Money Market

A REPORT ON MONEY MARKET

1

INDEX 1

INTRODUCTION

1

2

THE ROLE OF MONEY MARKET

4

3

FINANCIAL SECTOR REFORMS

4

4

WHAT IS MONEY MARKET?

12

5

MONEY MARKET INSTRUMENTS

14

5.1 CALL/NOTICE MONEY

14

5.2 TREASURY BILLS

16

5.3 INTER-BANK TERM MONEY

17

5.4 CERTIFICATE OF DEPOSIT

18

5.5 COMMERCIAL PAPERS

19

5.6 READY FORWARD CONTRACTS

21

5.7 COMMERCIAL BILLS

24

2

(1) INTRODUCTION INDIAN FINANCIAL SYSTEM The economic development of a nation is reflected by the progress of the various economic units, broadly classified into corporate sector, government and household sector. While performing their activities these units will be placed in a surplus/deficit/balanced budgetary situations. There are areas or people with surplus funds and there are those with a deficit. A financial system or financial sector functions as an intermediary and facilitates the flow of funds from the areas of surplus to the areas of deficit. A Financial System is a composition of various institutions, markets, regulations and laws, practices, money manager, analysts, transactions and claims and liabilities.

FINANCIAL SYSTEM The word "system", in the term "financial system", implies a set of complex and closely connected or interlined institutions, agents, practices, markets, transactions, claims, and liabilities in the economy. The financial system is concerned about money, credit and finance-the three terms are intimately related yet are somewhat different from each other. Indian financial system consists

of

financial

market,

financial

instruments

intermediation. These are briefly discussed below;

3

and

financial

FINANCIAL MARKETS

A Financial Market can be defined as the market in which financial assets are created or transferred. As against a real transaction that involves exchange of money for real goods or services, a financial transaction involves creation or transfer of a financial asset. Financial Assets or Financial Instruments represents a claim to the payment of a sum of money

4

sometime in the future and /or periodic payment in the form of interest or dividend.

• Money Market The money market ifs a wholesale debt market for low-risk, highly-liquid, short-term instrument. Funds are available in this market for periods ranging from a single day up to a year. This market is dominated mostly by government, banks and financial institutions.

• Capital Market The capital market is designed to finance the long-term investments. The transactions taking place in this market will be for periods over a year.

• Forex Market The Forex market deals with the multicurrency requirements, which are met by the exchange of currencies. Depending on the exchange rate that is applicable, the transfer of funds takes place in this market. This is one of the most developed and integrated market across the globe. •

Credit Market

Credit market is a place where banks, FIs and NBFCs purvey short, medium and long-term loans to corporate and individuals.

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(2) THE ROLE OF MONEY MARKET IN OUR NATIONAL ECONOMY The money market is an integral part of the economy and it plays a vital role in the development of the economy. This is endorsed by the fact that in the less developed countries, money market too is undeveloped. Consequently, in the absence of well-developed money market in these countries great difficulty is experienced in pooling funds large enough to finance private enterprise. Up to the latter half of the Eighties money market in India was lopsided. Reserve bank too the initiative and introduced financial sector reforms to make the money market broad-based and integrated.

(3) FINANCIAL SECTOR REFORMS Objective

of

Financial

Sector

Reforms

by

Government of India & RBI To widen, deepen and integrate the different segments of financial sector, namely, the money market, debt market (particularly Government securities) and foreign exchange market.

Condition of Money Market in the Pre-Reform Period (Before 1991)

6

•

Financial system functioned in an environment of constriction, driven primarily by fiscal compulsions. It was geared to provide significant support for Government expenditure.

•

The monetary and debt management policy was underlined by excessive monetization of Central Government's fiscal deficit.

•

Money and Govt. Securities market did not display any vibrancy and had limited significance in the indirect conduct of monetary policy.

•

Money Market instruments were few

•

Market had a narrow base and limited to a few participants commercial banks and six all India Financial Institutions

•

Rate of interest on money market instruments was regulated.

•

Money market instruments consisted of Treasury Bills (91-days TBills) and term securities of different maturities issued by the Central and State Governments.

•

The average maturity of securities remained fairly long, that is above 20-years, reflecting the preference of more the Issuers than those of the Investors

•

Government borrowings were done at rates, which were far below the market rates. For example, for 30-year securities the interest rate was low at 6.5 per cent in 1977-78.

•

The Policy led to distortions in the Banking System with high lending rates on certain segments combined with relatively low interest rates on deposits.

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The Report of the Committee to Review the Working of the Monetary System - 1985 (Sukkmoy Chakravarthi Committee) The committee made several recommendations for the development of money and government securities markets. As a follow up the RBI set up the working group on money market (Chairman Mr.N.Vaghul), this submitted its report in 1987. The working group recommended a four pronged strategy to activate the money market. 1. Attempt to be made to widen and deepen the market by selective increase in the number of participants 2. An endeavor to be made to activate existing instruments so as to have a well-diversified mix of instruments suited to the different requirements of borrowers and lenders. 3. A gradual shift from administered interest rates to market determined rates. 4. To create an active secondary market for money and Securities, through a process of establishing new sets of institutions, this would impart sufficient liquidity to the system.

Follow up Measures initiated by R.B.I based on Chakravarthi Committee and Vaghul Committee Reports during the period 1985-91

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Measures taken to encouraging a secondary market in securities: 1. Maximum coupon rate, which was as low as 6.5 per cent in 1977-78, was raised in stages to 11.5 per cent in 1985-86. Along with this the maximum maturity period was reduced from 30 years to 20 years. 2. 182 days Treasury bills were introduced in November 1986 for the first time 3. The Discount and Finance House of India Ltd. was set up in April 1988 as a money market institution jointly by RBI, Public sector banks and all India financial institutions, to develop a secondary market for money market instruments and to provide liquidity to these instruments. Steps taken to strengthen Money Market 1. Interest rate ceiling was completely withdrawn for all operations in the call/notice money market and also on rediscounting of commercial bills in May 1989. 2. In May 1990 THE GIC, IDBI and NABARD were allowed to enter the Call Money Market as lenders. Also 13 financial institutions, which were already operating in the Bills Rediscounting Scheme, were granted entry in the call money market as lenders in October 1990. 3. Certain other non-banking institutions were permitted in October 1991 to enter the call money market as lender through the DFHI (Discounting and Finance of India Ltd. 4. New money market instruments viz. Certificate of Deposit (CD), Commercial Paper (CP) and inter-bank participation certificates 9

entered the market in 1989-90. RBI framed guidelines for the issuance of these instruments.

Recommendations of the Committee on Financial System (the Narasimhan Committee) A comprehensive package of stabilization and structural reform measures was initiated by the Government in mid-1991, in the financial sector based on the recommendations of the Narasimhan Committee. A second Report was submitted by Narasimhan in 1987 called as the Report of Narasimhan Committee II

Reforms with regards to Call, Notice, Term Money Market) In pursuance of the recommendations of the Narasimhan Committee II, the RBI has a taken a decision to restrict the call, notice, term money market as a pure inter-bank market with additional access only to PDs. Steps have been taken to phase out non-bank participants from the market by granting them permission to operate in the repo market.

Reasons for the step

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Since the withdrawal of the ceiling on the call rate, the call money rate has shown a tendency to fluctuate significantly on occasions. The sharp imbalances that arise in the demand and supply of money due to combination of several factors have led to such volatile behavior. The most important of these has been bunching of banks' needs for short-term funds in order to meet the CRR compliance. Reforms in Primary market •

Auction system of issuing securities has been introduced for both treasury bills and term securities since 1992-93, in order to pave the way for market related rates of interest for government paper.

•

The base for treasury bills market was widened with auctioning of different types, introduction of 364-day TB in April 1992 and 91-day TB in January 1993, and reintroduction of 182-day TBs in May, 1999.

•

Funding of auctioned TBs into term securities at the option of holder as part of debt management.

•

New instruments such as Zero coupon bonds, tap stock, partly paid tap and floating rate bonds were introduced.

•

Bringing down the maximum maturity rate government securities from 30 to 20 years.

•

Developments of instruments for repurchase o agreements (repos) between RBI and commercial banks beginning from December 1997.

•

Since April 1997, a new approach was followed by the RBI in its open market operations that is, sale/purchase operations in government securities. In setting its price, the RBI responded to market expectations. It was also prepared to purchase certain securities in cash. 11

The effect of the above reform measures resulted in expanding the investor base gradually to non-traditional investors. The auction system contributed to a new treasury culture and progressive development of bidding and portfolio management skills.

Reforms in Secondary market in Government Securities. •

A phased reduction in SLR requirements from an effective 37.4 per cent in March 1992 to a little over 28 per cent in March 1996.It has since been reduced to the statutory benchmark level of 25%.

•

The DFHI was authorised to deal in government securities in 1992-93

•

The Securities Trading Corporation of India (STCI) was set up in 1994 by the RBI jointly with public sector banks and all India financial institutions with the main objective of fostering the development of the government securities market (It commenced operations in September 1994)

•

Market transparency was achieved through regular publication of details of SGL transactions in Government securities put though Mumbai PDO since September 1994.

•

After its establishment and becoming operational in June 1994, the National Stock Exchange provided secondary market treading facilities through its wholesale debt market segment.

•

A system of Delivery Versus Payment (DVP) in Government securities was introduced in Mumbai in June 1995 to ensure that the transactions in government securities were fully secured.

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•

The Repo market has been activated by allowing repos/reverse repos transactions in all government securities besides treasury bills of all maturities.

•

Non-bank entities which are holders of account with the RBI have been allowed to enter reverse repo (but not direct) transactions with banks/PDs

•

With a view to encouraging Mutual Funds to set up gilt funds in government securities either by way of outright purchase or reverse repos to the extent of 20 per cent of the outstanding investments.

•

Guidelines for satellite dealers in government securities market were announced in December 1996 And in April 1997 and the RBI granted approval to 17 entities for registration as satellite dealers in government securities, to promote/activate retailing in Government securities

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(4) WHAT IS MONEY MARKET? Money market refers to the market for short term assets that are close substitutes of money, usually with maturities of less than a year. A well functioning money market provides a relatively safe and steady incomeyielding avenue, for short term investment of funds both for banks and corporate and allows the investor institutions to optimize the yield on temporary surplus funds. The RBI is a regular player in the money market and intervenes to regulate the liquidity and interest rates in the conduct of monetary policy to achieve the broad objective of price stability, efficient allocation of credit and a stable foreign exchange market. As per definition given by RBI the money market is "the centre for dealings, mainly shortterm character, in money assets. It meets the short-term requirements of borrower and provides liquidity or cash to the lenders. It is the place where short-term surplus investible funds at the disposal of financial and other institutions and individuals are bid by borrowers, again comprising Institutions, individuals and also the Government itself".The main segments of the money market are the call/notice money, term money, commercial bills, treasury bills, commercial paper and certificate deposits. Mr.G. Crowther in his treatise "An Outline of Money defines money market as "the collective name given to the various firms and institutions that deal in the 14

various grades of near-money". The money market is as concrete as any other market and one could see it in operation in London's Lambard Street or New York's Wall Street. Typical of any other commodity market, there is very close relationship between different segments of the money market, (like bankers' Call Money market, commercial paper, treasury bills) that the one is affected by the other. In other words different segments of the moneymarket are broadly integrated.

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(5) MONEY MARKET INSTRUMENTS Call/Notice Money Treasury Bills Inter Bank term Money Certificate of Deposit (CD) Commercial Paper (C.P) Commercial Bills Inter Bank Participation Certificates

(5.1) CALL/NOTICE MONEY The most active segment of the money market has been the call money market, where the day to day imbalances in the funds position of scheduled commercial banks are eased out. The call notice money market has graduated into a broad and vibrant institution. Call/Notice money is the money borrowed or lent on demand for a very short period. When money is borrowed or lent for a day, it is known as Call (Overnight) Money. Intervening holidays and/or Sunday are excluded for this purpose. Thus money, borrowed on a day and repaid on the next working day, (irrespective of the number of intervening holidays) is "Call Money". When money is borrowed or lent for more than a day and up to 14 days, it is "Notice Money". No collateral security is required to cover these transactions.

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The entry into this field is restricted by RBI. Commercial Banks, Cooperative Banks and Primary Dealers are allowed to borrow and lend in this market. Specified All-India Financial Institutions, Mutual Funds, and certain specified entities are allowed to access to Call/Notice money market only as lenders. Reserve Bank of India has recently taken steps to make the call/notice money market completely inter-bank market. Hence the non-bank entities will not be allowed access to this market beyond December 31, 2000. From May 1, 1989, the interest rates in the call and the notice money market are market determined. Interest rates in this market are highly sensitive to the demand - supply factors. Within one fortnight, rates are known to have moved from a low of 1 - 2 per cent to dizzy heights of over 140 per cent per annum. Large intra-day variations are also not uncommon. Hence there is a high degree of interest rate risk for participants. In view of the short tenure of such transactions, both the borrowers and the lenders are required to have current accounts with the Reserve Bank of India. This will facilitate quick and timely debit and credit operations. The call market enables the banks and institutions to even out their day to day deficits and surpluses of money. Banks especially access the call market to borrow/lend money for adjusting their cash reserve requirements (CRR). The lenders having steady inflow of funds (e.g. LIC, UTI) look at the call market as an outlet for deploying funds on short term basis.

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(5.2) TREASURY BILLS Treasury Bills are short term (up to one year) borrowing instruments of the union government. It is an IOU of the Government. It is a promise by the Government to pay a stated sum after expiry of the stated period from the date of issue (14/91/182/364 days i.e. less than one year). They are issued at a discount to the face value, and on maturity the face value is paid to the holder. The rate of discount and the corresponding issue price are determined at each auction.

The salient features of the auction system of T-Bills are : •

The 14/91/182/364-day’s bills are issued for a minimum value of Rs.25, 000 and multiples thereof.

•

They are issued at a discount to face value.

•

Any person in India including individuals, firms, companies, corporate bodies, trusts and institutions can purchase the bills.

•

The bills are eligible securities for SLR purposes.

•

All bids above a cut-off price are accepted and bidders are permitted to place multiple bids quoting different prices at each auction. Till November 6, 1998, all types of T-Bills auctions were conducted by means of 'Multiple Price Auction'. However, since November 6, 1998, auction of 91-days T-Bills are being conducted by means of 'Uniform Price Auction'. In the case of 'Multiple Price Auction' method successful bidders pay their own bid prices, whereas under 'Uniform Price Auction' method, all successful bidders pay an uniform price, i.e. the cut-off price emerged in the auction.

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•

The bills are generally issued in the form of SGL - entries in the books of Reserve Bank of India. The SGL holdings can be transferred by issuing a SGL transfer form. For non-SGL account holders, RBI has been issuing the bills in scrip form.

(5.3) INTER-BANK TERM MONEY Inter-bank market for deposits of maturity beyond 14 days is referred to as the term money market. The entry restrictions are the same as those for Call/Notice Money except that, as per existing regulations, the specified entities are not allowed to lend beyond 14 days. The market in this segment is presently not very deep. The declining spread in lending operations, the volatility in the call money market with accompanying risks in running asset/liability mismatches, the growing desire for fixed interest rate borrowing by corporate, the move towards fuller integration between forex and money markets, etc. are all the driving forces for the development of the term money market. These, coupled with the proposals for rationalization of reserve requirements and stringent guidelines by regulators/managements of institutions, in the asset/liability and interest rate risk management, should stimulate the evolution of term money market sooner than later. The DFHI (Discount & Finance House of India), as a major player in the market, is putting in all efforts to activate this market.

(5.4) CERTIFICATES OF DEPOSIT

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Certificates of Deposit (CDs) - introduced since June 1989 - are negotiable term deposit certificates issued by a commercial banks/Financial Institutions at discount to face value at market rates, with maturity ranging from 15 days to one year. Being securities in the form of promissory notes, transfer of title is easy, by endorsement and delivery. Further, they are governed by the Negotiable Instruments Act. As these certificates are the liabilities of commercial banks/financial institutions, they make sound investments. DFHI trades in these instruments in the secondary market. The market for these instruments is not very deep, but quite often CDs are available in the secondary market. DFHI is always willing to buy these instruments thereby lending liquidity to the market.

• Salient features: •

CDs can be issued to individuals, corporations, companies, trusts, funds, associates, etc.

•

NRIs can subscribe to CDs on non-repatriable basis.

•

CDs attract stamp duty as applicable to negotiable instruments.

•

Banks have to maintain SLR and CRR on the issue price of CDs. No ceiling on the amount to be issued.

•

The minimum issue size of CDs is Rs.5 lakhs and multiples thereof.

•

CDs are transferable by endorsement and delivery.

•

The minimum lock-in-period for CDs is 15 days.

CDs are issued by Banks, when the deposit growth is sluggish and credit demand is high and a tightening trend in call rate is evident. CDs are 20

generally considered high cost liabilities and banks have recourse to them only under tight liquidity conditions.

(5.5) COMMERCIAL PAPERS Commercial Papers are unsecured debts of corporate. They are issued in the form of promissory notes, redeemable at par to the holder at maturity. Only corporate who get an investment grade rating can issue CPs, as per RBI rules. Though CPs is issued by corporate, they could be good investments, if proper caution is exercised. CPs enable highly rated corporate borrowers to diversify their sources of short-term borrowings and raise a part of their requirement at competitive rates from the market. The introduction of Commercial Paper (CP) in January 1990 as an additional money market instrument was the first step towards securitization of commercial bank's advances into marketable instruments. The market is generally segmented into the PSU CPs, i.e. those issued by public sector unit and the private sector CPs. CPs issued by top rated corporate is considered as sound investments. DFHI trades in these certificates. It will buy these certificates, subject to its perception of the instrument and will also be offering them for sale subject to availability of stock.

Salient Features 21

•

CPs is issued by companies in the form of usance promissory note, redeemable at par to the holder on maturity.

•

The tangible net worth of the issuing company should be not less than Rs.4 crores.

•

Working capital (fund based) limit of the company should not be less than Rs.4 crores.

•

Credit rating should be at least equivalent of P2/A2/PP2/Ind.D.2 or higher from any approved rating agencies and should be more than 2 months old on the date of issue of CP.

•

Cooperators are allowed to issue CP up to 100% of their fund based working capital limits.

•

It is issued at a discount to face value.

•

CP attracts stamp duty.

•

CP can be issued for maturities between 15 days and less than one year from the date of issue.

•

CP may be issued in the multiples of Rs.5 lakh.

•

No prior approval of RBI is needed to issue CP and underwriting the issue is not mandatory.

•

All expenses (such as dealers' fees, rating agency fee and charges for provision of stand-by facilities) for issue of CP are to be borne by the issuing company,

The purpose of introduction of CP was to release the pressure on bank funds for small and medium sized borrowers and at the same time allowing highly rated companies to borrow directly from the market.

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(5.6)

READY

FORWARD

CONTRACTS

(REPOS) Ready forward or Repos or Buyback deal is a transaction in which two parties agree to sell and repurchase the same security. Under such an arrangement, the seller sells specified securities with an agreement to repurchase the same at a mutually decided future date and a price. Similarly, the buyer purchases the securities with an agreement to resell the same to the seller on an agreed date in future at a prefixed price. For the purchaser of the security, it becomes a Reverse Repo deal. In simple terms, it is recognized as a buy back arrangement. In a standard ready forward transaction when a bank sells its securities to a buyer it simultaneously enters into a contract with him (the buyer) to repurchase them on a predetermined date and price in the future. Both sale and repurchase prices of securities are determined prior to entering into the deal. In return for the securities, the bank receives cash from the buyer of the securities. It is a combination of securities trading (involving a purchase and sale transaction) and money market operation (lending and borrowing). The repo-rate represents the borrowing/lending rate for use of the money in the intervening period. As the inflow of cash from the ready forward transaction is used to meet temporary cash requirement, such a transaction in essence is a short term cash management technique. The motivation for the banks and other organizations to enter into a ready forward transaction is that it can finance the purchase of securities or otherwise fund its requirements at relatively competitive rates. On account of this reason the ready forward transaction is purely a money lending 23

operation. Under ready forward deal the seller of the security is the borrower and the buyer is the lender of funds. Such a transaction offers benefits both to the seller and the buyer. Seller gets the funds at a specified interest rate and thus hedges himself against volatile rates without parting with his security permanently (thereby avoiding any distressed sale) and the buyer gets the security to meet his SLR requirements. In addition to pure funding reasons, the ready forward transactions are often also resorted to manage short term SLR mismatches. Internationally, Repos are versatile instruments and used extensively in money market operations. While inter-bank Repos were being allowed prior to 1992 subject to certain regulations, there were large scale violation of laid down guidelines leading to the 'securities scam' in 1992; this led Government and RBI to clamp down severe restrictions on the usage of this facility by the different market participants. With the plugging of loophole in the operation, the conditions have been relaxed gradually. RBI has prescribed that following factors have to be considered while performing repo: purchase and sale price should be in alignment with the ongoing market rates No sale of securities should be affected unless the securities are actually held by the seller in his own investment portfolio. Immediately on sale, the corresponding amount should be reduced from the investment account of the seller. The securities under repo should be marked to market on the balance sheet date. 24

The relaxations over the years made by RBI with regard to repo transactions are: In addition to Treasury Bills, all central and State Government securities are eligible for repo. Besides banks, PDs are allowed to undertake both repo/reverse repo transactions. RBI has further widened the scope of participation in the repo market to all the entities having SGL and Current with RBI, Mumbai, thus increasing the number of eligible non-bank participants to 64. It was indicated in the 'Mid-Term Review' of October 1998 that in line with the suggestion of the Narasimham Committe II, the Reserve Bank will move towards a pure inter-bank (including PDs) call/notice money market. In view of this non-bank entities will be allowed to borrow and lend only through Repo and Reverse Repo. Hence permission of such entities to participate in call/notice money market will be withdrawn from December 2000. In terms of instruments, repos have also been permitted in PSU bonds and private corporate debt securities provided they are held in dematerialized from in a depository and the transactions are done in a recognized stock exchange. Apart from inter-bank repos RBI has been using this instrument effectively for its liquidity management, both for absorbing liquidity and also for injecting funds into the system. Thus, Repos and Reverse Repo are resorted to by the RBI as a tool of liquidity control in the system. With a view to absorbing surplus liquidity from the system in a flexible way and to prevent

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interest rate arbitraging, RBI introduced a system of daily fixed rate repos from November 29, 1997. Reserve Bank of India was earlier providing liquidity support to PDs through the reverse repo route. This procedure was also subsequently dispensed with and Reserve Bank of India began giving liquidity support to PDs through their holdings in SGL A/C. The liquidity support is presently given to the Primary Dealers for a fixed quantum and at the Bank Rate based on their bidding commitment and also on their past performance. For any additional liquidity requirements Primary Dealers are allowed to participate in the reverse repo auction under the Liquidity Adjustment Facility along with Banks, introduced by RBI in June 2000. The major players in the repo and reverse repurchase market tend to be banks who have substantially huge portfolios of government securities. Besides these players, primary dealers who often hold large inventories of tradable government securities are also active players in the repo and reverse repo market.

(5.7) COMMERCIAL BILLS Bills of exchange are negotiable instruments drawn by the seller (drawer) on the buyer (drawee) for the value of the goods delivered to him. Such bills are called trade bills. When trade bills are accepted by commercial banks, they are called commercial bills. If the seller wishes to give some period for payment, the bill would be payable at a future date (usance bill). During the

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currency of the bill, if the seller is in need of funds, he may approach his bank for discounting the bill. One of the methods of providing credit to customers by bank is by discounting commercial bills at a prescribed discount rate. The bank will receive the maturity proceeds (face value) of discounted bill from the drawee. In the meanwhile, if the bank is in need of funds, it can rediscount the bill already discounted by it in the commercial bill rediscount market at the market related rediscount rate. (The RBI introduced the Bill Market Scheme in 1952 and a new scheme called the Bill Rediscounting Scheme in November 1970). The eligibility criteria prescribed by the Reserve Bank of India for rediscounting commercial bill inter-alia are that the bill should arise out of genuine commercial transaction evidencing sale of goods and the maturity date of the bill should not be more than 90 days from the date of rediscounting.

Derivative Usance Promissory Notes (DUPN) IT is an innovative instrument issued by the RBI to eliminate movement of papers and facilitating easy rediscounting. DUPN is backed by up to 90 days Usance commercial bills. Government has exempted stamp duty on DUPN to simplify and steam-line the instrument and to make it an active instrument in the secondary market. The minimum rediscounting period is 15 days. With a view to eliminating movement of papers and facilitating multiple rediscounting, the RBI introduced an innovative instrument known as "Derivative Usance Promissory Notes" backed by such eligible commercial bills for required amounts and usance period (up to 90 days). Government 27

has exempted stamp duty on derivative usance promissory notes. This has indeed simplified and streamlined the bill rediscounting by Institutions and made commercial bill an active instrument in the secondary money market. Rediscounting institutions have also advantages in that the derivative usance promissory note, being a negotiable instrument issued by a bank, is good security for investment. It is transferable by endorsement and delivery and hence is liquid. Thanks to the existence of a secondary market the rediscounting institution can further discount the bills anytime it wishes prior to the date of maturity. In the bill rediscounting market, it is possible to acquire bills having balance maturity period of different days upto 90 days. Bills thus provide a smooth glide from call/overnight lending to short term lending with security, liquidity and competitive return on investment. As some banks were using the facility of rediscounting commercial bills and derivative usance promissory notes for as short a period as one day merely a substitute for call money, RBI has since restricted such rediscounting for a minimum period of 15 days.

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PRIMARY DEALERS In March 1995 the RBI announced guidelines for setting up of primary dealers (PD) with the objectives of a.

Strengthening the infrastructure of the government securities market in order to make it vibrant, liquid and broad based.

b.

Ensuring development of underwriting and market capabilities of government securities outside the RBI.

c.

Improving the secondary market trading system, which could contribute to price discovery, enhanced liquidity and to turn over and encourage voluntary holdings of government securities outside the RBI.

d.

Making PDs an effective conduit for conducting open market operations.

The full extent of notified amount of the dated government securities were offered for underwriting and the underwriting fees and amounts to be allowed to each PD prior to auction of each security. In respect of TBs, the PDs are required to give minimum holding commitments and fixed underwriting fees are paid for successful bids. The RBI granted liquidity support for PDs against their holding in SGL Account. Market transparency was established through regular publication of details of SGL transactions in government securities put through at Mumbai PDO since September 1994. The NSC which became operational in June 1994 also provided secondary market trading facilities through its wholesale debt market segment since 1994-95. 29

Guidelines for satellite dealers in the government securities market were announced in December 1996 and in April 1997. Satellite dealers in government securities are expected to activate retailing of government securities.

SATELLITE DEALERS In the Mid-term Review of October 2001, RBI announced its decision to undertake a review of the Satellite Dealer (SD) system in consultation with market participants. After obtaining the views of the Primary Dealers Association of India (PDAI) and after further discussions in TAC and considering their role in the present conditions, it has been decided to discontinue the system. Accordingly: No new SDs will be licensed. Existing SDs will be required to make action plans, satisfactory to RBI for termination of their operations as SDs by May 31, 2002.

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(6)Foreign Institutional Investor (FII) FII means an entity established or incorporated outside India which proposes to make investment in India. The FIIs have been a major driver in Indian equities' upward journey in the recent past and resumption of positive momentum is unlikely before FIIs start purchasing again. One who propose to invest their proprietary funds or on behalf of "broad based" funds or of foreign corporate and individuals and belong to any of the under given categories can be registered for FII. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13.

Pension Funds Mutual Funds Investment Trust Insurance or reinsurance companies Endowment Funds University Funds Foundations or Charitable Trusts or Charitable Societies who propose to invest on their own behalf, and Asset Management Companies Nominee Companies Institutional Portfolio Managers Trustees Power of Attorney Holders Bank

The parameters on which SEBI decides eligibility of a FII Applicant. 1) Applicant’s track record, professional competence, financial soundness, experience, general reputation of fairness and integrity. (The applicant should have been in operation for at least one year) 2) whether the applicant is registered with and regulated by an appropriate Foreign Regulatory Authority in the same capacity in which the application is filed with SEBI 3) Whether the applicant is a fit & proper person.

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As per Regulation 6 of SEBI (FII) Regulations, 1995, Foreign Institutional Investors are required to fulfill the following conditions to qualify for grant of registration: •

•

•

• • •

•

Applicant should have track record, professional competence, financial soundness, experience, general reputation of fairness and integrity; The applicant should be regulated by an appropriate foreign regulatory authority in the same capacity/category where registration is sought from SEBI. Registration with authorities, which are responsible for incorporation, is not adequate to qualify as Foreign Institutional Investor. The applicant is required to have the permission under the provisions of the Foreign Exchange Management Act, 1999 from the Reserve Bank of India. Applicant must be legally permitted to invest in securities outside the country or its in-corporation / establishment. The applicant must be a "fit and proper" person. The applicant has to appoint a local custodian and enter into an agreement with the custodian. Besides it also has to appoint a designated bank to route its transactions. Payment of registration fee of US $ 5,000.00

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Current scenario of FII The FII inflow has slowed down considerably in the past few days, partly due to valuations getting expensive in India, and the overseas investors have started exploring other markets with better valuations. Foreign Institutional Investors (FII) have sold shares worth a net of about Rs 1,000 crore so far in November against a net purchase of shares worth over Rs 20,000 crore in October.

So far in 2007, the FIIs have made a net purchase worth over Rs 70,000 crore (more than 17 billion dollars) -- the highest annual inflow so far.

India funds have seen a net outflow of 792 million dollar so far in 2007, against an inflow of 1,751 million dollar in the same period last year.

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