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Mrunal [Economy 4 Newbie] Money market, Repo Rate & Call Money Print

[Economy 4 Newbie] Money market, Repo Rate & Call Money

Mrunal update October-18-2012: This is Old and outdated article. dont pay much attention, Ill refine and rewrite it later.

What is money market

In simple terms, if I borrow money from you for less than 1 year = the place where we do this deal is Money market For long term loans = Capital market. See this diagram

Technical definition
market refers to the market for short-term funds, i.e., up to one-year maturity. money market is the place where lending and borrowing is done through instruments having an original maturity of up to one year.

Use of money market

money market provides a mechanism to balance the demand for and supply of short-term funds. the opportunity for players to invest their short-term surplus funds and to borrow short-term funds in case of deficit. Its interlinked with Foreign Exchange market (read my article on currency devaluation for more on this)
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Mrunal [Economy 4 Newbie] Money market, Repo Rate & Call Money Print

Call/ Notice/Term Money Market

It is the market for borrowing and lending for short-term periods (usually upto 14 days, but at times more than that) The deals mostly by commercial banks. It is a telephonic market, i.e., deals are struck over telephone and reported to RBI. (thats why its call market) Commercial banks often face temporary shortages of funds (e.g., to meet CRR and SLR requirements, or sudden outgo of funds) or temporary surpluses. When a bank is in shortage of funds, it telephones & borrows from another bank which is in surplus.

3 types of deals in Call Market

Call Money
If borrowing (or lending) is made for one day (overnight), it is known as Call Money. This segment is also called overnight money market.

Notice Money
If the maturity of borrowing (or lending) is more than 1 day but up to 14 days, then it is known as Notice Money.

Term Money
Term Money refers to money borrowed (or lent) for more than 14 days but less than one year. In Indian money market, most of the transactions are of call money and notice money.
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Mrunal [Economy 4 Newbie] Money market, Repo Rate & Call Money Print

Players in Call Market

commercial banks and primary dealers can both borrow and lend, LIC, UTI, GIC, IDBI, NABARD, ICICI & Mutual Fund managers can lend money in this market (but theyre not allowed to borrow from this market) RBI, as regulator, routinely participates in the market to inject liquidity (lend) or to mop up liquidity (borrow).

Repos/Reverse Repos
repo (also known as ready forward contract) transaction, Example Suppose I write on a piece of paper anyone who gives me 100 Rs. Ill give him 120 Rs. After 1 year this piece of paper is security. Now I give that paper to you and collect 100 Rs. And tell you that Ill buy (repurchase) that paper after 6 months and give you 110 Rs. This is called repo-contract And this period (6 months) is repo period. Now remember the mirror in the mirror my left hand will show as my right hand. Same is for Reverse Repo Rate
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Mrunal [Economy 4 Newbie] Money market, Repo Rate & Call Money Print

When you buy a security and sign contract that youll sell it after 6 months = this is reverse repo contract. one party borrows funds for a specific period (known as repo period) against the collateral of specific securities at pre-determined rate (known as repo rate) for buyer its reverse repo rate (RRR) and for seller its repo rate.(RR) And whether the transection is RRR or RR is classified by who initiated the deal? If the buyer initiated the deal then its RRR If the seller initiated the deal then its RR To prevent the topic getting confusing and complicated. Lets take an example First the easy exampleIm the RBI manager. When I give you security (paper) & take money from you this is Repo. When I buy the security (paper) from you and give you money- this is reverse Repo. Now the more correct example Im the RBI manager. When I give you security (paper) & take money from you & promise you that Ill buy the same paper back from you after few months this is Repo. When I buy the security (paper) from you and give you money & you promise me that youll buy back that paper from me after few months- this is reverse Repo.

The players in Repo / Reverse Repo Rate

RBI, Scheduled banks & Primary dealers can borrow and lend Non-Bank participants (Finacial institutions) + companies listed in stock market can only lend , they cant borrow.
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Mrunal [Economy 4 Newbie] Money market, Repo Rate & Call Money Print

Lets rewind the liquidity tape

1. Liquidity = How much money in the market? = if money is plenty= easy to get loans @ 2. 3. 4. 5.
cheaper interest rate = this is called cheap / easy money. When there is less liquidity =hard to get loans and the interest rate will be higher = this is Dear money. Where there is too much money= inflation When there is too less money= bad to business as you cant get loans easily to run your works. So RBIs work is to fine tune the liquidity (money supply.) = tuning the dear money / easy money policy based on the situation.

See this diagram

RBI & Repo

absorption of short-term liquidity, RBI carries out overnight (one day) repo auction at a fixed rate. Currently, fixed-rate repo and reverse repo auctions are conducted by the RBI on a daily basis (excluding Saturdays, Sundays and other public holidays) for 1 day (overnight) tenor. This means, RBI is ready to sell as much securities as is demanded by the participants at the fixed rate. This rate is fixed in the sense that it does not change on a daily basis depending upon the supply-demand condition of short-term liquidity Changes in the fixed repo rate are usually made in the Annual Monetary and Credit Policy or in the Mid-Term Review of the Monetary and Credit Policy.

RBI & Reverse Repo

In order to inject liquidity into the system, RBI conducts fixed rate auctions of reverse repo at a rate higher than the repo rate.
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Mrunal [Economy 4 Newbie] Money market, Repo Rate & Call Money Print

The reverse repo rate is linked to the repo rate in the sense that it is set at specific percentage point above the repo rate.

Definition difference from international market.

Keep in mind, the terms repo and reverse repo have been defined above, is just opposite to the international practice. That is, what is repo in Indian terminology is reverse repo in international parlance, and what is reverse repo in India is internationally known as repo. In a fast globalising environment, this may create confusion. Consequently, RBI has changed the definitions of repo and reverse repo to bring them in line with international practice with effect from 27th October 2004. However, in this article, we have throughout followed the older (Indian) definition. Money market topic doesnt stop here, there are other remaining items like Commercial papers, Treasury bills, Certificate of Deposits etc which will be dealt in some other article.

URL to article: http://mrunal.org/2010/02/economy-4-newbie-money-market-reporate.html Posted By On 01/02/2010 @ 14:48 In the category Economy

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