Indian Money Market – AHSEC Class 12 Finance Chapter 7

Here is a comprehensive study note for the AHSEC Class 12 Finance textbook, focusing on Chapter 7: Indian Money Market.

Chapter 7: Indian Money Market

Summary Note

This chapter provides a specific look at the money market in India, detailing its structure, the instruments traded, its key participants, and its inherent defects.

• Structure of the Indian Money Market: The Indian Money Market is broadly divided into two sectors:
  1. Organised Sector: This sector is systematically coordinated and regulated by the Reserve Bank of India (RBI). It includes:
     • Reserve Bank of India (RBI): The apex institution and leader of the money market.
     • Scheduled Banks: Banks listed in the 2nd Schedule of the RBI Act, 1934. This includes Public Sector Banks, Private Sector Banks, Foreign Banks, Regional Rural Banks (RRBs), Small Finance Banks, and Payments Banks.
     • Development Banks and other Financial Institutions: Institutions like IFCI, SFCs, NABARD, etc., which operate indirectly through banks.
     • Discount and Finance House of India (DFHI): A specialized institution established in 1988 to provide liquidity to money market instruments and develop a secondary market.
  2. Unorganised Sector: This sector consists of indigenous bankers and money lenders. Its activities are not directly controlled or coordinated by the RBI.
     • Indigenous Bankers: Individuals or private firms that accept deposits and deal in hundis (traditional credit instruments).
     • Money Lenders: Individuals who lend money from their own funds, mainly in rural areas, often for consumption purposes.
• Instruments Traded in the Indian Money Market: These are the tools used for short-term borrowing and lending.
  1. Treasury Bills (T-Bills): Short-term instruments (91-day, 182-day, 364-day) issued by the RBI on behalf of the Central Government to meet temporary deficits. They are issued at a discount and redeemed at face value.
  2. Commercial Bills: Bills of exchange arising from genuine trade transactions. When accepted by a commercial bank, they are called commercial bills.
  3. Commercial Papers (CPs): Unsecured promissory notes issued by highly-rated corporate bodies to raise short-term working capital.
  4. Certificate of Deposits (CDs): Short-term, negotiable time deposits issued by commercial banks and select financial institutions to raise large sums of money.
  5. Call Money/Notice Money: Very short-term loans between banks to manage their day-to-day liquidity. Loans for one day are ‘call money’ (overnight), and for 2 to 14 days are ‘notice money’.
• Lenders and Borrowers:
  • Lenders: The main lenders in the organised sector are the RBI, SBI, commercial banks, cooperative banks, and institutions like LIC, GIC, and DFHI. In the unorganised sector, indigenous bankers and money lenders are the lenders.
  • Borrowers: Borrowers include the Central and State Governments, local bodies, traders, industrialists, farmers, and the general public.
• Defects of the Indian Money Market:
  1. Division between Organised and Unorganised Sectors: Lack of integration makes it difficult for the RBI to have effective control over the entire market.
  2. Existence of an Unorganised Sector: This sector is largely unregulated and often exploitative.
  3. Unhealthy Competition: Competition exists between different types of banks (e.g., Indian vs. foreign banks) and between the organised and unorganised sectors.
  4. Inadequate Banking Facilities: Banking facilities are still not sufficient for the size and population of the country, especially in rural areas.
  5. Shortage of Funds: Due to low savings rates and underdeveloped banking habits, there is a general shortage of funds.
  6. Disparity in Interest Rates: Interest rates vary significantly across different institutions and regions.
  7. Absence of a Well-Developed Bill Market: The bill market for trade bills is not well-developed, limiting a key source of short-term finance.

Complete Textual Question Answers

Here are the answers to all the questions given at the end of Chapter 7.

A. Very Short Answer Questions (1 Mark each)

1. In which year was the DFHI established?
   Ans: The DFHI (Discount and Finance House of India) was established in 1988.
2. What is ‘ad hocs’?
   Ans: ‘Ad hocs’ or Ad hoc Treasury Bills were a type of treasury bill issued only in favour of the RBI, against which the RBI could issue currency notes. They were used by the Central Government to raise finance.

B. Short Answer Questions (2 Marks each)

1. What is indigenous bankers?
   Ans: An indigenous banker is an individual or a private firm that operates like a traditional bank by receiving deposits and dealing in hundis or lending money. They are part of the unorganised sector of the Indian Money Market.
2. What is money lenders?
   Ans: Money lenders are individuals whose principal business is to lend money from their own funds. They generally do not accept deposits and operate mainly in rural areas, often lending for consumption purposes.
3. Name two factors which causes shortages of funds in the Indian money market.
   Ans: Two factors that cause a shortage of funds in the Indian money market are:
   i. Low saving capacity of the people.
   ii. Inadequate banking facilities, particularly in rural areas.
4. Write two defects of Indian money market.
   Ans: Two defects of the Indian money market are:
   i. Division between organized and unorganized sector: This creates a lack of uniformity and control.
   ii. Shortage of Funds: There is a scarcity of capital funds due to low savings and underdeveloped banking habits.
5. What is Treasury bill?
   Ans: A Treasury bill is a short-term debt instrument issued by the RBI on behalf of the Central Government to meet temporary government deficits. It is issued in the form of a promissory note at a discount and redeemed at face value upon maturity.
6. What is commercial bill?
   Ans: A commercial bill arises from a genuine trade transaction (credit sale). It is a bill of exchange drawn by the seller on the buyer. When such a trade bill is accepted by a commercial bank, it is called a commercial bill.
7. What is commercial paper?
   Ans: Commercial paper is a short-term, unsecured promissory note issued by eligible and highly-rated corporate bodies to raise funds for their working capital needs. It is issued at a discount to its face value.
8. What is certificate of deposit?
   Ans: A certificate of deposit (CD) is a negotiable, short-term time deposit receipt issued by commercial banks and select financial institutions. It is issued at a discount to face value for raising large sums of money.
9. What is call money?
   Ans: Call money refers to very short-term loans, typically for one day (overnight), transacted between banks to manage their day-to-day liquidity requirements. No collateral is required for these loans.

C. Long Answer Questions (Type-I) (5 Marks each)

1. Write five defects of Indian Money Market.
   Ans: Five major defects of the Indian Money Market are:
   • Division between organized and unorganized sector: The market is split into two parts, with the unorganised sector (money lenders, indigenous bankers) remaining outside the RBI’s direct control, making monetary policy less effective.
   • Shortage of Funds: There is a persistent shortage of funds due to the low rate of savings in the country and underdeveloped banking habits among the populace.
   • Disparity in the rates of Interest: There is no single, uniform interest rate. Rates vary widely between different institutions, regions, and between the organised and unorganised sectors.
   • Absence of a Well-Developed Bill Market: Unlike in developed economies, the bill market in India is underdeveloped. Businesses still prefer cash credit over using bills of exchange, which restricts the market’s depth.
   • Seasonal Fluctuations of Funds: The demand for funds fluctuates seasonally, being high during the busy season (November to June) for harvesting and marketing, and low during the slack season (July to October). This creates instability.
2. Write about any two instruments traded in the India Money Market.
   Ans: Two important instruments traded in the Indian Money Market are:
   • (i) Treasury Bills (T-Bills): These are short-term debt instruments issued by the RBI on behalf of the Central Government. They are used by the government to finance its temporary budget deficits. T-Bills are issued at a discount to their face value and are redeemed at par upon maturity (e.g., 91-day, 182-day, or 364-day). They are considered very safe investments as they are backed by the government.
   • (ii) Commercial Paper (CP): This is an unsecured promissory note issued by large, highly-rated corporations to raise short-term funds for their working capital needs. CPs are issued at a discount and have a fixed maturity. They are a popular instrument for corporates to access short-term funds directly from the market without relying solely on bank credit.
3. What is scheduled bank? Give the classification of scheduled banks.
   Ans: A scheduled bank is a bank whose name is listed in the Second Schedule of the Reserve Bank of India Act, 1934. To be included, a bank must have a paid-up capital and reserves of not less than ₹5 lakhs and must conduct its affairs in a manner that is not detrimental to the interests of its depositors.
   Scheduled banks are classified as:
   • Cooperative Banks: (State Cooperative Banks and Urban Cooperative Banks).
   • Commercial Banks: These are the main suppliers of funds and are further classified into:
     • Scheduled Public Sector Banks: e.g., State Bank of India, Bank of Baroda.
     • Scheduled Private Sector Banks: e.g., HDFC Bank Ltd., ICICI Bank Ltd.
     • Regional Rural Banks (RRBs): e.g., Assam Gramin Vikash Bank.
     • Foreign Scheduled Banks: e.g., HSBC Ltd., Standard Chartered Bank.
     • Scheduled Small Finance Banks: e.g., North East Small Finance Bank Ltd.
     • Scheduled Payments Banks: e.g., India Post Payments Bank Ltd.

D. Long Answer Questions (Type-2) (8 Marks each)

1. Discuss the structure of the India Money Market.
   Ans: (For this answer, provide a detailed explanation of the two main sectors: Organised and Unorganised. Under the Organised sector, describe the role of the RBI, Scheduled Banks (with their classifications), DFIs, and DFHI. Under the Unorganised sector, explain the functioning of Indigenous Bankers and Money Lenders).
2. Discuss the defects of the India Money Market.
   Ans: (This is an expanded version of C.1. Discuss in detail the various defects, such as the dualistic structure, the unregulated unorganised sector, unhealthy competition, inadequate banking facilities, shortage of funds, disparity in interest rates, seasonal fluctuations, and the absence of a well-developed bill market, explaining how each defect hampers the efficiency of the market).
3. Discuss the various instruments traded in the Indian Money Market.
   Ans: (For this answer, describe each of the five main instruments in detail: Treasury Bills, Commercial Bills, Commercial Papers, Certificate of Deposits, and Call/Notice Money. Explain what each instrument is, who issues it, its purpose, and its key features).

Previous Year AHSEC Question Answers (2015-2025)

Short Questions (1-2 Marks)

• What is a Treasury Bill? (AHSEC 2015, 2019)
  Ans: A Treasury Bill is a short-term debt instrument issued by the RBI on behalf of the government to meet its temporary cash needs. It is issued at a discount and redeemed at face value.
• What is Commercial Paper? (AHSEC 2016, 2020)
  Ans: Commercial Paper is a short-term unsecured promissory note issued by large, creditworthy corporations to raise funds for their working capital requirements.
• Mention two defects of the Indian Money Market. (AHSEC 2017, 2022)
  Ans: Two defects of the Indian Money Market are: (i) The division between the organised and unorganised sectors, and (ii) The shortage of funds.
• What is Call Money? (AHSEC 2018)
  Ans: Call money refers to very short-term, unsecured loans between banks, usually for one day (overnight), to manage their liquidity.

Long Questions (5-8 Marks)

• Discuss the structure of the Indian Money Market. (AHSEC 2018)
  Ans: (This answer is the same as the textual Long Answer Question D.1. Please refer to that answer above).
• Explain the defects of the Indian Money Market. (AHSEC 2021)
  Ans: (This answer is the same as the textual Long Answer Question D.2. Please refer to that answer above).

10 Most Important Questions

1. What is the main difference between the organised and unorganised sectors of the Indian Money Market?
   Ans: The main difference is regulation; the organised sector is controlled and regulated by the RBI, while the unorganised sector (indigenous bankers, money lenders) operates largely outside the RBI’s direct control.
2. Who are the main lenders and borrowers in the Indian Money Market?
   Ans: The main lenders are the RBI and commercial banks. The main borrowers are the government, traders, and industrialists.
3. What is a Certificate of Deposit (CD)?
   Ans: A Certificate of Deposit is a negotiable, short-term time deposit receipt issued by a bank or financial institution for a large sum of money, which can be traded in the money market.
4. Why is the bill market in India considered underdeveloped?
   Ans: The bill market is underdeveloped because most businesses prefer to use cash credit or overdraft facilities from banks rather than using bills of exchange to finance their trade transactions.
5. What is the role of the Discount and Finance House of India (DFHI)?
   Ans: The DFHI was established to provide liquidity to money market instruments by creating an active secondary market for them, i.e., by being ready to buy and sell them.
6. Differentiate between a Treasury Bill and a Commercial Bill.
   Ans: A Treasury Bill is issued by the government to meet its financial needs and is purely a finance bill. A Commercial Bill arises from a genuine trade transaction between a buyer and a seller.
7. What are ‘hundis’?
   Ans: Hundis are traditional, indigenous financial instruments used in India for centuries. They are similar to bills of exchange and are used for credit and remittance purposes, primarily in the unorganised sector.
8. Why does the Indian Money Market face a shortage of funds?
   Ans: It faces a shortage of funds due to the low savings rate of the population, inadequate banking facilities to mobilize savings (especially in rural areas), and underdeveloped banking habits among people.
9. What is the difference between Call Money and Notice Money?
   Ans: Call Money is a loan for a single day (overnight). Notice Money is a loan for a period between 2 and 14 days.
10. How does the existence of an unorganised sector act as a defect?
    Ans: The unorganised sector acts as a defect because it is not regulated by the RBI, its interest rates are often very high and exploitative, and its presence prevents the RBI’s monetary policy from being uniformly effective across the entire economy.