The money market is a key component of the financial system as it is the fulcrum of monetary operations conducted by the central bank in its pursuit of monetary policy objectives. It is a market for short-term funds with maturity ranging from overnight to one year and includes financial instruments that are deemed to be close substitutes of money. The money market performs three broad functions. One, it provides an equilibrating mechanism for demand and supply of short-term funds. Two, it enables borrowers and lenders of short term funds to fulfill their borrowing and investment requirements at an efficient market clearing price. Three, it provides an avenue for central bank intervention in influencing both quantum and cost of liquidity in the financial system, thereby transmitting monetary policy impulses to the real economy. The objective of monetary management by the central bank is to align money market rates with the key policy rate. As excessive money market volatility could deliver confusing signals about the stance of monetary policy, it is critical to ensure orderly market behavior, from the point of view of both monetary and financial stability. Thus, efficient functioning of the money market is important for the effectiveness of monetary policy.
In order to meet these basic functions efficiently, money markets have evolved over time spawning new instruments and participants with varying risk profiles in line with the changes in the operating procedures of monetary policy. Changes in financial market structures, macroeconomic objectives and economic environment have called for shifts in monetary regimes, which, in turn, have necessitated refinements both in the operating instruments and procedures and in institutional arrangements by central banks.
In India, although the ultimate goals of monetary policy,