Money market is the market where short-term funds are traded. In simple term, it means that all the financial assets or instruments which can be easily converted into money are traded in this market. The short-term money requirement of the borrowers can be easily met with the funds provided by the money market.
Money markets play a key role in banks’ liquidity management and the monetary policy of RBI. Though the discussion has been taken place keeping RBI in mind, the intricacies explained in the following paragraphs apply to international scenarios as well. Also, recent international trends in the money market have been highlighted at the end.
(a) Banks’ liquidity management
Banks have to maintain Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR). CRR is the reserve which the Banks have to keep with Reserve Bank of India (RBI). On the other hand, SLR is the amount which the banks have to keep with themselves. Banks are often evaluated on the basis of their liquidity, or their ability to meet cash and collateral obligations without incurring substantial losses.SLR requirements help banks to do that. Whenever the RBI issues treasury bills on behalf of the Government, CRR and SLR requirements of banks are automatically met.
(b) Monetary policy
Monetary policy affects rates of interest, inflation and business cycle. Government through the introduction of repos and reverse repos tweak the rate of interest, thus, reducing or increasing money supply by impacting inflation, thereby effecting changes in business cycles. Also, by introducing treasury bills and other money market instruments, it affects money supply and consequently inflation and business cycles.
In normal times, money markets are among the most liquid in the financial sector. By providing the appropriate instruments for liquidity trading, the money market allows the refinancing of short and medium-term positions and facilitates the mitigation of one’s business liquidity risk with the help of commercial papers, commercial bills and certificate of deposits.
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