Banking Terms — Set 6

Correct Answer: D. Existence of unorganized sector

• **Existence of unorganized sector** = the biggest drawback of the Indian money market is the large unregulated segment of moneylenders and indigenous bankers. • **Non-uniform rates** — the unorganised sector charges varying interest rates across regions, making it hard for RBI to implement uniform monetary policy. • 💡 Wrong-option analysis: [Electronic trading]: a strength, not a drawback; electronic platforms improve efficiency; [High transparency]: also a positive feature of the organised market; [RBI regulation]: RBI regulation is a strength that ensures stability.

Correct Answer: B. Difference between borrowing and lending rates

• **Difference between borrowing and lending rates** = Spread is the margin between the rate at which a bank borrows funds and the rate at which it lends them. • **Efficiency indicator** — a narrow spread signals a competitive, efficient market; banks use the spread to cover operating costs and generate profit. • 💡 Wrong-option analysis: [Distribution of bills]: a physical description unrelated to rate terminology; [Large area of market]: 'spread' in financial context is about rate difference, not geographic size; [Growth of banks]: bank growth is measured by assets or profits, not spread.

Correct Answer: D. Hundi

• **Hundi** = an indigenous bill of exchange used in India for centuries, providing informal credit to small traders in the unorganised market. • **Vernacular instrument** — Hundis are written in local languages, follow local customs, and remain outside formal RBI regulation. • 💡 Wrong-option analysis: [Commercial Paper]: issued by large rated corporates, not small traders; [T-Bill]: a government instrument for sovereign borrowing; [Repo]: a secured inter-bank instrument, not a tool for rural or small-trade credit.

Correct Answer: C. Banks park more money with RBI

• **Banks park more money with RBI** = an increase in Reverse Repo Rate makes it attractive for banks to deposit surplus cash with RBI rather than lending it. • **Inflation control** — by drawing excess liquidity into RBI vaults, a higher Reverse Repo Rate reduces money supply and helps combat inflation. • 💡 Wrong-option analysis: [Banks lend more to public]: the opposite; higher Reverse Repo Rate incentivises parking, not lending; [Inflation increases]: reduced money supply lowers inflation, not raises it; [Money supply increases]: money supply contracts when banks park more funds with RBI.

Correct Answer: B. Commercial Paper

• **Commercial Paper** = an unsecured short-term promissory note issued by corporates, Primary Dealers, and AIFIs to raise short-term funds. • **Introduced in 1990** — CP was launched in India in 1990; it is issued at a discount with maturities of 7 days to 1 year. • 💡 Wrong-option analysis: [Treasury Bill]: issued by the Government of India through RBI, not by corporates; [Certificate of Deposit]: issued by banks to raise money from investors, not by corporates; [Call Money]: overnight inter-bank borrowing, not a promissory note issued by companies.

Correct Answer: C. Up to 1 year

• **Up to 1 year** = the Tri-party Repo (TREPS) can have tenures ranging from overnight to one year, with CCIL acting as the third-party intermediary. • **Most active segment** — TREPS is currently the most active segment of the Indian money market, replacing CBLO after it was phased out. • 💡 Wrong-option analysis: [1 to 14 days]: too narrow; TREPS allows tenures up to one year; [Up to 10 years]: far beyond the money market ceiling; [Overnight only]: TREPS allows multi-day tenures, making this too restrictive.

Correct Answer: C. Vaghul Committee

• **Vaghul Committee** = the Vaghul Working Group on the Money Market (1987) recommended introducing Commercial Paper in India. • **1990 launch** — following the Vaghul Committee's recommendation, CP was introduced in India in 1990 to modernise money market instruments. • 💡 Wrong-option analysis: [Raghuram Rajan Committee]: focused on financial sector reforms in a later period; [Urjit Patel Committee]: recommended changes to the monetary policy framework, specifically inflation targeting; [Narasimham Committee]: focused on banking sector reforms, not money market instruments specifically.

Correct Answer: B. T+0 or T+1

• **T+0 or T+1** = money market secondary market trades in India are settled on the same day or the next working day for rapid liquidity management. • **Speed essential** — fast settlement ensures that banks can manage their statutory reserve requirements on a daily basis without liquidity gaps. • 💡 Wrong-option analysis: [T+2]: a settlement cycle used for equity shares in India, not money market instruments; [T+3]: even slower; not the standard for money market trades; [T+5]: far too delayed for the short-term nature of money market instruments.

Correct Answer: D. Risk of government default

• **Risk of government default** = Sovereign Risk is the probability that a national government will fail to repay its debt obligations. • **Zero domestic sovereign risk** — T-Bills carry virtually zero sovereign risk in domestic currency since the government can print money to repay. • 💡 Wrong-option analysis: [Risk of theft]: a physical security risk, not a financial market term; [Risk of bank failure]: that is called 'credit risk' or 'counterparty risk', not sovereign risk; [Risk of stock market crash]: equity market volatility is 'market risk', not sovereign risk.

Correct Answer: A. Call Money Market

• **Call Money Market** = a pure inter-bank market where only commercial banks and Primary Dealers can borrow and lend overnight funds. • **Non-banks phased out** — insurance companies and mutual funds were progressively restricted from the call market to give RBI tighter control over liquidity. • 💡 Wrong-option analysis: [Commercial Paper Market]: open to corporates and institutional investors, not exclusively banks; [Gold Market]: open to multiple participants including the general public; [Stock Market]: open to any registered investor.