Chapter 4 Indian Money Market Instruments, Operations and Policy

Overview of the Money Market

The money market is the segment of the financial system that deals in assets closely substitutable for money, typically overnight to short-term funds and instruments with maturities of one year or less. It is not a physical exchange like a stock market; transactions are arranged over the telephone and through other communication channels. As the principal source of short-term liquidity, the money market plays a vital role in the functioning of the Indian financial system.

Rather than a single unified marketplace, the money market is a collection of interconnected markets for various short-term debt instruments. It operates largely on a wholesale basis, where large-value transactions between institutions are the norm. A defining feature of the market is its reliance on creditworthiness and trust: the reputation and standing of counterparties are crucial, since many dealings depend on prompt payment and settlement. Participants include the Reserve Bank of India (RBI), the Discount and Finance House of India (DFHI), the Securities Trading Corporation of India (STCI), primary dealers, commercial banks, mutual funds, insurance companies, non-banking finance companies (NBFCs), corporate treasuries, state governments, provident funds, public sector undertakings (PSUs), and non-resident Indians. The market is essentially need-driven — supply and demand for short-term funds determine prices and volumes — and transactions can be either secured (backed by collateral) or unsecured (based solely on credit).

Money Market Functions and Policy Role

The money market performs three interrelated functions that are central to short-term finance and overall monetary management. First, it acts as a balancing mechanism, smoothing mismatches between the demand for and supply of short-term funds so that temporary surpluses and deficits among banks, non‑bank financial institutions, and corporations can be adjusted efficiently. Second, it provides a focal point for central bank action: by intervening in the money market, the central bank can influence liquidity conditions and the general level of short-term interest rates across the economy. Third, it gives borrowers and lenders reasonable and timely access to short-term funds, allowing them to meet temporary financing and investment needs at market‑clearing prices.

Closely linked to these functions, the money market is a primary channel for monetary policy transmission. Changes in policy rates and open-market operations filter through money-market instruments and rates, then pass on to other financial markets and, ultimately, to spending, investment and price behaviour in the real economy.

A well-functioning money market also supports the development of longer-term securities markets. Very short-term interest rates set in the money market serve as reference points for pricing longer-dated instruments, and these rates incorporate market expectations about how the policy rate and liquidity conditions are likely to evolve in the near term.

Benefits of Money-Market Liquidity

An efficient money market strengthens the financial system by widening and stabilising sources of short-term funding for banks. Beyond customer deposits, banks gain access to alternative financing and greater competition, which helps them optimise funding costs. This access also allows banks to manage interest-rate risk and to better match the maturities of their assets and liabilities, improving overall balance-sheet resilience.

A well-developed inter‑bank market underpins liquidity across the money market and supports active secondary markets for instruments such as commercial paper and treasury bills. Greater liquidity and market depth encourage the growth of non‑bank intermediaries, intensifying competition for funds and giving savers a broader range of short‑term investment options to suit differing needs and risk preferences.

Liquidity in the money market benefits borrowers as well. While the money market deals primarily with short-term instruments, its depth and tradability lower funding costs for large borrowers and enable efficient management of short-term funding gaps or surpluses. By making securities easier to buy and sell, a liquid money market also strengthens the longer‑term debt market and helps develop a functioning government securities market.

Beyond debt markets, a liquid money market is a prerequisite for healthy capital markets, foreign‑exchange markets and derivatives trading. The certainty of prompt cash settlement—which liquid money markets provide—is essential for forwards, swaps and futures. For the government, deeper money markets widen the investor base for public debt and improve pricing of sovereign borrowings, thereby facilitating the government’s market‑borrowing programme.

Finally, effective monetary management by the central bank depends on money‑market liquidity. Instruments such as repos and open market operations work best when trading is active and deep: policy signals transmit faster and with fewer distortions, making indirect monetary control more precise and reliable.

Indian Money Market: Size and Turnover

The average daily turnover of the Indian money market exceeds ₹1,00,000 crore. That volume represents more than 3 per cent of the funds circulating in the system and, strikingly, is equivalent to roughly 2 per cent of India’s annual GDP being traded in a single day. Although the money market is several times larger than the domestic capital market, its daily turnover remains small compared with the volumes seen in developed-market money markets.

RBI's Money Market Operations

The Reserve Bank of India is the principal regulator and active operator in India’s money market; the market falls directly under its regulatory authority and policy reach. Its interventions aim above all to align short-term liquidity and interest rates with the broader objectives of monetary policy, chiefly price stability, while also ensuring sufficient credit flows to productive sectors and fostering orderly conditions in the foreign exchange market.

To achieve these aims, the Reserve Bank uses a compact set of tools that influence the availability and cost of short-term funds. One basic instrument is the cash reserve ratio (CRR), the proportion of deposits that commercial banks must hold with the central bank; by raising or lowering the CRR the RBI directly absorbs or releases liquidity. Through open market operations (OMOs)—the buying and selling of government securities—the Bank injects liquidity into the system or absorbs excess funds, thereby nudging short-term interest rates. Repurchase agreements (repos) operate as short-term collateralised loans against government securities, allowing the RBI to provide temporary liquidity or withdraw it by adjusting repo rates and volumes.

The RBI also employs changes in the bank rate to influence the overall cost of funds in the banking system, and, when needed, uses foreign exchange swap operations to manage rupee liquidity and maintain order in the external segment of the money market. Together these instruments give the Reserve Bank the means to steer short-term rates and liquidity in ways consistent with its policy goals.

Development and Reform of India's Money Market

The Indian money market is conventionally divided into formal (organized) and informal (unorganized) segments. Over the past five decades one of the most significant accomplishments of India’s financial system has been the steady decline in the relative importance of the informal sector and the corresponding growth in the reach and influence of the formal sector.

Until the mid-1980s the Indian money market was shallow, offered only a small range of instruments and operated under tight controls on interest rates. At that time the market was dominated by a few instruments and institutions: the inter‑bank call market, treasury bills, commercial bills and participation certificates formed the core of short‑term finance.

Recognizing these limitations, policymakers initiated a programme of reforms in the latter half of the 1980s, which continued into the 1990s. These measures were aimed at developing the market’s depth and diversity and strengthening the role of the organized segment, thereby improving the overall efficiency of short‑term financial intermediation.

In the mid-1980s, a committee under Sukhamoy Chakravorty was appointed (1985) to review the working of India’s monetary system and it highlighted the need to develop money market instruments. As a follow-up, the Reserve Bank constituted a working group on the money market chaired by N. Vagul, which submitted its report in 1987. That report provided the blueprint for building a formal money market and prompted a series of policy measures by the Reserve Bank.

In 1988 the Reserve Bank, together with public sector banks and financial institutions, established the Discount and Finance House of India (DFHI) to provide liquidity to money market instruments and to help develop a secondary market for them. Around the same time, new instruments were introduced to broaden short-term funding and investment options: the 182-day treasury bill, certificates of deposit and inter‑bank participation certificates in 1988–89, followed by commercial paper in January 1990.

To improve price discovery, the Reserve Bank also began liberalising interest rate controls from October 1988. Interest rate ceilings on call and notice money were removed in stages, starting with DFHI operations, and by May 1989 ceilings on inter‑bank term money, rediscounting of commercial bills, and risk‑free inter‑bank participation were withdrawn. These steps ushered in a gradual shift from administered interest rates to rates largely determined by market forces.

In August 1991 the government appointed a high‑level committee under M. Narasimham to review the structure, organisation, functions and procedures of the financial system. The recommendations of the Narasimham Committee set the tone for a series of money‑market reforms which the Reserve Bank accepted and began to implement. As part of this reform drive, the Securities Trading Corporation of India was established in June 1994 to deepen the secondary market for government dated securities and public sector bonds.

Barriers to entry were progressively lowered to increase participation and liquidity. The primary dealer system was introduced in 1995 and a satellite dealer system in 1999. At the same time, issuance and subscription norms for money‑market instruments were relaxed, yields were increasingly allowed to be determined by market demand and supply, regulatory constraints such as bank‑guarantee requirements for commercial paper were removed, and new categories of participants — including foreign institutional investors, non‑bank financial entities and mutual funds — were permitted to operate in the market.

A number of new instruments and practices were introduced to promote market pricing and liquidity. Treasury bills of varying maturities and RBI repos became standard instruments, and the adoption of auctioned treasury bills led to market‑determined interest rates. The system also saw a gradual shift from a cash‑credit framework to a loan‑based approach, transferring the onus of cash management from banks to borrowers and fostering a short‑term funds market governed by market rates. In April 1997 ad hoc and on‑tap 91‑day treasury bills were discontinued and replaced by Ways and Means Advances (WMA) linked to the bank rate, thereby limiting the near‑automatic funding of government needs.

The Reserve Bank revived and developed indirect monetary instruments to improve transmission. The bank rate was reactivated in April 1997, and during 1998–99 a mix of auctions, private placements and open market operations was used to manage liquidity. In June 2000 the Liquidity Adjustment Facility (LAF) was introduced, which helped make interest rates a central channel of monetary transmission. Concurrently, the minimum lock‑in period for money‑market instruments was reduced to seven days, and inter‑bank liabilities were exempted from Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) requirements to encourage a term money market.

Market innovations continued with the introduction of forward rate agreements and interest rate swaps in 1999, and by making instruments such as certificates of deposit and commercial paper accessible to non‑bank participants. The payment and settlement infrastructure was strengthened: the Negotiated Dealing System (NDS) was launched in February 2002, the Clearing Corporation of India Limited (CCIL) became operational in April 2002 and supported the operationalisation of the Collateralised Borrowing and Lending Obligation (CBLO) in January 2003, and the Real Time Gross Settlement (RTGS) system was implemented from April 2004. These changes helped transform the call and notice market into a pure inter‑bank market by August 2005. Further improvements included the screen‑based NDS‑CALL system for clearing call/notice and term money trades in September 2006, the widening of collateral for LAF operations to include state government securities from April 2007, and the requirement from November 2012 that all such transactions be reported through NDS‑CALL.

In later years additional refinements were made: repos in corporate banks were permitted in March 2010, and a reporting platform for secondary market transactions in commercial paper was operationalised in July 2010.

Taken together, these reforms changed the profile of the Indian money market. The core objective has been to introduce new instruments and ensure their appropriate pricing, while creating market segments that specialise by asset, liability and participant type. The Reserve Bank has imposed prudential limits on inter‑bank exposures and rationalised standing and exceptional liquidity support to ensure systemic stability. The integration of market segments through the LAF, and the improvements in trading and clearing provided by NDS and CCIL, have accelerated the evolution of a more robust, market‑driven money market and supported the growth of a vibrant repo market outside the LAF.

India’s money market is concentrated in three centres: Mumbai, Delhi and Kolkata. Among these, Mumbai is the dominant and most active centre—serving as the country’s financial hub where short‑term funds from across India converge and are transacted—while Delhi and Kolkata play relatively smaller, more regional roles.

Treasury Bills and Auctions

The Indian money market comprises a range of short-term instruments, including Treasury bills (T-bills), Cash Management Bills (CMBs), the call/notice money market (overnight call and short‑notice transactions up to 14 days), commercial paper (CP), certificates of deposit (CDs), commercial bills (CBs) and the Collateralized Borrowing and Lending Obligation (CBLO). These instruments serve different participants and purposes: T-bills and CMBs are short‑term government securities used for deficit and cash management; CPs are unsecured, short‑term promissory notes issued by corporations; CDs are time deposits issued by banks and financial institutions; commercial bills arise from trade credit; and CBLOs are collateralized short‑term borrowings in the interbank market.

Among these, the call/notice market and Treasury bills constitute the most important segments of the Indian money market. Treasury bills, the call money market and certificates of deposit are primary sources of liquidity for the government and banks, while commercial paper and commercial bills channel short‑term funds to the corporate sector and other intermediaries. Together, these markets ensure the smooth functioning of short‑term funding and liquidity management across the financial system.

Treasury bills are short-term government securities issued by the Reserve Bank of India on behalf of the central government to manage temporary liquidity shortfalls. They are used to raise short-term funds to bridge seasonal or temporary gaps between the government’s receipts (both revenue and capital) and its expenditure, and constitute one of the most important segments of the money market in India and worldwide. Treasury bills are zero-coupon instruments repaid at par on maturity: the investor pays less than the face value at purchase, and the difference between the purchase price and the maturity value is the interest earned, commonly referred to as the discount. Tax deducted at source (TDS) is not applicable on returns from treasury bills.

Treasury bills (T‑bills) are short‑term, negotiable government securities that can be readily bought and sold in the secondary market. Their short tenure and active inter‑bank repo market make them highly liquid, while sovereign backing means they carry virtually no default risk. T‑bills offer an assured yield with relatively low transaction costs and are eligible for inclusion among securities held to satisfy the Statutory Liquidity Ratio (SLR).

T‑bills are issued in dematerialised form rather than as physical scrip; purchases and sales are settled through the Subsidiary General Ledger (SGL) account. Currently, the common tenors are 91‑day, 182‑day and 364‑day instruments. The Reserve Bank of India auctions 91‑day T‑bills every Friday and 364‑day T‑bills on alternate Wednesdays (the Wednesday preceding the reporting Friday). The minimum investment size is ₹25,000, with additional purchases permitted in multiples of that amount.

Treasury bills (T-bills) are issued in three categories, which are primarily distinguished by their maturity periods. These categories provide investors with short-term government securities of differing tenors to suit varying liquidity needs and investment horizons.

On‑tap bills—so called because they could be purchased from the Reserve Bank at any time—carried a fixed yield of 4.66 per cent. Having become largely redundant, these instruments were withdrawn with effect from 1 April 1997.

Ad hoc bills were introduced in 1955 as a mechanism for the Government of India to maintain minimum cash balances with the Reserve Bank. Under the arrangement the government agreed to keep a minimum cash balance of Rs. 50 crore on Fridays and Rs. 4 crore on other days, free of any obligation to pay interest. Whenever the balance fell below these minimums, the government account was replenished by creating ad hoc 91‑day treasury bills in favour of the Reserve Bank. These instruments were essentially an accounting entry on the Reserve Bank’s books and, in practice, amounted to an automatic monetization of the government’s budget deficit. The term “monetized deficit” refers to the increase in net Reserve Bank credit to the central government, which arises from increases in the Reserve Bank’s holdings of (a) the Government of India’s dated securities, (b) 91‑day treasury bills, and (c) rupee coins reflecting changes in cash balances with the Reserve Bank.

During the 1970s and 1980s a large portion of outstanding ad hoc bills was converted into longer‑term dated and undated government securities — a process known as funding. The growing stock of such funded liabilities limited the Reserve Bank’s ability to conduct independent monetary policy, and the ad hoc arrangement was therefore discontinued with effect from 1 April 1997. Outstanding ad hoc treasury and tap bills as on 31 March 1997 were converted on 1 April 1997 into special securities without specified maturity, carrying an interest rate of 4.6% per annum. To replace ad hoc bills and to meet temporary mismatches between the government’s receipts and payments, a system of Ways and Means Advances was introduced from 1 April 1997.

Auctioned Treasury bills (T‑bills) are the most liquid money‑market instrument in India, introduced in April 1992. The Reserve Bank conducts auctions in which participants submit competitive bids; bills are allotted at the auction cut‑off, so their yield is determined by market forces. These instruments are not credit‑rated and cannot be rediscounted with the Reserve Bank—that is, they cannot be sold back to the central bank before maturity. Currently the RBI issues T‑bills with maturities of 91 days, 182 days and 364 days.

The development of T-bills lies at the core of a well-functioning money market. As short-term, government-issued instruments that carry virtually no credit risk, T-bills are indispensable for the government’s day-to-day cash management and for absorbing or providing short-term liquidity in the financial system.

Because their yields are effectively risk-free and available at different maturities, T-bills provide the benchmark term structure of short-term interest rates. Those benchmark yields are used to price a wide range of floating-rate products and other money-market instruments. For central banks, the T-bill market is the preferred instrument for intervening in money markets to steer liquidity and influence short-term interest rates; a well-developed T-bill market is therefore a prerequisite for effective open market operations.

Ad hoc 91‑day treasury bills were introduced in the mid‑1950s to replenish, on an automatic basis, the central government’s cash balance with the Reserve Bank so that only a minimum level was maintained. While this mechanism ensured ready availability of cash, it also opened an era of largely uncontrolled monetization of the government deficit. Until the 1960s the market for treasury bills was active, supported by weekly auctions of the 91‑day paper.

In the mid‑1960s the auction route for 91‑day bills was replaced by on‑tap issuance—bills made available on demand rather than through competitive bidding. Until 1974 the rate on tap bills moved with changes in the bank rate, which helped sustain market interest. After 1974, however, the discount rate on ad hoc and tap bills was fixed uniformly at 4.6 per cent, and the market lost much of its vitality under this administered‑rate regime.

Interest in treasury bills revived in the late 1980s. The 182‑day bill was reintroduced on an auction basis in November 1986, and the creation of the Discount and Finance House of India (DFHI) in 1988 gave the money market an institutional boost. As part of reform measures, the 182‑day bill was discontinued in 1992 and replaced by a 364‑day auction bill in April of that year; the 91‑day auction bill was brought back in January 1993. Parallel issuance of 91‑day tap and ad hoc bills continued until March 1997.

To broaden investor access and provide an avenue for state governments and some foreign central banks to park surpluses, a 14‑day intermediate bill and other auction bills were introduced in April 1997. The 182‑day bill was again reintroduced to add variety to the treasury bill menu, although both the 182‑ and 14‑day bills were discontinued in March 2001; the 182‑day bill returned once more in April 2005.

A significant structural change came with the end of ad hoc and on‑tap 91‑day issuance: the Reserve Bank’s purchase and holding of treasury bills became entirely voluntary. Before auctioned issuance became the norm, the RBI held a substantial majority of T‑bills; with auctions, more than 25 per cent of T‑bills began to be held by investors other than the RBI. Auction procedures were also streamlined: notified amounts are specified for competitive bids while non‑competitive bids are accepted outside the notified amount. On an experimental basis in 1998–99 a uniform‑price auction was introduced for the 91‑day bill (in which successful bidders pay a common price), and it has since been adopted successfully.

Participants in the T‑bill market include the Reserve Bank of India, commercial and foreign banks, mutual funds, financial institutions, primary dealers, provident funds, corporates, and foreign institutional investors. State governments can also invest their surplus funds in T‑bills of any maturity as non‑competitive bidders, meaning they accept the yield determined by the auction rather than submitting a competitive price. Together, these diverse players contribute liquidity and depth to the short‑term government securities market.

The sale of treasury bills is carried out through auctions, which serve as a mechanism for price discovery—allowing market prices to reflect relative demand and supply and thereby promote efficient allocation of resources. In an auction, participants submit competitive bids to the Reserve Bank, which then determines a cut‑off yield or price and allots bills accordingly. For auctions to produce meaningful and fair prices, bidding must be competitive and participation should be broad and diverse; wider participation increases competition, improves price outcomes and strengthens market signals. Primary dealers, banks, corporates, mutual funds and other institutional players typically take part in such competitive bids.

In addition to competitive bidding, the Reserve Bank also accepts non‑competitive bids from certain categories of participants, notably state governments, non‑government provident funds and other central banks. Non‑competitive bids are designed to include participants who either lack the expertise or prefer not to engage in competitive bidding. Allowing non‑competitive applications is a more efficient way to encourage retail and institutional participation than requiring large numbers of small investors to bid competitively.

The Reserve Bank itself may also bid on a non‑competitive basis to cover any under‑subscribed issues. Non‑competitive bidders receive allotments at the weighted average price (or yield) of the successful competitive bids. Such non‑competitive applications are accepted over and above the auction’s notified amount, helping to ensure both inclusiveness and full subscription of T‑bill issues.

Auctions are broadly classified into two forms: multiple-price (also called discriminatory) and uniform-price (also called single-price). In a multiple-price auction each successful bidder pays the exact price they offered, so different winners may end up paying different amounts. In a uniform-price auction all successful bidders pay the same clearing price determined by the auction, regardless of their individual bids. The choice of format influences bidders’ strategies and the auction’s final allocation.

In a multiple-price auction the Reserve Bank invites bids by price, asking participants to quote the price (per 2100 face value) at which they wish to purchase the security. The Bank then determines a cut-off (marginal) price that exhausts the issue; any bids above that cut-off are accepted and each successful bidder pays the exact price it offered. This method allows the Bank to discover the maximum price each bidder is willing to pay and can encourage aggressive, competitive bidding because winners pay their own bids rather than a single low clearing price. Its principal drawback is strategic caution: bidders may understate their bids to avoid overpaying, since those who pay more than the subsequent market level risk large capital losses — a phenomenon known as the “winner’s curse.” That risk is especially acute in markets with high price volatility, and it prompted the Reserve Bank to experiment with an alternative format for 91‑day Treasury bills.

Under the uniform-price auction the Bank accepts bids in descending order until the issue is fully absorbed, but all successful bidders pay the same uniform price set by the Bank. By making the clearing price common to all winners, this method tends to reduce uncertainty and broaden participation. At the same time, uniform pricing can weaken incentives to prepare carefully for an auction, and it creates scope for irresponsible bidding or tacit collusion among participants because the marginal cost of bidding aggressively is lower.

Globally, most countries have historically used the multiple-price format, but there has been a recent shift toward uniform-price auctions. The Reserve Bank introduced the uniform-price method experimentally for 91‑day T‑bills on 6 November 1998, and from 1999–2000 these auctions have been conducted regularly on a uniform-price basis. T‑bill auctions follow a fixed calendar; the Reserve Bank issues a press communication two to three days before each auction announcing the date, the amount on offer and the auction format. Since 22 October 2003 the T‑bill auction module has been operational on the Public Debt Office—Negotiated Dealing System (PDO‑NDS), with announcements and processing conducted online in a Straight‑Through‑Process (STP).

91-day Treasury bills were sold on tap from 1965 to commercial banks and the public at a fixed discount rate of 4.6 per cent, a practice that was discontinued on April 1, 1997. A separate category of 91-day ad hoc T-bills, issued in favour of the Reserve Bank of India, was phased out during 1997–98 and also terminated on April 1, 1997. Both the ad hoc and tap issues were converted into special securities without a specific maturity and carrying the same 4.6 per cent per annum interest.

In 1992–93 the government introduced auctioned 91-day T-bills issued in predetermined amounts; the cut-off yields at these auctions were materially higher than the old fixed discount on tap bills. The notified amount for each auction was Rs. 2,500 crore up to March 14, 1997, and was briefly reduced to Rs. 2,100 crore from March 21. In the 2000s the notified amount was revised several times: it was adjusted to Rs. 2,250 crore in May 2001, raised to Rs. 7,500 crore in 2003 and then sharply increased to Rs. 72,000 crore from April 2004 — the latter expansion reflecting the introduction of the Market Stabilization Scheme (MSS).

The size of the 91‑day Treasury bill market can be judged by gross issues and the amount outstanding. In one period, gross issuance totalled Rs. 224,050 crore. Gross issues fell sharply in 1997–98 when the notified auction amounts were kept in a narrow band (about Rs. 2,100–7,300 crore), and volumes remained muted in the years that followed because notified amounts were kept low. To widen the availability of short‑term paper, the notified auction amounts were increased from 18 May 2001. Thereafter, buoyant liquidity, sustained capital inflows and a cut in the repo rate contributed to a rise in both gross issues and the outstanding stock of 91‑day T‑bills.

The Reserve Bank’s share in subscriptions — measured as a percentage of gross issues — fell in 1993–94 and 1994–95, but climbed sharply in 1995–96 when tight liquidity conditions pushed the central bank to subscribe more. The subsequent decline in the Reserve Bank’s subscriptions in 2000–01 reflected stronger market absorption as liquidity eased.

Average net holdings of 91‑day T‑bills by the Reserve Bank, which were around 85% in 1992–93, had fallen to almost nil by 2000–01. This change signals heightened market interest in short‑term bills and effective conduct of open market operations; indeed, the Reserve Bank has not subscribed to 91‑day T‑bill issues since 2001–02.

Outstanding amounts fell substantially between 1997–98 and 1999–2000 when notified auction sizes were reduced to around Rs. 7,100 crore from earlier higher levels. Since 2001–02, however, the amount outstanding has risen markedly, mirroring the overall increase in system liquidity.

The 364-day Treasury bills were introduced in April 1992 to replace the earlier 182-day bills, providing a short-term government security with an almost one-year maturity. These bills are issued through a multiple (discriminatory) price auction in which successful bidders pay the exact price—or accept the yield—they submitted, rather than a single uniform price for all winners.

When first launched, auctions for the 364-day bills were held fortnightly and attracted strong interest from banks and other financial institutions. The bills are not rediscountable with the Reserve Bank of India, and from 1998–99 the auction frequency was changed from fortnightly to monthly. Aside from their longer maturity relative to the 182-day bills, their basic features are similar; investor demand is influenced by factors such as volatility in the government securities market, changes in the statutory liquidity ratio (SLR), and prevailing yields.

The notified amount for these bills has been increased several times: from Rs 500 crore to Rs 7,750 crore effective 13 December 2000, then to Rs 71,000 crore from April 2002, and further to Rs 72,000 crore from April 2004 following the introduction of the Market Stabilization Scheme (MSS).

The 182-day T-bills were introduced in November 1986 as a short-term investment instrument for banks, financial institutions and other market participants. Issued at a discount to face value for a minimum amount of ₹1 lakh and in multiples thereafter, these bills were aimed at developing the short-term money market and proved useful for parking short-term liquid funds. They were eligible for statutory liquidity ratio (SLR) purposes and could be used for borrowing under the Reserve Bank’s “stand-by refinance facility,” but they could not be rediscounted with the Reserve Bank. State governments, provident funds and the Reserve Bank itself did not purchase these bills.

Initially auctioned monthly, the frequency was changed from July 1988 to fortnightly auctions to align with scheduled commercial banks’ reporting Fridays. Yields on the bills were freely determined by market forces and an active secondary market developed around them. The notified amount at each auction was kept at 7,100 crore.

The issue experienced several interruptions. Auctions were suspended from 28 April 1992 until 25 May 1999, when the bills were reintroduced. After May 1999 the government raised 25,500 crore through these bills; non-competitive bids of 2,600 crore were accepted in 1999–2000 (none in 2000–01), and devolvement on the Reserve Bank amounted to 645 crore in 1999–2000 and 250 crore in 2000–01. High average cut-off yields (about 9.89 per cent) and a tendency for yields to rise year on year made the instrument attractive to investors.

The bills were discontinued again in May 2001 and later reintroduced in April 2005 with a notified amount of 500 crore.

Treasury bills are issued at a discount, so the investor’s return is simply the gap between the purchase price and the redemption (face) value. Historically, the official treasury bill rate rose from 2.25 per cent in 1955–56 to 4.60 per cent by 1974. Until 1993 this rate was administered by the authorities and remained the lowest broadly prevailing interest rate. Since 1993 the treasury bill rate has been market-determined and has frequently exceeded the earlier 4.60 per cent level, producing higher yields for investors.

“Yield” denotes the rate of return on a financial instrument; the “implicit yield” is the yield an investor realizes if the instrument is held to maturity. In plain terms, implicit yield equals the gain (redemption value minus purchase price) expressed as a percentage of the purchase price and annualized to account for the bill’s remaining life. The Reserve Bank of India publishes these implicit yields in its weekly bulletins.

Despite their apparent simplicity, implicit yields have limitations as market benchmarks. Primary dealers are often obliged to bid a minimum amount at T‑bill auctions, which can distort auction outcomes and push yields away from pure market clearing levels. The Reserve Bank itself may take on devolvement (accept unsold amounts) to smooth yields or to signal its stance on interest rates. Because T‑bill yields are also sensitive to short‑term liquidity conditions in the money market, they do not always reflect an unhindered market price and therefore are not ideal benchmark rates. Frequent and sometimes abrupt movements in implicit yields have likewise made it difficult to construct a smooth, continuous yield curve.

Treasury Bill Auction Mechanism

Treasury bills in India are short-term government securities issued by the Reserve Bank of India (RBI) with a maximum tenor of 364 days. They are sold on an auction basis, with the RBI announcing the date, place and exact tenors from time to time, along with the nominal amounts offered to competitive bidders. Issues are made at a discount to face value.

Auctions may be conducted either as a uniform-price auction or a multiple-price auction; the RBI announces the method before each sale. In a uniform-price auction, all successful competitive bidders pay the same price — the cut-off or minimum discounted price determined at the auction — regardless of the prices they tendered. In a multiple-price auction, successful competitive bids up to the cut-off are accepted at the individual bid prices. Competitive bids that are lower than the cut-off are rejected in both auction types. Non-competitive bids are allocated at the discretion of the RBI; such allocations are outside the notified amount and are made at the weighted average price of the accepted competitive bids.

To illustrate, suppose the RBI notifies Rs. 7,300 crore for competitive bidders and receives the following bids: A — Rs. 90 crore at 98.50; B — Rs. 60 crore at 98.40; C — Rs. 80 crore at 98.35; D — Rs. 70 crore at 98.30; E — Rs. 85 crore at 98.20; F — Rs. 30 crore at 98.00. If the cut-off price is fixed at 98.30, bids A through D (total Rs. 300 crore) are accepted and E and F are rejected. Under a uniform-price auction each successful bidder would pay 98.30 (i.e., Rs. 98.30 per Rs. 100 face value), so the total amount payable would be 98.30/100 × 300 = Rs. 294.90 crore. Under a multiple-price auction each accepted bidder pays their own bid price, giving a total payable of (98.50/100 × 90) + (98.40/100 × 60) + (98.35/100 × 80) + (98.30/100 × 70) = Rs. 295.18 crore.

The RBI has full discretion to accept or reject any or all bids, in whole or in part, without assigning a reason. The Bank may also choose to participate as a non-competitive buyer and purchase part or all of the amount notified at the cut-off price.

Eligibility to invest through the competitive route includes any person resident in India — firms, companies, corporate bodies, institutions and trusts. Non-Resident Indians and foreign investors may invest subject to government approval and the provisions of the Foreign Exchange Management Act, 1999, and its regulations, in addition to other applicable laws. Certain entities may participate on a non-competitive basis for specified bills as decided by the RBI; these include state governments, eligible provident funds in India, the Nepal Rastra Bank and any other persons or institutions specified by the RBI with government approval. Individuals may participate on a non-competitive basis as retail investors; retail allocations are restricted to a maximum of 5% of the aggregate nominal amount of the issue within the notified amount, or such other percentage as may be specified by the Government of India or the RBI. (Eligible provident funds are non-government provident funds governed by the Provident Funds Act, 1925 and the Employees’ Provident Fund and Miscellaneous Provisions Act, 1952, whose investment pattern is decided by the Government of India.)

The minimum subscription is Rs. 10,000 and bills are issued in multiples of Rs. 10,000 for both competitive and non-competitive bidders. Bills are issued either in the form of a promissory note or by credit to a Subsidiary General Ledger (SGL) account. They are transferable under the Government Securities Act, 2006 and the Government Securities Regulations, 2007, and are repaid at par on maturity at the RBI office where they are registered.

Rights of subscribers and holders are governed by the Government Securities Act, 2006 and the Government Securities Regulations, 2007, read together with RBI notifications issued in consultation with the Government of India. Indian tax laws apply for assessment of liability on investors or holders, and any disputes in relation to the bills are subject to the jurisdiction of Indian courts.

The treasury bills market in India has grown substantially in both issuance volume and outstanding stock. The RBI’s move away from on-tap and ad hoc issues toward auctioned treasury bills has helped develop the market and make yields market-determined. The establishment of primary dealers and satellite dealers has further activated trading in this instrument. There remains potential for deeper development if the market is broadened by increasing the number of participants and instruments; additional measures, such as the introduction of futures on treasury bills, could enhance liquidity and make the market more attractive.

Cash Management Bills

The Reserve Bank of India issues, on behalf of the Government of India, short-term instruments called Cash Management Bills (CMBs) to meet temporary mismatches in the government’s cash flow. CMBs resemble Treasury bills in structure — they are issued at a discount and redeemed at face value — but are specifically used for very short tenures, with maturities shorter than 91 days. The exact tenure, notified amount and date of issue are determined by the government’s immediate cash requirements.

Auctions of CMBs are announced by the RBI through a press release one day prior to the auction, and allotment settlements take place on a T+1 basis (trade date plus one day). Unlike some government papers, the non‑competitive bidding facility is not available for CMBs, so bids are routed through the competitive auction process. These instruments are tradable in the secondary market and qualify for the ready‑forward facility, which enhances their liquidity.

For banks, investment in CMBs is treated as an eligible investment in government securities for meeting the Statutory Liquidity Ratio (SLR) under the Banking Regulation Act, 1949. The first set of CMBs was issued on May 12, 2010. CMBs are also used under the Market Stabilization Scheme as a tool for liquidity management.

Commercial Paper in India

The introduction of commercial paper in India was recommended by the Working Group on the Money Market in 1987, and the Reserve Bank formally permitted their issuance in January 1990. Although they became widespread in India only at that time, commercial papers have existed in the United States since the nineteenth century and gained global prominence in money markets from the 1980s onward.

A commercial paper is an unsecured, short‑term promissory note that is negotiable and transferable by endorsement and delivery, with a fixed maturity. Typically issued at a discount by creditworthy, highly rated borrowers, it is used primarily to meet short‑term working capital needs. Depending on the issuer, the instrument is also called a finance paper, industrial paper, or corporate paper.

The issuer base has been broadened over time. Initially only top‑rated corporates could issue commercial papers; later regulations extended issuance rights to primary dealers and all‑India financial institutions, and at subsequent dates primary and satellite dealers were permitted to issue CPs to expand market activity. Corporates, primary dealers, financial institutions and similar entities may issue CPs, while non‑resident Indians may be issued CPs only on a non‑transferable and non‑repatriable basis. Banks are not allowed to underwrite or co‑accept CP issues. Foreign institutional investors may invest in commercial papers subject to the limits set by SEBI.

Commercial papers are usually privately placed with investors through merchant bankers or banks. Issuers must obtain a specified credit rating (for example, a P2 rating from CRISIL or an equivalent) before placement. A CP may be issued as a physical unsecured promissory note or in dematerialized form, and is sold at a market‑determined discount. Pricing typically lies between the lending rates of scheduled commercial banks and representative money‑market rates.

Regulatory provisions set practical limits and procedural requirements. Corporates may issue CPs up to 100 per cent of their fund‑based working capital limits. The instrument attracts stamp duty, but no prior approval from the Reserve Bank is required and underwriting is not mandatory.

The composition of the CP market has shifted over time. In the early 2000s most CPs were issued by manufacturing companies, generally for maturities of around three months or less. In 2001–02 manufacturing and related companies issued about 67.4 per cent of CPs, leasing and finance companies 21.5 per cent, and financial institutions the remainder. Over the next several years the manufacturing share declined—averaging about 56 per cent in 2002–03 and falling to around 28.9 per cent by 2008–09—while the share of leasing and finance companies rose markedly (peaking near 76.5 per cent in March 2008 and remaining significant thereafter). The reduced share of manufacturing firms reflects improved operational efficiency, longer internal accrual cycles and better cash management. Nonetheless, leasing and finance companies together with manufacturing firms continue to be the principal issuers.

The CP market tends to be concentrated among larger corporates, especially those with tangible net worth of Rs. 250 crore and above. In 2004 the Reserve Bank’s guidelines on bank investment in non‑SLR securities exempted commercial papers from certain restrictions, enabling financial institutions to increase CP borrowings from 2004 onward.

Commercial Paper Issuance and Market Dynamics

A company wishing to issue a commercial paper must first obtain a board resolution approving the issue and authorizing specific executives to execute the necessary documents in accordance with the Reserve Bank’s norms. The issue must be rated by a credit rating agency, a process that ordinarily takes two to three weeks after the agency receives the required information. The issuer must also appoint an Issuing and Paying Agent (IPA), which has to be a scheduled bank. The IPA verifies all submitted documents—such as the board resolution and the signatures of authorized signatories—and issues a certificate confirming that the documentation is in order. It also ensures that the issuer meets the minimum credit rating prescribed by the Reserve Bank and that the amount raised does not exceed the limits indicated by the credit rating agency for the given rating. The IPA must certify that it has a valid agreement with the issuer and retains certified copies of the verified original documents in its custody.

The company then arranges dealers—merchant bankers, brokers or banks—to place the commercial papers; placement must be completed within two weeks of the issue opening. Every CP issue is reported to the Reserve Bank through the IPA, which serves as the official conduit for regulatory reporting and compliance.

Scheduled commercial banks are the principal investors in commercial papers, and their participation depends largely on liquidity in the banking system. Banks often prefer investing in CPs to advancing term loans because loans carry higher transaction costs and tie up funds for longer periods, whereas CPs are short-term instruments that allow banks to park surplus funds when liquidity is abundant. Some banks finance their CP investments by borrowing in the call money market. Because call money rates are typically lower than commercial paper rates, banks can earn a margin by arbitraging between the two markets. Empirically, CP issuance tends to move inversely with prevailing money market rates: when short-term rates fall and liquidity is ample, CP activity rises, and vice versa.

Commercial Paper: Issuance and Market Structure

Commercial Paper (CP) is an unsecured money‑market instrument issued as a promissory note. Introduced in India in 1990 to give highly rated corporates an additional short‑term funding route, CP issuance was later extended to Primary Dealers (PDs) and all‑India Financial Institutions (FIs). The guidelines below consolidate all amendments to date and set out eligibility, issuance mechanics, investment norms, paperwork, trading and the roles and responsibilities of market participants.

Eligibility to issue CP is open to companies, PDs and FIs. A company may issue CP only if, according to its latest audited balance sheet, its tangible net worth is not less than Rs. 4 crore, it has an approved working capital facility from banks or FIs, and its borrowal account is classified as a standard asset by the financing bank or institution.

CP is intended to be a stand‑alone instrument; banks and FIs are not obliged to provide standby facilities to CP issuers. Where banks or FIs decide—subject to their prudential norms and board approval—to provide credit enhancement such as standby assistance or back‑stop facilities, they may do so. Non‑bank entities may give unconditional and irrevocable guarantees as credit enhancement provided the issuer meets eligibility criteria, the guarantor’s rating is at least one notch higher than the issuer’s as assigned by a SEBI‑registered credit rating agency (CRA), and the offer document discloses the guarantor’s net worth, details of similar guarantees given, the extent of such guarantees and the conditions for invocation.

The aggregate amount of CP outstanding for an issuer must always remain within the lower of (a) the limit approved by its board and (b) the quantum indicated by the CRA for the issuer’s rating. Banks and FIs may set working capital limits taking CP into account. Issues by FIs must also conform to the umbrella limits in the Reserve Bank of India’s resource‑raising norms for FIs. The total amount proposed in an issue should be raised within two weeks of opening for subscription; CPs may be issued on a single date or in tranches provided all tranches share the same maturity date. Every fresh issue or renewal of a CP is treated as a new issue.

Investment in CP is permitted to individuals, banks, corporate bodies and unincorporated bodies registered or incorporated in India, Non‑Resident Indians and Foreign Institutional Investors (FIIs). Financial institutions investing in CP must also comply with conditions set by SEBI and with the provisions of the Foreign Exchange Management Act, 1999 and related foreign exchange regulations.

CPs are issued as promissory notes, either in physical form or in dematerialized form through SEBI‑registered depositories. However, all RBI‑regulated entities must deal in and hold CP only in dematerialized form, and fresh investments by such entities must be dematerialized. The instrument is issued in denominations of Rs. 5 lakh and multiples thereof; the minimum investment by a single investor is Rs. 5 lakh (face value). CPs are issued at a discount to face value. Underwriting or co‑acceptance is not permitted, and options such as calls or puts are disallowed.

Maturities run from a minimum of 7 days up to a maximum of one year from the date of issue, and the maturity date cannot extend beyond the period for which the issuer’s credit rating remains valid. A credit rating of at least A3 from a SEBI‑registered CRA is mandatory; the rating must be current and not overdue for review at the time of issuance.

Procedurally, every issuer must appoint an Issuing and Paying Agent (IPA). The issuer should disclose its latest financial position to potential investors following standard market practice. After a deal is confirmed, the issuer will arrange, through the IPA, for crediting the CP to the investor’s demat account with the depository; the IPA must issue a certificate confirming the validity of its agreement with the issuer and that documents are in order. Investors pay the discounted value of the CP to the issuer’s account through the IPA. On maturity, physical certificate holders must present the instrument for payment through the IPA, while dematerialized holdings are redeemed and paid through the IPA.

Documentation and operational procedures for CPs are standardized in consultation with the Fixed Income Money Market and Derivatives Association of India (FIMMDA) and are to be followed by issuers and IPAs with RBI approval. All over‑the‑counter trades in CP must be reported to the Clearcorp Dealing System (India) Ltd. (CDSIL) within 15 minutes. Settlement of OTC trades takes place through the clearing houses of the National Stock Exchange (NSCCL), Bombay Stock Exchange (ICCL) and MCX‑Stock Exchange (CCL), as per their norms, with settlement cycles of either T+0 or T+1.

Issuers may buy back their CPs through the secondary market at prevailing market prices, subject to a minimum period of seven days from the date of issue and after board approval; the IPA must be informed of any buyback.

Duties and obligations are clearly allocated. Issuers must comply with these guidelines. The IPA must ensure the issuer has the minimum credit rating and that the amount raised is within limits set by the CRA or the issuer’s board; it must certify the issuer agreement, verify and retain certified copies of supporting documents, file issuance details on RBI’s Online Returns Filing System within two days, and promptly report defaults or buybacks to the Reserve Bank. CRAs must follow SEBI’s Code of Conduct for rating agencies, specify the review date when issuing a rating, monitor issuers’ performance at regular intervals and publicize any rating revisions.

The Non‑Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions, 1998 do not apply to the acceptance of deposits by issuance of CP by any NBFC that issues CP in accordance with these guidelines. The cost of raising CP includes interest to investors, IPA fees, stamp duty, rating and arranger fees, depository participant and registrar and transfer agent fees, and depository charges. The development of the CP market over time is summarized in Table 4.1.

Commercial paper (CP) in India is subject to stamp duty under the Indian Stamp Act, with administration resting with the central government. The overall rate structure was significantly reduced with an across-the-board scaling down that took effect on March 1, 2004.

Despite that reduction, stamp duty treatment remains uneven across issuers and tenors. Non-bank entities face rates that are five times higher than those charged to banks, and importantly, stamp duty is levied on each CP issuance for a fixed period of 90 days regardless of the instrument’s actual tenor. This fixed 90-day levy makes very short-dated CP issuances relatively costly, thereby influencing issuer choices on tenor and pricing.

The size of the commercial paper (CP) market is measured by the total outstanding amount of CPs issued by corporates. In the early years the market expanded rapidly: outstanding CPs rose from about ₹577 crore in March 1993 to a peak of ₹23,264 crore in March 1994, while the average discount rate fell from 15.5% to 11% during 1993–94. This buoyant phase was followed by a sharp contraction in 1994–95 and 1995–96, a development attributed to the withdrawal of the stand-by facility for CPs in October 1994, rising interest rates, and a reduction in short-term surplus funds available with banks.

From 1996–97 the market recovered. CPs were often available at rates lower than short-term prime lending rates of commercial banks, and at levels below other high-cost short-term borrowings, making them an attractive source of working capital. Banks also began using the CP market to park surplus credit funds. Since 2000–01 the market has grown at roughly 12–14% annually.

By 31 March 2017 the outstanding amount of CPs stood at ₹3,979.7 billion, with prevailing interest rates ranging roughly from 5.99% to 13.33%. Pricing in the CP market depends on credit ratings, the issuing company’s standing and track record, and market demand–supply conditions. Regular high-rated issuers include BPCL, HPCL, IPCL, IOC, ACC, Telco, L&T, Tata Coffee, Dabur, IL&FS, M&M Finance, GE Capital, EID Parry, Electrosteel Castings and Ashok Leyland.

On the investor side, nationalized banks participate in the primary CP market, typically increasing allocations when overall credit off-take is low. Leasing and finance companies were once predominant issuers, reflecting in part the Reserve Bank’s policy of restricting their access to public deposits. Mutual funds have become major buyers of CPs because SEBI’s ceiling on investment in unlisted paper (10%) does not apply to CPs; as a result a large flow of mutual fund money into CPs helped push yields down to about 6.33% in February 2005.

For corporates, CPs offer quick, direct access to institutional investors and a cheaper alternative to conventional bank credit. The decline in stamp duty on CPs has further enhanced their attractiveness.

Historically, the secondary market for commercial paper (CP) saw limited activity because investors generally preferred to hold these short‑term instruments until maturity rather than trade them. That pattern has been changing as new players enter the market and liquidity has gradually improved.

The emergence of foreign and private sector banks has been a key driver of this development; these institutions have become important intermediaries and market‑makers in CPs. At the same time, mutual funds have become active participants in the secondary market. A practical reason for this shift is a difference in stamp‑duty treatment: mutual funds face a higher stamp duty on issuing CPs (0.5 per cent) compared with banks (0.2 per cent). As a result, mutual funds often acquire CPs in the secondary market—frequently buying paper that banks issued and on which the banks paid the lower stamp duty in the primary market—making mutual funds significant buyers in the evolving secondary market.

Commercial paper, while an effective instrument for raising short‑term finance, remains under‑developed in India for several interrelated reasons. The relatively high minimum investment (Rs. 5 lakh) discourages retail participation, and issues of commercial paper involve administrative hurdles and cumbersome procedural formalities that deter potential issuers and investors alike. Non‑bank institutional investors such as LIC, UTI and GIC have been only marginal participants, partly because of a Reserve Bank directive that confines much of their short‑term money‑market exposure to treasury bills and partly because their portfolios are already skewed toward equities and other long‑term assets.

The secondary market for commercial paper is weak despite initiatives by the Discount and Finance House of India (DFHI), and episodic volatility in the market has further limited corporate interest. Many corporates are reluctant to rely on commercial paper because there is no underwriting facility or formal roll‑over mechanism to guarantee refinancing at maturity. Stamp duty burdens have also made commercial paper less attractive compared with other short‑term credit; although the central government has reduced stamp duty, a persistent disparity remains between the rates paid by banks and those paid by non‑bank investors. Banks effectively pay only about one‑fifth of the stamp duty levied on non‑bank subscribers, a distortion that pushes non‑bank buyers to acquire paper indirectly through banks to save costs. This uneven stamp duty structure also discourages any shortening of the minimum maturity period.

At present the minimum maturity in India is seven days, which constrains flexibility. In several developed markets (for example, the United States and France) commercial paper can be issued overnight because there is no stamp duty and settlement can be completed on a T+0 basis. In India, reducing the minimum maturity would require abolition of stamp duty and the establishment of a full‑fledged real‑time gross settlement (RTGS) mechanism for same‑day settlement. Finally, in recent years many large corporates have found it cheaper to borrow from banks at base rates or to meet needs from internal accruals, reducing their reliance on commercial paper as a funding source.

Commercial Bills: Market and Regulation

Business firms meet their working capital needs from banks primarily through cash credits and overdrafts, and by selling or discounting commercial bills. A commercial bill is a short-term, negotiable and self‑liquidating instrument used when goods are sold on credit: it creates an obligation to pay a specified sum on a particular date, thereby converting a trade receivable into marketable short‑term finance.

Under the Negotiable Instruments Act, 1881, a bill of exchange is a written document containing an unconditional order, signed by the maker, directing payment of a certain amount either to a specified person or to the bearer. In commercial practice, the seller (drawer) draws a bill of exchange on the buyer (drawee) for the value of goods supplied; such instruments are known as trade bills. When a commercial bank accepts and discounts these trade bills, they become commercial bills in the banking system.

Banks discount commercial bills by applying a margin and crediting the net proceeds to the seller, thus providing immediate funds. If banks themselves need liquidity, they can have these bills rediscounted with other financial institutions (historically including entities such as LIC, UTI, GIC, ICICI and IRBI). Typical maturities for commercial bills are short — commonly 30, 60 or 90 days — depending on the credit terms prevalent in the industry.

Commercial bills gained prominence in the Indian money market from the 1970s, when the Reserve Bank of India began rediscounting genuine trade bills at the bank rate or at rates it specified. The growth of the bills market gave banks and financial institutions a convenient avenue to deploy short‑term surplus funds across instruments of varying maturities.

Commercial bills are a primary instrument for financing credit sales. They may be classified by when they fall due: a demand bill is payable immediately on presentation or “at sight,” while a usance bill is payable after a specified period, giving the buyer time to arrange payment.

Another useful distinction is whether documents accompany the bill. A clean bill carries no trade documents and rests solely on the credit of the drawer; a documentary bill is accompanied by documents of title (such as invoices, transport or insurance papers) and these documents are released to the drawee either against acceptance (documents against acceptance, DA) or against payment (documents against payment, DP). In documentary transactions, banks often hold the documents until the bill is paid or accepted.

Bills are also classified by geography. Inland bills arise from transactions made in and payable within India, or are drawn on persons resident in India. Foreign bills involve parties or payments outside India: they may be drawn abroad and payable abroad, or drawn abroad but payable in India, or drawn in India and payable outside India. Closely related are export and import bills: export bills arise from shipments to foreign buyers and are drawn by exporters, whereas import bills originate with foreign suppliers and are drawn on importers in India.

India’s indigenous bill—known as the hundi—has a long tradition as a means of financing trade, remitting funds and raising short-term credit. Historically prevalent among indigenous bankers, the hundi played a central role in the domestic bill market. However, financial-sector reforms and a shrinking supply of private funds have reduced the relative importance of indigenous bankers and the hundi in recent decades.

To modernise bill rediscounting and reduce cumbersome paper movement, the Reserve Bank introduced an innovative instrument called the Derivative Usance Promissory Note (DUPN). Backed by eligible commercial bills up to a usance of 90 days, DUPNs enjoy stamp-duty exemption and are negotiable instruments issued by banks. This arrangement simplified rediscounting, allowed multiple rediscountings in the secondary money market, and made commercial bills more attractive to rediscounting institutions, which may further discount such instruments prior to maturity.

Some entities had been using rediscounting facilities for extremely short tenors—even one day—so the Reserve Bank imposed a minimum rediscounting period of 15 days. The RBI’s eligibility rules require that a bill submitted for rediscounting must arise from a genuine commercial transaction with evidence of sale of goods, and its maturity from the date of rediscounting must not exceed 90 days.

Commercial bills are short-term negotiable instruments that banks discount to provide credit to customers; the borrower repays the credit when the bill matures. If a bank needs immediate funds before maturity, it can rediscount these bills in the money market to raise cash. Because they can be transferred by endorsement and delivery, commercial bills offer a high degree of liquidity and are generally regarded as a secure form of investment. Their negotiability and ready marketability also help improve the quality of bank lending and the efficiency of money management.

Although bill markets are well developed in industrial countries, they remain limited in India. The volume of commercial bills rediscounted by banks with financial institutions is small — under Rs 21,000 crore. Two main factors have constrained development: the dominance of the cash‑credit system of credit delivery, which places the responsibility for cash management with banks rather than encouraging trade finance instruments; and the absence of an active secondary market that would sustain liquidity and wider use of bill finance.

The Reserve Bank established the Discount and Finance House of India (DFHI) in part to foster a vibrant commercial bills market. To support this objective it sanctioned a refinance facility for the DFHI, accepting treasury bills and eligible commercial bills as collateral so that holders of bills could obtain liquidity through rediscounting.

To make rediscounting more market‑oriented, the statutory interest‑rate ceiling of 12.5 per cent on the rediscounting of commercial bills was removed with effect from 1 May 1989, allowing rediscounting rates to be set by market forces and thereby encouraging greater activity and price discovery in the bills market.

Market participation was widened in the mid‑1990s. The Securities and Exchange Board of India (SEBI) permitted 14 mutual funds to act as lenders in the bills rediscounting market in 1995–96; in 1996–97 seven additional mutual funds were admitted and four primary dealers were allowed to participate as both lenders and borrowers. Broadening the investor base helped deepen the market and improve liquidity.

Complementing these measures, the Reserve Bank in October 1997 urged banks to promote a “bills culture” by ensuring that at least 25 per cent of inland credit purchases by borrowers be routed through bills. This directive sought to shift a portion of short‑term finance from informal or direct credit arrangements into negotiable bill instruments, further strengthening the commercial bills ecosystem.

The commercial bills market in India has remained small and thinly traded, a fact reflected in several measures of rediscounting activity. One indicator fell from ₹24,612 crore in 1991–92 to just ₹906 crore by end‑March 2002, underscoring the sharp contraction in traditional rediscounting channels. At the same time, commercial banks’ monthly average rediscounting with non‑bank financial institutions was calculated at ₹71,131 crore during 2001–02, with the Small Industries Development Bank of India (SIDBI) accounting for 63.7 per cent of that flow. Activity fell again in 2002–03, where SIDBI’s share rose to about 75 per cent, and a subsequent increase in SIDBI’s rediscounting helped lift volumes in 2003–04. Overall, however, the market’s depth and breadth have been limited.

Banks show clear preferences within the bills market: they tend to discount inland bills and to purchase bills arising from foreign trade. The share of bill finance in total bank credit rose between 1993–94 and 1995–96, but fell thereafter, reflecting an underdeveloped market structure and limited commercial reliance on bill instruments.

Several factors explain this underdevelopment. Historically, the Reserve Bank’s rediscounting support — which had encouraged the bill of exchange as a cash‑of‑last‑resort acceptance instrument — was progressively withdrawn: facilities were available until 1974, moved to a discretionary basis in the early 1980s, and were stopped in 1981. Although the Reserve Bank later set up the Discount and Finance House of India (DFHI) and extended refinance to it, DFHI’s trading has focused more on other money‑market instruments such as call money and treasury bills, and commercial bill business has consequently dwindled. The small role of foreign trade in national income also constrains the bill market, since trade bills are a major use of this instrument; many export and import bills are drawn in foreign currency, which limits their negotiability. Operational weaknesses have also played a part: a significant proportion of bills presented for discounting are not genuine commercial bills but artefacts created by converting cash‑credit or overdraft exposures. Moreover, cash‑credit and overdraft facilities are often cheaper and simpler to use than the more procedural and time‑consuming processes of discounting and rediscounting.

Misuse of the market in the early 1990s further damaged confidence: banks and finance companies at times refinanced accommodation bills when they could not be refinanced legitimately, channeling funds into undesirable uses and undermining market discipline.

To restore integrity, the Reserve Bank issued revised guidelines on 24 January 2003 governing the purchase, discounting, negotiation and rediscounting of commercial and trade bills. Under these norms, banks may open letters of credit and purchase or discount bills under LCs only for genuine commercial or trade transactions of borrowers who have been granted regular credit facilities; accommodation bills must not be bought or discounted. The practice of drawing bills or LCs marked “without recourse” is to be discouraged because such clauses deny the negotiating bank the right of recourse under the Negotiable Instruments Act. Rediscounting is to be confined to usance bills held by other banks; banks are generally barred from rediscounting bills earlier discounted by non‑bank financial companies, except for bills arising from the sale of light commercial vehicles and two‑ or three‑wheelers. When discounting bills from the services sector, banks must satisfy themselves that actual services have been rendered and must not discount accommodation bills; service sector bills are not eligible for rediscounting. Finally, banks are prohibited from entering into repo transactions using bills that have been discounted or rediscounted as collateral.

Certificates of Deposit in India

Certificates of Deposit (CDs) are unsecured, negotiable, short-term time deposits issued in bearer form by commercial banks and development financial institutions. Introduced in June 1989, their issue was initially restricted to scheduled commercial banks (excluding Regional Rural Banks and Local Area Banks). In 1992 the Reserve Bank permitted other financial institutions to issue CDs as well, subject to an overall umbrella limit set by the RBI.

Functionally, CDs resemble fixed deposits in being time-bound deposits with a specified maturity, but their bearer and negotiable character makes them transferable and tradable in the market—unlike ordinary fixed deposits. They are subject to the statutory reserve requirements applicable to banks, including the Cash Reserve Ratio (CRR) and the Statutory Liquidity Ratio (SLR), and attract stamp duty as negotiable instruments. There is no regulatory ceiling on the aggregate amount a bank may raise through CDs, and they may be issued to a wide range of investors, including individuals, corporates, companies, trusts, funds and associates. Non-resident Indians may subscribe to CDs on a non-repatriable basis.

Banks typically tap the CD market during periods of tight liquidity, offering relatively higher yields; consequently, CDs constitute a high-cost liability compared with ordinary deposits. They are used especially when deposit growth is weak but credit demand is strong, enabling banks to mobilize large sums for short tenors with lower transaction costs than many retail deposit schemes. CDs are generally issued at a discount to face value. Where banks and financial institutions choose to issue floating-rate CDs, the method for computing the floating rate must be objective, transparent and market‑based.

Certificates of deposit (CDs) in India evolved from a tightly regulated instrument to a market-determined short‑term resource for banks and selected financial institutions. In 1989–90 banks could raise CDs only up to 1 per cent of the fortnightly average of their outstanding aggregate deposits, and this ceiling translated into separate bank‑wise limits because those deposits were subject to reserve requirements. Over the early 1990s these limits were progressively relaxed: banks were allowed in April 1993 to issue CDs without any ceiling on the interest rate, and the bank‑wise issuance limits were abolished with effect from 16 October 1993. As regulation eased, CDs increasingly came to be priced by the market and were often used by banks as discretionary relationship instruments for high‑net‑worth clients.

The scope of issuers was also widened. In 1992 six development financial institutions — IDBI, IFCI, ICICI, SIDBI, IRBI and EXIM Bank — were permitted to issue CDs with maturities longer than one year and up to three years, subject to an aggregate issuance cap of Rs 2,500 crore. Later, on 3 May 1997, the RBI replaced earlier instrument‑wise limits for three large financial institutions (IDBI, ICICI and IFCI) with an umbrella limit covering term money borrowings, CDs, term deposits and inter‑corporate deposits; the overall ceiling under this umbrella was set equal to the institution’s net owned funds. Similar umbrella limits were applied to EXIM Bank and SIDBI in June and August 1997 respectively.

Commercial banks normally issue CDs at a discount to face value, while CDs issued by development financial institutions may carry coupons. Discount and coupon rates are determined by market forces and the Reserve Bank publishes these deposit rates periodically (fortnightly and monthly) to promote transparency. To align CDs with other short‑term instruments, the minimum maturity was shortened to 15 days in 2000–01, bringing them on par with commercial paper and term deposits.

Regulatory changes to broaden the CD market continued into the early 2000s: the minimum size of an issue was gradually reduced, and from 30 June 2002 banks and financial institutions were required to issue CDs only in dematerialized form. Issuers are also permitted to offer floating‑rate CDs provided the method for computing the floating rate is objective, transparent and market‑based; the issuer is free to determine the initial discount or coupon, and the floating rate is reset periodically according to a predetermined formula that specifies the spread over a transparent benchmark.

Two important constraints protect market integrity: banks and financial institutions cannot advance loans against CDs, nor may they buy back their own CDs before maturity. These rules, together with the move to dematerialization and market‑based pricing, have helped deepen and formalize the Indian CD market.

Certificates of Deposit: Issuance, Transfer, Settlement

Certificates of Deposit (CDs) are negotiable money‑market instruments issued either in dematerialised form or, where permitted, as a usance promissory note against funds deposited with a bank or an eligible financial institution for a specified period. They provide short‑term funding to issuers while offering investors a negotiable claim on the issuer for the deposit amount plus applicable discount or interest.

Only certain entities may issue CDs: scheduled commercial banks (regional rural banks and local area banks are excluded) and selected All‑India financial institutions that the Reserve Bank of India has authorised to raise short‑term resources within an overall umbrella limit set by the RBI. Banks may decide their issuance volumes to meet funding needs, whereas financial institutions must operate within the umbrella limit prescribed in the RBI’s master circular or directions on resource‑raising norms for FIs, as updated from time to time.

The minimum size of an individual CD subscription is Rs. 1 lakh, and issuances are made in multiples of Rs. 1 lakh thereafter. CDs may be subscribed to by a wide range of investors including individuals, corporations, trusts, funds, banks, primary dealers and associations. Non‑Resident Indians may also subscribe but only on a non‑repatriable basis; this restriction must be clearly stated on the certificate and such CDs cannot be endorsed to another NRI in the secondary market.

Maturity norms differ by issuer type. Banks may issue CDs with maturities of not less than seven days and not exceeding one year from the date of issue. Permitted financial institutions may issue CDs for periods of not less than one year and not exceeding three years. Issuers may price CDs either at a discount to face value or on a coupon (including floating‑rate) basis. Floating‑rate CDs are permitted provided the rate‑setting methodology is objective, transparent and market‑based; the formula and any spread over a transparent benchmark must be pre‑determined and clearly communicated to investors.

Banks are required to maintain the appropriate reserve requirements — namely the Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) — on the issue price of CDs. In physical form, CDs are freely transferable by endorsement and delivery; in dematerialised form they are transferable in accordance with the usual depository procedures. There is no lock‑in period for transfer.

All over‑the‑counter trades in CDs must be reported promptly to the Financial Market Trade Reporting and Confirmation Platform (F‑TRAC) of Clearcorp Dealing System (India) Ltd. (CDSL). The requirement to exchange physical confirmations for trades matched on F‑TRAC may be waived where participants enter into a one‑time bilateral agreement or the multilateral agreement drafted by the Fixed Income Money‑Market and Derivatives Association (FIMMDA), comply with applicable laws such as stamp duty, and maintain sound risk management and regulatory practices. FIMMDA and the Clearing Corporation of India Limited (CCIL) will publish the list of entities that have signed the multilateral agreement.

Settlement of all OTC CD trades must occur under Delivery‑Versus‑Payment (DVP I) through authorised clearing houses — National Securities Clearing Corporation Limited (NSCCL), Indian Clearing Corporation Limited (ICCL), and MCX Stock Exchange Clearing Corporation Limited (CCL). Banks and financial institutions are not permitted to grant loans against CDs, nor may they buy back their own CDs prior to maturity, except where the RBI issues a specific, temporary relaxation by notification.

Issuers are expected to prefer dematerialised issuance; however, under the provisions of the Depositories Act, 1996, investors retain the right to a physical certificate if they insist. In such cases, the issuing bank or FI should inform the Chief General Manager, Financial Markets Regulation Department, Reserve Bank of India, Central Office, Fort, Mumbai, about instances where investors require physical certificates. Issuance of physical CDs attracts stamp duty. There is no grace period for repayment: if a maturity date falls on a holiday, the issuing bank or FI should make payment on the immediately preceding working day, and should therefore set deposit periods to avoid maturity dates that coincide with holidays.

Given that physical CDs are transferable by endorsement, issuers must guard against fraud and tampering by printing certificates on good‑quality security paper, taking appropriate precautions and ensuring signatures by two or more authorised signatories. When presenting physical certificates for payment, the last holder may present them, but to mitigate risks relating to chain‑of‑endorsements the bank should make payment by a crossed cheque and caution market participants accordingly.

Holders of dematerialised CDs should instruct their depository participant to transfer the specific ISIN to the issuer’s “CD Redemption Account” and should notify the issuer by letter or fax enclosing a copy of the delivery instruction and the desired payment location to facilitate prompt settlement. On receipt of the demat credit in the CD Redemption Account, the issuer will effect repayment on the maturity date by banker’s cheque or other high‑value instrument.

If a physical certificate is lost, a duplicate may be issued after compliance with certain safeguards: publication of notice in at least one local newspaper, lapse of a reasonable period (typically around 15 days) from the date of the notice, and execution of an indemnity bond satisfactory to the issuer. The duplicate certificate is issued in physical form without fresh stamping — it must be clearly marked as a duplicate and state the original value date, due date, and the date on which the duplicate was issued.

Certificates of Deposit Market Dynamics

Certificates of Deposit (CDs) are negotiable instruments and, in principle, can be bought and sold in the secondary money market. In practice, however, this market has largely remained dormant because investors often find it more profitable to hold high‑yielding CDs until they mature rather than sell them. To improve flexibility and deepen trading, the time restriction on the transferability of CDs issued by both banks and financial institutions was removed with effect from October 10, 2000. Despite this change and the provision of two‑way quotes by the Discount and Finance House of India (DFHI), actual trading volumes have stayed very low. CDs are also eligible for trading on the NSE’s Wholesale Debt Market (WDM) segment, but their share in total trading activity there is negligible.

The size of the certificates of deposit (CD) market is measured by the total outstanding amount issued by commercial banks and financial institutions. This outstanding stood as the key indicator of how large and active the primary market for CDs was.

Banks’ mobilization through CDs rose steadily up to 1997–98, reflecting rapid growth in primary issuance. In particular, between 1994–95 and 1997–98, tight conditions in the money market and relatively firm call money rates rekindled banks’ interest in CDs as a source of short‑term funding. From 1998–99, however, banks’ reliance on these relatively high‑cost instruments fell. A downward trend in yields on alternative money‑market instruments, strong growth in retail deposits and a slowdown in non‑food bank credit reduced the need for CDs. At the same time, deregulation of term deposit interest rates and a shortening of minimum maturities to 15 days helped banks manage liabilities more flexibly, further lowering issuance pressure.

Policy changes in 2003–04 reversed this decline and produced a sharp surge in CD issues. A reduction in stamp duty on CDs, the withdrawal of the facility of premature closure of deposits in respect of CDs, and an exemption for bank investments in CDs from the rules on non‑SLR investments of under one year together increased the attractiveness of CDs. These measures, in turn, stimulated demand from mutual funds and other investors.

From 2004–05 onwards, demand was bolstered further by private sector banks, which found CDs cost‑competitive relative to fixed deposits. Compared with fixed deposits, CDs generally do not permit premature closure and are not subject to tax deducted at source (TDS), making them appealing to certain investors. The reduction of the minimum maturity period from 15 days to 7 days also broadened their appeal to both private banks and mutual funds. By end‑March 2008, outstanding CDs accounted for 4.8 per cent of the issuing banks’ aggregate deposits.

Interest conditions on CDs moved with money‑market liquidity. The weighted average discount rate on CDs was 8.94 per cent at end‑March 2008, rose slightly to 9.31 per cent at end‑March 2009, and increased to 11.13 per cent in 2011–12. The spike in 2011–12 reflected tight liquidity in the money market and a reluctance among mutual funds to roll over CDs after asset management companies were made accountable for fair valuation on a mark‑to‑market basis.

Certificates of Deposit (CDs) issued by commercial banks account for only about 2 per cent of aggregate deposits, so there is considerable room for growth. Several interrelated factors, however, have constrained their expansion.

The secondary market for CDs remains underdeveloped. Participation is limited, many CDs are not listed, and trading activity is low. Paradoxically, the relatively high interest rates offered on these instruments encourage investors to hold them to maturity rather than trade them, which in turn depresses liquidity and deters the development of an active secondary market.

Product design and institutional constraints also play a role. The reliance of financial institutions on CDs has fallen, partly because maturities are not optimally structured; a rationalization of tenor could make CDs more attractive as a funding tool. Banks also do not generally provide loans against CDs, nor do they buy them back before maturity, which reduces their usefulness as short-term collateral and limits flexibility for investors.

Other market frictions further restrict demand. The minimum investment size remains high, narrowing the investor base and excluding smaller investors. Stamp duty charges increase the cost of issuance and deter both banks and buyers. Finally, most CDs carry a fixed discount rate; introducing floating‑rate CDs could broaden appeal by making returns more responsive to market interest-rate movements.

Commercial banks play two complementary roles in the short-term debt market: they are the major investors in commercial papers and they also raise short-term funds by issuing certificates of deposit. Interest rates on both instruments move with the banks’ liquidity—tighter liquidity generally pushes rates up, while easier liquidity brings them down.

The outstanding volumes of certificates of deposit (CDs) and commercial papers (CPs) have tended to move in opposite directions. For example, when liquidity tightened in 1995–96 and demand for bank credit rose, CDs surged to a peak of Rs 216,316 crore while CP issues fell to only Rs 276 crore. From 1999 onwards, as credit demand slackened and liquidity eased, the outstanding amount of CDs declined. By contrast, easing liquidity and the enlargement of limits supported a pickup in CP issuance from around 1997.

Historically, minimum rates on CDs were lower than those on CPs, and the CD market was larger than the CP market up to 1998. With falling interest rates and weak credit off-take after 1999, the CP market began to grow. The CD market then expanded sharply in the mid-2000s—trebling in some years—driven by high credit off-take and tight liquidity conditions.

Call Money Market Operations

The call money market is the most visible segment of the Indian money market, where day‑to‑day surplus funds—primarily those of banks—are traded. It contributes a large share of the market’s overall turnover and has been a central component of India’s money market since its inception in 1955–56, registering substantial growth in activity over the decades.

This market deals in very short‑term funds that are repayable on demand, with maturities ranging from one day up to a fortnight. Funds lent or borrowed for a single business day are termed call (overnight) money, while transactions for more than one day and up to fourteen days are referred to as notice money. Non‑business days such as intervening holidays and Sundays are excluded when calculating these maturities. These trades are unsecured—no collateral is required—which makes the market highly liquid (only cash is more liquid) but also relatively risky and subject to sharp volatility because of the short maturities and uncollateralised nature of the transactions.

Banks routinely need very short-term funds to manage day-to-day cash flows, most importantly to meet the minimum cash balances mandated by the central bank. To bridge temporary shortfalls without posting collateral, commercial banks borrow from other banks in the unsecured interbank market. This routine, short-dated borrowing is the origin of the call money market.

The cash reserve requirement (CRR) is the portion of a bank’s deposits that must be held as cash with the central bank and is a primary instrument of monetary policy. The Reserve Bank of India stipulates the CRR and adjusts it to influence macroeconomic objectives such as inflation, growth and exchange-rate stability. CRR is expressed as a percentage of a bank’s total demand and time liabilities (DTL). Historically the CRR has been reduced over time—for example, from 15 per cent in March 1991 to 5 per cent in January 2009.

Banks’ liabilities used to compute reserve requirements are measured as net demand and time liabilities (NDTL), which captures a bank’s claimed obligations to both the banking system and the public. Until May 2000, banks were required to maintain 85 per cent of their fortnightly reserve requirement on a daily basis. At that time, branch networking and day‑to‑day reporting were not sufficiently advanced to allow head offices to consolidate positions quickly, making daily maintenance burdensome.

To give banks greater flexibility in managing intra‑fortnight cash flows, the Reserve Bank introduced a lagged reserve maintenance system in November 1999, allowing banks to maintain reserves based on the last Friday of the second preceding fortnight. Subsequent relaxations followed: from May 6, 2000, the daily minimum requirement for the first 13 days of the fortnight was reduced from 85 per cent to 65 per cent; from August 11, 2000, the requirement for the first seven days was lowered further to 50 per cent while the remaining seven days, including the reporting Friday, remained at 65 per cent. These adjustments were intended to smooth liquidity across surplus and deficit segments and to prevent sudden spikes in overnight call rates.

Every reporting Friday, therefore, banks must satisfy their reserve obligations, which often requires short-term borrowing in the call/notice money market. This market is essentially over‑the‑counter, dominated by interbank trades (accounting for more than 80 per cent of transactions), and serves as the principal mechanism for banks to balance their cash positions within the fortnightly maintenance cycle.

The call money market was, for most of its early history, predominantly an inter-bank market. This began to change in 1971 when institutions such as the erstwhile UTI and LIC were permitted to operate as lenders. Until March 1978, brokers also took part by matching lenders and borrowers in return for brokerage fees. During the 1990s participation was progressively widened to include a range of financial institutions—DFHI, STCI, GIC, NABARD, IDBI, money market mutual funds, corporates and private-sector mutual funds—primarily as lenders.

A core set of participants routinely played both lending and borrowing roles: scheduled and non-scheduled commercial banks, foreign banks, and cooperative banks at the state, district and urban levels, together with DFHI. Other borrowers in the market included brokers and dealers active in the securities, bullion and bills markets, and occasionally high‑net‑worth individuals.

In 1996–97 the Reserve Bank permitted primary dealers to participate as both borrowers and lenders, and entities with demonstrable surplus funds were allowed to channel their lending through primary dealers. The minimum size for routed transactions was reduced from Rs 20 crore to Rs 3 crore with effect from May 9, 1998. Finally, with effect from August 6, 2005, the call money market was reconstituted as a pure inter‑bank money market.

By conducting repo auctions, the Reserve Bank intervenes indirectly in the call money market. Repo auctions temporarily inject funds into the banking system, increasing liquidity and exerting downward pressure on call rates, while reverse repo auctions absorb surplus liquidity and tend to push rates up. These operations therefore help align short-term market rates with the Reserve Bank’s monetary policy stance.

Such intervention is necessary because the call money market is closely linked with other segments of the domestic money market and with the foreign exchange market. Disruptions or sharp movements in the call market can quickly transmit across markets, so Reserve Bank operations stabilise liquidity, smooth policy transmission and reduce systemic risk.

Movements in the call money market influence—and are influenced by—other short-term money market instruments. When call rates rise, banks prefer to raise funds through certificates of deposit (CDs) rather than borrow overnight; conversely, when call rates are low, banks often borrow in the call market to fund commercial paper (CP) issues, exploiting the arbitrage between different money-market segments. In this way, changes in overnight rates help determine the mix and timing of short-term funding instruments.

Large government securities issuances and discretionary policy actions also have a direct impact on overnight liquidity and call rates. Heavy subscription to government paper by banks withdraws funds from the banking system and increases demand in the call market, pushing call rates up. Similarly, monetary operations that absorb liquidity—most notably an increase in the cash reserve ratio (CRR) or a rise in the repo rate—tighten available funds and put upward pressure on call rates.

The call money market is closely linked with the foreign exchange market through cross-market arbitrage. When domestic call rates climb, banks may borrow dollars from overseas branches, convert them into rupees and lend those rupees in the call market; to cover the foreign-currency repayment, they simultaneously buy dollars forward, which tends to raise the forward premia on the rupee–dollar pair. Conversely, when banks meet foreign-currency funding needs by withdrawing rupee funds from the call market, that withdrawal reduces rupee liquidity and can further elevate call rates.

The interest charged on very short-term, often overnight, interbank loans is known as the call rate. Because these loans are used to meet immediate liquidity needs, the call rate is highly volatile—it can change from day to day, hour to hour, and sometimes minute to minute—and reacts quickly to even small shifts in the demand for and supply of funds. Extreme swings have occurred: within a single fortnight, rates have moved from around 1–2% to well over 140% per annum.

Until 1973 the call rate was left to market forces. In December of that year, however, a tightening of credit policy—marked by an increase in the bank rate and the withdrawal of refinance and rediscount facilities—pushed the call rate up to about 30%, causing liquidity stress and bank defaults. In response, the Indian Banks’ Association began to curb volatility by informally imposing ceilings on the rate.

These administrative controls were removed with effect from May 1, 1989, and since then the call rate has again been determined freely by demand and supply in the call money market. More recently, electronic platforms such as the NSE and information services like Reuters have helped establish a reference rate that market participants use as a benchmark.

The National Stock Exchange introduced the Mumbai Inter-bank Bid Rate (MIBID) and the Mumbai Inter-bank Offer Rate (MIBOR) on June 15, 1998 to provide transparent reference rates for the overnight money market. These rates are compiled from quotes submitted by a representative panel of 31 banks, institutions and primary dealers. Quotations are pooled and processed daily by the exchange—at 09:40 IST for the overnight rate and at 11:30 IST for the 14‑day, 1‑month and 24‑month rates—and then adjusted using the boost trap method, a statistical trimming technique, to produce an efficient estimate of the reference rate. The resulting benchmark is widely used to price floating‑rate debentures and term deposits and serves as the market rate at which short‑term funds are raised; it also underpins hedging strategies and pricing in forwards and swaps.

A separate Reuters series, often called Reuters MIBOR (Mumbai Inter‑bank Overnight Average), is calculated as a weighted average of call‑money transactions among about 22 banks and other market participants. Whether compiled by the NSE or provided by Reuters, MIBOR functions as an official benchmark for interest rate swaps (IRS) and forward rate agreements (FRAs), valued for being market‑determined, transparent and broadly acceptable to counterparties.

In India the money and credit situation follows a predictable seasonal pattern each year. Activity in the call money market—measured by the number and value of transactions and by the level of call rates—reflects these fluctuations. Demand for call and notice money falls more sharply during the slack season (mid‑April to mid‑October) than it does in the buy season (mid‑October to mid‑April), producing characteristic swings in both volumes and rates.

Determinants of Call Money Rates

Liquidity in the economy reflects the balance between the supply of money available to banks and other financial institutions and the demand for that money. On the supply side this is influenced by how well deposits are mobilized, capital flows from abroad, and the reserve requirements that banks must hold (for example, the cash reserve and statutory liquidity ratios). On the demand side it is shaped by factors such as tax outflows, the government’s borrowing programme, the pace of non-food credit off-take by the economy, and predictable seasonal swings in spending and receipts.

These supply and demand forces determine whether liquidity is “easy” or “tight,” and that condition shows up in the interbank call market. When liquidity is easy, the overnight call rate typically trades close to the Reserve Bank’s repo rate; when liquidity is tight, the call rate tends to rise toward the higher bank rate. In other words, movements in short‑term interbank rates provide a real‑time signal of the underlying liquidity stance.

Changes in the Cash Reserve Ratio (CRR) have a direct and predictable impact on interbank liquidity: a reduction in the CRR injects funds into the banking system and tends to lower overnight call rates, while an increase withdraws liquidity and pushes call rates up. In practice, however, banks often meet reserve requirements reactively rather than through forward planning, so their short-term demand for funds fluctuates sharply and contributes to volatility in the call market.

Until April 1997, the central bank’s method of calculating reserves included inter‑bank transactions. This produced a pronounced distortion every reserve calculation day — which fell on every second Friday — as banks tried to pare down their reserve liabilities by cancelling inter‑bank borrowings. The resulting collapse in overnight call rates to nearly zero on those days effectively brought money‑market activity to a standstill and prevented the emergence of a liquid yield curve beyond about 13 days.

Structural factors are the underlying institutional and regulatory conditions that shape the market for short-term funds. They include government legislation and the broader regulatory framework, as well as the state of the stock markets and other market infrastructure. These factors influence the supply and demand for overnight and very short-term credit—so changes in laws, prudential norms or market functioning can alter liquidity or market confidence, while volatile equity markets often raise demand for margin finance and short-term liquidity. Together, such structural elements determine how much the short-term or call money rate will move and how volatile it will be.

Call-money rates tend to rise when the foreign exchange market becomes volatile. Two forces drive this rise. First, monetary authorities may take measures to tighten liquidity, reducing the amount of short-term funds available in the banking system. Second, market participants often take short positions in the domestic currency and long positions in the US dollar when they expect the rupee to depreciate; to carry those foreign‑currency positions, banks need additional funding.

Banks meet this funding need by withdrawing short-term funds from the inter‑bank call money market—the market where banks lend to and borrow from each other overnight. When many banks draw down these inter‑bank resources simultaneously, liquidity in the call market shrinks and the price of overnight funds—the call money rate—goes up. The combined effect of policy tightening and a shift of funds toward foreign‑exchange positions therefore pushes call money rates higher during periods of forex volatility.

Stabilising the Call Money Market

The Reserve Bank of India has used a mix of liquidity operations and regulatory changes to reduce volatility in the call money market. At the heart of this effort have been repo and reverse repo operations, refinancing facilities and periodic adjustments in reserve requirements. Repo auctions were resumed in November 1996 to provide a reasonable floor to call rates and a short-term avenue for banks to park surplus funds, while reverse repos have been used to inject liquidity when the market tightened. To make these interventions more systematic, the Reserve Bank introduced the Liquidity Adjustment Facility (LAF) on June 5, 2000; through its repo and reverse‑repo windows the LAF enables daily modulation of short‑term liquidity and helps stabilise market conditions.

In April 1997 the Reserve Bank also freed inter‑bank liabilities from reserve requirements, a move intended to smooth the yield curve and reduce the cyclical pattern in call rates that produced predictable troughs on reporting Fridays. This change, together with the LAF and other market operations, helped to contain erratic movements in overnight rates over the late 1990s, although episodes of volatility still occurred.

The sharp rise in call and notice money rates in 1995–96 reflected a set of structural and policy pressures. Banks faced a mismatch between assets and liabilities as rapid non‑food credit growth outpaced sluggish deposit mobilisation. At the same time the Reserve Bank intervened in the foreign exchange market to prevent rupee depreciation, and temporarily withdrew some money‑market support to concentrate resources on stabilising the external sector. These actions together tightened liquidity in the short end of the market.

Once the LAF was operational, the call rate generally moved within the repo–reverse‑repo corridor, with the repo rate effectively setting a market floor. The Reserve Bank also complemented these operations with conventional easing—cuts in the bank rate and in the Cash Reserve Ratio (CRR)—when conditions permitted, helping to keep volatility within a narrower band.

The size of the call money market has changed markedly over time. Annual and average daily turnovers rose sharply at various points: for example, average daily turnover jumped to ₹747,543 crore in April 2002 from ₹239,808 crore in March 2002, before moderating to ₹322,852 crore by January 2005. Primary dealers, whose funding needs are linked to the government’s market borrowing programme, became the largest class of borrowers in 2003–04. The overall expansion in turnover reflected greater market breadth and depth after the 1990s reforms and increased activity by primary dealers, supported by Reserve Bank refinance facilities and repo operations that improved liquidity and provided a floor for rates.

Despite periods of stability—call rates remained generally subdued in 2003–04 and traded below the reverse‑repo rate—pressure reappeared at times. In October–November 2004 higher non‑food credit off‑take, increases in reserve requirements and seasonal festival cash demands pushed banks toward greater borrowings, prompting a rise in call rates. The Reserve Bank responded by injecting liquidity through LAF repo operations. Similar upward pressure on call rates recurred in 2005–06, 2008–09 and 2011–12 when tighter liquidity conditions and changes in the fixed reverse‑repo rate strained the market.

Over the later period the structure of the overnight market shifted substantially. Average daily turnovers showed wide swings, and a large part of overnight activity migrated to the Collateralized Borrowing and Lending Obligation (CBLO) segment because CBLO rates were typically lower than unsecured call rates. Non‑bank entities were phased out of the call market effective 6 August 2005, and more than 70 per cent of overnight activity moved into CBLO at one stage. Consequently, the share of the call money market in total overnight transactions fell from about 51 per cent in April 2005 to roughly 20 per cent by March 2009, although in 2011–12 the call segment’s share rose again as CBLO activity declined.

Call and Notice Money Market Operations

Call and notice money form an important segment of the Indian money market, dealing in very short‑term funds that are close substitutes for cash. Instruments in this market are valued for their liquidity: they can be converted into cash quickly and at low cost, enabling the efficient matching of temporary surplus funds of lenders with short‑term funding needs of borrowers. In the call market, funds are typically transacted overnight, while the notice market covers tenors from two days up to fourteen days.

Participants in this market are limited to scheduled commercial banks (excluding regional rural banks), cooperative banks (other than land development banks) and Primary Dealers (PDs). These entities may act both as lenders and borrowers; non‑bank institutions other than PDs are not permitted to participate.

Prudential limits regulate both outstanding borrowings and lendings. For scheduled commercial banks, on a daily average basis over a reporting fortnight, borrowing should not exceed 100% of capital funds (the sum of Tier I and Tier II capital) as per the latest audited balance sheet, although banks may borrow up to 125% of capital funds on any single day within the fortnight. Lending by scheduled banks, measured as a daily average in a reporting fortnight, should not exceed 25% of capital funds; however, banks are permitted to lend as much as 50% of capital funds on any individual day during the fortnight. State cooperative banks, district central cooperative banks and urban cooperative banks must ensure that their outstanding borrowings in call/notice money on any day do not exceed 2.0% of aggregate deposits as at end‑March of the previous financial year; there is no specified limit on their lending. Primary Dealers may borrow, on a daily average basis in a reporting fortnight, up to 225% of their Net Owned Funds (NOF) as at end‑March of the previous financial year, and may lend up to 25% of their NOF on a daily average basis in a reporting fortnight.

Institutions may, with board approval, set prudential limits that differ from the standard ceilings described above, provided those limits follow the broad guidelines. Such board‑approved limits should be communicated to the Clearing Corporation of India Ltd. (CCIL) for implementation in the NDS‑Call system, with an advice copy to the Financial Markets Regulation Department of the Reserve Bank of India.

Market participants are free to determine interest rates in call and notice transactions. The calculation of interest payable on these deals follows the methodology laid down in the Handbook of Market Practices published by the Fixed Income, Money Market and Derivatives Association of India (FIMMDA).

Dealing in the call/notice/term money market normally takes place between 9:00 a.m. and 5:00 p.m. on each business day, or as otherwise specified by the Reserve Bank of India. Participants may adopt the standard documentation recommended by FIMMDA. Transactions can be executed either on the screen‑based, negotiated, quote‑driven electronic platform known as NDS‑Call (managed by CCIL) or over the counter through bilateral communication.

Reporting requirements seek to ensure transparency and timely record‑keeping. Deals executed on NDS‑Call do not require separate reporting. All OTC call/notice/term money deals, however, must be reported on the NDS‑Call reporting platform by members; such deals should be reported within 15 minutes of execution, irrespective of deal size or whether the counterparty is an NDS‑Call member. Parties that are not NDS‑Call members are advised to report OTC transactions to the Financial Markets Regulation Department, Reserve Bank of India, in the prescribed format. The reporting cut‑off for OTC call/notice/term money deals on NDS‑Call is normally 5:00 p.m. on each business day or as notified by the RBI. Any instance of misreporting or repeated erroneous reporting should be promptly brought to the attention of the Financial Markets Regulation Department, Reserve Bank of India, Central Office, Fort, Mumbai.

Challenges in India's Term Money Market

The term money market is the segment of the money market that deals with maturities beyond the overnight tenor, typically from about three months up to one year, and commonly used for three- to six-month placements. In India this segment has remained underdeveloped. Turnover was mostly below Rs 200 crore in 2001–02, although activity picked up thereafter: average daily turnover increased to about Rs 7,526 crore in 2004–05 from Rs 3,341 crore in 2003–04. Despite this rise, volumes are still small, there is little participation from large players and a reliable term money yield curve has yet to form.

Several structural and behavioural factors constrain growth. Banks are generally reluctant to take a view on term rates and prefer to operate in the overnight market where they are comfortable. Many foreign and private banks run short of short-term resources and therefore rely heavily on the call/notice market. Public sector banks, though often in surplus, frequently exhaust their exposure limits to other banks, limiting their ability to extend term funds. At the same time, many corporates prefer cash credit facilities rather than term loans, which keeps banks’ deployment focused on meeting short-term liquidity needs through call/notice transactions rather than committing funds to longer tenors.

Regulatory steps have sought to encourage development. The Reserve Bank of India permitted select financial institutions — including IDBI, ICICI, IFCI, TBI, SIDBI, EXIM Bank, NABARD, IDFC and NHB — to borrow in the term market for three- to six-month maturities. In April 1997, banks were exempted from maintaining Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) on inter‑bank liabilities to facilitate term market activity. Nevertheless, market participants have remained cautious because the market is shallow and counterparties are limited.

The conversion of the call/notice market into a pure inter‑bank market has also shifted behaviour. Non‑bank entities that were phased out of the call market have looked to the term market instead, and banks have had to reduce some of their overnight exposures; these surplus funds could, with greater willingness and sufficient liquidity, be channelled into term deals and help deepen the market. To improve transparency and monitoring, from April 30, 2005 all members of the Negotiated Dealing System (NDS) have been required to report their term money transactions on the NDS platform.

CBLO Market Structure and Operations

The Clearing Corporation of India Limited (CCIL) introduced the product Collateralized Borrowing and Lending Obligation (CBLO) on January 20, 2003 to provide an organised source of short‑term liquidity to entities that had been restricted from the call money market. CBLOs are discounted, book‑entry obligations in which the borrower undertakes to return funds on a specified future date and the lender has the right to receive repayment on that date; this right can be transferred for value. Initially quoted for maturities of 1 to 19 days, CBLO maturities may extend up to one year as permitted by the Reserve Bank of India. Eligible collateral comprises central government securities, including treasury bills, with a residual maturity exceeding six months. There are no prescribed minimum denominations or lock‑in restrictions for secondary market transfers.

Participation in the CBLO market is organised around membership. Banks, cooperative banks, financial institutions, insurance companies, mutual funds and primary dealers that are members of the Negotiated Dealing System (NDS) may transact directly. Other entities — corporates, NBFCs, pension and provident funds, trusts — can participate by taking associate membership in the CBLO segment; these associate members are typically not eligible to maintain current accounts or SGL accounts with the Reserve Bank. Full members normally access the CBLO dealing system via INFINET, while associate members use the Internet. The automated, order‑driven, anonymous matching platform provided by CCIL’s Clear Corp Dealing System (CCDS) matches buy and sell orders, disseminates information on concluded deals, volumes and rates, and issues market notifications. Associate members are also required to open a current account with a settlement bank designated by CCIL to effect funds settlement.

Trading in CBLOs takes place in two distinct markets: a continuous normal market and an auction market. The normal market operates continuously with orders matched online on the basis of yield and time priority; it is available to all members, including associates, and supports two settlement cycles, T+0 and T+1. Members may borrow up to their sanctioned limits or meet funding needs by selling CBLOs they hold instead of carrying them to maturity. Participants enter buy (lend) and sell (borrow) orders through the system’s order entry screen, and trades are executed on Best Yield‑Time Priority. The auction market, by contrast, is available only to NDS members for overnight borrowing with T+0 settlement. In the auction, members submit borrow requests (indicating amount, maturity and cap rate) before the session (typically 10:30 a.m. to 11:00 a.m.), and lenders bid during the auction window. Associate members are excluded from the auction market. Minimum order sizes differ across markets: the normal market has a minimum lot of 25 lakh and multiples of 25 lakh, while the auction market currently has a minimum lot of 750 lakh and multiples of 75 lakh; an order lot denotes the minimum amount required for a successful trade.

Because CCIL guarantees repayment of borrowings under the CBLO segment, all participants must maintain collateral or cash margin with CCIL. CCIL prescribes borrowing limits against deposited government securities, which must be physically delivered and are subject to daily revaluation and haircuts. These haircuts protect CCIL from potential losses arising from declines in the market value of collateral. Any shortfall between collateral value and outstanding borrowings is met through an end‑of‑day margin call.

CBLO interest rates generally mirror overnight call money rates, but borrowing through CBLO has typically been cheaper than the call market. Large suppliers of funds in the CBLO market have been mutual funds and insurance companies, which often have surplus liquidity, while cooperative banks, public and private sector banks and primary dealers have been major borrowers attracted by the lower cost of funds.

Turnover in the CBLO market expanded significantly as rates fell. Market participants, including foreign exchange dealers, sometimes exploited the rate differential by borrowing rupees in the CBLO market to buy dollars and simultaneously agreeing to sell them a day later, investing the proceeds in higher‑yielding overnight dollar deposits abroad. Average daily turnover rose from ₹22,506 crore in March 2004 to a peak of ₹1,09,125 crore in March 2009. A key driver of this volume growth was the Reserve Bank’s progressive exclusion of non‑bank entities from the call money market, completed for most non‑banks (except primary dealers) from August 6, 2005. As a result, CBLO emerged as the preferred overnight market in 2005–06 because it offers anonymity, real‑time transparency and lower funding costs. In 2007–08 the average CBLO rate was 5.20 per cent compared with 6.07 per cent in the call market and 5.5 per cent in market repos (outside the LAF), and CBLO accounted for nearly 80 per cent of total money‑market volume that year. Volumes later declined in 2011–12 after the RBI introduced a new operating procedure for its policy instruments and the call rate stabilised.

To further deepen and widen participation, CCIL has planned an Internet‑based trading platform for CBLO that would enable corporates and other non‑banking entities to access the institutional lending and borrowing segment of the money market.

Money Market and Monetary Policy

Monetary policy comprises the objectives, tools and actions aimed at regulating the supply of money and the cost and availability of credit in the economy. It sits as a component of broader economic policy and shares the same principal goals: sustained growth, price stability, and social justice, with the emphasis between growth and price stability shifting over time according to prevailing conditions. In India these goals are pursued by the monetary authority—the Reserve Bank of India (RBI)—which seeks to ensure adequate credit availability, maintain the external value of the rupee and preserve overall financial stability. Monetary impulses reach the real economy through changes in financial prices (interest and exchange rates, yields and asset prices) and financial quantities (money and credit aggregates, issuance of government and foreign‑currency bonds); internationally the interest‑rate channel is the dominant route of transmission. The money market plays a central role in this process, because it is the principal market through which policy actions influence real activity.

The RBI manages monetary conditions primarily by controlling liquidity, using a mix of direct and indirect instruments. Under an administered or controlled financial regime, the central bank uses direct measures—varying reserve requirements, limits on refinance, administered interest rates and qualitative or quantitative credit restrictions—to influence the cost, availability and allocation of funds. Such instruments alter liquidity and credit flows by command rather than by market signals.

Since the economic reforms of 1991, interest rates in India have largely become market‑determined, and the RBI’s emphasis has shifted towards market‑based, indirect tools. These include open market operations (outright purchase or sale of government securities), repo operations (short‑term liquidity provided to banks against collateral with a reverse transaction at a predetermined date), standing facilities and market‑based discount windows. Repos are useful for short‑term liquidity injection; open market operations are the preferred tool when the central bank intends to change liquidity on a more enduring basis. Standing facilities and discount windows are made available at the discretion of eligible market participants, providing limited or contingent access to reserves either through direct lending, rediscounting or purchase of assets.

The effectiveness of these indirect instruments depends critically on the existence of a vibrant, liquid and well‑integrated money market linked to the government securities and foreign exchange markets. India’s financial sector has been in transition throughout the reform period: markets are increasingly integrated but still lack adequate depth and liquidity, which constrains policy transmission. As a result, the RBI continues to use the cash reserve ratio (CRR) as an operating instrument. The central bank re‑activated the bank rate in 1997 as a reference and signalling device; various RBI accommodation rates, including refinance, are linked to the bank rate, and changes in it have been reflected in commercial banks’ prime lending rates.

To enhance day‑to‑day liquidity management the RBI first created an interim liquidity adjustment facility (ILAF), providing formula‑based support such as collateralized lending, export credit refinance and liquidity to primary dealers, with access linked to the bank rate. The ILAF was subsequently converted into the full‑fledged Liquidity Adjustment Facility (LAF), which evolved into an effective mechanism for injecting or absorbing liquidity on a daily basis in a flexible manner.

With market‑determined interest rates, new transmission channels strengthened and indirect instruments gained prominence. Open market operations and repo operations emerged as routine tools to contract liquidity and to neutralize the expansionary effects of capital inflows. Repo rates not only reflect prevailing liquidity conditions but also act as a floor for overnight money market rates; when markets tighten, RBI support to primary dealers enables direct intervention to moderate pressures in the call money market. The LAF framework has also helped the RBI lower the CRR without jeopardizing systemic liquidity.

To absorb excess liquidity, the RBI introduced fixed‑rate repos and supplemented them with outright operations in government dated securities and treasury bills. Until 2003–04 the LAF and open market operations were used effectively; however, large capital inflows and high systemic liquidity reduced the stock of government securities held by the RBI, shifting more of the sterilization burden onto LAF operations. To address enduring liquidity absorption needs, the RBI operated the Market Stabilisation Scheme (MSS), which provided additional flexibility in market operations.

In practice the RBI uses a combination of instruments—direct and indirect, standing and discretionary—to ensure that liquidity conditions remain appropriate for achieving its broader objectives of price stability, growth and financial stability.

Reserve Requirements and Interest Rate Reforms

Reserve requirements are two primary tools the Reserve Bank uses to manage liquidity in the money market: cash reserve ratio (CRR) and statutory liquidity ratio (SLR). CRR requires banks to hold a specified proportion of their demand and time liabilities as cash with the Reserve Bank; SLR requires banks to hold a mandated share of their liabilities in prescribed liquid assets, principally government securities. Both measures are fiscal buffers and instruments of monetary control: CRR directly drains or injects cash from the banking system, while SLR ensures banks maintain a portfolio of safe, marketable instruments.

The legal basis for these requirements lies in the banking statutes. Under Section 42(1) of the Reserve Bank of India Act, scheduled banks must maintain an average daily balance with the RBI as CRR. The mandatory character of SLR is provided under Section 24(2A) of the Banking Regulation Act, 1949, as amended; SLR serves as a safeguard against sudden runs by ensuring banks hold unencumbered approved securities or other prescribed liquid assets. For non-scheduled banks and non-scheduled cooperative banks, CRR requirements are governed by Sections 18 and 56 of the Banking Regulation Act respectively; these institutions must maintain CRR equivalent to 3 per cent of their NDTL as on a specified date.

Historically, CRR and SLR occupied a large share of incremental deposits. During the early 1990s both preempted over 60 per cent of incremental deposits: CRR peaked at 15 per cent in March 1991 before being progressively reduced to 4.75 per cent by October 2002 and 4.5 per cent in April 2003; it was subsequently raised to 7.0 per cent by August 2007. SLR reached a high of 38.5 per cent in April 1992 and was brought down to 25 per cent by October 1997. Even after statutory SLR was cut to 25 per cent, many banks continued to hold government securities in excess of the requirement because yields on these instruments became increasingly market-determined; at end-March 2008, commercial banks’ holdings of SLR securities were about 27.8 per cent of NDTL.

The RBI has used CRR and SLR actively to respond to macro conditions. Between April 2007 and August 2008 the CRR was raised by 3 percentage points to mop up excess liquidity and moderate inflationary pressures. Facing the severe liquidity squeeze triggered by the global sub-prime crisis, the RBI cut CRR by 250 basis points on October 11, 2008 — the first reduction since June 2003 — and temporarily permitted banks to borrow against a portion of their SLR holdings, effectively lowering SLR to 24 per cent. Subsequent adjustments include a reduction of CRR to 4 per cent of NDTL on March 19, 2013.

Operational rules around CRR maintenance have also evolved to improve cash management. The daily minimum CRR that banks must hold during a reporting fortnight was reduced from 85 per cent to 70 per cent of the average daily required reserves, allowing smoother liquidity transfers between surplus and deficit banks and reducing sudden spikes in call money rates. Banks report NDTL on alternate Fridays and are given a one-fortnight lag in CRR maintenance to facilitate better cash management; they may keep up to 70 per cent of the required reserves during the fortnight provided they square up to 100 per cent on the reporting Friday. Since October 2001 interest paid on eligible CRR balances has been linked to the bank rate, and certain short-term inter-bank liabilities were exempted from CRR prescription from August 2001.

Legal changes in the mid-2000s broadened the RBI’s flexibility. An amendment to Section 3 of the Reserve Bank of India Act, 1934 notified in 2007 removed the earlier statutory floor (3 per cent) and ceiling (20 per cent) for CRR, giving the RBI discretion to set the CRR percentage without a fixed limit and eliminating the obligation to pay interest on CRR balances. Similarly, the Banking Regulation Amendment Act, 2007 removed the 25 per cent floor for SLR and empowered the RBI to determine eligible SLR assets.

Despite these flexibilities, reducing CRR further faces constraints, chiefly the high fiscal deficit: a large portion of government borrowing cannot be absorbed entirely by the market and therefore requires substantial accommodation by the RBI. CRR remains a blunt instrument — it does not differentiate between banks with surplus cash and those facing shortfalls — but it continues to be an important tool in the RBI’s liquidity management toolkit, used alongside open market operations, policy rates and other instruments.

Interest rates are a key channel through which monetary policy affects the economy. During the 1980s India operated an administered interest rate system whose principal aim was to provide concessional credit to selected priority sectors. To achieve that, banks charged lower rates to those sectors, which in turn required higher lending rates for the non‑concessional commercial sector and artificially low deposit rates. This system produced cross‑subsidization and grew increasingly unwieldy as the list of priority sectors and concessional schemes multiplied.

The Chakravarty Committee (1985) recognised one consequence of that system: real deposit rates had fallen close to zero, a form of financial repression that discouraged saving. It recommended making deposit rates more attractive, and the authorities raised deposit returns accordingly, but the overall interest rate framework remained highly complex. By the late 1980s there were roughly fifty lending categories and a large number of prescribed rates that varied with loan size, purpose and borrower type.

A more fundamental change followed the Narasimham Committee’s recommendations of 1991, which argued that concessional interest rates should not be used as a vehicle for budgetary subvention and that interest rates ought to be market‑determined with positive real returns. Reforms were therefore introduced across the money, credit and government securities markets to move away from administered pricing.

From 1992–93 the government progressively deregulated yields in the government securities market, introducing an auction system, and simplified the structure of bank lending rates. The bank rate was reactivated in April 1997 and, after an initial linking to short‑term deposit rates, has since served mainly as a signaling rate. With interest rates moving to market determination, the government has borrowed at market‑related yields and public sector undertakings and financial institutions have increasingly raised resources from the market rather than relying on budgetary support. As a result, interest rates have become a central instrument for allocating financial resources in the economy.

The Benchmark Prime Lending Rate (BPLR) was introduced in 2003 as the minimum lending rate charged by banks to their best corporate customers, and was intended to serve as a transparent benchmark for pricing loan products by reflecting banks’ actual cost of funds. In practice, however, the system failed to deliver the expected transparency because banks began lending at rates below the BPLR—so-called sub-BPLR rates. The share of sub-BPLR lending (excluding export credit and small loans) by scheduled commercial banks rose to about 77 per cent in September 2008 and remained high, at around 70 per cent by June 2010. This widespread use of sub-BPLR rates made it difficult to judge how effectively Reserve Bank policy rate changes were being passed on to borrowers.

To address these shortcomings, the Reserve Bank set up a Working Group (chair: Deepak Mohanty) in the 2009–10 Annual Policy Statement to review the BPLR framework and recommend reforms. The Group submitted its report in October 2009, and the Reserve Bank issued guidelines in April 2010 to introduce a new Base Rate system, which came into effect on 1 July 2010 and replaced the BPLR regime.

Under the Base Rate framework the effective lending rate charged to a borrower is the Base Rate plus borrower‑specific margins such as risk premia and administrative charges. The Base Rate is the floor for all new rupee loans, and banks are not permitted to lend below it except in specified cases—differential rate of interest (DRI) advances, loans to banks’ own employees, loans to depositors against their own deposits, loans supported by government interest‑rate subvention (for example on some agricultural loans) and rupee export credit, and certain restructured loans. At the same time, interest rates on small loans up to ₹2 lakh and on rupee export credit were deregulated to improve the flow of credit to small borrowers and exporters. Taken together, these measures completed the deregulation of rupee lending rates by commercial banks.

The shift to the Base Rate has improved loan pricing and made lending rates more transparent, thereby enhancing the ability to assess how monetary policy changes are transmitted through the banking system.

MCLR Calculation and Loan Pricing

From April 1, 2016, banks were required to price rupee loans and renewals with reference to the Marginal Cost of Funds‑based Lending Rate (MCLR), which serves as the internal benchmark for loan pricing. The MCLR is built from four elements: the marginal cost of funds, the negative carry on account of the Cash Reserve Ratio (CRR), operating costs, and a tenor premium. Because MCLR is tenor‑linked, the MCLR for a given maturity is calculated by adding the appropriate tenor premium to the sum of the marginal cost of funds, the negative CRR carry and operating costs. Banks must publish MCLR figures for several standard maturities—overnight, one‑month, three‑month, six‑month and one‑year—and may, if they wish, publish rates for longer maturities as well.

The marginal cost of funds itself comprises the marginal cost of borrowings and the return on net worth. Practically, banks compute the marginal cost of borrowings by weighting the cost of different funding sources: the core portions of current and savings deposits identified under asset‑liability management guidelines, term deposits of various maturities, foreign currency deposits (to the extent they are used for rupee lending, with swap and hedge costs included), and short‑ and long‑term borrowings. Short‑term borrowing costs are taken as the average rates at which such funds were raised over the previous month; for long‑term borrowings banks may use either the actual weighted average cost of past long‑term raises or the benchmark yield for bank bonds published by FIMMDA. Foreign currency borrowings used for rupee lending are included at their all‑in cost, including swap and hedge charges. In the marginal cost formula, borrowings carry a weight of 92% and return on net worth carries 8%, yielding: marginal cost of funds = 0.92 × marginal cost of borrowings + 0.08 × return on net worth.

The return on net worth component is based on the amount of Common Equity Tier 1 capital that must be maintained under capital adequacy norms; at the time of the guideline this equated to 8% of risk‑weighted assets. Banks should compute the cost of equity as the minimum desired return on equity, expressed as a margin over a risk‑free rate; established models such as the Capital Asset Pricing Model (CAPM) may be used and the rate should be reviewed annually. For newly established banks whose lending is mainly financed by capital, a higher weight for the net worth component may be allowed in proportion to capital used for lending for a limited period of three years from commencement of operations.

The negative carry on CRR arises because CRR balances earn no interest; it is calculated using the marginal cost of funds arrived at above and the statutory CRR proportion, by the formula: Required CRR × (marginal cost) / (1 − CRR). Operating costs include all costs associated with providing the loan product, including costs of raising funds, but must exclude costs already recovered separately through service charges.

Tenor premium compensates for costs associated with longer‑tenor commitments. It must be uniform across borrowers and loan classes for a given residual tenor — that is, changes in tenor premium cannot be borrower‑specific or loan‑class specific. Because MCLR is tenor‑linked, the tenor premium for each maturity is added to the other components to arrive at the MCLR for that maturity.

Separately from the benchmark, banks must have a Board‑approved policy that defines the components and permissible ranges of the spread charged to customers and delegates pricing authority. Broadly, banks are expected to structure spreads around two principal components: a business‑strategy component that reflects competitive positioning, embedded product options and market liquidity, and a credit‑risk premium derived from appropriate credit scoring or rating models that account for customer relationships, expected losses and collateral. For existing borrowers, spreads should not be increased except where the borrower’s credit risk profile has materially deteriorated; such changes must be supported by a full risk‑profile review. This protection does not apply to loans under consortium or multiple‑banking arrangements.

Actual lending rates are set by adding the appointed spread to the relevant MCLR. Loans linked to an MCLR maturity must not be priced below that MCLR, and the chosen reference benchmark must be explicitly included in the loan contract. Certain categories are exempt from the MCLR requirement: loans under special Government of India schemes where prescribed interest rates apply; working capital term loans, funded interest term loans and similar instruments issued as part of restructuring packages; loans under refinance schemes where interest is charged at the prescribed scheme rate to the extent refinance is available (any portion not covered by refinance must follow MCLR rules); advances against a depositor’s own deposits; loans to a bank’s employees (including retired employees); loans to the bank’s CEO and whole‑time directors; loans linked to a market‑determined external benchmark; and fixed‑rate loans. For hybrid loans that combine fixed and floating components, the floating portion must follow MCLR guidelines.

Banks must review and publish their MCLRs for different maturities at least monthly on a pre‑announced date, with Board or delegated committee approval. A transitional dispensation allowed banks without adequate systems to review quarterly for the first year up to March 31, 2017; thereafter all banks were expected to adopt monthly reviews. For floating‑rate loans, banks may specify interest reset dates tied either to the loan sanction date or to the date of MCLR review. The MCLR prevailing on the sanction date applies until the next reset date regardless of interim benchmark movements. Reset periodicity must be one year or less and the exact reset frequency must be part of the loan terms.

Finally, existing loans and limits linked to the earlier Base Rate regime may continue until repayment or renewal, and banks must continue to publish Base Rate as before. Existing borrowers have the option to migrate to an MCLR‑linked loan on mutually acceptable terms; such migration should not be treated as foreclosure of the original facility.

Bank Rate: Definition and Role

The rate of discount set by the central bank for rediscounting eligible commercial paper is known as the bank rate. It is also the rate charged by the central bank on advances to banks against specified collateral. The term is statutorily defined in Section 49 of the Reserve Bank of India Act, 1934 as the standard rate at which the Bank is prepared to buy or rediscount bills of exchange and other commercial papers eligible under the Act.

After a long period of inactivity—revisions occurred only three times between 1975 and 1996—the bank rate was reactivated in April 1997. Initially, short-term deposit rates (up to one year) were linked to it: from 16 April 1997 the maximum term deposit rate of scheduled commercial banks (for maturities up to one year) was set at two percentage points below the bank rate, and rates on advances from the Reserve Bank were tied to it. Deposit rates were fully deregulated in October 1997, but the bank rate continued to serve as the reference for other RBI lending rates and emerged as an important signalling tool for monetary policy. Banks used it when pricing loans, and changes in the bank rate visibly influenced commercial banks’ prime lending rates.

Between May 1998 and April 2003 the bank rate was progressively reduced: from 9.00 per cent in May 1998 to 6.5 per cent in October 2001, then to 6.25 per cent in October 2002 (the lowest since 1973), and finally to 6.00 per cent in April 2003. The rate then remained unchanged at 6.00 per cent for some years. Meanwhile, conventional rediscounting of bills by the Reserve Bank fell into disuse, so the bank rate’s direct operational role diminished and it ceased to be an active tool.

Monetary policy signalling shifted to the Liquidity Adjustment Facility (LAF), using repo and reverse repo rates (until 3 May 2011) and thereafter the policy repo rate under the revised operating procedure. Under further refinements to the operating framework, the Reserve Bank instituted the marginal standing facility (MSF)—set at 100 basis points above the policy repo rate—as the instrument serving the functional purpose of the bank rate. From 13 February 2012 the bank rate was aligned with the MSF rate, and any penal interest rates linked to the bank rate (for example, on reserve shortfalls) were adjusted accordingly. As of May 2017, the bank rate stood at 6.5 per cent.

Interest rates as an instrument of monetary policy continue to evolve. Because rates operate across credit, money and securities markets, coherence among these markets and their respective rates is important. Monetary policy aims, among other things, to achieve low real interest rates, but this objective depends on stable inflationary expectations and price stability. Several structural constraints make it difficult to lower interest rates effectively in practice: high intermediation costs in the banking system, large non-performing assets in banks, and the government’s substantial borrowing programme are among the key impediments.

RBI Standing Liquidity Facilities

The Reserve Bank deploys refinance facilities to ease liquidity shortages, shape monetary and credit conditions, and channel lending to priority sectors. The amount (quantum) and price (cost) of refinance extended to scheduled commercial banks change with the overall liquidity in the banking system and with the need to maintain credit flow to selected sectors; together, these choices express the stance of monetary policy in reaction to market conditions.

Historically, the Reserve Bank has provided sector-specific refinance lines—for example for food credit, export credit, investment in government securities, and discretionary standby refinance—to scheduled banks. At present, however, only two reference refinance schemes are in operation for banks and primary dealers: the Export Credit Refinance and the Special Export Credit Refinance schemes.

The Reserve Bank of India (RBI) offers an Export Credit Refinance (ECR) facility to banks under Section 17(3A) of the Reserve Bank of India Act, 1934. The scheme provides refinance against eligible outstanding rupee export credit at both the pre‑shipment and post‑shipment stages, with the quantum of facility determined from time to time in line with the RBI’s monetary policy stance.

All scheduled banks (excluding Regional Rural Banks) that are authorised dealers in foreign exchange and have extended export credit are eligible to avail themselves of the facility. Currently, scheduled banks may obtain refinance up to 50% of their outstanding export credit eligible for refinance, measured as at the end of the second preceding fortnight. This limit was raised from 15% to 50% with effect from the fortnight beginning June 30, 2012, to enhance credit flow to exporters; the detailed definition of “outstanding export credit eligible for refinance” is set out in Annex I.

ECR is available at the repo rate under the Liquidity Adjustment Facility (LAF), as announced by the RBI. Interest is charged with monthly rests; amounts calculated on daily balances are debited to the bank’s current account at the end of the month, or earlier if the outstanding balance is extinguished. Standing liquidity support under ECR and Special ECR (and collateralised support to Primary Dealers) has been provided at revised repo rates as announced from time to time—for example, at 7.5% with effect from March 19, 2013.

No margin is required for ECR. The facility is repayable on demand or on the expiry of fixed periods not exceeding 180 days. Refinance is extended against the bank’s Demand Promissory Note (DPN), supported by a declaration that the bank has extended export credit and that the outstanding amount eligible for refinance is at least equal to the loan/advance drawn from the RBI.

The minimum amount that can be availed under ECR is Rs. 1 lakh and multiples thereof. The facility can be obtained at any centre where the Reserve Bank maintains a Banking Department.

Where a scheduled bank irregularly avails ECR, the RBI will levy a penal rate of interest as decided from time to time. Illustrative instances of irregularity include utilisation exceeding the sanctioned limit, incorrect calculation or reporting of the refinance limit, non‑repayment of refinance within 180 days, and delays in reporting excess utilisation.

The ECR scheme has been periodically reviewed to reflect monetary policy objectives and was merged into system‑level liquidity provision with effect from the fortnight beginning February 7, 2015.

Special Export Credit Refinance Facility

The Reserve Bank introduced a temporary AUS dollar–rupee swap facility on January 21, 2013 to support incremental pre‑shipment export credit in foreign currency (PCFC). Under this arrangement scheduled commercial banks (excluding regional rural banks) could enter into currency swaps with the RBI and, to the extent of the outstanding swap, seek rupee refinance under a special export credit refinance facility. The intent was to encourage banks to extend additional PCFC by providing a matching rupee funding avenue linked to the swap.

The facility was available for fixed tenors of three and six months between January 21 and June 28, 2013. In any particular month a bank’s entitlement to buy US dollars from the RBI under the swap was limited to the incremental PCFC it had disbursed over a base date (November 30, 2012), subject to individual limits notified separately to banks. These limits were to be reviewed periodically in light of utilization and market conditions. Operationally, a participating bank bought dollars from the RBI and simultaneously sold the same amount forward for the swap tenor at prevailing market swap rates; at the end of the swap term the bank delivered dollars back to the RBI and received rupees. The RBI’s pricing for the swap was final.

Banks wishing to use the facility had to furnish a declaration, signed by authorized signatories, confirming actual disbursement of the eligible incremental PCFC in the preceding month(s). The Financial Markets Department in Mumbai managed day‑to‑day operations and retained the discretion to determine, on any operational day, which banks could participate and the maximum amount of swap it would undertake overall and with each bank, depending on market conditions. Banks seeking rupee refinance under the special export credit refinance facility were required to approach the RBI’s Regional Office at Fort, Mumbai with the necessary promissory note and a declaration that the refinance sought did not exceed the outstanding swap amount.

Marginal Standing Facility (MSF)

The Marginal Standing Facility, effective from May 9, 2011, provides an overnight liquidity window to scheduled commercial banks that maintain a current account and an SGL account with the RBI in Mumbai. Under the MSF a bank may borrow overnight up to one per cent of its Net Demand and Time Liabilities (NDTL) as recorded at the end of the second preceding fortnight. Except for intervening holidays, the borrowing is for one day; on Fridays the facility can cover the longer weekend period, maturing on the next working day. If a bank’s statutory liquidity ratio (SLR) holding falls below the statutory requirement by up to one per cent as a result of using the MSF, it is not required to seek a special waiver in terms of the notification issued under subsection (2A) of Section 24 of the Banking Regulation Act, 1949.

The MSF window is available on working days in Mumbai (excluding Saturdays) between 3:30 p.m. and 4:30 p.m. Interest on funds availed under the MSF is charged at 100 basis points above the LAF repo rate, or at such other rate as the RBI may specify. The RBI retains full discretion to accept or reject MSF requests, wholly or partially.

Operational mechanics mirror those of LAF repos. Requests are normally submitted electronically through the Negotiated Dealing System (NDS); members facing genuine system problems may submit physical, sealed requests at the RBI’s Mumbai office. While the NDS allows multiple submissions, participants are encouraged to submit a single request where possible. MSF transactions are conducted as ‘hold‑in‑custody’ repos. On acceptance, the applicant’s RC SGL account is debited with the requisite securities and the bank’s current account is credited with the MSF amount; the reverse leg restores the original positions, with reversal taking place on the next working day if the scheduled date is a holiday. MSF transactions involving RC SGL operations do not require separate SGL forms. Securities are priced at face value for MSF purposes and accrued interest as of the transaction date is ignored.

The minimum request size is ₹1 crore and multiples thereof. Eligible collateral includes all SLR‑eligible, transferable Government of India dated securities, Treasury Bills and State Development Loans (SDLs). A margin is applied to collateral: five per cent for GOI dated securities and Treasury Bills, and ten per cent for SDLs—meaning the face value of securities required will be higher than the cash borrowed to cover the margin. Settlement of accepted MSF applications takes place on the same day after the window for acceptance closes, and extant RBI/DBOD instructions on SLR and securities held in repo SGL accounts continue to apply. For historical reference, the MSF rate was fixed at 9.00 per cent with effect from January 29, 2014.

Liquidity Adjustment Facility (LAF)

The Liquidity Adjustment Facility was recommended by the Narasimham Committee (1998) and introduced by the RBI in phases to develop a vibrant short‑term money market and to provide a day‑to‑day liquidity management tool. The interim LAF, launched in April 1999, combined repos, export credit refinance and open market operations to inject or absorb liquidity; it offered collateralized lending to banks and primary dealers under quantitative limits. Over time the interim arrangements were converted into the full‑fledged LAF. Stages of this evolution replaced earlier refinance mechanisms with the additional collateralized lending facility, introduced variable reverse repo auctions, and, with the operationalization of RTGS, allowed the RBI to conduct LAF operations at different times of the same day when necessary.

Introduced formally on June 5, 2000, the LAF operates through repos and reverse repos to inject or absorb liquidity by sale/purchase of securities with a simultaneous agreement to repurchase/resell. Auctions are normally held daily (except Saturdays), with repo tenor typically overnight except on Fridays and days preceding holidays. Interest rates for both repos and reverse repos are discovered through cut‑off rates emerging from multiple‑price auctions—a format adopted to promote responsible bidding. Since 2002 bids are submitted electronically through the NDS. The RBI has periodically experimented with longer tenors (short‑term repos of several days and, at times, up to a few weeks) and retains the flexibility to introduce longer or fixed‑rate operations as conditions warrant. Minimum bid sizes have been reduced over time to encourage participation by smaller market players, and LAF operations are usually conducted in the forenoon.

A second window (SLAF) was introduced in November 2005 to give market participants an additional opportunity to manage liquidity needs; it was withdrawn and reintroduced at different times and ultimately discontinued with the launch of the MSF in May 2011. In practice the LAF allows the RBI to fine‑tune the structure of short‑term interest rates, moderate sudden liquidity shocks, reduce volatility in the overnight call market and government securities market, and help banks manage temporary mismatches in liquidity without forcing them to assume market risk by purchasing securities outright. Along with judicious open market operations, the LAF has become the principal operational instrument of monetary policy.

Repo Operations and Market Structure

The primary function of the money market is to provide liquidity, and to smooth out short-term fluctuations the Reserve Bank routinely uses repo operations. Repos serve as a practical instrument for adjusting short-term funding among banks and financial institutions, allowing participants to manage temporary surpluses and deficits of cash with precision.

A repo is a transaction in which one party obtains immediate funds by selling securities and simultaneously agrees to repurchase the same (or similar) securities at a specified future date and price. In effect, it is a collateralised, short-term loan executed through a sale-and-repurchase of debt instruments. Legally and economically it takes the form of a temporary sale—ownership, including voting and financial rights, transfers to the buyer—paired with a forward repurchase commitment; for this reason it is sometimes called a ready-forward transaction. Because the repurchase price is fixed at the outset, repos provide a secured and predictable funding route and can be used as a hedging tool.

A reverse repo is simply the other side of the same arrangement: for the buyer it is a reverse repo, where cash is deployed to buy securities with a commitment to sell them back later. Institutions undertake reverse repos to earn yield on idle cash or to manage statutory liquidity requirements. The lender’s return equals the difference between the sale and repurchase prices; this spread effectively embodies the interest on the secured loan. The cost of funds in a repo is expressed as the repo rate, an annualised rate that is typically lower than unsecured inter‑bank rates because the transaction is fully collateralised. Key determinants of the repo rate include the borrower’s credit standing, the liquidity and marketability of the collateral, and prevailing rates on comparable money‑market instruments.

Repurchase agreements (repos) are short-term, collateralized loans in which eligible securities are sold with an agreement to repurchase them at a later date. Because securities change hands and serve as collateral, repos carry far less counterparty risk than unsecured instruments such as call/notice money or inter-corporate deposits; the immediate transfer of ownership titles further reduces credit exposure.

As market-based instruments, repos perform several important functions for financial markets and monetary authorities. They allow central banks to inject or absorb short-term liquidity effectively, helping to balance the supply and demand for funds. By linking the money market with the government securities market, repos add depth and liquidity to both markets and support the formation of a short-term yield curve. Through repo operations, monetary policy signals are transmitted to the money market, with consequential effects on the government securities market and the foreign exchange market. Internationally repos are among the most versatile and widely used money-market tools; in India they developed rapidly but were notably misused during the 1992–93 period.

Two types of repos operate in India: market repos and RBI repos. The evolution of market repos illustrates how regulation responded to market practice and misconduct.

Initially, the Reserve Bank permitted banks to enter into repo transactions among themselves and with institutions such as DFHI and STCI. Until 1988, all government securities and PSU bonds were eligible for repos. From April 1988 until mid‑June 1992, repo activity was restricted to inter‑bank transactions in government securities. Market repos became particularly popular in 1991–92 because banks preferred not to buy securities outright given the risk of depreciation, and because the limited range of money‑market instruments made repos a useful hedge against interest‑rate fluctuations.

Following misuse of repo deals by banks and brokers in the 1992 securities scam, repo transactions were banned in all securities except treasury bills. In June 1995 the ban was eased, but under tight limits: repos were initially allowed only in treasury bills and five dated securities traded on the NSE, and participation was restricted. Banks and primary dealers were permitted to undertake ready forward transactions, but only in Mumbai and only if these trades were routed through the Reserve Bank’s SGL accounts. These constraints were relaxed progressively.

Today, the market repo framework is fully liberalized: all central and state government dated securities and treasury bills of all maturities are eligible for repo, and participants are required to hold the underlying securities in their portfolios before entering into repo transactions.

The Reserve Bank of India allows a range of repo transactions in the government securities market to broaden access to short‑term liquidity. Gilt account holders may enter into repos with their custodian or with another gilt account holder of the same custodian. Co‑operative banks are permitted to undertake repo transactions with all eligible market participants, including NBFCs. Listed companies can borrow or lend under repos with all eligible participants (including banks) without the erstwhile seven‑day minimum tenor restriction. Eligible unlisted companies may borrow from any eligible market participant against special Government of India securities issued to them. NBFCs registered with the RBI — including certain government companies defined under the Companies Act, 2013 that comply with RBI prudential norms — may also borrow and lend under repos with all eligible market participants.

At its core a repo (repurchase agreement) is a collateralised short‑term loan: when the RBI conducts a repo it lends to banks against government securities, thereby injecting liquidity; when it conducts a reverse repo it sells government securities and agrees to repurchase them later, thereby absorbing excess liquidity. The RBI uses repo operations to give banks an outlet for managing short‑term liquidity, to even out money‑market fluctuations and to optimise returns on short‑term surpluses. Liquidity support through repo facilities is extended to primary dealers and gilt mutual funds, and the RBI conducts repo/reverse repo transactions with primary dealers and scheduled commercial banks as part of its open market operations.

Repo operations under the Liquidity Adjustment Facility (LAF) also influence the overnight call money market, helping to moderate volatility in short‑term rates and strengthening the link between the money market and the securities market. Historically, reverse repo operations were introduced on 10 December 1992 to manage short‑term liquidity. Auction tenors varied through the 1990s — from 1–14 days initially, stabilising at 14 days in 1993, then being suspended and reintroduced as market conditions required. In November 1997 the RBI moved from discriminatory auctions to a fixed‑rate daily auction system, pre‑announcing repo rates and requiring participants to bid only on volume. The fixed‑rate approach helped stabilise money and foreign‑exchange markets during the Asian financial turmoil of the late 1990s.

Reverse repo rates were adjusted frequently in that period — rising from an initial 4.5 per cent to as high as 9 per cent in early 1998 and then being gradually reduced as conditions normalised. The absorption and injection of liquidity were integrated with the inter‑bank LAF in 1999–2000, and since June 2000 the RBI has been injecting liquidity daily through fixed‑rate repos. In October 2004 the RBI discontinued the 7‑ and 14‑day repos and made standard repo operations overnight to give banks greater flexibility; in times of tight liquidity it still conducts short‑tenor (e.g., 2/3/7 day) operations under additional LAF. Repo/reverse repo auctions are held on specified working days (except certain Saturdays) and are generally restricted to scheduled commercial banks and primary dealers. Except for Ways and Means Advances, most forms of liquidity support are provided at the repo rate. In the broader market framework the reverse repo rate serves as a floor for short‑term rates while the repo and bank rates act as caps; changes in these rates therefore transmit signals about monetary policy and affect market interest rates and asset prices. Along with the Cash Reserve Ratio, the repo has become a central instrument of the RBI’s liquidity and monetary management toolkit.

In 2017 the RBI issued draft directions for a structured collateralised segment known as the Tri‑party repo. A Tri‑party repo involves a third‑party agent — the tri‑party agent — who facilitates collateral selection, valuation, custody, payment and settlement functions between the repo counterparties. Eligible collateral under the tri‑party framework includes high‑rated listed corporate debt (in demat form) with original maturity beyond one year, short‑term instruments such as commercial paper, certificates of deposit and NCDs of up to one year (subject to minimum rating thresholds), and highly rated bonds issued by multilateral financial institutions (for example, World Bank Group entities and regional development banks) as notified by the RBI.

Participation in tri‑party repos is open to a defined set of regulated entities: scheduled commercial banks (excluding regional rural banks and local area banks), authorised primary dealers, RBI‑registered NBFCs (with some exclusions), All‑India Financial Institutions (Exim Bank, NABARD, NHB, SIDBI), India Infrastructure Finance Company Limited, eligible scheduled urban cooperative banks (subject to RBI conditions), and other regulated entities (mutual funds, housing finance companies and insurance companies) subject to regulator approval, as well as any other entity specifically permitted by the RBI. Tri‑party repos may be traded over‑the‑counter, including on electronic platforms, and trades must be reported to the tri‑party agent (and onward to an authorised trade repository) within 15 minutes.

Participants are expected to enter into standard bilateral master repo agreements and separate agreements with the tri‑party agent as required. Tenors may range from one day up to one year. Settlements can occur on T+0, T+1 or T+2 under a Delivery versus Payment (DvP‑I, gross) framework and are to be processed through recognised clearing houses — for example, the clearing corporations linked to the National Stock Exchange, Bombay Stock Exchange and MCX‑Stock Exchange — which compute obligations on the reversal date and facilitate settlement on a DvP‑I basis.

Risk mitigation under the tri‑party arrangement includes a rating‑based minimum haircut applied to the market value of collateral on the first leg of the trade; the RBI prescribes these minimum haircuts, and current minimums range across rating bands (with lower haircuts for the highest‑rated collateral and higher haircuts for lower‑rated instruments). Participants may apply higher haircuts depending on repo tenor and remargining frequency.

Tri‑party agents must be authorised by the RBI before commencing operations. Scheduled commercial banks can act as tri‑party agents, and other regulated entities may be eligible provided they obtain regulatory approval, have no recent material adverse regulatory history, meet financial thresholds (including minimum net owned funds), possess relevant experience (typically at least five years in financial services, preferably with custodial experience), and maintain adequate systems infrastructure. The tri‑party agent’s responsibilities include collateral revaluation and margining, handling income payments on collateral, facilitating substitution, establishing transparent valuation norms, reporting trades to the designated repository within 15 minutes of trade notification, maintaining trade records for at least eight years, and taking reasonable measures to ensure compliance with RBI directions. The agent does not, in general, undertake settlement unless it is a bank.

Repo, Re‑repo and MSS Guidelines

The Reserve Bank’s revised guidelines set out the framework for repo, reverse repo and re‑repo transactions in government securities, covering eligibility, trading and settlement, valuation, and related operational requirements.

Repo transactions are permitted in dated central government securities, treasury bills and state development loans (SDLs). Market participants may enter into repos either directly through an SGL (Subsidiary General Ledger) account with the RBI or via a gilt account maintained with a bank or other entity authorised to hold a Constituent Subsidiary General Ledger account (the custodian). Permitted counterparties include scheduled commercial banks; primary dealers authorised by the RBI; NBFCs registered with the RBI (including government companies) that follow applicable prudential norms; mutual funds registered with SEBI; housing finance companies registered with the National Housing Bank; insurance companies regulated by IRDAI; pension and provident funds regulated by PFRDA; non‑scheduled urban cooperative banks; state and district central cooperative banks; all‑India financial institutions such as EXIM Bank, NABARD, NHB and SIDBI; listed companies with gilt accounts; unlisted companies to which the Government has issued special securities; and any other entity specifically permitted by the RBI. Repos are allowed between SGL account holders and gilt account holders (GAHs) in various combinations: SGL ↔ SGL, SGL ↔ its own GAH, SGL ↔ GAH under another custodian, GAHs under the same custodian, and GAHs across different custodians.

Trades may be conducted either on approved electronic platforms or bilaterally over‑the‑counter. OTC trades must be reported on the prescribed reporting platform within 15 minutes of execution. Where gilt accounts are involved, the custodian maintaining those accounts is responsible for reporting deals on behalf of its GAHs. Settlement of repo transactions takes place in SGL/CSGL accounts maintained with the RBI, with the Clearing Corporation of India Ltd (CCIL) acting as central counterparty; however, the securities leg of repos between a custodian and its own GAH, or between two GAHs of the same custodian, may be settled bilaterally in the books of the custodian and the RBI. Listed companies may undertake repos for tenors under seven days (including overnight), while eligible unlisted companies may borrow under repo only against the special securities issued to them by the Government of India. Banks may use only securities held in excess of the Statutory Liquidity Ratio (SLR) for repo transactions. Custodians must maintain robust internal controls and concurrent audit arrangements, and all regulated entities must observe prudential norms prescribed by their respective regulators.

Re‑repo policy and mechanics
The RBI permits re‑repoing of securities acquired under reverse repo with the objective of deepening the term money market. In a reverse repo, the RBI receives funds from a market participant and transfers government securities to that participant; re‑repo allows the recipient to put those securities back into the market if it needs funds. Re‑repo is allowed only for securities acquired under RBI reverse repo auctions and is limited to certain entities: SGL holders such as scheduled commercial banks and primary dealers; mutual funds and insurance companies holding SGL accounts, subject to regulator approval; and other SGL account holders as specified. Re‑repo transactions must be flagged as such on the authorised reporting platform, and may be undertaken only after confirmation/matching of the first leg of the repo. The re‑repo tenor cannot exceed the residual period of the initial repo. Securities received in RBI reverse repo auctions can be transferred from the participant’s Reverse Repo Constituent (RRC) account to their SGL account to enable re‑repoing; withdrawals from the RRC account for this purpose are permitted up to two working days (i.e., days when the government securities market is functional) prior to the second‑leg settlement date of the term reverse repo. Re‑repo of securities received in overnight reverse repo auctions is not permitted. Withdrawals are limited net of the initial margin ascertained at the first leg (presently 4% for central government securities and 6% for SDLs), and when multiple securities are provided the margin applies on a security‑by‑security basis. All re‑repoable securities must be rounded to multiples of ₹10,000.

Valuation and margins for repo/reverse repo transactions with the RBI
Valuation rules apply to all repo/reverse repo operations with the RBI, including LAF, variable rate operations and the Marginal Standing Facility. Eligible collateral comprises all SLR‑eligible central government dated securities, SDLs and treasury bills. Market value is determined using the daily price/yield data published by FIMMDA for those working days on which the G‑Sec market is open; for any operation on a given day, the applicable prices are those published on the previous working day. The dirty price of government dated securities is calculated using a 30/360 day‑count convention; T‑Bill prices use the Actual/365 convention. For T‑Bills of intermediate residual tenor, yields are derived by linear interpolation between published benchmark tenors; for residual maturities under seven days, the seven‑day YTM is applied. Prices and yields are rounded to four decimal places. The initial margin is set at 4% for central government securities and 6% for SDLs, subject to future review. If the FIMMDA file for a day is unavailable, the most recent prior data are used. Collateral exchanged in repo and reverse repo transactions is rounded (after applying margin) to multiples of ₹10,000 to avoid under‑collateralisation. The RBI provides illustrative examples in its circulars showing the computation of dirty prices, margins and resulting face values to be debited from participant accounts.

Security substitution facility
For term repos conducted under the Liquidity Adjustment Facility, participants may substitute collateral with securities of equivalent market value based on the latest FIMMDA prices. The required face value of the substitute security is calculated by taking the market value of the security being withdrawn and dividing it by the latest market price of the security offered as substitution, with appropriate rounding. SDLs offered for substitution continue to attract the higher margin applicable to state securities.

Market Stabilization Scheme
The Market Stabilization Scheme (MSS) is an instrument the RBI uses to absorb durable rupee liquidity arising mainly from large capital inflows, thereby helping to stabilise the foreign exchange market and support monetary management. Following heavy foreign exchange inflows and a depletion of the RBI’s stock of government securities in the early 2000s, the RBI and the Government of India signed an MOU in March 2004 and put the MSS into effect on April 1, 2004. Under the MSS the RBI issues government securities (short‑dated dated securities, treasury bills and cash management bills), and proceeds are held in a separate account used solely for redeeming those securities; the government’s liability is confined to the interest payments on MSS securities. The scheme’s ceiling is periodically reviewed and was subsequently increased in response to sustained capital inflows; the MOU was amended on February 26, 2009 to permit transfer of sequestered liquidity from the MSS cash account to the government’s normal cash account, and the limit on MSS securities was raised further (notably on November 29, 2016) to address large and continuous inflows. By providing a tool to mop up durable liquidity, the MSS complements LAF and OMOs, facilitating the transition from direct to indirect instruments and supporting the RBI’s objectives of stabilising short‑term money market rates and managing day‑to‑day liquidity mismatches.

Monetary Policy Operating Framework

The operating procedure of monetary policy in India has evolved substantially. In the mid‑1980s the Reserve Bank used reserve money as the operating target and broad money (M3) as an intermediate target. Structural reforms in the 1990s shifted emphasis toward interest‑rate signalling. Against this backdrop, the Liquidity Adjustment Facility (LAF) was introduced in June 2000 and became the principal operating framework, with the repo and the reverse repo as the main instruments. LAF was supported by other liquidity tools such as the Cash Reserve Ratio (CRR), Open Market Operations (OMO) and the Market Stabilisation Scheme (MSS). Under LAF the Reserve Bank provided liquidity through repo operations in tight conditions and absorbed liquidity through reverse repo in surplus conditions; overnight interest rates, however, could become highly volatile in extreme episodes. This alternation between repo and reverse repo rates created uncertainty about the effective policy stance. In the decade that followed, large swings in capital flows and sharp fluctuations in government cash balances further complicated liquidity management and exposed the absence of a single, clearly signalled policy rate and a firm corridor.

To address these weaknesses, the Reserve Bank introduced a revised operating procedure in May 2011, designed to establish an explicit operating target, a single independently varying policy rate, and a formal corridor. The weighted average overnight call money rate was made the operating target of policy. The repo rate was designated as the sole, independently varying policy rate to signal monetary stance. Simultaneously, a new Marginal Standing Facility (MSF) was introduced, allowing scheduled commercial banks to borrow overnight up to 1.0 per cent of their Net Demand and Time Liabilities (NDTL) at 100 basis points above the repo rate, thereby creating a safety valve against unforeseen liquidity shocks.

The revised corridor had a fixed width of 200 basis points, with the repo rate placed at the centre, the reverse repo rate 100 basis points below it, and the MSF rate 100 basis points above it; the Reserve Bank retained the flexibility to change the corridor width if warranted by monetary conditions. In April 2016 the corridor was narrowed to ±50 basis points around the repo rate as part of a move toward greater neutrality in liquidity management. After these changes, the call rate stabilised within the formal corridor and moved more closely with other money market rates, contributing to better integration of financial markets and clearer transmission of monetary policy.

Flexible Inflation Targeting Framework

On 20 February 2015 the Government of India and the Reserve Bank entered into the Monetary Policy Framework Agreement (MPFA), making price stability the primary objective of monetary policy and defining it in numerical terms. The agreement set a near‑term target of consumer price index (CPI) inflation below 6 per cent for 2015–16 (to be achieved by January 2016) and a medium‑term target of 4 per cent with a tolerance band of plus or minus 2 percentage points for subsequent years. With this, India formally adopted Flexible Inflation Targeting (FIT). The MPFA also requires the Reserve Bank to specify an operating target and the procedures it will use to achieve that target.

The agreement defines failure as CPI inflation remaining above 6 per cent or below 2 per cent for three consecutive quarters. In that event the Reserve Bank must report to the government explaining the reasons for the deviation, the remedial measures it proposes, and an estimated time frame for returning inflation to the target. The Bank is also required to publish a document identifying the sources of inflation and providing inflation forecasts for the next six to eighteen months.

Institutionally, the MPFA represents a significant reform: it binds the Reserve Bank to pursue FIT with greater transparency, predictability and accountability. The government’s commitment to the framework strengthens its credibility and supports market confidence, since credible monetary policy works best alongside fiscal consolidation and effective supply management—both important for sustaining price stability.

Money Market Reforms and Challenges

A well-functioning money market is a precondition for effective monetary policy. Reforms have therefore focused on removing structural inefficiencies and excess liquidity, broadening participation, and strengthening linkages between money-market segments and other financial markets. This has required introducing a range of short-term instruments and market-price innovations to ensure liquidity across segments and to lay the foundations of a short-term yield curve.

Progress to date shows a mixed picture. A base has been created: treasury bills have expanded substantially in size and turnover, and new instruments such as commercial paper, certificates of deposit and commercial bills have been introduced. However, many of these markets remain relatively illiquid. The call-money market has become more active, but its rates have also grown more volatile. With interest-rate deregulation, short-term rates have emerged as an important mechanism for asset allocation. New liquidity-management tools such as repos and the Liquidity Adjustment Facility (LAF) are increasingly used by the Reserve Bank, while private data providers and exchanges have begun publishing overnight benchmark rates such as MIBOR. New participants — non-bank entities, foreign institutional investors, primary and satellite dealers — now operate in the market, and hedging instruments like interest-rate swaps and forward-rate agreements have been introduced.

In the second phase of reforms the Reserve Bank has aimed explicitly at developing a short-term rupee yield curve. The strategy has four strands: operate the LAF so that short-term rates remain within a defined corridor; develop the call-money market as a pure interbank market; rationalize traditional, sector-specific refinance support; and expand the repo market so non-bank participants can access it. Together, these measures are intended to produce a reliable short-term term structure of interest rates that will guide pricing across the financial system.

Despite these steps, the money market has not yet attained the depth and liquidity required for a smoothly functioning short-term interest-rate mechanism. Several Reserve Bank policy decisions have constrained market development: the ban on repos after the securities scam of 1992, the tight stance in the busy-season credit policy of 1995, and interventions to defend the rupee in the wake of the South‑east Asian crisis all disrupted market activity and weakened institutions. Delays in technological modernization — notably in rolling out a VSAT network and electronic dealing systems — also slowed market expansion and transparency.

A deep, liquid money market is essential for a thriving derivatives market, since effective hedging requires reliable underlying cash markets. To complete the structure and strengthen market functioning, a set of reforms is still needed. A transparent benchmark short-term rate should be developed and a genuine term money market nurtured so that a benchmark interbank term rate emerges, which is vital for integrating money and foreign-exchange markets. Regulatory and supervisory incentives should encourage banks and financial institutions to manage risk and pursue profitability efficiently.

Practical steps to deepen secondary activity in commercial paper and certificates of deposit include permitting underwriting, introducing revolving underwriting finance facilities and floating-rate commercial paper, and rationalizing the tenors of financial-institution CDs with the option of floating-rate CDs. Stamp-duty rationalization is also important, since multiple or overlapping stamp prescriptions raise transaction costs and administrative burdens. Equally important is a shift in regulatory mindset: moving the focus from controlling quantities of liquidity to managing its price will allow more orderly market development. Finally, prudent government debt and cash management will complement monetary policy and give the Reserve Bank greater flexibility in choosing its operating procedures.

Indian Money Market Overview

The money market consists of financial assets that are close substitutes for money, dealing in overnight to short-term funds and instruments with maturities of one year or less. It smooths short-term mismatches between demand and supply of funds, serves as the key arena for central bank intervention to influence liquidity and short-term interest rates, and provides an efficient market-clearing venue for borrowers and lenders of short-term funds.

Instruments traded in the Indian money market include treasury bills (T‑bills), call/notice money (overnight and short‑notice up to 14 days), commercial papers (CPs), certificates of deposit (CDs), commercial bills, and collateralized borrowing and lending obligations (CBLOs). Treasury bills, issued by the Reserve Bank of India on behalf of the government, are the backbone of the market and are used to manage short-term government liquidity needs. T‑bills exist in three historical categories—on‑tap, ad hoc and auctioned bills—but the active market today revolves around auctioned papers, typically in 91‑day and 364‑day tenors. Sales are conducted by auction, either multiple‑price or uniform‑price, and participants include the RBI, banks, mutual funds, financial institutions, primary dealers, provident funds, corporates, and foreign investors; state governments may also invest as non‑competitive bidders.

Commercial paper is an unsecured, negotiable short‑term promissory note issued at a discount by highly rated corporates to meet working capital needs. Commercial bills are short‑term, negotiable, self‑liquidating instruments that document payment obligations arising from credit sales; in India the bill market has remained underdeveloped, largely because the cash‑credit system places cash‑management responsibility with banks and because a secondary market for bills did not emerge. Certificates of deposit are unsecured, negotiable, short‑term bearer instruments issued by commercial banks and development financial institutions, typically used when banks seek funds in tight liquidity conditions. Observed market behaviour shows an inverse relationship between outstanding CDs and CPs—when CD issuance rises, CP outstanding often falls, and vice versa.

The call/notice money market is highly visible because banks trade day‑to‑day surplus funds there. Call money is repayable on demand and typically has maturities from one day up to a fortnight; the interest rate on such loans is the volatile call rate. Banks use the call market to manage their cash reserve requirement (CRR) and other liquidity needs. The Indian money market displays seasonal patterns—demand for call/notice funds is higher in the “buy” season (roughly mid‑October to mid‑April) and falls in the slack season (mid‑April to mid‑October), with corresponding effects on volumes and the call rate. Non‑bank participants were gradually phased out of the call/notice market beginning in May 2001 and, except for primary dealers, removed completely by August 2005.

Term money—funds traded for three to six months—remains relatively underdeveloped in India. CBLOs operate under the clearing and settlement guarantee of the CCIL: members hold constituent SGL accounts with CCIL to deposit securities as collateral, borrowing limits and lending availability being set by the marked‑to‑market value of these securities. Typical CBLO trades are overnight to 14 days, though maturities can extend up to one year. Money market mutual funds (MMMFs) play an intermediary role by pooling small investors’ savings and investing them in short‑term debt instruments, thereby linking retail savings to the wholesale money market.

The Reserve Bank of India manages monetary conditions and liquidity using a mix of direct and market‑based instruments. Direct tools include adjustments in cash reserve requirements, limits on refinance, administered interest rates and qualitative or quantitative credit restrictions. Market‑based or indirect instruments include open market operations, standing refinance facilities, discount windows and repo/reverse‑repo operations. Reserve requirements comprise the CRR—cash banks must hold with the RBI as a percentage of their demand and time liabilities—and the statutory liquidity ratio (SLR), which mandates minimum holdings in government securities.

Other important rates and facilities include the prime lending rate (PLR), historically the minimum rate charged to top corporate customers; PLRs and bank lending rates have been progressively deregulated since the early 1990s. The bank rate is the rate at which the central bank rediscounts eligible paper or lends against specified collateral. Refinance facilities currently available to banks include export credit refinance and general refinance. Day‑to‑day liquidity management is largely conducted through the Liquidity Adjustment Facility (LAF), which uses repo and reverse repo transactions to inject or absorb liquidity. In a repo the borrower receives funds against securities collateral and agrees to repurchase them at maturity (typically 1–14 days), making repos an effective market‑based tool for short‑term liquidity management and for linking the money and securities markets.

Risk‑management and interest‑rate derivative activity has expanded in the Indian market. Interest rate swaps (IRS) are contracts in which two parties exchange streams of interest payments—typically fixed for floating or vice versa—on a notional principal. Forward rate agreements (FRA) are contracts that lock in an interest rate for a future period by settling the difference between the agreed rate and the market reference rate on the settlement date; in India the NSE/Reuters Mibor is commonly used as the benchmark. Both IRS and FRA markets have seen substantial growth in contract numbers and notional amounts, reflecting increasing hedging and speculative activity in short‑term interest rates.