Capital Market and Money Market

Financial Markets

Financial markets in any economy are divided into two distinct segments:

Money Market: Focuses on short-term funds, typically for a period of up to 364 days.

Capital Market: Deals with long-term funds, which are for periods exceeding 364 days.

Note: The Chakravarthy Committee (1985) first emphasized the need to formalize the money market, while the Vahul
Committee (1987) provided a framework for its development.

Money Market

The money market includes various instruments, such as:

• Treasury Bills
• Commercial Paper
• Call Money
• Certificates of Deposit

Treasury Bills

• Issued by the RBI on behalf of the government.

• The government uses T-bills to address short-term liquidity needs.
• They are considered sovereign zero-risk instruments.
• Currently, there are three types of T-bills: 91-day, 182-day, and 364-day.
• State governments are not permitted to issue T-bills.
• They are issued under the Market Stabilization Scheme (MSS).
• Minimum Investment: Available for a minimum amount of ₹25,000 or in multiples thereof.

Call Money

• The call money market is an interbank market where funds are borrowed and lent for one day or less.
• Funds lent for one day are known as "Call Money," while loans exceeding one day but less than 15 days are
termed "Notice Money."
• The call money market typically involves transactions with durations of 1 to 14 days.
• Participants include mutual funds, scheduled commercial banks, and cooperative banks, which act as both
borrowers and lenders.
• Institutions like LIC, GIC, NABARD, and IDBI serve exclusively as lenders.

Certificate of Deposit (CDs)

• Issuers: Issued by scheduled commercial banks and other financial institutions; Regional Rural Banks (RRBs)
and local area banks cannot issue CDs.
• Pricing: CDs are issued at a discount to face value, with the discount rate negotiated between the issuer and
the investor.
• Minimum Amount: The minimum investment is ₹1 lakh.
• Maturity: CDs issued by banks have a maturity period ranging from 15 days to 1 year, while those from select
financial institutions have maturities from 1 year to 3 years.
• CDs can be issued to individuals or firms.

Commercial Paper (CP)

• CPs are unsecured promissory notes issued by large corporates, primary dealers, satellite dealers, and all-
India financial institutions.
• Maturity: The maturity period ranges from 7 days to 1 year from the date of issue.
• Minimum Investment: The minimum investment amount is ₹5 lakhs or multiples thereof.
 • CPs must have a credit rating from a recognized credit rating agency.

Capital Market

• Duration: Capital market instruments typically have maturities exceeding 364 days.
• Participants: It includes a variety of participants such as companies, government entities, and institutional
investors.
• Instruments: Common instruments in the capital market include:
o Equity Shares: Represent ownership in a company.
o Debentures and Bonds: Fixed-income securities that represent a loan made by an investor to a
borrower.
• Purpose: The capital market serves to channel funds from savers and investors to entities that require
financing for growth, expansion, or development projects.
• Types: The capital market can be divided into:
o Primary Market: Where new securities are issued for the first time.
o Secondary Market: Where existing securities are traded among investors.
• Regulation: Capital markets are regulated by financial authorities to ensure transparency, fairness, and
efficiency in the trading of securities.

Reserve Bank of India (RBI)

History of RBI

• The Reserve Bank of India (RBI) was established under the Reserve Bank of India Act of 1934.
• Initially privately owned, it was nationalized in 1949 and has since been fully owned by the Government of
India (GoI).
• The RBI began operations on April 1, 1935, in accordance with the provisions of the Reserve Bank of India
Act.
• The establishment of the RBI was influenced by the Hilton-Young Commission, which recommended the
creation of a central bank for India.

Governance Structure

• Governor: One Governor (5-year term) [Present Governor: Shaktikanta Das]

• Deputy Governors: Four Deputy Governors (5-year term)
• Directors: Fifteen Directors

Branches and Support Bodies

• Headquarters: Located in Mumbai

• Zonal Offices: Four zonal offices in Chennai, Delhi, Kolkata, and Mumbai
• Regional Offices: 21 regional offices and 11 sub-offices across India

Functions of RBI

• The RBI performs several key functions, including:

o Overseeing monetary policy
o Issuing currency
o Managing foreign exchange
o Acting as a banker to the government
o Serving as a banker for scheduled commercial banks
o Promoting overall economic growth in the country

Subsidiaries of RBI

• Fully Owned Subsidiaries:

o Deposit Insurance and Credit Guarantee Corporation of India (DICGC)
o Bharatiya Reserve Bank Note Mudran Private Limited (BRBNMPL)
 o Reserve Bank Information Technology Private Limited (ReBIT)
o Indian Financial Technology and Allied Services (IFTAS)
o Reserve Bank Innovation Hub (RBIH)
• Note: NABARD and NHB were previously subsidiaries of RBI but are no longer under its purview as of
February 26, 2019.

Monetary Policy

Credit Control:

Reserve Ratio

i) Cash Reserve Ratio (CRR)

• All banks must maintain a minimum Cash Reserve Ratio (CRR) based on their Net Demand and Time
Liabilities (total deposits) with the Reserve Bank of India (RBI) in cash.

• This cash can be held in the RBI's currency chest.

• The previous ceiling limits of 3% to 20% have been lifted, allowing the RBI to set this ratio without any
maximum limit.

• This requirement is stipulated in Section 42(1) of the RBI Act, 1934, as amended by the RBI (Amendment)
Act, 2006.

• Scheduled banks are mandated to keep a specific percentage of their NDTL in cash in a special account at the
RBI to ensure monetary stability in the country.

• There are no minimum or maximum rates set for this ratio.

Example:
If a bank receives Rs. 100 in deposits and the CRR is set at 10%, it must deposit Rs. 10 with the RBI, leaving it with Rs.
90 to lend. This Rs. 90 is loaned to a borrower, who then deposits it in another bank. That second bank must deposit
Rs. 9 with the RBI, leaving it with Rs. 81 to lend. This process can continue, with each subsequent bank depositing a
portion with the RBI.

ii)Statutory Liquidity Ratio (SLR)

• All banks are required to maintain a portion of their total deposits with the RBI in the form of cash, gold, or
approved securities.

• This requirement is outlined in Section 24 of the Banking Regulation Act, 1949, which was amended by the
Banking Regulation (Amendment) Act, 2007.

• While there is no minimum rate, the maximum limit for the SLR is set at 40%.

• Banks must hold a specified percentage of their Net Demand and Time Liabilities (NDTL) in these forms, as
determined periodically.

Policy Rates

i) Repo Rate

• The repo rate is the interest rate at which banks sell securities to the RBI with a promise to repurchase them
at a later date.

• This arrangement is known as a repurchase agreement. When the RBI lowers the repo rate, banks can
borrow more funds at a reduced cost.

• The minimum loan amount for this facility is Rs. 5 crore, and it typically involves short-term borrowing (1 to
90 days).
ii) Reverse Repo Rate

• The reverse repo rate is the interest rate paid by the RBI to banks when it borrows money from them. It
functions as the opposite of the repo rate.

• An increase in the reverse repo rate encourages banks to deposit more funds with the RBI due to its
attractive interest rates, allowing the RBI to absorb excess liquidity from the banking system.

iii) Marginal Standing Facility (MSF)

• The minimum amount that can be accessed through the MSF is Rs. 1 crore, and subsequent amounts must
be in multiples of Rs. 1 crore.

• While all member banks can borrow under the repo facility, the MSF specifically offers an overnight
borrowing option from the RBI.

• No additional collateral is needed; securities already provided for the SLR can be used.

• Only scheduled commercial banks are eligible to utilize this facility.

iv) Bank Rate

• The bank rate is the interest rate at which the central bank lends money to domestic banks. This can occur
through direct loans or by rediscounting commercial banks' bills and treasury bills. As such, the bank rate is
often referred to as the discount rate.

• Loans issued under the bank rate do not require collateral.

• It represents the interest rate for long-term lending (greater than 365 days). Typically, banks and financial
institutions utilize this facility, and it significantly impacts the long-term lending activities within the financial
system.

4. Open Market Operations (OMO)

• Open Market Operations refer to the actions taken by the RBI to manage liquidity in the economy by either:

o Purchasing government securities to inject liquidity.

o Selling government securities to absorb liquidity from the system.

National Bank for Agriculture and Rural Development (NABARD)

NABARD is a development bank primarily focused on the rural sector of India. It serves as the apex banking
institution providing financial support for agriculture and rural development.

• Headquarters: Mumbai

• Chairman: Shaji K V

• Establishment and Background

• NABARD was established based on the recommendations of the B. Sivaraman Committee.

• It was formed by the National Bank for Agriculture and Rural Development Act, 1981, and commenced
operations on July 12, 1982.

• The initial corpus of NABARD was ₹100 crores. Following a revision in the share capital structure between
the Government of India and the RBI, the paid-up capital as of May 31, 2017, was ₹6,700 crores, entirely
held by the Government of India (100% share).

• The authorized share capital of NABARD is ₹30,000 crores.

 Payments Banks Overview

• Background: The RBI established a committee in 2013, led by Nachiket Mor, which recommended creating
payments banks in its 2014 report.
• Guidelines: Draft guidelines were released on July 17, 2014, with final guidelines published on November 27,
2014.

Key Features

• Deposit Limits: Accept deposits up to ₹100,000 per customer.

• Account Types: Can operate current and savings accounts.

• Services: Offer ATM/debit cards, net banking, and mobile banking.

Regulatory Framework

• Licensing Authority: RBI grants licenses under the Banking Regulation Act.

• Minimum Capital: ₹100 crores required to establish a payments bank.

• Foreign Investment: Allowed per FDI rules for private banks.

• Promoter Stake: Must maintain at least 40% for the first five years.

Bharti Airtel launched India’s first operational payments bank.

Small Finance Banks

Establishment: Small finance banks are set up as public limited companies in the private sector under the Companies
Act, 1956.

Governance: They are governed by the Reserve Bank of India Act, 1934, the Banking Regulation Act, 1949, and other
relevant statutes.

Key Points

• Eligibility: Existing NBFCs, microfinance institutions, and local area banks can apply to become small finance
banks.

• Objectives: Aimed at promoting rural and semi-urban savings and providing credit for local economic
activities.

• Lending Requirements:

o 75% of net credits must be in priority sector lending.

o 50% of loans should be in the ₹25 lakh (US$38,000) range.

• Capital Requirement: Minimum capital of ₹100 crores (US$15 million) is required.

• Promoter Experience: Promoters need at least 10 years of experience in banking and finance.

• Equity Stake: Initial promoter stake must be at least 40%, reducing to 26% within 12 years. Joint ventures are
not allowed.

• Foreign Investment: Allowed according to FDI rules for private banks in India.
 Inflation

Inflation

Inflation is a quantitative measure that indicates the rate at which the average price level of a specific basket of
goods and services in an economy increases over time. In simple terms, inflation reflects rising prices resulting from
currency devaluation.

Major Types of Inflation

1. Demand-Pull Inflation:

o This type occurs when increased liquidity and demand for consumer goods lead to a surge in overall
product demand. Companies respond by raising prices to align with what consumers are willing to
pay.

2. Cost-Push Inflation:

o Also known as "supply shock inflation," this happens when there is a decrease in aggregate supply.
Factors contributing to this may include natural disasters, higher input costs, increased corporate
taxes, or rising wages.

3. Built-In Inflation:

o This inflation is influenced by adaptive expectations and is often linked to the "price/wage spiral."
Workers aim to keep their wages in line with rising prices, prompting firms to pass on higher labor
costs to consumers, which perpetuates a cycle of price increases.

Deflation

Deflation refers to a decline in the overall price level of goods and services, occurring when the inflation rate drops
below 0% (i.e., a negative inflation rate). While inflation diminishes the value of currency over time, deflation
enhances it, enabling consumers to buy more goods and services with the same amount of money.

Stagflation

Stagflation describes a situation characterized by slow economic growth and high unemployment, coupled with rising
prices (inflation). It is marked by inflation occurring alongside a decrease in gross domestic product (GDP).

Galloping Inflation

Galloping inflation, also known as hopping, jumping, or runaway inflation, signifies extremely high inflation rates,
often reaching double or triple digits (e.g., 50% or 200% per year).

Causes of Inflation

Demand-Side Factors Supply-Side Factors

• Expansion of the money supply • Increase in administered prices

• Growth in exports • Unstable agricultural growth

• Rise in disposable income • Agricultural pricing policies

• Deficit financing • Insufficient industrial growth

• Increase in foreign exchange reserves

Measurement of Inflation

• Consumer Price Index (CPI)

• Producer Price Index (PPI)

Measures of Inflation

Monetary Policy

• Credit control

• Currency demonetization

• Introduction of new currency

Fiscal Policy

• Cut unnecessary expenditures

• Raise taxes

• Promote savings

• Implement surplus budgets

• Manage public debt

Other Measures

• Enhance production

• Establish a rational wage policy

Banking order (Largest to Smallest)

1. State Bank of India 6. Indian Bank + Allahabad Bank:- Indian Bank

2. PNB +OBC +United Bank:- Punjab National 7. Central bank of India
Bank 8. Indian Overseas Bank
3. Bank of Baroda + Vijya Bank+ Dena Bank:- 9. UCO Bank
Bank of Baroda 10. Bank of Maharashtra
4. Canara + Syndicate Bank:- Canara Bank 11. Punjab and Sind Bank
5. Union Bank + Andhra Bank +Corporation
Bank: Bank of India
Currency Notes and their dimensions:

Denomination Dimensions (mm) Base Colour Motif

₹1 97 x 63 Pink Sagar Samrat

₹10 63 x 123 Chocolate Brown Sun Temple (Odisha)

₹20 63 x 147 Greenish Yellow Ellora Caves (Maharashtra)

₹50 66 x 135 Fluorescent Blue Hampi with Chariot (Karnataka)

₹100 66 x 142 Lavender Rani Ki Vav (Gujarat)

₹200 66 x 146 Bright Yellow Sanchi Stupa (Madhya Pradesh)

₹500 66 x 150 Stone Grey Red Fort (Delhi)

₹2000 66 mmX166 mm Magenta Mangalyaan