Structure of financial market
The structure of financial markets can be studied from different angles, namely, functional, institutional, or sectoral. Accordingly, financial markets, institutions, and instruments can be classified in any one or more of these ways. The functional classification is based on the term of credit, whether the credit supplied is short-term or long-term. Accordingly, markets are called money markets or capital markets.
The institutional classification tells us whether the financial institutions are organized on commercial or cooperative principles and whether they belong to the organized or unorganized sector. The sectoral classification identifies credit arrangements for various sectors of the economy: agriculture, manufacturing industry, trade and others.
Various classifications are not intended to be water-tight or mutually exclusive. Their aim is to give a broad idea of the scope of financial markets, their several dimensions and functions. Combining the first two bases of study, we give a single functional- cum-institutional classification in Figure 3.1
Functionally, financial markets are broadly sub-divided under two heads money markets and capital markets. The former are markets in short-term funds; the The latter are long-term funds. We have construed the word money market more generally, including the notional money market of monetary theory.
This market is coterminous with the overall economy. The asset it trades in is money; the demanders are money holders (the general public), and the providers are the government, the RBI, and the banks. Money is obtained via the typical process of selling commodities, services, and assets in all marketplaces, since money is the common medium of exchange (in all monetary transactions).
Money does not have its own market, like bills, bonds, or stock shares do. When the word “money market” is used in academic debates of monetary theory and policy, it refers to the money market described above. However, in business, the word “money market” nearly typically refers to the short-term loan market.
The short-term credit market is divided into two sectors: organized and unstructured. The organized market includes the RBI and banks. It is considered organized because its components are methodically coordinated by the RBI.
Non-bank financial institutions, like the LIC, GIC, and UTI subsidiaries, participate in this market indirectly via banks rather than directly. Quasi-government organizations and significant corporations may also make their short-term excess cash accessible to the market via banks.
Aside from commercial banks, which dominate the organized money market, there are cooperative banks. They are members of co-operative credit institutions with a three-tier structure. State co-operative banks are at the top (since cooperation is a state matter), whereas central co-operative banks are at the district level. Locally, there are primary credit societies and urban cooperative banks. The whole cooperative credit system is tied to the RBI and depends on it for money. The RBI only does business with state cooperative banks. Because of their scale, methods of operation, and relations with the RBI and commercial banks, only state and central co-operative banks should be considered as part of the organized money market; the others (local co-operative credit societies) are only loosely associated with it.
The unorganized market is mostly made up of indigenous bankers and moneylenders, both professional and unprofessional. It is disorganized because the operations of its constituents are not systematically coordinated by the RBI or any other authority.
Private moneylenders operate across the nation, although there is no relationship between them. Indigenous bankers are better structured on a local level, such as in Bombay and Ahmedabad. However, this kind of organization is simply a loose affiliation.
The characteristics of the money market are critical to the effectiveness of monetary and credit policy. The unorganized segment of the market is essentially immune to monetary and credit regulations. It is not subject to reserve, capital or investment regulations. Its reliance on the RBI or banks for money is quite low.
As a result, it is not immediately influenced by economic policies such as monetary constraint. The RBI has no control over the quality or content of loans in this market, either. This serves as a key constraint on the operation of monetary policy in India. However, since 1947, the situation has changed dramatically, with the rapid development of banking in the nation and the relative reduction of the unorganized sector of the money market. There are three major components to the organized sector of the money markets.
There are three types of markets: inter-bank call money, bill market, and bank loan.
The unorganized sector has similar markets. However, its call money market is tiny and limited to Gujarati shroffs (a subset of indigenous bankers). The last two markets are fairly significant. The indigenous banknotes are known as hundis, and the hundi market is quite active. Indigenous bankers and moneylenders remain the primary source of short-term loans for small borrowers.
The primary role of the money market is to give short-term cash to deficit spenders, whether government or private. It does this primarily by leveraging short-term surpluses from both financial and non-financial institutions, such as state governments, municipal governments, and quasi-governmental organizations.
Banks achieve so by’selling’ a variety of deposits, participation certificates, and reduced bills. The RBI sells treasury notes ‘on tap’. The RBI acts as the market’s lender of last resort. Funds must also be shifted between regions and from one location to another based on demand. An efficient and well-developed system does this quickly and cheaply.
It also prevents regional or sectoral funding shortages. Surpluses in certain centers or sectors are instantly transferred to those in inadequate supply. This ensures an equitable supply of capital and liquidity across the economy. Banks and other money market participants must have an interconnected network of branches and offices, a quick communication and remittance system, and well-trained employees.
The actual economy may also follow a seasonal pattern, resulting in periodic fluctuations in the need for finance. In the Indian economy, seasonality is mostly caused by the seasonal nature of agriculture and other agro-based businesses (such as sugar) and their significant weight in the overall economy. Thus, the Indian money market has typically had two seasons: the active season from October to April and the quiet season from May to September.
During the busy season, the primary crops (Kharif) are harvested and sold, while sugarcane is crushed. As a result, the demand for bank loans from merchants and sugar makers increases. During the slow season, the need for finances decreases. The RBI has been implementing a pro-seasonal monetary policy to ensure that any specific funding constraints do not exist during the busy season, which may harm legitimate economic activity.
For some time, with increased double cropping of cultivated land, significant increases in wheat (a major rabi crop) and autumn rice output, growth of perennial industries, and a higher proportion of bank credit going to manufacturing industries, the previous seasonal ups and downs in fund demand have largely lost their significance. This tendency is expected to strengthen over time.
The capital market deals with medium- and long-term finances. Similar to the money market, the capital market is divided into two sectors: organized and unorganized. The organized sector includes the stock market, RBI, banks, development banks (e.g. Industrial Development Bank of India), LIC, GIC, subsidiaries, and UTI.
The unorganized sector includes indigenous bankers and moneylenders, chit funds, nidhis, and other financial institutions, as well as investment and finance firms, hire purchase companies, and corporate deposits. The unorganized sector has a little influence in the capital market.