Role of money market in the financial system

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Role of money market in the financial system

We keep hearing how money markets show the first sign of change when a currency gains or loses value.  This is because it deals in short-term instruments that are close substitutes for money. These short term instruments are easily marketable, highly liquid and can be bought and sold easily. Since the holding time is less than a year, the returns you receive are quick, unlike traditional instruments that have long maturity time. In reality, money market isn’t really a market, it is rather a collective name given to the various instruments and institutions that deal with the various grades of near ­money.

It is important to keep the money flowing in a financial system. Especially now, when the whole world can be treated as one large market, money market is an integral part of the financial system in any economy.

Why is money market important?

  • Promotes savings

The people who trade in money market are basically investing short term and trying to get returns on it. The money is invested to fulfill a need of the investor. It provides the investor with the flexibility to go forward with investing the sum that he wants to invest and the time period of the investment (within a year). This helps the financial system by keeping money in the cycle. There are many money market instruments that give good returns and ensure safety of the funds invested.

  • Makes funds available

There are public and private institutions that need short-term financing to meet their working capital requirements. By using money market instruments and securing the capital they need via an intermediary, they can really prosper. This way the money market also helps in the development of industry and trade within and outside the country.

  • Use of surplus funds

When money is kept idle, it becomes a burden on the financial system since it is not in circulation. These funds are kept idle because they are usually considered surplus. They make also be kept out of circulation in order to cater to any on-the-go need, which may arise anytime because investment is seen as a long time commitment and is not considered to be highly liquid. By investing in money market, there is an assurance that the instrument can be sold off easily, being highly liquid and also there is no long time commitment that is to be made with respect to the investment.

  • Help for the Government

The instrument that helps government in borrowing short term loans from money market is Treasury bills. It is a low interest instrument. It helps the government by availing low interest loans and also a secure investment for the investor. Normally if the government were to borrow from the Reserve Bank i.e. the central bank, it would lead to increase of inflation which would lead to pressure on the financial system which would automatically alter every aspect of the economy.

  • Increases financial mobility

The whole aim of a financial system that is in place is to help in the flow of money. Money market facilitates transfer of funds from one sector to another. Financial mobility is essential for the development of any industry in the economy.

  • Encourages entrepreneurs

For small and medium size business, it is tough to secure loans at a low interest rate. Money market makes it possible for such businesses to secure their source of capital. It also provides the opportunity for these firms to discount bills of exchange.

Money markets are integral to the financial system of any country. Among the largest financial markets in the world, these markets serve as the channel for movement of money. They also help successfully implementing monetary policies. It is through money market that the central banks control banking system which in turn influences commerce and industry. It also promotes safety of the financial assets by encouraging savings and investments. Money market is the force that brings equilibrium between demand and supply of loanable funds. This is done by allocating savings into investment channels. They lead to efficient distribution of liquidity among financial institutions, and hedging of short term risks.

Money market is used by a huge spectrum of participants. Huge companies raising money to individual investors planning to save money for a short term depend on money market. It is that segment of the financial market that keeps the juices flowing.

A financial system will cease to function in the absence of the flow of money via the money market, thus making its role indispensable.

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