Money Market Functions, Structure, Objectives and Nature

Table of Contents:

Functions of Money Market

The important functions of the money market within the financial system include price discovery, risk mitigation, short-term borrowing and lending, liquidity management, reserve management for banks, financing trade and commerce, central bank operations, and support for government funding needs, etc.

The money market serves as a suitable platform for trading highly liquid and low-risk financial instruments. It facilitates lending of funds and short-term borrowing, contributes to liquidity management and ensures efficient capital allocation in the financial system. Understanding the detailed functions of the money market is essential for people dealing with the complex field of financial institutions and instruments. Whether it’s about influencing interest rates or financing short-term needs the money market plays an important role in the economy.

The major functions of the money market are given as follows:

1) Maintain Monetary Equilibrium: It means to keep a balance between the demand for and supply of money for short-term monetary transactions.

2) Promote Economic Growth: The money market can do this by making funds available to various units in the economy such as agriculture, small-scale industries, etc.

3) Provide Help to Trade and Industry: The money market provides adequate finance to trade and industry. Similarly, it also provides the facility of discounting bills of exchange for trade and industry.

4) Help in Implementing Monetary Policy: It establishes a mechanism for the effective implementation of monetary policy.

5) Help in Capital Formation: The money market makes available investment avenues for short-term periods. It helps in generating savings and investments within the economy.

6) Provides Non-Inflationary Sources of Finance to Government: It is possible to issue treasury bills to raise short loans. However, this does not result in a price increase.

Structure of Money Market

The entire money market in India can be classified into two different segments. They are the organised money market and the unorganised money market. The unorganized money market can also be referred to as an unauthorized money market. Both of these components comprise several constituents. The following topics will help in understanding the organizational structure of the Indian money market.

The structure of the money market can be divided into two:

  • Organised Money Market
  • Unorganised Money Market

Organised Money Market

That part of the money market which is under the control of the government is called the organised sector of the money market. It includes the following institutions:

  • Co-operative Banks
  • Reserve Bank of India
  • Commercial Bank

1) Co-operative Banks: Co-operative banks are also taking part in the money market. These banks comprise a three-tier structure. State cooperative banks are at the top of the structure. At the district level, central cooperative banks deal in short-term loans; at a local level, there are rural primary and urban cooperative banks.

2) Reserve Bank of India: The Reserve Bank of India is the highest institution in the Indian financial market. This is the Central Bank of India. It is an issue of short-term loans when any bank has any need for short-term money.

3) Commercial Bank: Commercial banks are the strong constituents of the organised sector of the money market. In commercial banks, there are SBI, nationalised banks, rural banks, and private banks which deal in short-term loans with each other, one bank can take or give short-term loans to each other when they need extra money, they want to invest in short-term govt, security.

Unorganised Money Market

The unorganised segment of the Indian money market is composed of unregulated non-bank financial intermediaries, indigenous bankers and money lenders which exist even in small towns and big cities. Their lending activities are mostly restricted to small villages and towns. The people who normally borrow from this unorganised sector include farmers, artisans, small traders and small-scale producers who do not have any access to modern banks.

The following are some of the components of the unorganised money market in India.

  • Money Lenders
  • Indigenous Bankers
  • Unregulated Non-Bank Financial Intermediaries

1) Money Lenders: They advance loans to small borrowers, such as marginal and small farmers, agricultural labourers, artisans, factory and mine workers, low-paid staff, and small traders, at a very high rate of interest. The money lenders adopt various malpractices to manipulate the loan records of these poor borrowers. There are broadly three types of money lenders:

  • Itinerant money lenders, such as Kabulis and Pathans.
  • Non-professional money lenders.
  • Professional money lenders dealing solely with money lending

2) Indigenous Bankers: These include those individuals and private firms which are engaged in receiving deposits and giving loans, and, thereby, act like a mini bank. Their activities are not at all regulated. With the growth of commercial banks and cooperative banks, the area of operations of indigenous bankers has again contracted further.

3) Unregulated Non-Bank Financial Intermediaries: There are different types of unregulated non-bank financial intermediaries in India. They are mostly constituted by finance or loan companies, chit funds and nidhis. A good number of finance companies in India are engaged in collecting substantial amounts of funds in the form of deposits, borrowings and other receipts. They normally give loans to wholesale traders, retailers, artisans, and different self-employed people at a high rate of interest ranging between 36 and 48 per cent.

Nature of the Unorganized Money Market

The following are the nature of an unorganized money market:

1) Simple Accounting System: The indigenous bankers and money lenders of the Indian money market maintain their accounts in a very simple and indigenous form in the local language.

2) Secrecy of Business: The dealing of the unorganized sector or Indian market is kept secret, Kakar Gopal in his book, named “Unorganized Money Markets India” has commented regarding the working of the unorganized sector of the money market as follows-“It is in the method of working rather than like the business that indigenous agencies like moneylenders and indigenous bankers stand in marked contrast with modern institutions of the Indian money market”.

3) Informal Dealings: The dealings between the agencies of the unorganized sector and the borrowers are informal.

4) Personal Contract with the Borrowers: Most of the business of unorganized agencies of the Indian money market depends on personal contracts with the borrowers.

5) Mixed Business of Money Lending and Trading: The unorganized agencies of the Indian money market, viz., indigenous bankers and money lenders conduct mixed business of money lending and trading.

6) Flexibility in Lending: The loan operation of agencies in the unorganized sector of the Indian money market is very flexible without following rigid rules. In some cases, they grant second loans without payment of the first loan.

Nature of Money Market

The following points explain the nature of money market:

  • An Apex Central Bank
  • Adequate Availability of Credit Instruments
  • Highly Organized Commercial Banking System
  • Existence of a Large Number of Sub-Markets
  • Proper Coordination among Sub-Markets
  • Integrated Interest Structure
  • Remittance Facilities
  • Number of Dealers
  • Other Factors
  • Responsive

1) An Apex Central Bank

The second essential characteristic of a developed money market is the presence of an apex central bank at the top. The main function of the central bank is to help, control and stabilize the monetary and banking system of the country. It is generally a very powerful bank that exercises control over the other constituents of the money market.

2) Adequate Availability of Credit Instruments

In a developed money market, there is adequate availability of credit instruments like promissory notes, bills of exchange, treasury bills, short-period government bonds, etc.

3) Highly Organized Commercial Banking System

Commercial banks are the most important constituent of money markets. A fully developed money market is characterized by the presence of a highly organized commercial banking system, while in an underdeveloped money market, the banking system is not fully developed. In a developed money market, the other constituents of the money market are well-linked with the commercial banks and through them to the central bank.

4) Existence of a Large Number of Sub-Markets

Another essential characteristic of a developed money market is the existence of many specialized sub-markets, such as call market, bill market, collateral market and acceptance market. The larger the number of specialized sub-markets, the more highly developed is the money market.

5) Proper Coordination among Sub-Markets

The whole organization of the money market should work in a properly coordinated and integrated manner. In a developed money market, various sub-markets should complement each other and not be independent or isolated.

6) Integrated Interest Structure

The money market to be a developed one should have a well-coordinated and integrated interest structure. Any change in the bank rate in the country should bring proportional changes in the interest rates in the market.

7) Remittance Facilities

In a developed money market, cheap facilities for the remittance of funds from one place to another are readily available. The money market cannot work smoothly in the absence of the remittance facilities.

8) Number of Dealers

There should be several dealers and brokers in the developed money market that should buy and sell the credit instruments. An underdeveloped money market, on the other hand, is characterized by the absence of adequate credit instruments and dealers to deal with them.

9) Other Factors

In addition to the above-mentioned important characteristics of a developed money market, there are other contributory factors such as a large volume of trade, stable political conditions, etc.

10) Responsive

A developed money market is highly responsive to domestic and international events. An event that takes place in the economic or political field anywhere in the world affects the money market.

Objectives of Money Market

A well-developed money market serves the following given objectives:

1) Providing an equilibrium mechanism to iron out short-term surpluses and deficits.

2) It enables lenders to turn their idle funds into productive investments benefits both the lender and the borrower.

3) Providing short-term funds at reasonable prices to government, individual investors etc.

4) Providing a focal point for central bank intervention to influence liquidity in the economy.

5) Financing the government sector for both national and foreign trade.

6) Providing necessary funds to organizations that are short on working capital requirements.

7) Providing users of short-term money with access to meet their requirements at a reasonable price.

8) As the Reserve Bank of India regulates the money market, it in turn helps regulate the levels of liquidity in the Indian economy.

Meaning of Money Market

The term money market is used in a composite sense to mean financial institutions, which deal with short-term funds in the economy. It refers to the institutional arrangements facilitating the 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 need short-term funds. In a money market, funds can be borrowed for a short period varying from a day, a week, a month, or 3 to 6 months and against different types of instruments, such as bills of exchange, bankers’ acceptances, bonds, etc., called ‘near money. One of the key functions of the money market is to provide a platform for the trading of financial instruments that have high liquidity. 

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 transfer 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, individuals’ borrowing, and government short-term obligations, it differs from the long-term or capital market which devotes its attention to dealings in bonds, corporate stocks and mortgage credit”.

According to Crowther, “The money market is the collective name given to the various firms and institutions that deal in the various grades of near money”.

Reserve Bank of India describes the Money Market as, “The centre for dealings, mainly of a short-term character, in monetary assets; it meets the short-term requirements of borrowers and provides liquidity or cash to the lenders”.

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