Money Market Instruments and Repo under Chapter IIID of the RBI Act

Every evening some banks are short of money and others are long, and the difference has to clear before the books do. The money market is where that happens: a market in which the commodity is money itself for very short periods, the participants are institutions, and the prices set there, above all the overnight rate at which banks lend to one another, are what monetary policy actually steers. Its instruments look informal, a day's unsecured lending, a discounted note, a sale and repurchase, but each sits on a precise statutory footing that the examiner expects a candidate to know.

1. The statutory footing: Chapter IIID of the RBI Act

The money market ran for decades on circulars of uncertain parentage, until the Amendment Act of 2006 inserted Chapter IIID, Sections 45U to 45W, into the Reserve Bank of India Act, 1934.

• Section 45U supplies the definitions. A repo is an instrument for borrowing funds by selling securities with an agreement to repurchase them at a future date at an agreed price which includes interest for the funds borrowed. A reverse repo is the mirror: lending by buying with an agreement to resell. Money market instruments include call or notice money, term money, repo, reverse repo, certificates of deposit, commercial usance bills and commercial paper, and like instruments of a maturity up to one year as the Bank may specify. Derivatives over rupee interest rates and the rest are defined alongside.
• Section 45V declares that a derivative transaction is valid where at least one party is the Reserve Bank, a scheduled bank or another regulated agency, notwithstanding anything in any other law, which closed the old argument that such contracts were wagers.
• Section 45W empowers the Reserve Bank to regulate the money market: it may determine policy and give directions to agencies dealing in securities, money market instruments, foreign exchange and derivatives, and may call for information. Every master direction on these instruments is issued under this section.

Figure 1: The instruments, from a day to a year

2. The unsecured segment: call, notice and term money

• Call money is lending overnight; notice money for 2 to 14 days; term money for 15 days up to one year. All three are unsecured.
• Participation is confined by direction to banks, including small finance banks, payments banks, regional rural banks and cooperative banks, and primary dealers. Everyone else was moved out years ago, into the collateralised segment, precisely because unsecured interbank exposure is systemic.
• Each participant sets prudential limits on its call borrowing and lending under the directions, by reference to its capital funds, so that no bank funds itself overnight beyond what a shock could refinance.
• The weighted average call rate is the operating target of monetary policy: the whole liquidity adjustment framework exists to keep it aligned with the policy repo rate, which is why this small market matters far beyond its size.

3. The collateralised segment: repo and its relatives

• A market repo is the Section 45U transaction done between market participants in government securities, and now also in corporate bonds, under the repurchase directions. Title to the collateral passes to the lender, which is what makes the protection real: if the borrower fails, the lender owns the securities and needs no insolvency court.
• A tri party repo adds an agent, the tri party agent, which holds the collateral, values it daily and manages margins, so that participants face an infrastructure rather than each other's back offices. The clearing corporation's platform performs this role for the bulk of the market.
• The Reserve Bank's own liquidity adjustment facility, the repo and reverse repo it conducts against the system, and the marginal standing facility above it, use the same legal form; they belong to monetary policy rather than to the interbank market, but the instrument is identical.
• A haircut keeps the collateral worth more than the loan, and daily margining keeps it so as prices move. These two mechanics are why repo survived every liquidity scare that emptied the call market.

Figure 2: Clean against collateralised, which is the market's deepest divide

4. The negotiable instruments of the market

Certificates of deposit

A certificate of deposit is a negotiable, unsecured money market instrument representing a deposit with a bank, issued in dematerialised form. Under the master direction of 4 June 2021, it may be issued by scheduled commercial banks, regional rural banks and small finance banks, in a minimum denomination of ₹5 lakh and multiples of it, for a tenor of 7 days to 1 year, at a discount to face value or on a floating rate reset against a recognised benchmark. The issuing bank may buy back its certificates, but only 7 days after issue, by an offer to all holders of the issue on identical terms at the prevailing market price, and banks may not lend against certificates of deposit unless the Reserve Bank specifically permits it. The commercial sense: a certificate is a deposit the depositor can sell instead of breaking, and the bank cannot be made to fund a loan secured on its own liability.

Commercial paper

Commercial paper is the corporate counterpart: an unsecured money market instrument issued as a promissory note at a discount, in a minimum denomination of ₹5 lakh, for 7 days to 1 year, by companies, non-banking financial companies, all India financial institutions and other eligible issuers, some of which must have a net worth of at least ₹100 crore, and carrying a minimum credit rating of A3. The current framework sits in the Directions of 3 January 2024, in force from 1 April 2024, which govern commercial paper together with non convertible debentures of original maturity up to one year, those running from 90 days to 1 year. For the issuing company, paper is disintermediation: it borrows from the market directly at rates below its bank's lending rate, and the bank's role shrinks to standby lines and investment.

Figure 3: Who lives at which maturity

5. Benchmarks and conduct

• The market's reference rates, the overnight interbank rate and the rest, are computed and published by the benchmark administrator the Reserve Bank recognises, after the global rate scandals made polled, unverified benchmarks untenable. Directions on financial benchmark administrators govern the computation.
• Dealing is governed by market timings, reporting of trades to the trade repository, and the fair practice requirements of the directions, with the Reserve Bank's inspection and direction powers under Section 45W behind them.
• For a bank's balance sheet, money market assets are classified under the investment directions, usually as held for trading or available for sale, and call exposures count within the interbank prudential limits.

6. Quick Revision

1. A repo is a sale with a repurchase agreement, so title in the collateral passes and the lender is protected without a court.
2. A tri party agent holds, values and margins the collateral between the parties.
3. Certificates of deposit are the bank's own negotiable liability; commercial paper is the corporate borrower's.
4. Both are discounted instruments in dematerialised form, and both ride on the one year boundary that defines the money market.
5. The liquidity adjustment facility uses the repo form for monetary policy rather than for interbank funding.

7. Frequently Asked Questions

Why is the call market restricted to banks and primary dealers?

Because it is unsecured, and unsecured overnight exposure between institutions is how trouble travels. When a wide set of institutions could lend call money, a rumour about one borrower froze funding for all of them, and a failure would have passed losses straight through the system. Policy therefore pushed every other participant into the collateralised segment, where repo and tri party repo give the lender securities instead of promises, and reserved the clean market for the institutions the Reserve Bank itself supervises and, through the liquidity facilities, can refinance. The restriction also sharpened the call rate as a policy target, since it is now a price formed only by regulated balance sheets.

If a repo is legally a sale, why is it treated as borrowing?

Both characterisations are true at different layers, and the statute chose deliberately. In form, Section 45U makes it a sale with a binding repurchase: title passes, so the lender can deal with the securities and keep them on the borrower's failure without invoking any security law. In substance, the price of the repurchase includes interest for the period, so the economics are a loan, and accounting and regulation treat it as secured borrowing: the securities stay on the seller's balance sheet for valuation and the cash raised counts as a liability. The form gives safety, the substance gives honest books, and the definition was drafted to deliver both at once.

Why can a bank not lend against its own certificate of deposit?

Because the loan would unwind the deposit while pretending not to. A certificate is money the bank has borrowed for a fixed term; a loan against it returns the money to the depositor while the certificate remains outstanding, which is premature withdrawal in disguise, defeats the instrument's purpose of giving the bank stable term funding, and lets the pricing of the loan quietly rewrite the pricing of the deposit. The direction therefore bars lending against certificates and channels early exit through the buyback route instead, which is transparent: an offer to all holders of the issue, at the market price, and only after the certificate has lived at least 7 days.

What makes commercial paper different from a loan from the bank?

The lender, the form and the discipline. Paper is sold to the market, money market mutual funds, banks, insurers, so the issuer borrows at a price set by competition rather than by one banker's judgment, and usually below the loan rate. The form is a negotiable promissory note at a discount, so the holder can sell rather than wait. And the discipline is the rating: access exists only at the minimum A3 grade and vanishes the day the rating does, which is precisely what happened to several large issuers in the funding squeezes of recent years. Banks remain in the picture as investors and as providers of standby facilities that pay the paper if the market will not roll it.

8. Related Topics and Provisions

• Instruments of monetary control and the liquidity adjustment facility
• Government securities and the investment portfolio of banks
• Monetary policy and the Monetary Policy Committee
• Capital adequacy and the Basel framework in Indian banking
• The Reserve Bank's regulation of non-banking financial companies