Pre–Conditions for an Efficient Money Market
A well developed money market–
(a) uses a broad range of financial instruments (treasury bills, bills of exchange etc).
(b) channelises savings into productive investments (like working capital),
(c) promote financial mobility in the form of inter sectoral flows of funds and
(d) facilitate the implementation of monetary policy by way of open market operations.
The development of money market into a sophisticated market depends upon certain critical conditions. They are:
(i) Institutional development, relative political stability and a reasonably well developed banking and financial system.
(ii) Unlike capital market or commodity markets, tradings in money market are concluded over telephone followed by written confirmation from the contracting parties. Hence, integrity is sine qua non. Thus banks and other players in the market may have to be licensed and effectively supervised by regulators.
(iii) The market should be able to provide an investment outlet for any temporarily surplus funds that may be available. Thus, there must be supply of temporarily idle cash that is seeking short-term investment in an earning asset. There must also exist a demand for temporarily available cash either by banks or financial institutions for the purpose of adjusting their liquidity position and finance the carrying of the relevant assets in their balance sheets.
(iv) Efficient payment systems for clearing and settlement of transactions. The introduction of Electronic Funds Transfer (EFT), Depository System, Delivery versus Payment (DVP), High Value Inter-bank Payment System, etc. are essential pre-requisites for ensuring a risk free and transparent payment and settlement system.
(v) Government/Central Bank intervention to moderate liquidity profile.
(vi) Strong Central Bank to ensure credibility in the system and to supervise the players in the market.
(vii) The market should have varied instruments with distinctive maturity and risk profiles to meet the varied appetite of the players in the market. Multiple instruments add strength and depth to the market; and
(viii) Market should be integrated with the rest of the markets in the financial system to ensure perfect equilibrium. The funds should move from one segment of the market to another for exploiting the advantages of arbitrage opportunities.
(ix) In India, as many banks keep large funds for liquidity purpose, the use of the commercial bills is very limited. RBI should encourage banks to make use of commercial papers instead of making transactions in cash.
The money market in India has been undergoing rapid transformation in the recent years in the wake of deregulation process initiated by Government of India/Reserve Bank of India. The institutions of Primary Dealers (PDs) and Satellite Dealers have been set up as specialised institutions to facilitate active secondary market for money market instruments. New money market instruments have been introduced and more institutions have been permitted as players in the market. Interest rates in respect of all money market instruments have been completely freed and are allowed to be fixed in terms of market forces of demand and supply.
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