up of three
major parts:
(1) Stock market,
(2) Bond market, and
(3) Money market.It also works as an exchange for trading existing claims on capital in the form of shares.
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Money Market Vs. Capital Market:
Basically the difference between the capital markets and money markets is that
capital markets are for long term investments, companies are selling stocks and bonds
in order to borrow money from their investors to improve their company or topurchase assets. Whereas money markets are more of a short term borrowing or
lending market where banks borrow and lend between each other, as well as finance
companies and everything that is borrowed is usually paid back within thirteen
months.
Another difference between the two markets is what is being used to do the
borrowing or lending. In the capital markets the most common thing used is stocks
and bonds, whereas with the money markets the most common things used are
commercial paper and certificates of deposits.
Features of Money Market:
The following are the general features of a money market:
1. It is market purely for short-term funds or financial assets called near money.2. It deals with financial assets having a maturity period up to one year only.3. It deals with only those assets which can be converted into cash readily without loss and with
minimum transaction cost.
4. Generally transactions take place through phone i.e., oral communication. Relevant documentsand written communications can be exchanged subsequently. There is no formal place like stock
exchange as in the case of a capital market.
5. Transactions have to be conducted without the help of brokers.6. The components of a money market are the Central Bank, Commercial Banks, Non-banking
financial companies, discount houses and acceptance house. Commercial banks generally play a
dominant in this market.
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Objectives:
The following are the important objectives of a money market:
To provide a parking place to employ short-term surplus funds. To provide room for overcoming short-term deficits. To enable the Central Bank to influence and regulate liquidity in the economy through its
intervention in this market.
To provide a reasonable access to users of Short-term funds to meet their requirements quickly,adequately and at reasonable costs.
Characteristic features of a developed Money Market:
In every country of the world, some type of money market exists. Some of them are
highly developed while others are not well developed. Prof. S.N. Sen has described certain
essential features of a developed money market.
1. Highly organized banking system: The commercial banks are the nerve centre of the wholemoney market. They are principal suppliers of short-term funds. Their policies regarding loans
and advances have impact on the entire money market. The commercial banks serve as vital link
between the central bank and the various segments of the highly organized banking system co-
exist. In an underdeveloped money market, the commercial banking system is not fully
developed.
2. Presence Of A Central Bank: The Central Bank acts as the bankers bank. It keeps their cashreserves and provides them financial accommodation in difficulties by discounting their eligible
securities. In other words, it enables the commercial banks and other institutions to convert their
assets into cash in times of financial crisis. Through its open market operations, the central bankabsorbs surplus cash during off-seasons and provides additional liquidity in the busy seasons.
Thus, the central bank is the leader, guide and controller of the money market. In an
underdeveloped money market, the central bank is in its infancy and not in a position to
influence and control the money market.
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3. Availability of Proper Credit Instruments: It is necessary for the existence of a developedmoney market a continuous availability of readily acceptable negotiable securities such as bills
of exchange, treasury bills etc. in the market. There should be a number of dealers in the money
market to transact in these securities. Availability of negotiable securities and the presence of
dealers and brokers in large numbers to transect in these securities are needed for the existence
of a instruments as well as dealers to deal in these instruments in an underdeveloped money
market.
4. Existence of Sub-Markets: The number of sub-markers determines the development of amoney market. The lager the number of sub-makers, the broader and more developed will be the
structure of money market. The several sub-makers together make a coherent money market. In
an underdevelopment money market, the various sub-makers, particularly the bill market, are
absent. Even of sub-makers exist, there is no co-ordination between them. Consequently,
different money rates prevail in the sub-makers and they remain unconnected with of funds.
5. Ample Resources: There must be availability of sufficient funds to finance transactions in thesub-makers. These funds may come from within the country and also from foreign countries.
The London, New York and Paris money markets attract funds from all over the world. The
underdeveloped money markets are starved of funds.
6. Existence of Secondary Market:There should be an active secondary market in theseinstruments.
7. Demand And Supply Of Funds: There should be a large demand and supply of short-termfunds. It presupposes the existence of a large domestic and foreign trade. Besides, it should have
adequate amount of liquidity in the form of large amounts maturing within a short period.
8. Other factors: Besides the above, other factors also contribute to the development of a moneymarket. Rapid industrial development leading to the emergence of stock exchange, large volume
of international trade leading to the system of bills exchange, political stability, favorable
conditions for foreign investment, price stabilization etc. are the other factors that facilitate the
development of money market in the country.
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London Money Market is a highly developed money market because it satisfies all requirements
of a developed money market. If any one or more of these factors are absent, then the money
market is called an underdeveloped one.
Importance of Money Market
A developed money market plays an important role in the financial system of a
country by supplying short-term funds adequately and quickly to trade and industry. The money
market is an integral part of a countrys economy. Therefore, a developed money market is
highly indispensable for the rapid development of the economy. A developed money market
helps the smooth functioning of the financial system in any economy in the following ways:
Development Of Trade And Industry: Money market is an important source of financingtrade and industry. The money market, through discounting operations and commercial papers,
finances the short-term working capital requirements of trade and industry and facilities the
development of industry and trade bothnational and international.
Development Of Capital Market: The short-term rates of interest and the conditions thatprevail in the money market influence the long-term interest as well as the resource
mobilization in capital market. Hence, the development of capital depends upon the existence
of a development of capital money market.
Smooth Functioning of Commercial Banks: The money market provides the commercialbanks with facilities for temporarily employing their surplus funds in easily realizable assets.
The banks can get back the funds quickly, in times of need, by resorting to the money market.
The commercial banks gain immensely by economizing on their cash balances in hand and at
the same time meeting the demand for large withdrawal of their depositors. It also enables
commercial banks to meet their statutory requirements of cash reserve ratio (CRR) and
Statutory Liquidity Ratio (SLR) by utilizing the money market mechanism.
Effective Central Bank Control: A developed money market helps the effective functioningof a central bank. It facilities effective implementation of the monetary policy of a central bank.
The central bank, through the money market, pumps new money into the economy in slump
and siphons if off in boom. The central bank, thus, regulates the flow of money so as to
promote economic growth with stability.
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Formulation Of Suitable Monetary Policy: Conditions prevailing in a money market serve asa true indicator of the monetary state of an economy. Hence, it serves as a guide to the
Government in formulating and revising the monetary policy then and there depending upon
the monetary conditions prevailing in the market.
Non-Inflationary Source Of Finance To Government: A developed money market helps theGovernment to raise short-term funds through the treasury bills floated in the market. In the
absence of a developed money market, the Government would be forced to print and issue
more money or borrow from the central bank. Both ways would lead to an increase in prices
and the consequent inflationary trend in the economy.
Composition of money market:
The money market is not a single homogeneous market. It consists of a number of sub-
markets which collectively constitute the money market. There should be competition within
each sub-market as well as between different sub-markets. The following are the main sub-
markets of a money market:
Call Money Market. Commercial Bills Market or Discount Market. Acceptance Market. Treasury bill Market.
Call Money Market:The call money market refers to the market for extremely short period loans; say one day
to fourteen days. These loans are repayable on demand at the option of either the lender or the
borrower. As stated earlier, these loans are given to brokers and dealers in stock exchange.
Similarly, banks with surplus lend to other banks with deficit funds in the call money market.Thus, it provides an equilibrating mechanism for evening out short term surpluses and deficits.
Moreover, commercial bank can quickly borrow from the call market to meet their statutory
liquidity requirements. They can also maximize their profits easily by investing their surplus
funds in the call market during the period when call rates are high and volatile.
http://www.mbaknol.com/investment-management/the-call-money-market/http://www.mbaknol.com/investment-management/the-call-money-market/http://www.mbaknol.com/investment-management/commercial-bills-market-or-discount-market/http://www.mbaknol.com/investment-management/commercial-bills-market-or-discount-market/http://www.mbaknol.com/investment-management/treasury-bill-markets/http://www.mbaknol.com/investment-management/treasury-bill-markets/http://www.mbaknol.com/investment-management/treasury-bill-markets/http://www.mbaknol.com/investment-management/commercial-bills-market-or-discount-market/http://www.mbaknol.com/investment-management/the-call-money-market/ -
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Operations in Call Market:
Borrowers and lenders in a call market contact each other over telephone. Hence, it is basically
over-the-telephone market. After negotiations over the phone, the borrowers and lenders arrive at
a deal specifying the amount of loan and the rate of interest. After the deal is over, the lender
issues FBL cheque in favor of the borrower. The borrower is turn issues call money borrowing
receipt. When the loan is repaid with interest, the lender returns the lender the duly discharges
receipt.
Instead of negotiating the deal directly, it can be routed through the Discount and Finance House
of India (DFHI), the borrowers and lenders inform the DFHI about their fund requirement and
availability at a specified rate of interest. Once the deal is confirmed, the Deal settlement advice
is lender and receives RBI cheque for the money borrowed. The reverse is taking place in the
case of landings by the DFHI. The duly discharged call deposit receipt is surrendered at the time
of settlement. Call loans can be renewed on the back of the deposit receipt by the borrower.
Call loan market transitions and participants:
In India, call loans are given for the following purposes:
1. To commercial banks to meet large payments, large remittances to maintain liquidity with theRBI and so on.
2. To the stock brokers and speculators to deal in stock exchanges and bullion markets.3. To the bill market for meeting matures bills.4. To the Discount and Finance House of India and the Securities Trading Corporation of India to
activate the call market.
5. To individuals of very high status for trade purposes to save interest on O.D or cash credit.The participants in this market can be classified into categories viz.
1. Those permitted to act as both lenders and borrowers of call loans.2. Those permitted to act only as lenders in the market.
The first category includes all commercial banks. Co-operative banks, DFHI and STCI. In the
second category LIC, UTI, GIC, IDBI, NABARD, specified mutual funds etc., are included.
They can only lend and they cannot borrow in the call market.
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Advantages of call money:
In India, commercial banks play a dominant role in the call loan market. They used to borrow
and lend among themselves and such loans are called inter-bank loans. They are very popular in
India. So many advantages are available to commercial banks. They are as follows:
High Liquidity: Money lent in a call market can be called back at any time when needed. So, itis highly liquid. It enables commercial banks to meet large sudden payments and remittances
by making a call on the market.
High Profitability: Banks can earn high profiles by lending their surplus funds to the callmarket when call rates are high volatile. It offers a profitable parking place for employing the
surplus funds of banks temporarily.
Maintenance Of SLR: Call market enables commercial bank to minimum their statutoryreserve requirements. Generally banks borrow on a large scale every reporting Friday to meet
their SLR requirements. In absence of call market, banks have to maintain idle cash to meet5
their reserve requirements. It will tell upon their profitability.
Safe and Cheap: Though call loans are not secured, they are safe since the participants have astrong financial standing. It is cheap in the sense brokers have been prohibited form operating
in the call market. Hence, banks need not pay brokers on call money transitions.
Assistance To Central Bank Operations: Call money market is the most sensitive part of anyfinancial system. Changes in demand and supply of funds are quickly reflected in call money
rates and give an indication to the central bank to adopt an appropriate monetary policy.
Moreover, the existence of an efficient call market helps the central bank to carry out its open
market operations effectively and successfully.
Drawbacks of call money:
The call market in India suffers from the following drawbacks:
Uneven Development: The call market in India is confined to only big industrial andcommercial centers like Mumbai, Kolkata, Chennai, Delhi, Bangalore and Ahmadabad.
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Generally call markets are associated with stock exchanges. Hence the market is not evenly
development.
Lack Of Integration: The call markets in different centers are not fully integrated. Besides, alarge number of local call markets exist without an\y integration.
Volatility In Call Money Rates: Another drawback is the volatile nature of the call moneyrates. Call rates very to greater extant indifferent centers indifferent seasons on different days
within a fortnight. The rates very between 12% and 85%. One cannot believe 85% being
charged on call loans.
Commercial Bills Market or Discount Market:A commercial bill is one which arises out of a genuine trade transaction, i.e. credit
transaction. As soon as goods are sold on credit, the seller draws a bill on the buyer for the
amount due. The buyer accepts it immediately agreeing to pay amount mentioned therein after a
certain specified date. Thus, a bill of exchange contains a written order from the creditor to the
debtor, to pay a certain sum, to a certain person, after a creation period. A bill of exchange is a
self-liquidating paper and negotiable/; it is drawn always for a short period ranging between 3
months and 6 months.
Definition of a bill:
Section 5 of the negotiable Instruments Act defines a bill exchange a follows:
an instrument in writing containing an unconditional order, signed by the maker, directing
a certain person to pay a certain sum of money only to, or to the order of a certain person ort to
the beater of the instrument.
Types of Bills:
Many types of bills are in circulation in a bill market. They can be broadly classified as follows:
1.
Demand and ursine bills.2. Clean bills and documentary bills.3. Inland and foreign bills.4. Export bills and import bills.5. Indigenous bills.6. Accommodation bills and supply bills.
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7. Demand and Ursine BillsDemand bills are others called sight bills. These bills are payable immediately as soon
as they are presented to the drawee. No time of payment is specified and hence they are payable
at sight. Usince bills are called time bills. These bills are payable immediately after the expiry of
time period mentioned in the bills. The period varies according to the established trade custom or
usage prevailing in the country.
Clean Bills and Documentary Bills
When bills have to be accompanied by documents of title to goods like Railways,
receipt, Lorry receipt, Bill of Lading etc. the bills are called documentary bills. These bills can be
further classified into D/A bills and D/P bills. In the case of D/A bills, the documents
accompanying bills have to be delivered to the drawee immediately after acceptance. Generally
D/A bills are drawn on parties who have a good financial standing. On the order hand, the
documents have to be handed over to the drawee only against payment in the case of D/P bills.The documents will be retained by the banker. Till the payment o0f such bills. When bills are
drawn without accompanying any documents they are called clean bills. In such a case,
documents will be directly sent to the drawee.
Inland and Foreign Bills
Inland bills are those drawn upon a person resident in India and are payable in India.
Foreign bills are drawn outside India an they may be payable either in India or outside India.
They may be drawn upon a person resident in India also. Foreign boils have their origin outside
India. They also include bills drawn on India made payable outside India.
Export and Foreign Bills
Export bills are those drawn by Indian exports on importers outside India and import
bills are drawn on Indian importers in India by exports outside India.
Indigenous Bills
Indigenous bills are those drawn and accepted according to native custom or usage of
trade. These bills are popular among indigenous bankers only. In India, they called hundis thehundis are known by various names such as Shah Jog, Nam Jog, Jokhani, Termainjog.
Darshani, Dhanijog, and so an.
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Accommodation Bills and Supply Bills
If bills do not arise out of genuine trade transactions, they are called accommodation
bills. They are known as kite bills or wind bills. Two parties draw bills on each other purely
for the purpos4 of mutual financial accommodation. These bills are discounted with bankers and
the proceeds are shared among themselves. On the due dates, they are paid. Supply bills arethose neither drawn by suppliers or contractors on the government departments for the goods nor
accompanied by documents of title to goods. So, they are not considered as negotiable
instruments. These bills are useful only for the purpose of getting advances from commercial
banks by creating a charge on these bills.
Operations in Bill Market:
From the operations point of view, the bill market can be classified into two viz.
Discount Market Acceptance Market
Discount Market
Discount market refers to the market where short-term genuine trade bills are
discounted by financial intermediaries like commercial banks. When credit sales are effected, the
seller draws a bill on the buyer who accepts it promising to pay the specified sum at the specified
period. The seller has to wait until the maturity of the bill for getting payment. But, the presence
of a bill market enables him to get payment immediately. The seller can ensure payment
immediately by discounting the bill with some financial intermediary by paying a small amount
of money called Discount rate on the date of maturity, the intermediary claims the amount of
the bill from the person who has accept6ed the bill.
In some countries, there are some financial intermediaries who specialize in the field of
discounting. For instance, in London Money Market there are specialise in the field discounting
bills. Such institutions are conspicuously absent in India. Hence, commercial banks in India have
to undertake the work of discounting. However, the DFHI has been established to activate this
market.
Acceptance MarketThe acceptance market refers to the market where short-term genuine trade bills are
accepted by financial intermediaries. All trade bills cannot be discounted easily because the
patties to the bills may not be financially sound. In case such bills are accepted by financial
intermediaries like banks, the bills earn a good name and reputation and such bills can readily
discounted anywhere. In London, there are specialist firms called acceptance house which accept
bills drawn by trades and import greater marketability to such bills. However, their importance
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has declined in recent times. In India, there are no acceptance houses. The commercial banks
undertake the acceptance business to some extent.
Advantages of commercial bills:
Commercial bill market is an important source of short-term funds for trade andindustry. It provides liquidity and activates the money market. In India, commercial banks lay a
significant role in this market due to the following advantages:
Liquidity: Bills are highly liquid assets. In times of necessity, bills can be converted into cashreadily by means of rediscounting them with the central bank. Bills are self-liquidating in
character since they have fixed tenure. Moreover, they are negotiable instruments and hence
they can be transferred freely by a mere delivery or by endorsement and delivery.
Certainty Of Payment: Bills are drawn and accepted by business people. Generally, businesspeople are used to keeping their words and the use of the bills imposes a strict financial
discipline on them. Hence, bills would be honored on the due date.
Ideal Investment: Bills are for periods not exceeding 6 months. They represent advances for adefinite period. This enables financial institutions to invest their surplus funds profitably by
selecting bills of different maturities. For instance, commercial banks can invest their funds on
bills in such a way that the maturity of these bills may coincide with the maturity of their fixed
deposits.
Simple Legal Remedy: In case the bills are dishonored\, the legal remedy is simple. Suchdishonored bills have to be simply noted and protested and the whole amount should be debited
to the customers accounts.
High And Quick Yield: The financial institutions earn a high quick yield. The discount isdedicated at the time of discounting itself whereas in the case of other loans and advances,
interest is payable only when it is due. The discounts rate is also comparatively high.
Easy Central Bank Control: The central bank can easily influence the money market bymanipulating the bank rate or the rediscounting rate. Suitable monetary policy can be taken by
adjusting the bank rate depending upon the monetary conditions prevailing in the market.
Drawbacks of commercial bills:
In spite of these merits, the bill market has not been well developed in India. The
reasons for the slow growth are the following:
Absence Of Bill Culture: Business people in India prefer O.D and cash credit to bill financingtherefore, banks usually accept bills for the conversion of cash credits and overdrafts of their
customers. Hence bills are not popular.
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Absence Of Rediscounting Among Banks: There is no practice of re-discounting of billsbetween banks who need funds and those who have surplus funds. In order to enlarge the
rediscounting facility, the RBI has permitted financial institutions like LIC, UTI, GIC and
ICICI to rediscount genuine eligible trade bills of commercial banks. Even then, bill financial is
not popular.
Stamp Duty: Stamp duty discourages the use of bills. Moreover, stamp papers of requireddenomination are not available.
Absence Of Secondary Market: There is no active secondary market for bills. Rediscountingfacility is available in important centers and that too it restricted to the apex level financial
institutions. Hence, the size of the bill market has been curtailed to a large extant.
Difficulty In Ascertaining Genuine Trade Bills: The financial institutions have to verify thebills so as to ascertain whether they are genuine trade bills and not accommodation bills. For
this purpose, invoices have to be scrutinized carefully. It involves additional work.
Limited Foreign Trade: In many developed countries, bill markets have been establishedmainly for financing foreign trade. Unfortunately, in India, foreign trade as a percentage to
national income remains small and it is reflected in the bill market also.
Absence Of Acceptance Services: There is no discount house or acceptance house in India.Hence specialized services are not available in the field of discounting or acceptance.
Attitude Of Banks: Banks are shy rediscounting bills even the central bank. They have atendency to hold the bills till maturity and hence it affects the velocity of circulation of bills.
Again, banks prefer to purchase bills instead of discounting them.
Bill Market Schemes:
The development of bills discounting as a financial service depends upon the
existence of a full fledged bill market. The Reserve Bank of India (RBI) has constantly
endeavored to develop the commercial bills market. Several committees set up to examine the
system of bank financing, and the money market had strongly recommended a gradual shift to
bills finance and phase out of the cash credit system. The most notable of these were: (1) Dehejia
Committee, 1969, (2) Tandon Committee, 1974, (3) Chore Committee, 1980 and (4) Vaghul
Committee, 1985.This section briefly outlines the efforts made by the RBI in the direction of the
development of a full fledged bill market.
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Bill Market Scheme, 1952 :
The salient features of the scheme were as follows:
(1) The schemes was announced under section 17(4)(c) of RBI Act enables it tomake advances to scheduled banks against the security of issuance of promissory
notes or bills drawn on and payable in India and arising out of bonafide
commercial or trade transaction bearing two or more good signatures one of
which should be that of scheduled bank and maturing within 90 days from the
date of advances.
(2)The scheduled banks were required to convert a portion of the demand promissorynotes obtained by them, from their constituents in respect of loans/overdrafts and
cash credits granted to them into usance promissory notes maturing within 90
days, to be able to avail of refinance under the scheme;
(3)The existing loan, cash credit or overdraft accounts were, therefore, required to besplit up into two parts viz.,
(A) one part was to remain covered by the demand promissory notes, in thisaccount further withdrawals or repayments were as usual being permitted.
(B) the other part, which would represent the minimum requirement of theborrower during the next three months would be converted into usance
promissory notes maturing within ninety days.
(4) This procedure did not bring any change in offering the same facilities as offeredbefore by the banks to their constituents. Banks could lodge the usance
promissory notes with the RBI for advances as eligible security for borrowing so
as to replenish their loanable funds.
(5)The amount advanced by the RBI was not to exceed the amount lent by thescheduled banks to the respective borrowers.
(6) The scheduled bank applying for accommodation had to certify that the paperpresented by it as collateral arose out of bona fide commercial transactions and
that the party was creditworthy.
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Bill Market Scheme, 1970:
In pursuance of the recommendations of the Dehejia Committee, the RBI constituted a working
group to evolve a scheme to enlarge the use of bills. Based on the scheme suggested by the study
group, the RBI introduced, with effect from November 1, 1970 the new bill market scheme in
order to facilitate the re-discounting of eligible bills of exchange by banks with it. To popularize
the use of bills, the scope of the scheme was enlarged, the number of participants was increased,
and the procedure was simplified over the years.
The salient features of the scheme are as follows:
Eligible Institutions: All licensed scheduled banks and those which do not require a
license (i.e. the State Bank of India, its associate banks and nationalized banks) are eligible to
offer bills of exchange to the RBI for rediscount. There is no objection to a bill, accepted by such
banks, being purchased by others banks and financial institutions but the RBI rediscounts only
those bills as are offered to it by an eligible bank.
Eligibility of Bills: The eligibility of bills offered under the scheme to the RBI is determined by
the statutory provisions embodied in section 17(2)(a) of the Reserve Bank of India Act, which
authorize the purchase, sale and rediscount of bills of exchange and promissory notes, drawn on
and payable in India and arising out of bona fide commercial or trade transactions, bearing two
or more good signatures one of the which should be that of a scheduled bank or a state
cooperative bank ands maturing:
(1) In the case of bills of exchange and promissory notes arising out of any such transactionrelating to the export of goods from India, within one hundred and eighty days
(2) In any other case, within ninety days from the date of purchase or rediscount
exclusive of days of grace;
(3) The scheme is confined to genuine trade bills arising out of genuine sale of goods.
The bill should normally have a maturity of not more than 90 days. A bill having a
maturity of 90 to 120 days is also eligible for rediscount, provided at the time of offering
to the RBI for rediscount it has a usance not exceeding 90 days. The bills presented for
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rediscount should bear at least two good signatures. The signature of a licensed scheduled
bank is treated as a good signature;
(4) Bill of exchange arising out of the sale of commodities covered by the selective credit
control directives of the RBI has been excluded from the scope of the scheme, to
facilitate the selective credit controls and to keep a watch on the level of outstanding
credit against the affected commodities.
Treasury Bill markets:Just like commercial bills which represent commercial debt, treasury bills
represent short-term borrowings of the Government. Treasury bill market refers to the market
where treasury bills are bought and sold. Treasury bills are very popular and enjoy higher degree
o9f liquidity since they are issued by the government.
Meaning and Features of Treasury Bills:
A treasury bills nothing but promissory note issued by the Government under
discount for a specified period stated therein. The Government promises to pay the specified
amount mentioned therein to the beater of the instrument on the due date. The period does not
exceed a period of one year. It is purely a finance bill since it does not arise out of any trade
transaction. It does not require any grading or endorsement or acceptance since it is clams
against the Government. Treasury bill are issued only by the RBI on behalf of the Government.
Treasury bills are issued for meeting temporary Government deficits. The Treasury bill rate of
discount is fixed by the RBI from time-to-time. It is the lowest one in the entire structure of
interest rates in the country because of short-term maturity and degree of liquidity and security.
Types of Treasury Bills:
In India, there are two types of treasury bills viz. (I) ordinary or regular and (ii) ad
hoc known as ad hocs ordinary treasury bills are issued to the public and other financial
institutions for meeting the short-term financial requirements of the Central Government. These
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Institutional investors like commercial banks, DFHI, STCI, etc, maintain a subsidiary General
Ledger (SGL) account with the RBI. Purchases and sales of TBs are automatically recorded in
this account invests who do not have SGL account can purchase and sell TBs though DFHI. The
DFHI does this function on behalf of investors with the helps of SGL transfer forms. The DFHI
is actively participating in the auctions of TBs. It is playing a significant role in the secondary
market also by quoting daily buying and selling rates. It also gives buy-back and sell-back
facilities for periods upto 14 days at an agreed rate of interest to institutional investors. The
establishment of the DFHI has imported greater liquidity in the TB market.
The participants in this market are the followers:
1. RBI and SBI2. Commercial banks3. State Governments4. DFHI5. STCI6. Financial institutions like LIC, GIC, UTI, IDBI, ICICI, IFCI, NABARD, etc.7. Corporate customers8. Public
Through many participants are there, in actual practice, this market is in the hands at the banking
sector. It accounts for nearly 90 % of the annual sale of TBs.
Importance of Treasury Bills:
Safety: Investments in TBs are highly safe since the payment of interest and repayment ofprincipal are assured by the Government. They carry zero default risk since they are issued by
the RBI for and on behalf of the Central Government.
Liquidity: Investments in TBs are also highly liquid because they can be converted into cash atany time at the option of the inverts. The DFHI announces daily buying and selling rates for
TBs. They can be discounted with the RBI and further refinance facility is available from the
RBI against TBs. Hence there is a market for TBs.
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Ideal Short-Term Investment: Idle cash can be profitably invested for a very short period inTBs. TBs are available on top throughout the week at specified rates. Financial institutions can
employ their surplus funds on any day. The yield on TBs is also assured.
Ideal Fund Management: TBs are available on top as well through periodical auctions. Theyare also available in the secondary market. Fund managers of financial institutions build
portfolio of TBs in such a way that the dates of maturities of TBs may be matched with the
dates of payment on their liabilities like deposits of short term maturities. Thus, TBs help
financial managers it manage the funds effectively and profitably.
Statutory Liquidity Requirement: As per the RBI directives, commercial banks have tomaintain SLR (Statutory Liquidity Ratio) and for measuring this ratio investments in TBs are
taken into account. TBs are eligible securities for SLR purposes. Moreover, to maintain CRR
(Cash Reserve Ratio). TBs are very helpful. They can be readily converted into cash and
thereby CRR can be maintained.
Source Of Short-Term Funds: The Government can raise short-term funds for meeting itstemporary budget deficits through the issue of TBs. It is a source of cheap finance to the
Government since the discount rates are very low.
Non-Inflationary Monetary Tool: TBs enable the Central Government to support itsmonetary policy in the economy. For instance excess liquidity, if any, in the economy can be
absorbed through the issue of TBs. Moreover, TBs are subscribed by investors other than the
RBI. Hence they cannot be mentioned and their issue does not lead to any inflationary pressure
at all.( Recommended reading: Treasury bills and inflation control )
Hedging Facility: TBs can be used as a hedge against heavy interest rate fluctuations in thecall loan market. When the call rates are very high, money can be raised quickly against TBs
and invested in the call money market and vice versa. TBs can be used in ready forward
transitions.
Defects of Trasury Bills:
Poor Yield: The yield form TBs is the lowest. Long term Government securities fetch moreinterest and hence subscriptions for TBs are on the decline in recent times.
http://www.mbaknol.com/investment-management/investment-management/treasury-bills-and-inflation-control/http://www.mbaknol.com/investment-management/investment-management/treasury-bills-and-inflation-control/ -
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Absence Of Competitive Bids: Though TBs are sold through auction in order to ensure marketrates for the investors, in actual practice, competitive bids are competitive bids are
conspicuously absent. The RBI is compelled to accept these non-competitive bids. Hence
adequate return is not available. It makes TBs unpopular.
Absence Of Active Trading: Generally, the investors hold TBs till maturity and they do notcome for circulation. Hence, active trading in TBs is adversely affected.
Money Market Instruments:
A varity of instruments are available in developed money market. In india ,till 1986 ,only a few
instruments were available. they were:
i. Treasury bills in the treasury market.ii. Money at call and short notice in the call loan market.
iii. Commercial bills,and promissory notes in the bill market.
Now ,in addition to the above ,the following new instruments are available:
1. Commercial papers2. Certificate of deposit3. Inter-bank participation certificates.4. Repo instruments.
1) Commercial papers
Commercial paper is a type of fixed-maturity unsecured short-term negotiable debt issued
generally in bearer form and primarily by non-banks. At the beginning of the 1980s issuance of
commercial paper was confined to the United States, Canada and Australia. The years which
followed saw the opening of commercial paper markets in several countries and the
establishment of a market for Euro-commercial paper. Although the US market has been the
model for several of these new markets, there are many significant differences in the way in
which each is organised, the characteristics of the instruments traded, the type of issuer and the
nature of the regulations applicable.
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What is a commercial paper?
An unsecured obligation issued by a corporation or bank to finance its short-
term credit needs, such as accounts receivable and inventory. Maturities typically range from 2 to
270 days. Commercial paper is available in a wide range of denominations, can beeither discounted or interest-bearing, and usually have a limited or nonexistent secondary market.
Commercial paper is usually issued by companies with highcredit ratings, meaning that
the investment is almost always relatively low risk.
Issuers :
All private sector company,publics sector units,non-banking company etc.
Investors:
Individuals,banks,corporates and also NRIs. Usualy banks,large corporate bodies and
public sector units with investible funds participate in CP market.
Features of Commercial Paper
1. Commercial paper is a short-term money market instrument comprising usince promissory notewith a fixed maturity.
2. It is a certificate evidencing an unsecured corporate debt of short term maturity.3. Commercial paper is issued at a discount to face value basis but it can be issued in interest
bearing form.
4. The issuer promises to pay the buyer some fixed amount on some future period but pledge noassets, only his liquidity and established earning power, to guarantee that promise.
5. Commercial paper can be issued directly by a company to investors or through banks/merchantbanks.
Advantages of Commercial Paper
Simplicity: The advantage of commercial paper lies in its simplicity. It involves hardly anydocumentation between the issuer and investor.
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Flexibility: The issuer can issue commercial paper with the maturities tailored to match thecash flow of the company.
Easy To Raise Long Term Capital: The companies which are able to raise funds throughcommercial paper become better known in the financial world and are thereby placed in a more
favorable position for rising such long them capital as they may, form time to time, as require.
Thus there is in inbuilt incentive for companies to remain financially strong.
High Returns: The commercial paper provides investors with higher returns than they couldget from the banking system.
Movement of Funds: Commercial paper facilities securitization of loans resulting in creationof a secondary market for the paper and efficient movement of funds providing cash surplus to
cash deficit entities.
Commercial Paper Market in Other Countries
The roots of commercial paper can be traced way back to the early nineteenth century when the
firms in the USA began selling open market paper as a substitute for bank loan needed for short
term requirements but it developed only in 1920s. The development of consumer finance
companies in the 1920s and the high coat of bank credit resulting from the incidence of
compulsory reserve requirements in the 1960s contributed to the popularity of commercial paper
in the USA. Today, the US commercial paper market is the largest in the worlds. The
outstanding amount at the end of 1990 in the US commercial paper market stood at $557.8
billion. The commercial paper issues in the US are exempted from requirement if issue of
prospectus so long as proceeds are used to finance current transitions and the papers mortuary is
less than 270 days.
Most of the commercial paper market in Europe is modeled on the lines of the US market. In the
UK the Sterling Commercial Paper Market was launched in May 1986. In the UK, the borrower
must be listed in the stock exchange and he must met assets of least $50 million. However,
rating by credit agencies is not required. The maturities of commercial paper must be between 7
and 364 days. The commercial paper is exempted form stamp duty.
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In finance, commercial papers were thought of as a fixable alternative to bank loans. The
commercial paper was introduced in December 1985. Commercial paper can be issued only by
non-bank French companies and subsidiaries of foreign companies. The papers are in bearer
form. It can be either issued by dealers or placed directly. The maturity ranges form ten days to
seven years. Rating by credit agencies is essential. To protect investors. Law contains fairly
extensive disclosure requirements and requires publication of regular finance statements by
issue. The outstanding amount at the end of 1990 in France Commercial paper market was $31
billion.
The Canadian commercial paper market was launched in 1950s. The commercial paper is
generally used for terms of 30days to 365 days although terms such as overnight are available.
The commercial paper issued by Canadian companies is normally secured by pledge of assets.
The outstanding amount at the end of 1990 in the commercial market was $26.8 billions.
In Japan, the yen commercial paper market was opened in November 1987. The commercial
paper issues carry maturities from two weeks to nine months. Japan stands second in the
commercial paper market in the world an outstanding amount of $117.3 billions in 1990.
In 1980s many other countries launched commercial paper market, notably Sweden (early
1980s), Spain (1982s), Hong Kong (1982), Singapore (1984), Norway (1984).
Commercial Paper in India
In India, on the recommendations of the Vaghul working Group, the RBI announced on
27th March 1989, that commercial paper will be introduced soon in Indian money market. The
recommendations of the Vaghul Working Group on introduction of commercial paper in Indian
money market are as flowers:
1. There is a need have limited introduction of commercial paper. It should be carefully plannedand the eligibility criteria for the issuer should be sufficiently rigorous to ensure that the
commercial paper market develops on healthy lines.
2. Initially, access to the commercial paper market should be registered to rated companies havinga net worth of Rs. 5 cores and above with good dividend payment record.
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3. The commercial paper market should function within the overall discipline of CAS. The RBIwould have to administer the entry on the market, the amount if each issue the total quantum
that can be raised in a year.
4. Ni restriction be placed on the commercial paper market except by way of minimum size ofnote. The size of single issue should not be less than Rs. 1 core and the size of each lot should
not be less than Rs. 5 lakhs.
5. Commercial paper should be excluded from the stipulations on insecure advances in the case ofbanks.
6. Commercial paper would not be tied to any transaction and the maturity period may be 7 daysand above but not exceeding six months, backed up if necessary by a revolving underwriting
facility of less than three years .
7. The using company should have a net worth of net less than Rs. 5 cores, a debt quality ratio ofnot more than 105, current ratio of more than 1033, a debt servicing ratio closer to 2, and be
listed on the stock exchange.
8. The interest rate on commercial paper would be market dominated and the paper could be issuedat a discount to face value or could be interest bearing.
9. Commercial paper should not be subject to stamp duty at the time of issue as well as at the timetransfer by endorsement and delivery.
On the recommendations of the Vaghul Working Group, the RBI announced on 27 th March,
1989 that commercial paper will be introduced soon in Indian money market. Detailed guidelines
were issued in December 1989, through non-Banking companies (acceptance of Deposits
through commercial paper) Direction, 1989 and finally the commercial papers were instructed in
India from 1st January, 1990.
RBI Guidelines on Commercial Paper Issue
The important guidelines are:
1. A company can issue commercial paper only if it has:1. A tangible net worth of not less than Rs. 10croes as per the latest balance sheet;2. Minimum current ratio of 1.33:1,3. A fund based working capital limit of Rs. 25 crores or more.;
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4. A debt servicing ratio closer to 2;5. The company is listed on a stock exchange;6. Subject to CAS discipline;7. It is classified under Health Code no. 1 by the financing banks;8. The issuing company would need to obtain p1 from CRISIL;
2. Commercial paper shall be issued in multiples of Rs. 25 lakhs but the minimum amount to beinvested by a single investor shall be Rs. 1 crore.
3. The commercial paper shall be issued for minimum maturity period of 7 days and the maximumperiod of 6 months from the date of issue. There will be no grace period on maturity.
4. 0the aggregate amount shall not exceed 20% of the issuers fund based working capital.5. The commercial paper is issued in the form of usince promissory notes, negotiable by
endorsement and delivery. The rate of discount could be freely determined by the issuing
company. The issuing company has to bear all flotation cost, including stamp duty, dealers, fee
and credit rating agency fee.
6. The issue of commercial paper cannot be underwritten or co-opted in any manner. However,commercial banks can provide standby facility for redemption of the paper on the maturity date.
7. Investment in commercial paper can be made by any person or banks or corporate bodiesregistered or incorporated in India and un-incorporated bodies too. Non-resident Indians can
invest in commercial paper on non-repatriation basis.
8. The companies issuing commercial paper would be required to ensure that the relevantprovisions of the various statutes such as companies Act, 1956, the IT At, 1961 and the
Negotiable Instruments Act, 1981 are complied with.
Procedure and Time Frame Doe Issue Commercial Paper
1. Application to RBI through financing bank or leader of consortium bank for working capitalfacilities together with a certificate from credit rating agency.
2. RBI to communicate in writing their decision on the amount of commercial paper to be issued tothe leader bank.
3. Issue of commercial paper to be completed within 2 weeks from the date of approval of RBIthrough private placement.
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4. The issue may be spread shall bear the same maturity date.5. Issuing company to advise RBI through the bank/leader of the bank, the amount of actual issue
of commercial paper within 3 days of completion of the issue.
Implications of Commercial Paper
The issue of commercial paper is an important step in disintermediation bringing a large number
of borrowers as well as investors in touch with each other, without the intervention of the
banking system as financial intermediary. Directly from borrowers can get at least 20% of their
working capital requirements directly from market at rates which can be more advantageous than
borrowing through a bank. The forts class borrowers have the prestige of joining the elitist
commercial paper club with the approval of CRISIL, the banking system and the RBI, however
RBI has presently stipulated that the working capital limits of the banks will be reduced to the
extent of issue of commercial paper, industrialists have already made a plea that the issue of
commercial paper should be outside the scheme of bank finance and other guidelines such as
recommendation of banks and approval of RBI has not accepted the plea at present as
commercial paper is a unsecured borrowing and not related to a trade transaction. The main aim
of the RBI is to ensure that commercial paper develops a sound money market instrument.si, in
the initial stages emphasis should be on the quality rather than quantity.
Impact on commercial banks
The impact of issue of commercial paper on commercial banks would be of two dimensions. One
is that banks themselves can invest in commercial paper and show this as short term investment.
The second aspect is that the banks are likely to lose interest on working capital loan which has
been hitherto lent to the companies, which have, now started borrowing through commercial
paper.
Further, the larger companies might avail of the cheap funds available in the market during the
slack season worsening the banks surplus fund position\, but come to the banking system for
borrowing during the busy season when funds are costly. This would mean the banks are the
losers with a clear impact on profitability.
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However, the banks stand to gain by charging higher interest rate on reinstated portion especially
of it done during busy season and by way of service charge for providing standby facilities and
issuing and paying commission. Further when large borrowers are able to borrow directly from
the market, banks will correspondingly be freed from the pressure on resources.
Impact on the Economy
The process of disintermediation is taking place in the free economies all over the world. With
the introduction of CP financial disintermediation has been gaining momentum in the Indian
economy. If CPs are allowed to free play, large companies as well as banks would learn to
operate in a competitive atmosphere with more efficiently. This result greater excellence in the
service of banks as well as management of finance by companies.
Recent trends
RBI has liberalized the terms of issues of CP from May 30, 1991. According to the liberalizedterms, proposal by eligible companies for the issues of CP would not require the approval of
RBI. Such companies would have to submit the proposal to the financing bank which provided
working capital facility either as a sole bank or as a leader of the consortium. The bank, on
being satisfied of the compliance of the norms would take the proposal on record before the
issue of commercial paper.
RBI has further relaxed the rules in June 1992, the minimum working capital limit required bya company to issue CP has been reduced to Rs. 5 crores. The ceiling on amount of which can
be raised through CP has been raised to 75% of working capital. A closely held company has
also been permitted to borrow through CPs provided all the criteria are met. The minimum
rating required from CRISIL has been lowered to P2 from 1994 95, the standby facility by
banks for CP has been abolished. When CPs are issued, banks will have to effect a pro-rata
reduction in the criteria are met. The while minimum rating needed from ICRA is A2 instead of
A1.
According to the RBI monetary policy for the second half of 1994 95, the standby facility bybanks for CP has been abolished. When CPs are issued, banks will have to effect a pro-rata
reduction in the cash credit limit and it will be no longer necessary for banks to restore the cash
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credit limit to meet the liability on maturity of CPs. This will import a measure of
independence to CP as a money market instrument.
Future of Commercial Paper in India
Corporate enterprises requiring burgeoning funds to meet their expanding needs find it easier and
cheaper to raise funds from market by issuing commercial paper. Further, it provides greater
degree of flexibility in business finance to the issui9ng company in as much it can decide the
quantum of CP and its maturity on the basis of its future cash flows. CPs have made a good start.
Since the inception of CPs in India in January 1990, 23 companies have issued CPs worth RS.
419.4 crore till June 1991. The total issues amounted to Rs. 9,000 crore in June 1994. The
outstanding amount of CPs stood art Rs. 4,770 crore on March 31, 1999 and increased to Rs.
7,814 crore on March 31. 2000.
The issues of CPs declined to Rs. 5,663 crore on March 31, 2000. It shows that the CP market is
moribund. There is no increase in issuer base. i.e. the same companies are tapping this market for
funds. The secondary market is virtually non-existent. Only commercial banks pick these papers
and hold till mortuary. No secondary market is allowed to develop on any significant scale.
Further, trading is cumbersome as procedural requirements are onerous. The stamp duty payable
by banks subscribing charged to non-banking entities like, primary dealer, corporate and non-
banks instead of directly subscribing to them. The structural rigidities such as rating
requirements, timing of issue, terms of issue, maturity ranges denominational rang and interest
rate stand in the way of developing commercial paper market. The removal of stringent
conditions and imposing o such regulatory measures justifiable to issues, investors and dealers
will improve the potentiality of CP as a source of corporate financing.
2) Certificate of deposit(CD)A certificate of deposit ("CD") is a short to medium-term, FDIC insured investment
available at banks and savings and loan institutions. Customers agree to lend money to the
institutions for a certain amount of time. In exchange for doing so, the customers is paid a
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predetermined rate of interest. Often, banks will charge a penalty fee if the money is withdrawn
from the CD before it matures.
Issuers:
The issuers of certificate of deposits are commercial banks,financial institutions ect.
Subscribers:
CDs are available for subcription by individuals,corporation,trusts,assocation and NRIs.
Features of Certificate Of Deposit:
Document of title to time deposit. Unsecured negotiable promotes. Freely transferable by endorsement and delivery. Issued at discount to face value. Repayable on a fixed date without grace days. Subject to stamp duty like the usince promissory notes.
The banks in USA in 1960s introduced CDs which are freely negotiable and marketable any time
before maturity. The CDs were issued by big banks in the USA of $1 million at face value
bearing fixed interest with a maturity generally ranging from 1 to 6 months. Banks sold CDs
direct to investors or through dealers who subsequently traded this instrument in secondary
market. The American banks issued for the first time dollar CDs in London in 1966. The bank of
England gave permission to around 40 banks to make CD issue.
The feasibility of introducing CDs in India was examined by the Tamb Working Group in 1982
which did not, however, favour the introduction of this instrument. The matter was again studied
in 1987 by the Vaghul Working Group on the Money Market. The Vaghul Group recognized that
CP world be attractive both the banker and investor in that the bank is not required to encase the
deposit prematurely while the investor can liquefy the instrument before its maturity in the
secondary market.
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On the recommendations of the Vaghul Committee, the RBI formulated a scheme in June 1989
permitting scheduled commercial banks (excluding RRBs) to issue CDs. It terms of the scheme,
CDs can be issued by scheduled commercial banks at discount on face value and the discount
rates are market-determined. The RBI has issued detailed guidelines for the issue of CDs and ,
with the changes introduced subsequently, the scheme for CDs has been liberalized.
RBI Guidelines:
1. The denomination of CDs could be in multiples of Rs. 5 lakh subject to a minimum size of anissue to a single investor being Rs. 25 lakh. The CDs above Rs.25lakh will be in multiples of
Rs.5 lakh. The amount rates to face value (not mortuary value) of CDs issued.
2. The CDs are short-term deposit instruments with maturity period ranging from 3 months to oneyear. The banks can issues at their discretion the CDs for any member of months/ days beyond
the minimum usince period of three months and within the maximum usince of one year.
3. CDs can be issued to individuals, corporations, companies, trust funds, associations, etc. non-resident Indians (NRIs) can also subscribe to CDs but only on a non-repatriation.
4. CDs are freely transferable by endorsement and delivery but only after 45 days of the date ofissue the primary investor. As such, the maturity period of CDs available in the market can be
anywhere between 1 day and 320 days.
5. They are issued in the form of usince promissory notes payable on a fixed date without days ofgrace. CDs are subject to payment of stamp duty like the usince promissory notes.
6. Banks have to maintain CRR and SLR on the issue price of CDs and report them as deposits tothe RBI. Banks are neither permitted to grant loans against CDs nor to buy them back
prematurely.
7. From October 17, 1992, the limit for issue of CDs by scheduled commercial banks (excludingRegional Rural Banks) has been raised from 7 per cent to 10 per cent of the fortnightly
aggregate deposits in 1989 90. The ceiling on outstanding of CDs at any point of time are
prescribed by the Reserve Bank of India for each bank. Banks are advised by the RBI to ensure
that the individual bank wise limits prescribed for issue of CDs are not exceeded at any time.
At present the total permissible limits for issue of certificates of deposits (CDs). By the baking
system amounts to Rs. 15,038 crore equivalent to 10 per cent of the fortnightly average
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outstanding aggregate deposits in 1989 90. The outstanding amount of CD issued by 50
scheduled commercial banks as on February 5,1998 amounted to Rs.10,261 crore and formed
70.4 per cent of the limit set for these banks for issue of CDs. To enable banks to mobilize
deposits on comparative terms id has been decided to enhance the limits for issue of CDs .
Accordingly, with effect from April17m 1993 scheduled commercial banks (excluding Regional
Rural Banks) can issue CDs equivalent to 10 per cent of the fortnightly average outstanding
aggregate deposits inn 199192. Consequently the aggregate limits for issue of CDs by eligible
banks would increase from Rs. 15,038 crore of Rs. 20,552 crore. There financial instruments,
viz, industrial development banks in India, industrial credit and investment corporation of India
and industrial finance corporation of India, were permitted to issue CDs with a maturity
aggregate limit of Rs. 100 crore (enhanced to Rs. 1,350 crore in May 1992) . effective from July
29, 1992 the industrial reconstruction Bank of India has also been permitted by issue CDs upto a
limit of Rs. 100 crore.
Advantages of Certificate of Deposits:
1. Certificate of deposits are the most convenient instruments to depositors as they enabler theirshort term surpluses to earn higher return.
2. CDs also offer maximum liquidity as the are transferable by endorsement and delivery. Theholder can resell his certificate to another.
3. From the point of view of issuing bank,, it is vehicle to raise resource in times of need andimprove their lending capacity. The CDs are fixed term deposits which cannot be withdrawn
until the redemption date.
4. This is an ideal instrument for the banks with short term surplus found to invest at attractiverates.
3) Inter bank participations certificate:
The Working Group on the Money Market (Chairman Shri N.Vaghul) had recommended the
introduction of Inter-Bank Participations, with a view to providing an additional instrument for
evening out short term liquidity within the banking system. The said recommendation has been
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accepted and the following scheme of Participations has been framed. The salient features of
theScheme are given below:
There will be two types of Participations:
I. Inter-Bank Participations with Risk Sharing; and
II Inter-Bank Participations without Risk Sharing.
The Participations would be strictly inter bank confined to scheduled commercial banks.
I. Inter-Bank Participations with Risk SharingThe primary objective of the Participations is to provide some degree of flexibility in the credit
portfolio of banks and to smoothen the working of consortium arrangements.
1. Applicability of the Scheme
The scheme will be confined to scheduled commercial banks.
2. Period of Participations
The minimum period of such a Participation will be 91 days, while the maximum period
will be 180 days.
3. Rate of Interest
The rate of interest on Participations would be left free to be determined between the issuing
bank and the participating bank, subject to a minimum of 14.0 per cent per annum.
4. Selection of Accounts
Banks will allot such Participations only in respect of advances classified under Health Code
No. 1 status. The aggregate amount of such Participations in any account should not exceed 4
per cent of the out standings in the account at the time of issue. During the currency of the
Participations the aggregate amount of Participations should be covered by the outstanding
balance in the account. In case the outstanding balance falls short of the participations
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outstanding, the issuing bank will reduce the Participations to the extent necessary and if need
be, issue Participations for smaller amounts.
5. Accounting
In the case of the issuing bank, the aggregate amount of Participations would be reduced from
the aggregate advances outstanding. Such transactions will not be reflected in the individual
borrower's accounts but will be only netted out in the General Ledger. The participating bank
would show the aggregate amount of such Participations as part of its advances. The issuing
bank will maintain a register to record full particulars of such Participations.
There will be no privity of contract between the borrower and the participating bank and to
avoid any difficulty, banks will incorporate in the cash credit agreement of the borrowers an
appropriate clause permitting the lending bank to shift a part of the advance to any bank,
without notice to the borrowers, by way of Participations. The agreement may also provide that
in the event of issue of Participations the issuing bank would continue to represent the
participating bank in protecting the latter's interests.
6. Risk
The risk would be deemed to have crystallised when the issuing bank recalls the advances and
stops operations in the relative account. In such a case the issuing bank would give due notice to
the participating bank intimating the default.
7 . Repayment
The issuing bank will normally repay the amount of Participations together with interest to the
participant bank on the date of maturity, excepting when the risk has materialised. In cases
where risk has materialised the issuing bank will take necessary action, in consultation with the
participating bank and share the recoveries proportionately.
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8. Documentation
All banks wishing to participate in the scheme should subscribe to the "uniform code for
Participations" prepared by IBA which will spell out clearly their inter-se rights and obligations
in relation to the securities covered by the advances in question.
9. Transferability
Participations will not be transferable.
Il. Inter-Bank Participations without risk sharing
The primary objective of this type of Participation is to even out short term liquidity. The
Participation should be backed by the cash credit accounts of the borrowers.
1. Applicability of the scheme
The scheme will be confined to scheduled commercial banks only.
2. Period of Participation
The tenure of such Participations will not exceed 90 days.
3. Rate of Interest
The rate of interest would be determined by the two concerned banks subject to a ceiling of 12.5
per cent per annum.
4. Accounting
The issuing bank will show the amount of Participations as borrowing while the participating
bank will show the same under Advances to bank i.e. due from banks. The Participations would
be treated as part of the net Demand and Time Liabilities and net bank balances for purposes of
statutory reserve requirements.
5. Repayment
On the date of maturity, the issuing bank will pay the amount of Participations with interest to
the participating bank irrespective of the default if any in the advance in question.
6. Transferability
Participation will not be transferable.
7. Reporting of Data
As a result of outstanding Participations being treated as borrowings, the issuing bank should
report such borrowings in the fortnightly return under Section 42(2) of the Reserve Bank of
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India Act, 1934. The same should be done by including the amount of Participations, by the
issuing bank under 'Borrowings from banks' i.e. item l(b) in Form 'A'. The participating bank
should include the amount of Participations taken in advances to banks under item III(c) in
Form 'A'. The amount of Participations so included in the relative items of Form 'A' should be
clearly indicated as a foot-note to the return, showing separately also Participations on risk
sharing basis.
4) Repo instruments:In a repo transaction, a holder of securities sells them with an agreement to repurchase the same
after a certain period at a predetermined price which is higher than the sale price. In essence it
means that the parties exchange securities and cash with a simultaneous agreement to reverse the
transactions after a given period. Thus a repo represents a collateralized short term lending
transaction. The party which lends securities (or borrows cash) is said to be doing the repo and
the party which lends cash (or borrows securities) is said to be doing the reverse repo.
The salient features if repo transaction is as follows:
1. Repos are generally for a period not exceeding 14 days though there is norestriction on the maximum period for which a repo can be done.
2. G-secs treasury bills and select PSU and institutional bonds are the instrumentsused as collateral security for repo transaction.
3. While banks and primary dealers can do repos as well as reverse repos, otherparticipants such as institutions and corporates can only lend funds in the repo
market? Recently policy changes seek to do away with this restriction and
promote a phased expansion of the repo market. Such an expansion however,
would call for creating an enabling infrastructure such as the Clearing
Corporation and electronic settlements of transactions.
4. Repos are settled on DVP basis on the same day. So, the participants in repotransactions must hold SGL, account and current account with the RBI
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5. Repos are reported in the negotiated trade segment of the WDM segment of the
NSE.
Treasury Bills:
Treasury bills are short term debt instruments of the central government. Presently 91-day and
364 day treasury are issued. Treasury bills are sold through an auction process according to a
fixed auction calendar announced by RBI. Banks and primary dealers are the major bidders in
the competitive auction process. Provident funds and other investors can make non-competitive
bids. RBI makes allocation to non-competitive bidders at a weighted average yield arrived at on
the bass of the yields quoted by accepted competitive bids.
Treasury bills are issued at a discount and redeemed at par. Hence the implicit yield on a treasury
bill is a function of the size of the discount and the period of maturity.
Treasury bills are largely held by banks. Provident funds trusts, and mutual funds gave also in
recent years become important inverts in treasury bills. Most buyers of treasury bills hold them
till maturity and hence the secondary activity is quite limited.
Commercial Paper:
Commercial paper (CP) is an instrument of short term in secured borrowing issued by non-
banking companies. CPOs are issued at a discount and redeemed at par. CPs are meant primarily
to finance working capital needs of corporates and hence form part of the working capital limits
set by banks.
CP issues are regulated by RBI guidelines issued from time to time. According to October 2001
guidelines:
1. Corporates, all India financial institutions (FIs), Primary Dealers and SatelliteDealers can issue CPs. A corporate is eligible if its tangible net worth is at least
Rs 4 crore, if it has a sanctioned working capital limit from a bank or financial
institution ad if its borrowed account is a standard asset.
2. The minimum credit rating shall be P-2 of CRISIL or an equivalent thereof.3. The maturity period is 15 days to 1 year
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4. The denomination is Rs 5 lakh or a multiple, thereof.5. Only a scheduled banks can act as an IPA (Issuing and paying Agent)6. CP can be issued as a promissory note or in a demat form.
The RBI has mandated that all further issues of CPs should be in a demat form and that banks,
financial institutions, primary dealers and secondary dealers convert their CP holdings into
demat form from March 31, 2002 onwards. This reduces stamp duty in CP transactions.
The above discussions were pertaining to money market instruments with relative advantages.