Humans almost universally love to have money and interact on markets virtually every day. The money markets though – a place where money is being borrowed and lent continuously – are hardly known. If it were not for the global financial crisis of 2008, this part of our financial system wouldn’t even be known to wider circles within the financial industry itself.  

However, money markets are not just any part of today’s vastly complex financial system. Total money market funds make up $4.51 trillion¹ in assets with a daily turnover of about $1.5 to 2 trillion. In terms of volume, this puts worldwide money markets just behind the global foreign exchange market, which is said² to do up to almost $7 trillion in volume per day.  

This enormous size begs the question: What are money markets? They represent an essential component of financial markets as they allow for short-term financing. This means that money on money markets is usually lent and borrowed for up to two years in duration. On average though, the length of a money market trade is about one week to one month. Furthermore, money market trades can either be unsecured or collateralized with the latter commonly being referred to as repurchase or repo agreements. And in terms of assets, the most important ones within money markets are government bills, commercial papers, deposits, federal funds as well as short-lived mortgage- and asset-backed securities. Especially for short-term papers, it is due to money markets that short-term securities were commoditized and became an integral financing tool within financial markets.   

Functions of the money markets 

The borrowers and lenders on money markets are entities that have access to such wholesale markets. It’s institutions like banks, big corporate treasuries, or public authorities. Money markets today serve three main functions: 

• Financing trade 
• Financing industry
• Financing banks  

Financing trade is one of the most important roles money markets play today and this is also how they emerged a long time ago. It already started with companies like the Dutch East India Company that needed to raise money for ships, so merchants and tradesmen could sail to foreign continents hunting for spices and other types of commodities. With ships financed through credit, these commodities were transferred back to Europe and sold for profits that would pay for the principal and interest. Up to this day, money markets still play a vital role in financing domestic as well as international trade.

Another important function of the money markets is to serve as a place for all sorts of industry actors to finance themselves. Through money markets, companies can secure short-term loans to meet their working capital requirements. Additionally, borrowing and lending conditions on money markets also influence conditions as well as the interest of long-term loans that are typically provided by the capital markets.  

The third pillar is the financing of commercial banks. Be it a regional bank or an international bank, they all tap into the money markets to finance or refinance themselves. This way, they can keep their liquidity levels at the required legal levels. When it comes to banks acting in the money markets, it usually boils down to one bank lending to another bank.  

The importance of money markets 

It cannot be understated: Money markets provide the necessary liquidity for the global financial system including capital markets. They make the world go round. Through a chain of agreements domestic banks – and almost any bank for that matter – are connected to the big money markets in the world. While they could theoretically tap into global money markets directly, in practice these so-called tier-2 banks go through other international tier-1 banks. The latter are globally spread out and have a direct connection to different money markets all over the world. As systemically relevant banks, these big banks generally act as liquidity providers for smaller banks, domestic corporates, and local public authorities.  

One can say that if money markets break down, the entire world would come to a standstill as liquidity would freeze up rather quickly. This has been particularly obvious with the great financial crisis of 2008 when central banks had to step in and backstop money markets because borrowing and lending among different banks – due to trust issues – dried up. The money markets truly are the cardiovascular system of finance and if they stop, blood circulation in this cardiovascular system stops with detrimental consequences.