Money Market in India: Instruments, Participants, Liquidity and Reforms for RBI Grade B Finance

Last updated: 2026-11-13 · MockMentor

The Financial Markets unit of the RBI Grade B Finance syllabus covers "Primary and Secondary Markets (Forex, Money, Bond, Equity, etc.): functions, instruments, recent developments". The money market is where monetary policy starts working, which is why RBI tests it closely. Objective questions ask about the maturity of treasury bills, who can issue commercial paper, or what TREPS stands for. Descriptive questions in 2026 asked about RBI's liquidity management. This chapter covers the money market's role, its instruments and participants, and how RBI manages liquidity through it.

In one line: the money market is the market for borrowing and lending for up to one year, through instruments such as call money, repo, TREPS, treasury bills, commercial paper and certificates of deposit, and it is the channel through which RBI's policy rate reaches the rest of the economy.

Basic concepts

• Money market: the market for short-term funds, with maturities from overnight to one year, where banks, institutions, companies and the government manage their liquidity.
• Liquidity: the amount of money readily available to banks. A surplus pushes short-term rates down; a deficit pushes them up.
• Collateralised and uncollateralised borrowing: borrowing backed by securities (repo, TREPS) or without security (call money, commercial paper).
• Discount instrument: a security issued at a price below its face value and redeemed at face value, so the difference is the return. Treasury bills, commercial paper and certificates of deposit are discount instruments.
• Weighted Average Call Rate (WACR): the average rate in the overnight call money market, weighted by volumes. It is RBI's operating target for monetary policy.
• Overnight Index Swap (OIS): a derivative in which one party pays a fixed rate and receives a floating overnight rate; used to hedge or bet on short-term rates.

Why in News?

1. In October 2026, RBI raised the repo rate to 5.50%, with the Standing Deposit Facility (SDF) at 5.25% and the Marginal Standing Facility (MSF) at 5.75%. These form the corridor within which overnight rates move.
2. RBI has used a mix of variable rate repo and reverse repo auctions, open market operations and foreign exchange swaps in 2025 and 2026 to keep the overnight rate close to the repo rate.
3. The CRR, cut from 4% to 3% in four steps between September and November 2025, has added durable liquidity to the banking system.
4. Most overnight lending now happens in collateralised segments such as TREPS and market repo, which has raised the question of whether the uncollateralised call rate is still the best operating target.

Functions of the money market

1. Lets banks and institutions balance short-term surpluses and shortfalls, for example after large tax payments drain liquidity.
2. Provides short-term finance to companies (commercial paper) and the government (treasury bills).
3. Gives a safe, liquid place to park short-term funds, such as by money market mutual funds.
4. Transmits monetary policy: the repo rate first affects overnight rates, then other short-term rates, then deposit and loan rates.
5. Gives price signals about liquidity and expectations of future policy.

Features of a developed money market

• A wide range of instruments and participants.
• Many lenders and borrowers, so no one can control rates.
• An integrated structure, in which rates in different segments move together.
• Low transaction costs and electronic trading and settlement.
• A credible central bank that acts as lender of last resort.

Instruments of the money market

Call, notice and term money

Prudential limits apply: a scheduled commercial bank can borrow up to 100% of its capital funds (or 125% on any day during a fortnight) in the call market. Trading takes place on RBI's electronic platform, NDS-Call.

Repo and reverse repo

A repurchase agreement (repo) is a short-term loan in which the borrower sells securities and agrees to buy them back later at a higher price. The difference is the interest. For the lender, the same deal is a reverse repo.

Tri-Party Repo Dealing and Settlement (TREPS)

TREPS replaced the Collateralised Borrowing and Lending Obligation (CBLO) in November 2018. CCIL acts as the tri-party agent and central counterparty, holding the collateral and guaranteeing settlement. TREPS is the largest segment of the overnight money market, and mutual funds are its biggest lenders.

Treasury bills

Treasury bills (T-bills) are short-term borrowings of the central government.

The 14-day intermediate T-bills are issued only to state governments and certain central banks to invest their surplus cash.

Cash Management Bills (CMBs)

CMBs were introduced in 2009 to meet temporary mismatches in the government's cash flow. They have the features of T-bills but a maturity of less than 91 days. They are issued only when needed.

Commercial Paper (CP)

CPs are cheaper than bank loans for highly rated firms. After the IL&FS default in 2018, the CP market froze for weaker NBFCs, showing how quickly short-term funding can dry up.

Certificates of Deposit (CD)

Banks rely on CDs when deposit growth lags loan growth, which has happened often since 2023.

Other instruments

• Commercial bills: bills of exchange arising from trade, discounted by banks. The Trade Receivables Discounting System (TReDS) has given this segment a digital form for MSMEs.
• Inter-corporate deposits: short-term deposits between companies, mostly within groups.
• Money market mutual funds: liquid funds and overnight funds that invest in money market instruments.

Participants

RBI's liquidity management framework

Why liquidity matters

The banking system's liquidity changes every day because of government spending and tax receipts, currency demand, RBI's foreign exchange operations and changes in bank deposits. RBI uses its tools to keep the WACR close to the repo rate, so that the policy signal reaches the market.

The LAF corridor

The SDF replaced the fixed rate reverse repo as the floor in April 2022. Because it needs no collateral, RBI can absorb large surpluses without running out of government securities. The width of the corridor is 50 basis points.

Tools

1. Variable rate repo and reverse repo auctions of different tenors, as the main tools.
2. Open Market Operations: outright purchase or sale of government securities to change durable liquidity.
3. Foreign exchange buy-sell swaps, which add rupee liquidity for a fixed period.
4. Changes in the CRR, which release or absorb large amounts of liquidity at once.
5. Special facilities in stress, such as Long Term Repo Operations (LTROs) and Targeted LTROs during COVID-19.

Review of the framework

RBI reviews its liquidity framework from time to time. Its internal working group reported in 2025, and the broad design was kept: the WACR remains the operating target, variable rate auctions remain the main tools, and RBI uses longer operations, open market operations and swaps when the liquidity gap is large or lasting. Because uncollateralised call money is now a small part of overnight trading, there has been a debate on whether a rate based on secured transactions should take its place in future.

Money market benchmarks

RBI regulates financial benchmark administrators under directions issued in 2019.

Reforms in the money market

Reading liquidity conditions

Students are often asked how to tell whether the banking system has surplus or deficit liquidity. Three indicators matter.

Frictional and durable liquidity

• Frictional liquidity changes from day to day because of tax payments, government spending and currency demand around festivals. RBI handles it with short auctions of a few days.
• Durable liquidity is the lasting level of liquidity, driven by RBI's purchases or sales of foreign exchange, the growth of currency in circulation and the government's cash balance. RBI handles it with open market operations, long-term swaps or a CRR change.

Drivers of liquidity

This explains why RBI's dollar sales during rupee weakness tighten money market conditions, and why it sometimes pairs them with open market purchases or buy-sell swaps.

Government cash management

The central government keeps its cash balance with RBI. When the balance is low, it uses Ways and Means Advances (WMA), temporary loans from RBI within a limit agreed for each half of the year. If it exceeds the limit, the excess becomes an overdraft at a higher rate. When the balance is high, it can buy back securities or invest in auctions. Cash Management Bills and changes in the size of T-bill auctions help it smooth its needs. Large swings in the government's balance are one of the main sources of liquidity volatility in the money market.

Market Stabilisation Scheme (MSS)

The MSS, started in 2004 under an agreement between RBI and the government, lets RBI issue additional T-bills and dated securities to absorb excess liquidity caused by heavy foreign exchange inflows. The money raised is kept in a separate account and not used by the government. It is a tool of sterilisation and was used again in 2020.

Primary dealers

Primary Dealers (PDs) are institutions registered with RBI to support the government securities market. There are two types: standalone PDs, which are NBFCs, and bank PDs, which do the business departmentally.

• They must bid in, and underwrite, primary auctions of dated securities and T-bills.
• They act as market makers, quoting buy and sell prices in the secondary market.
• They can borrow in the call market and have access to RBI's liquidity facilities.
• They help retail and smaller investors take part in auctions.

Money market and interest rate derivatives

These derivatives let banks, companies and mutual funds manage the interest rate risk that comes from money market and bond holdings.

Money market mutual funds

Companies park surplus cash in these funds, and they are among the largest lenders in TREPS and buyers of CPs and CDs. SEBI requires liquid funds to keep at least 20% in cash, government securities and similar liquid assets, a rule introduced after the stress of 2018 to 2020.

How the money market transmits policy: an example

Suppose RBI raises the repo rate by 25 basis points, as it did in October 2026.

1. The LAF corridor shifts up: SDF, repo and MSF all rise by 25 basis points.
2. The overnight call rate, TREPS and market repo rates move up within days.
3. Rates on T-bills, CDs and CPs rise as markets price in the new level and the chance of more hikes.
4. Banks' cost of funds rises, and external benchmark linked loans reset at the next reset date.
5. Over the following months, MCLR and deposit rates rise, and credit demand slows.

The speed of steps 1 to 3 shows how well the money market works; the slower steps 4 and 5 depend on banks and their loan books.

Committees on the money market

Challenges

• Uncollateralised call money has shrunk, so the WACR is based on thin volumes.
• Liquidity can swing sharply around tax dates and because of the government's cash balances with RBI.
• The CP market depends on a few large issuers and is vulnerable to credit events.
• Foreign exchange intervention affects rupee liquidity, which complicates liquidity management.
• Transmission from money market rates to bank loan rates is still incomplete for MCLR-linked loans.

Way forward

• Move to a secured overnight benchmark as the secured market dominates.
• Improve forecasting of government cash balances and coordinate cash management with the government.
• Widen the investor base for CPs and CDs, including retail through online platforms.
• Strengthen the term money market so that banks can price loans better.
• Communicate the liquidity stance clearly to markets.

Possible exam and interview questions

1. Explain the role of the money market in the transmission of monetary policy. How does RBI manage liquidity through the LAF corridor? (620 words)
2. Compare commercial paper and certificates of deposit as money market instruments. (420 words)
3. What is TREPS, and why has it overtaken the call money market?
4. Why did RBI introduce the Standing Deposit Facility in 2022?
5. Interview: Should RBI target a secured overnight rate instead of the call rate?

Related reading: bond market, functions of RBI, and monetary policy.

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• Financial System
• Functions of RBI
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• Financial Institutions

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