Composition and Importance of Money Market

Composition of Money Market

The money market is not a single homogeneous market. It consists of a number of sub-markets which collectively constitute the money market. There should be competition within each sub-market as well as between different sub-markets. The following are the main sub-markets of a money market:

Indian money market was highly regulated and was characterized by limited number of participants. The limited variety and instruments were available. Interest rate on the instruments was under the regulation of Reserve Bank of India. The sincere efforts for developing the money market were made when the financial sector reforms were started by the government.

Money markets are the markets for short-term, highly liquid debt securities. Examples of these include bankers’ acceptances, repos, negotiable certificates of deposit, and Treasury Bills with maturity of one year or less and often 30 days or less. Money market securities are generally very safe investments, which return relatively; low interest rate that is most appropriate for temporary cash storage or short term time needs.

Importance of Money Market

A developed money market plays an important role in the financial system of a country by supplying short-term funds adequately and quickly to trade and industry. The money market is an integral part of a country’s economy. Therefore, a developed money market is highly indispensable for the rapid development of the economy. A developed money market helps the smooth functioning of the financial system in any economy in the following ways:

  • Development Of Trade And Industry: Money market is an important source of financing trade and industry. The money market, through discounting operations and commercial papers, finances the short-term working capital requirements of trade and industry and facilities the development of industry and trade both — national and international.
  • Development Of Capital Market: The short-term rates of interest and the conditions that prevail in the money market influence the long-term interest as well as the resource mobilization in capital market. Hence, the development of capital depends upon the existence of a development of capital money market.
  • Smooth Functioning of Commercial Banks: The money market provides the commercial banks with facilities for temporarily employing their surplus funds in easily realizable assets. The banks can get back the funds quickly, in times of need, by resorting to the money market. The commercial banks gain immensely by economizing on their cash balances in hand and at the same time meeting the demand for large withdrawal of their depositors. It also enables commercial banks to meet their statutory requirements of cash reserve ratio (CRR) and Statutory Liquidity Ratio (SLR) by utilizing the money market mechanism.
  • Effective Central Bank Control: A developed money market helps the effective functioning of a central bank. It facilities effective implementation of the monetary policy of a central bank. The central bank, through the money market, pumps new money into the economy in slump and siphons if off in boom. The central bank, thus, regulates the flow of money so as to promote economic growth with stability.
  • Formulation Of Suitable Monetary Policy: Conditions prevailing in a money market serve as a true indicator of the monetary state of an economy. Hence, it serves as a guide to the Government in formulating and revising the monetary policy then and there depending upon the monetary conditions prevailing in the market.
  • Non-Inflationary Source Of Finance To Government: A developed money market helps the Government to raise short-term funds through the treasury bills floated in the market. In the absence of a developed money market, the Government would be forced to print and issue more money or borrow from the central bank. Both ways would lead to an increase in prices and the consequent inflationary trend in the economy.

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