Meaning of security

A security is a document that is an evidence of specific claims on a stream of income and/or the particular assets. Debt securities include bonds and mortgages. Ownership securities include common stock certificates and the title to marketable assets. In addition, preferred stock is a hybrid security which entitles its owner to a mixture of both ownership and creditor ship privileges.

A good security should have the following characteristics:

1. Free from encumbrances

2. Easy marketability

3. Easy storability

4. Durability

5. Free from price fluctuations

6. Easy ascertainment of value

7. Earning of income

8. Free from heavy cost of handling

9. Free from disabilities

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Central Bank is a Banker to Commercial Banks

Broadly speaking, the central bank acts as the banker’s bank in three different capacities:

(a) It acts as the custodian of the cash reserves of the commercial banks

(b) It acts as the lender of the last resort

(c) It is the bank of central clearance, settlement and transfer.

We shall now discuss these three functions one by one.

(a) It acts as the custodian of the cash reserves of commercial banks: Commercial banks keep part of their cash balances as deposits with the central bank of a country known as centralization of cash reserves. Part of these balances are meant for clearing purposes, that is, payment by one bank to another will be simple book entry adjustment in the books of the central bank. There are many advantages when all banks keep part of their cash reserves with the central bank of the country. In the first place, with the same amount of cash reserves, a large amount of credit creation is possible. Secondly, centralized cash reserves will enable commercial banks to meet crises and emergencies. Thirdly, it enables the central bank to provide additional funds to those banking institutions which are in temporary difficulties. Lastly, it enables the central bank to influence and control the credit creation of commercial banks by making the cash reserves of the latter more or less.

(b) Lender of the last resort: As the banker’s bank, the central bank can never refuse to accommodate commercial banks. Any commercial bank wanting accommodation from the central bank can do so by re discounting (selling) eligible securities with the central bank or can borrow from the central bank against eligible securities.

By lender of the last resort, it is implied that the latter assumes the responsibility of meeting directly or indirectly all reasonable demands for accommodation by commercial banks in times of difficulties and crisis.

(c) Clearing agent: As the central bank becomes the custodian of cash reserves of commercial banks, it is but logical for it to act as a settlement bank or a clearing house for other banks. As all banks have their accounts with the central bank, the claims of banks against each other are settled by simple transfers from and to their accounts. This method of settling accounts through the central bank, apart from being convenient, is economical as regards the use of cash. Since claims are adjusted through accounts, there is usually no need for cash. It also strengthens the banking system by reducing withdrawals of cash in times of crisis.

Furthermore, it keeps the central bank of informed about the state of liquidity of commercial banks in regard to their assets.

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Usefulness of a Developed Money Market

The money market is an important institution in a modern economy and it has influenced profoundly industrial and commercial developments:

(a) In Financing Industry and Commerce: In the first place, the money market is of very great help in financing industry and commerce. Industries are helped in their working capital requirements through the system of finance bills, commercial paper, and so on. It has played a very important part in the financing of trade and commerce. Both internal as well as international trade is normally financed through the system of bills of exchange which are discounted by the bill market.

(b) Investment of Short-term Funds: The money market plays a very important role in providing necessary assets for the investment of short-term funds of commercial banks. Commercial banks find such assets in the call money market as well as in the bill market. Thus, the money market offers the commercial banks a very good means of temporarily employing their funds in liquid or near-money investments.

(c) Help to the Central Bank: The money market is of great help to the central bank of the country. For one thing, the money market and short-term rates of interest which prevail there serve as a good barometer of monetary and banking conditions in the country and thus provide a valuable guide to the determination of central banking policy. For another, the developed money market being a highly integrated structure enables the central bank to deal with the most sensitive of the sub-markets so that the influence of the operation of the central bank may spread to other sections also.

(d) Help to the Government: Lastly, the money market helps the government. The money market supplies the government with necessary short-term funds through the treasury bills.

Thus, a developed money market is of great assistance to industry and commerce, to the commercial banking system, to the central bank of the country and to the government.

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Financial Institutions of the Money Market

The money market may also be analyzed on the basis of the different institutions engaged in lending and borrowing short-term funds. The nature of these institutions may differ from country to country. The same institutions may also function both as borrower and as lender in the market. The lenders are:

1. The Central Bank: It is the lender of last resort. It lends money to commercial banks when they approach for financial assistance.

2. Commercial Banks: They form the most important class of lenders in the money market. They also borrow from the central bank directly or indirectly. The money that they lend comes from the public in the form of deposits repayable on demand. These funds are invested in various forms of assets. These assets which are considered the secondary reserve for the bank are closely linked with the money market.

3. Institutional Investors: They include savings banks, insurance companies, trust companies and investment trusts. The portion of their funds kept invested in liquid assets finds its way into the money market.

4. Private Individuals, Partnerships and Companies: Normally this group may not be interested in short-term funds. If the interest rates become attractive, they may divert a portion of their surplus funds to the money market.

The borrowers in the money market must satisfy certain conditions regarding the paper they offer for discounting. “The paper must be absolutely liquid, easily realizable and short of maturity.” These conditions are satisfied by bill brokers and dealers in stock exchange.

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Composition of the Money Market

The money market is composed of several financial agencies that deal with different types of short-term credit. We may describe the following important components of the money market:

1. Call Money Market: It is a market for short-period loans. Bill brokers and dealers in stock exchange require financial accommodation for very short periods. Money may be lent for periods not exceeding seven days. Sometimes money is lent only overnight. These loans are called call loans or call money as the banks recall these loans at very short notice. The banks prefer this kind of investment for two reasons.

Firstly, call loans can be treated almost like cash and they form the second line of defence for the banks after cash. Secondly unlike cash, the call loans earn some income, in the form of interest, for the banks. The commercial banks are the lenders and the bill brokers and dealers in stock exchange are the borrowers in the call money market. The call money market is an important section of the money market.

2. Collateral Loan Market: When loans are offered against collateral securities like stocks and bonds, they are called ‘collateral loans’ and the market is known as the collateral loan market. This market is geographically most diversified.

3. Acceptance Market: It refers to the market for bankers acceptances which arise out of trade-both inland and foreign. When goods are sold to anyone on credit, the buyer accepts a bill. Such a bill cannot be discounted anywhere easily. The banker adds his credit to the bill by accepting it on behalf of his customer who has purchased the goods. Such bills can be discounted anywhere. In London, there are specialist firms called acceptance houses which accept bills drawn on them by traders. They are well known all over the world. In the past, the acceptance market was a prominent section of London money market. Its importance has declined considerably in recent years. The function of the acceptance houses is being performed by the commercial banks is several countries.

4. Bill Market or Discount Market: It refers to the market where short-dated bills and other paper is discounted. Before the First World War the most important paper discounted in the London money market was the commercial bill which was used to finance both inland and foreign trade. During the inter-war period the importance of the commercial bills declined. This place has been taken by treasury bills. The treasury bills are promissory note of the government to pay a specified sum after a specified period, generally 90 days. The treasury bills are purchased by the investors and when necessary they are discounted in the discount market.

These markets are not water-tight compartments. They are related to one another.

The borrowers in the call money market deal in treasury bills which are discounted with them. Acceptance houses accept bills which are later discounted in the discount market. Thus, the various sections of the money market are intimately related to and are dependent on one another.

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Functions of Money Market

A well-organized and developed money market can help a country to achieve economic growth and stability. It performs a diversity of functions in the banking structure of the economy. They are:

(a) Money market provides outlets to commercial banks, non-banking financial concerns, business corporations and other investors for their short-term funds. It enables them to use their excess reserves in profitable investment.

(b) Money market also provides short-term funds to businessmen, industrialists, and traders etc. to meet their day-to-day requirements of working capital. Money market plays a crucial role in financing both internal as well as international trade.

(c) Money market provides short-term funds not only to private businessmen but also to government and its agencies.

(d) Money market enables businessmen, with temporary surplus funds, to invest them for a short period.

(e) Money market serves as a medium through which the central bank of the country exercises control on the creation of credit.

(f) Money market is also of great help to the government.

The functions of the money market are virtually the same in all the countries of the world. But the institutions, instruments and modes of operation are different in different money markets.

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Meaning of Money Market

The money market concerns trading in money instruments involving borrowing and lending for short periods. It is part of the securities market. The other part is capital market which deals with long-term instruments like equity or shares, debentures and bonds. It provides long-term finance to the government and firms, mostly large ones.

Money Market is a short-term credit market. It is the centre in which short-term funds are borrowed and lent. It consists of borrowers and lenders of short-term funds. The borrowers are generally merchants, traders, brokers, manufacturers, speculators and Government. The lenders are commercial banks, insurance companies, finance companies and the central bank. The money market brings together the lenders and the borrowers. It does not deal in cash or money. It deals in trade bills, promissory notes and government papers or bills, which are drawn for short-periods.

Dr. S.N. Sen defines money market as “the organisation for the lending of short-term funds, through the use of such instruments as commercial bills of exchange, short-term government securities and bankers acceptances.”

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

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