RICE

THE MONETARY MARKET

  • Money Market is the segment of the Financial Market where highly liquid, short-term financial assets with maturity up to 1 year are traded. 
  • It meets the short-term borrowing and working-capital needs of financial institutions and businesses. 
  • Due to their short maturity and high liquidity, money market instruments are often called cash investments. 
  • Money Market tools are of two types: Qualitative & Quantitative tools 

QUANTITATIVE TOOLS  

  1. Reserve Requirements: Changing the “Lending Pool”

These tools tell banks how much of their deposits they must keep aside and are not allowed to lend to customers. 

Cash Reserve Ratio (CRR) 

  • CRR is the percentage of a bank’s total deposits that it must keep as cash with the RBI. 
  • The bank cannot use this money for lending, and it earns no interest on it. 
  • Impact on Banks. 
When CRR increases When CRR decreases 
Banks have to keep more money with the RBI.  They have less money available to give as loans.  This can lead to higher interest rates on loans. Banks have to keep less money with the RBI.  More money becomes available for giving loans.  This can lead to lower interest rates and more lending. 

 Statutory Liquidity Ratio (SLR) 

  • SLR is the percentage of deposits that a bank must keep in safe and easily available assets, mainly Government Securities (G-Secs) and gold. 
  • Impact on Banks 
  • High SLR: Banks have to keep more money in safe assets like government securities, so less money is available for loans. 
  • Low SLR: Banks can use more money to give loans to businesses and individuals. 
  1. Policy Rates: Changing the “Cost of Funds”

These rates determine how expensive it is for commercial banks to borrow money to meet short-term shortfalls. 

Statutory Liquidity Ratio (SLR) 

  • SLR is the part of a bank’s deposits that it must keep in safe assets, mainly government securities and gold. 
  • Impact on Banks 
  • Higher SLR: More money is kept in safe assets → less money for loans. 
  • Lower SLR: Less money is kept aside → more money for loans. 

Repo Rate  

  • The interest rate banks pay when they borrow short-term money from the central bank by pledging their G-Secs as collateral. 
  • Impact on Banks: 

(a) When Repo Rate increases: To protect their profit margins, banks pass this cost down to the public by increasing lending rates (like MCLR or external benchmarks). 

(b) When Repo Rate decreases: They pass the benefit to consumers by lowering interest rates on home, car, and personal loans to stay competitive. 

Reverse Repo Rate 

  • It is the interest rate banks earn when they keep their extra money with the RBI. 
  • Higher Reverse Repo Rate: Banks earn more by keeping money with the RBI → they lend less money to people and businesses. 
  • Lower Reverse Repo Rate: Banks earn less by keeping money with the RBI → they are more likely to give loans. 

Marginal Standing Facility (MSF) & Bank Rate 

  • MSF allows banks to borrow emergency money from the RBI when they face a cash shortage. 
  • Banks have to pay a higher interest rate for this emergency borrowing. 
  • Impact on Banks 

(a) Higher MSF rate: Emergency borrowing becomes expensive → banks manage their money more carefully. 

(b) Lower MSF rate: Emergency borrowing becomes cheaper → banks can get funds more easily when needed. 

Standing Deposit Facility (SDF) 

  • SDF allows banks to keep their extra money with the RBI overnight and earn interest. 
  • Banks do not need to provide government securities as collateral. 
  • No collateral needed: The RBI can easily absorb extra money from banks. 
  • Impact on Banks 

(a) Higher SDF rate: Banks earn more by keeping money with the RBI → they may lend less to businesses and people. 

(b) SDF as the “floor”: Banks will generally not lend at a rate lower than the SDF rate, because they can earn that rate safely from the RBI. 

3. Open Market Operations (OMOs) 

  • OMOs are when the RBI buys or sells Government Securities (G-Secs) to control the amount of money available with banks. 
When RBI buys G-Secs from banks When RBI sells G-Secs to banks 
RBI gives cash to banks in exchange for government bonds.  Banks get more cash.  More cash means banks can give more loans. Banks pay cash to RBI to buy government bonds.  Banks have less cash available.  This means banks may give fewer loans. 

QUALITATIVE TOOLS OF MONETARY MARKET 

1. Margin Requirements – Controlling the Down Payment 

  • The central bank decides the minimum amount a borrower must pay from their own money when taking a loan against collateral. 
  • Higher margin: Borrower needs to pay more → less borrowing. 

2. Consumer Credit Regulation – Controlling EMIs 

  • The central bank can set the minimum down payment and maximum repayment period for consumer loans. 
  • This controls how easily people can buy expensive goods on credit. 

3. Rationing of Credit – Limiting Loans 

  • The central bank can set a maximum limit on how much a bank can lend to a particular sector or company. 
  • This prevents banks from giving too many loans to one area. 

4. Moral Suasion – Advising Banks 

  • The central bank talks to and advises banks on how they should manage lending. 
  • It may use meetings, letters or guidelines to influence banks. 

5. Direct Action – Taking Action Against Banks 

  • The central bank can penalize banks that break rules or do not follow its instructions. 
  • This may include restrictions or other regulatory action. 

PYQS  

1. Treasury Bills (T-Bills) in India are issued by the Reserve Bank of India on behalf of which authority? (RRB NTPC (Graduate) 2024)

    (a) State Bank of India   

    (b) Central Government of India   

    (c) State Governments   

    (d) SEBI 

    Correct Answer: (b) Central Government of India 

    2. What is the minimum denomination in which a Treasury Bill (T-Bill) can be purchased in India? ( RRB NTPC (UG) 2025)

      (a) ₹5,000 |  

      (b) ₹10,000 |  

      (c) ₹25,000 |  

      (d) ₹1,00,000 

      Correct Answer: (c) ₹25,000 

      3. Commercial Paper (CP), a money market instrument introduced in India in 1990, can only be issued by: (RRB NTPC ( Graduate ) 2025)

        (a) Commercial Banks   

        (b) Highly rated non-banking and corporate entities   

        (c) Regional Rural Banks   

        (d) Ministry of Finance 

        Correct Answer: (b) Highly rated non-banking and corporate entities 

        4. Who acts as the sole regulator and supervisor of the money market and its instruments in India? (RRB ALP 2025)

          (a) Securities and Exchange Board of India (SEBI)   

          (b) Reserve Bank of India (RBI)   

          (c) Ministry of Corporate Affairs   

          (d) State Bank of India 

          Correct Answer: (b) Reserve Bank of India (RBI) 

          5. When the RBI lends money to commercial banks against eligible government securities for very short durations to control liquidity, what is the agreement called? (RRB NTPC (UG) 2025)

            (a) Reverse Repo Agreement   

            (b) Repo (Repurchase Option) Agreement   

            (c) Bank Rate   

            (d) Marginal Standing Facility 

            Correct Answer: (b) Repo (Repurchase Option) Agreement