Study on Call Money & Commercial Paper Market

TERM PAPERONSTUDY OF CALL MONEY MARKET & COMMERCIAL PAPER MARKET ININDIAN MARKETCOURSE: FINANCIAL INSTITUTIONAL SERVICESCOURSE CODE: MGT 523

Submitted To:Gagandeep Bhatara

Submitted By:Varun Puri

Reg. No.: 10800464

Lovely School of Business

Lovely Professional University

Contents

Introduction to Money Market ...............................................................................................(1)

Objectives of Money Market History of Indian Money Market

Money Market Instruments .....................................................................................................(3)

Review of Literature ..................................................................................................................(4)

Call Money Market ......................................................................................................................(5) Meaning Volume of Call Money Market Committee Recommendations on Call Money Market Participants in the Call Money Market Call Money rates Prudential Limits Reporting Requirements The Hows & Whys of the Call Money Market

Commercial Papers .................................................................................................................(13) Meaning Salient Features Advantages / Disadvantages Issuance Process RBI Guidelines Growth in The Commercial Paper Market CP Market in India Vs. CP Market in other Parts of World Factors Hampering Growth of CP Market

References...................................................................................................................................(25)

1Study on Call Money Market &Commercial Paper Market

Introduction- Money Market

Money market refers to the market where money and highly liquid marketablesecurities are bought and sold having a maturity period of one or less than one year. It isnot a place like the stock market but an activity conducted by telephone. The moneymarket constitutes a very important segment of the Indian financial system.The highly liquid marketable securities are also called as ‘ money market instruments’like treasury bills, government securities, commercial paper, certificates of deposit, callmoney, repurchase agreements etc.The major player in the money market are Reserve Bank of India (RBI), Discount andFinance House of India (DFHI), banks, financial institutions, mutual funds, government,big corporate houses. The basic aim of dealing in money market instruments is to fill thegap of short-term liquidity problems or to deploy the short-term surplus to gain incomeon that.Definition of Money Market:

According to the McGraw Hill Dictionary of Modern Economics, “money market isthe term designed to include the financial institutions which handle the purchase, sale,and transfers of short term credit instruments. The money market includes the entiremachinery for the channelizing of short-term funds. Concerned primarily with smallbusiness needs for working capital, individual’s borrowings, and government short termobligations, it differs from the long term or capital market which devotes its attention todealings in bonds, corporate stock and mortgage credit.”According to the Reserve Bank of India, “money market is the centre for dealing,mainly of short term character, in money assets; it meets the short term requirementsof borrowings and provides liquidity or cash to the lenders. It is the place where shortterm surplus investible funds at the disposal of financial and other institutions andindividuals are bid by borrowers’ agents comprising institutions and individuals andalso the government itself.”


According to the Geoffrey, “money market is the collective name given to the variousfirms and institutions that deal in the various grades of the near money.”So after analyzing the above definitions, we can easily conclude with the followingfeatures of MONEY MARKET.

Short-term funds are borrowed and lent. No fixed place for conduct of operations, the transactions being conducted evenover the phone and therefore, there is an essential need for the presence of welldeveloped communications system. Dealings may be conducted with or without the help the brokers. The short-term financial assets that are dealt in are close substitutes for money,financial assets being converted into money with ease, speed, without loss andwith minimum transaction cost. Funds are traded for a maximum period of one year. Presence of a large number of submarkets such as inter-bank call money, billrediscounting, and treasury bills, etc. Short term credit is involve Institutions involved in channelizing short term credit Concerned with operating needs of financial institutions To fulfil short term obligations by government. Providing an equilibrium mechanism for ironing out short-term surplus anddeficits. Providing a focal point for central bank intervention for the influencing liquidityin the economy

Objectives of Money Market:A well developed money market serves the following objectives: Providing an equilibrium mechanism for ironing out short-term surplus anddeficits. Providing a focal point for central bank intervention for the influencing liquidityin the economy.


Providing access to users of short-term money to meet their requirements at areasonable price.History of Indian Money Market:Till 1935, when the RBI was set up the Indian money market remained highly,unorganized, shallow, disintegrated, narrow and therefore, very backward. The plannedeconomic development that commenced in the year 1951 market an importantbeginning in the annals of the Indian money market. The nationalization of banks in1969, setting up of various committees such as the Sukhmoy Chakraborty Committee(1982), the Vaghul working group (1986), the setting up of discount and finance houseof India ltd. (1988), the securities trading corporation of India (1994) and thecommencement of liberalization and globalization process in 1991 gave a further fillipfor the integrated and efficient development of India money market.

Money Market InstrumentsMoney market instruments are generally characterized by a high degree of safety ofprincipal and are most commonly issued in units of $1 million or more. Maturities rangefrom one day to one year; the most common are three months or less. Active secondarymarkets for most of the instruments allow them to be sold prior to maturity. Unlikeorganized securities or commodities exchanges, the money market has no specificlocation.Available from financial institutions, money markets give the smaller investor theopportunity to get in on treasury securities. The institution buys a variety of treasurysecurities with the money you invest. The rate of return changes daily, and services suchas check writing may be offered. The major participants in the money market arecommercial banks, governments, corporations, government-sponsored enterprises,money market mutual funds; futures market exchanges, brokers and dealers.Investment in money market is done through money market instruments. Moneymarket instrument meets short term requirements of the borrowers and providesliquidity to the lenders. Common Money Market Instruments are as follows:1. Treasury Bills2. Repurchase Agreements (Repo/Reverse Repo)3. Call Money4. Commercial paper5. Certificate of Deposits6. Bankers Acceptance


Review of Literature

Article: India call money ends near reverse repo rate, cash ampleReuters, 2/9/2009, Indian overnight money rates brought down to near the reverserepo rate of 3.25% on Wednesday as this cash surplus in the system will help banksmeet their reserve needs comfortably. Cheaper money available at the collateralisedborrowing and lending obligation (CBLO) also eased pressure on the inter-bank cashrates. At that day banks were guided to report their position to RBI once in two weeks.This amendment crated a expectation on liquidity resistance. Some analysts said thecentral bank may start rolling back the liquidity as early as December 2009, as thealready pressured consumer prices could pose significant inflationary threat to theeconomy, amid easy cash conditions Overnight rates are supported around the reverserepo rate because banks holding surplus funds could also deploy the same with centralbank at that rate in its daily liquidity adjustment auctions.Article: Money Market Integration in India: A Time Series StudyRastogi Nikhil, Says Indian financial markets have come a long way from the highlycontrolled pre-liberalization era. He signifies that the main focus is on achievingefficiency, which is the hallmark of any developed financial market. This research papertests the efficiency and extent of integration between financial markets empirically atthe short end of the market. The rates, mainly taken for the purpose of this study,comprise the call market rate, CD (Certificate of Deposit) rate, CP (Commercial Paper)rate, 91-day T-bill (Treasury bill) rate and 3-month forward premium. The results,though promising, are mixed.in his research he concluded that although markets haveachieved integration in some of its branches, they have still to achieve full integration.This has absolute implications on the monetary policy of the Reserve Bank of India(RBI) since changes in one market (gilt market) can be used to regulate the othermarket (forex market).Article: Market efficiency and financial markets integration in IndiaPrusty Sadananda, June, 2007 The author explored the impact of economic reforms onthe integration of various segments of the financial market in India through the time


series tools during the period from March 1993 to March 2005. The major findingswere: (i) various segments of the financial market in India have achieved marketefficiency, (ii) the 91-day Treasury bill rate is the appropriate 'reference rate' of thefinancial sector in India, (iii) the financial markets in India are largely integrated at theshort-end of the market, and (iv) the long-end of the market is integrated with theshort-end of the market. The above findings suggest that monetary policy should relymore on interest rate and asset price channels to control inflation.Call /Notice Money-Money Market

Meaning:Call/Notice money is the money borrowed or lent on demand for a very short period.When money is borrowed or lent for a day, it is known as Call (Overnight) Money.Intervening holidays and/or Sunday are excluded for this purpose. Thus money,borrowed on a day and repaid on the next working day, (irrespective of the number ofintervening holidays) is "Call Money". When money is borrowed or lent for more than aday and up to 14 days, it is "Notice Money". No collateral security is required to coverthese transactions.The call/notice money market forms an important segment of the Indian Money Market.Under call money market, funds are transacted on overnight basis and under noticemoney market; funds are transacted for the period between 2 days and 14 days. Themost active segment of the money market has been the call money market, where theday to day imbalances in the funds position of scheduled commercial banks are easedout. The call notice money market has graduated into a broad and vibrant institution.Participants in call/notice money market currently include banks (excluding RRBs) andPrimary dealers both as borrowers and lenders. Non Bank institutions are notpermitted in the call/notice money market with effect from August 6, 2005. Theregulator has prescribed limits on the banks and primary dealers operation in thecall/notice money market.


Call money market is for very short term funds, known as money on call. The rate atwhich funds are borrowed in this market is called `Call Money rate'. The size of themarket for these funds in India is between Rs 60,000 million to Rs 70,000 million, ofwhich public sector banks account for 80% of borrowings and foreign banks/privatesector banks account for the balance 20%. Non-bank financial institutions like IDBI, LIC,and GIC etc participate only as lenders in this market. 80% of the requirement of callmoney funds is met by the nonbank participants and 20% from the banking system.In pursuance of the announcement made in the Annual Policy Statement of April 2006,an electronic screen-based negotiated quote-driven system for all dealings in call/noticeand term money market was operationalized with effect from September 18, 2006. Thissystem has been developed by Clearing Corporation of India Ltd. on behalf of theReserve Bank of India. The NDS -CALL system provides an electronic dealing platformwith features like Direct one to one negotiation, real time quote and trade information,preferred counterparty setup, online exposure limit monitoring, online regulatory limitmonitoring, dealing in call, notice and term money, dealing facilitated for T+0settlement type for Call Money and dealing facilitated for T+0 and T+1 settlement typefor Notice and Term Money. Information on previous dealt rates, ongoing bids/offers onre al time basis imparts greater transparency and facilitates better rate discovery in thecall money market. The system has also helped to improve the ease of transactions,increased operational efficiency and resolve problems associated with asymmetry ofinformation. However, participation on this platform is optional and currently both theelectronic platform and the telephonic market are co-existing. After the introduction ofNDS-CALL, market participants have increasingly started using this new system more soduring times of high volatility in call rates.Volumes in the Call Money Market:Call markets represent the most active segment of the money markets. Though thedemand for funds in the call market is mainly governed by the banks' need for resourcesto meet their statutory reserve requirements, it also offers to some participants aregular funding source for building up short -term assets. However, the demand forfunds for reserve requirements dominates any other demand in the market. Figure 4.1displays the average daily volumes in the call markets.


Figure 1: Average Daily Volumes in the Call Market (Rs. cr.)

Committee Recommendation on Call Money Market:

The Sukhumoy Chakravarty Committee:The call money market for India was first recommended by the Sukhumoy ChakravartyCommittee, which was set up in 1982 to review the working of the monetary system.They felt that allowing additional non-bank participants into the call market would notdilute the strength of monetary regulation by the RBI, as resources from non-bankparticipants do not represent any additional resource for the system as a whole, andtheir participation in call money market would only imply a redistribution of existingresources from one participant to another. In view of this, the Chakravarty Committeerecommended that additional nonbank participants may be allowed to participate incall money market.The Vaghul Committee Report:The Vaghul Committee (1990), while recommending the introduction of a number ofmoney market instruments to broaden and deepen the money market, recommendedthat the call markets should be restricted to banks. The other participants could choosefrom the new money market instruments, for their short -term requirements. One of thereasons the committee ascribed to keeping the call markets as pure inter-bank markets


was the distortions that would arise in an environment where deposit rates wereregulated, while call rates were market determined.The Narasimham Committee II Report:The Narasimham Committee II (1998) also recommended that call money market inIndia, like in most other developed markets, should be strictly restricted to banks andprimary dealers. Since non- bank participants are not subject to reserve requirements,the Committee felt that such participants should use the other money marketinstruments, and move out of the call markets.Following the recommendations of the Reserve Banks Internal Working Group (1997)and the Narasimhan Committee (1998), steps were taken to reform the call moneymarket by transforming it into a pure interbank market in a phased manner. The non-banks exit was implemented in four stages beginning May 2001 whereby limits onlending by nonbanks were progressively reduced along with the operationalisation ofnegotiated dealing system (NDS) and CCIL until their complete withdrawal in August2005. In order to create avenues for deployment of funds by non-banks following theirphased exit from the call money market, several new instruments were created such asmarket repos and CBLO.Various reform measures have imparted stability to the call money market. With thetransformation of the call money market into a pure inter-bank market, the turnover inthe call/notice money market has declined significantly. The activity has migrated toother overnight collateralized market segments such as market repo and CBLO.Participants in the Call Money Market:

As lenders and borrowers: Banks and institutions such as commercialbanks, both Indian and foreign, State Bank of India, Cooperative Banks,Discount and Finance House of India ltd. (DFHL) and Securities TradingCorporation of India (STCI). As lenders: Life Insurance Corporation of India (LIC), Unit Trust of India(UTI), General Insurance Corporation (GIC), Industrial Development Bankof India (IDBI), National Bank for Agriculture and Rural Development


(NABARD), specified institutions already operating in bills rediscountingmarket, and entities/corporate/mutual funds.The participants in the call markets increased in the 1990s, with a gradual opening up ofthe call markets to non-bank entities. Initially DFHI was the only PD eligible toparticipate in the call market, with other PDs having to route their transactions throughDFHI, and subsequently STCI. In 1996, PDs apart from DFHI and STCI were allowed toend and borrow directly in the call markets. Presently there are 18 primary dealersparticipating in the call markets. Then from 1991 onwards, corporates were allowed tolend in the call markets, initially through the DFHI, and later through any of the PDs. Inorder to be able to lend, corporates had to provide proof of bulk lendable resources tothe RBI and were not suppose to have any outstanding borrowings with the bankingsystem. The minimum amount corporates had to lend was reduced from Rs. 20 crore, ina phased manner to Rs. 3 crore in 1998. There were 50 corporates eligible to lend in thecall markets, through the primary dealers. The corporates which were allowed to routetheir transactions through PDs, were phased out by end June 2001.Table: Number of Participants in Call/Notice Money Market

Source: Report of the Technical Group on Phasing Out of Non-banks from Call/NoticeMoney Market, March 2001.Banks and PDs technically can operate on both sides of the call market, though inreality, only the P Ds borrow and lend in the call markets. The bank participants aredivided into two categories: banks which are pre- dominantly lenders (mostly the publicsector banks) and banks which are pre- dominantly borrowers (foreign and privatesector banks). Currently, the participants in the call/notice money market currentlyinclude banks (excluding RRBs) and Primary Dealers (PDs) both as borrowers andlenders.


Call Money Rates:The rate of interest on call funds is called money rate. Call money rates arecharacteristics in that they are found to be having seasonal and daily variationsrequiring intervention by RBI and other institutions.The concentration in the borrowing and lending side of the call markets impactsliquidity in the call markets. The presence or absence of important players is asignificant influence on quantity as well as price. This leads to a lack of depth and highlevels of volatility in call rates, when the participant structure on the lending orborrowing side alters.Short-term liquidity conditions impact the call rates the most. On the supply side thecall rates are influenced by factors such as: deposit mobilization of banks, capital

flows, and banks’ reserve requirements; and on the demand side, call rates areinfluenced by tax outflows, government borrowing programme, seasonal

fluctuations in credit off take. The external situation and the behaviour of exchange

rates also have an influence on call rates, as most players in this market run integratedtreasuries that hold short term positions in both rupee and forex markets, deployingand borrowing funds through call markets.


Table 2: Call Money Rates

Source: Handbook of Statistics on Indian Economy, 2005-10, RBIDuring normal times, call rates hover in a range between the repo rate and the reverserepo rate. The repo rate represents an avenue for parking short -term funds, and duringperiods of easy liquidity, call rates are only slightly above the repo rates. During periodsof tight liquidity, call rates move towards the reverse repo rate. Table provides data onthe behaviour of call rates. Table: displays the trend of average monthly call rates.The behaviour of call rates has historically been influenced by liquidity conditions in themarket. Call rates touched a peak of about80% in March 2006-07, reflecting tightliquidity on account of high levels of statutory pre-emptions and withdrawal of allrefinance facilities, barring export credit refinance.


Prudential Limits:The prudential limits in respect of both outstanding borrowing and lending transactionsin call/notice money market for banks and PDs are as follows:-Table : Prudential Limits for Transactions in Call/Notice Money Market

Non-bank institutions are not permitted in the call/notice money market with effectfrom August 6, 2005.Reporting Requirements:All dealings in call/notice money on screen-based negotiated quote-driven system(NDS-CALL) launched since September 18, 2007 do not require separate reporting. It ismandatory for all Negotiated Dealing System (NDS) members to report their call/noticemoney market deals (other than those done on NDS-CALL) on NDS. Deals should bereported within 15 minutes on NDS, irrespective of the size of the deal or whether thecounterparty is a member of the NDS or not. In case there is repeated non-reporting ofdeals by an NDS member, it will be considered whether non-reported deals by thatmember should be treated as invalid.The reporting time on NDS is up to 5.00 pm on weekdays and 2.30 pm on Saturdays oras decided by RBI from time to time.With the stabilisation of reporting of call/notice money transactions over NDS as also toreduce reporting burden, the practice of reporting of call/notice/term moneytransactions by fax to RBI has been discontinued with effect from December 11, 2004.


However, deals between non-NDS members will continue to be reported to theFinancial Markets Department (FMD) of RBI by fax as hitherto.The hows and whys of the call money market:

Why does a bank borrow in the call market?Banks borrow in the call market to meet any temporary shortfall PROBELAM OFLiquidity funds on any given day. There are mainly two reasons why a bank may facesuch a shortfall. Banks normally lend out of the deposits that they mobilize. But thereare temporary gaps, or mismatches. The call money market is used to manage thesegaps.The second reason is to meet the cash reserve ratio (CRR) which is the cash reserves itmust maintain with the Reserve Bank of India, to meet daily cash needs of the banks’clientele. In India, banks have to keep 4.5 per cent(it fluctuates with changing economicconditions) of all their borrowings from the public (in the form of savings and termdeposits) and other banks with RBI. The CRR is calculated on the basis of the bank’sborrowing or net time and demand liabilities (NDTL), broadly its deposit base, everyalternate Friday. This day is also called the reporting Friday, on which the banks reporttheir positions to the RBI.For how long can a bank borrow these funds?Technically, the call money market is an overnight money market. But a bank canborrow these funds for one day up to 14 days. Normally, funds are borrowed for oneday, and up to three days on weekends.How is the rate of interest paid?The rate of interest is calculated on a daily basis; but the rate quoted in the market is anannualized one. Once the deal is struck the funds are immediately available to theborrowing bank and are returned with interest the next day. The funds are lent and paidback through a banker’s pay order which is cleared by the special high value banker’sclearing cell in the RBI.Can the RBI lend in the call market? What does intervention by the central bankmean?The RBI is the market regulator and cannot lend or borrow funds in the call market.However, as a regulator, it can intervene in the market as it did when rates go through


the roof. It intervenes in the market through two market intermediaries – the

Securities Trading Corporation of India and Discount Finance House of India. TheSTCI lends funds against the government securities that a bank holds with an offer tosell back the security (called repurchases or repos), while the DFHI lends funds that itreceives from the central bank against repos of certain securities specified aseligible for them. The RBI also allows banks to rediscount proceeds of export bills ofexchange.Why do rates fluctuate? What does this indicate?The rates fluctuate in the market depending on the demand and supply of money inthe market. High rates indicate a tightness of liquidity position. In India, rates in the callmarket are prone to fluctuations and are unidirectional. This is due to the fact that it hasa limited number of players whose needs are similar.

Commercial Papers:

Commercial Paper (CP) is an unsecured money market instrument issued in the form ofa promissory note. It was introduced in India in 1990 with a view to enabling highlyrated corporate borrowers/ to diversify their sources of short-term borrowings and toprovide an additional instrument to investors. Subsequently, primary dealers andsatellite dealers were also permitted to issue CP to enable them to meet their short-term funding requirements for their operations.A commercial paper is an unsecured short-term instrument issued by the large banksand corporations in the form of promissory note, negotiable and transferable byendorsement and delivery with a fixed maturity period to meet the short-term financialrequirement. There are four basic kinds of commercial paper: promissory notes, drafts,checks, and certificates of deposit.It is generally issued at a discount by the leading creditworthy and highly ratedcorporates.Depending upon the issuing company, a commercial paper is also known as “Financialpaper, industrial paper or corporate paper”. Commercial paper was initially meant to be


used by the corporates borrowers having good ranking in the market as established bya credit rating agency to diversify their sources of short term borrowings at a rate whichwas usually lower than the bank’s working capital lending rate.Commercial papers can now be issued by primary dealers, satellite dealers, and all-India financial institutions, apart from corporatist, to access short-term funds. Effectivefrom 6th September 1996 and 17th June 1998, primary dealers and satellite dealerswere also permitted to issue commercial paper to access greater volume of funds tohelp increase their activities in the secondary market. It can be issued to individuals,banks, and companies and other registered Indian corporate bodies and unincorporatedbodies. It is issued at a discount determined by the issuer company. The discount varieswith the credit rating of the issuer company and the demand and the supply position inthe money market. In India, the emergence of commercial paper has added a newdimension to the money market.Salient Features

They are unsecured debts of corporates and are issued in the form of promissorynotes, redeemable at par to the holder at maturity. Only corporates who get an investment grade rating can issue CPs, as per RBIrules. It is issued at a discount to face value Attracts issuance stamp duty in primary issue Has to be mandatorily rated by one of the credit rating agencies It is issued as per RBI guidelines It’s held in Demat form CP can be issued in denominations of Rs.5 lakh or multiples thereof. Amountinvested by a single investor should not be less than Rs.5 lakh (face value). Issued at discount to face value as may be determined by the issuer. Bank and FI’s are prohibited from issuance and underwriting of CP’s. Can be issued for a maturity for a minimum of 15 days and a maximum upto oneyear from the date of issue.


Figure Commercial Paper Issue Mechanism

Advantage of commercial paper:

High credit ratings fetch a lower cost of capital. Wide range of maturity provides more flexibility. It does not create any lien on asset of the company. Tradability of Commercial Paper provides investors with exit options.

Disadvantages of commercial paper:

Its usage is limited to only blue chip companies. Issuances of Commercial Paper bring down the bank credit limits. A high degree of control is exercised on issue of Commercial Paper. Stand-by-credit may become necessary.

Issuance Process of Commercial Paper:In the developed economies, a substantial portion of working capital requirementespecially those that are short-term, is promptly met through flotation of commercialpaper. Directly accessing market by issuing short-term promissory notes, backed bystand-by or underwriting facility enables the corporate to leverage its rating to save oninterest costs.


Typically commercial paper is sold at a discount to its face value and is redeemed at facevalue. Hence, the implicit interest rate is function of the size of discount and the periodof maturity. Scheduled commercial banks are major investors in commercial paper andtheir investment is determined by bank liquidity conditions. Banks prefer commercialpaper as an investment avenue rather than sanctioning bank loan. These loans involvehigh transaction costs and money is locked for a longer time period whereas acommercial paper is an attractive short-term instrument for banks to park funds duringtimes of high liquidity. Some banks fund commercial papers by borrowing from the callmoney market. Usually, the call money market rates are lower than the commercialpaper rates. Hence, banks book profits through arbitraged between the two moneymarkets. Moreover, the issuance of commercial papers has been generally observed tobe invested related to the money market rates.Illustration 3.1.X co.ltd issued commercial paper as per following details:Date of issue 17th January, 2009 No. of days 90 daysDate of maturity 17th April, 2009 Interest rate 11.25% p.a.What was the net amount received by the company on issue of commercial paper?Let us assume that the company has issued commercial paper worth Rs.10 crores?No of days = 90 daysInterest rate = 11.25 % p.a.Interest for 90 days = 11.25% p.a. X 90 days/ 365 days = 2.774%= 10 crores X 2.774 / 100+2.774 = Rs. 26, 99,126 crores= or 0.27 croresTherefore, net amount received at the time of issue = 10 crores –0.27 crores = Rs. 9.73 crores

RBI Guidelines on Issue of Commercial Paper:The summary of RBI guidelines for issue of Commercial paper is given below: Corporate, primary dealers, satellite dealers and all India financial institutionsare permitted to raise short term finance through issue of commercial paper,which should be within the umbrella limit fixed by RBI.


A corporate can issue Commercial Paper if:1. Its tangible net worth is not less than Rs.5 crores as per latestbalance sheet.2. Working capital limit is obtained from banks/ all India financialinstitutions, and3. Its borrowable account is classified as standard asset by banks/ allIndia financial institutions. Credit rating should be obtained by all eligible participants in cp issue from thespecified credit rating agencies like CRISIL, ICRA, CARE, and FITCH. Theminimum rating shall be equivalent to P-2 of CRISIL. Commercial paper can be issued for maturities between a minimum of 15 daysand a maximum of up to one year from the date of issue. The maturity date of commercial paper should not exceed the date beyond thedate up to which credit rating is valid. It can be issued in denomination of Rs. 5 lakhs or in multiples thereof. Amount invested by a single investor should not be less than Rs. 5 lakhs (facevalue). A company can issue commercial paper to an aggregate amount within the limitapproved by board of directors or limit specified by credit rating agency,whichever is lower. Banks and financial institutions have the flexibility to fix working capital limitsduly taking into account the resource pattern of company’s financing includingcommercial papers. The total amount of commercial paper proposed to be issued should be raisedwithin a period of two weeks from the date on which the issuer opens the issuefor subscription. Commercial paper may be issued on a single date or in parts on different datedprovided that in the latter case, each commercial paper shall have the samematurity date. Every commercial paper should be reported to RBI through issuing and payingagent (IPA). Only a scheduled bank can act as an IPA.


Commercial paper can be subscribed by individuals, banking companies,corporate, NRIs and FIIs. It can be issued either in the form of a promissory note or in a dematerialisedform. It will be issued at a discount to face value as may be determined by the issuer. Issue of commercial paper should not be underwritten or co-accepted. The initial investor in commercial paper shall pay the discounted value of thecommercial paper by means of a crossed account payee cheque to the account ofthe issuer through IPA. On maturity, if commercial paper is held in physical form, the holder ofcommercial paper shall present the investment for payment to the issuerthrough IPA. When the commercial paper is held in De-mat form, the holder of commercialpaper will have to get it redeemed through depository and received paymentfrom the IPA. Commercial paper is issued as a ‘stand alone’ product. It would not be obligatoryfor banks and financial institutions to provide stand-by facility to issuers ofcommercial paper. Every issue of commercial paper, including renewal, should be treated as a freshissue.

Growth in the Commercial Paper Market:Commercial paper was introduced in India in January 1990, in pursuance of the VaghulCommittee’s recommendations, in order to enable highly rated non-bank corporateborrowers to diversify their sources of short term borrowings and also provide anadditional instrument to investors. Commercial paper could carry on an interest ratecoupon but is generally sold at a discount. Since commercial paper is freely transferable,banks, financial institutions, insurance companies and others are able to invest theirshort-term surplus funds in a highly liquid instrument at attractive rates of return.A major reform to impart a measure of independence to the commercial paper markettook place when the ‘stand by’ facility* of the restoration of the cash credit limit andguaranteeing funds to the issuer on maturity of the paper was withdrawn in October


1994. As the reduction in cash credit portion of the MPBF impeded the development ofthe commercial paper market, the issuance of commercial paper was delinked from thecash credit limit in October 1997. It was converted into a standalone product fromOctober 2000 so as to enable the issuers of the service sector to meet short-termworking capital requirements.Banks are allowed to fix working capital limits after taking into account the resourcepattern of the company’s finances, including commercial papers. Corporates, PDs andall-India financial institutions (FIs) under specified stipulations have permitted to raiseshort term resources by the Reserve Bank through the issue of commercial papers.There is no lock in period for commercial papers. Furthermore, guidelines were issuedpermitting investments in commercial papers which has enabled a reduction intransaction cost.In order to rationalize the and standardize wherever possible, various aspects ofprocessing, settlement and documentation of commercial paper issuance, severalmeasures were undertaken with a view to achieving the settlement on T+1 basis. Forfurther deepening the market, the Reserve Bank of India issued draft guidelines onsecuritisation of standard assets on April 4, 2005.Accordingly the reporting of commercial papers issuance by issuing and paying agents(IPAs) on NDS platform commenced effective on April 16, 2005. Activity in thecommercial paper market reflects the state of market liquidity as its issuances tend torise amidst ample liquidity conditions when companies can raise funds throughcommercial papers at an effective rate of discount lower than the lending rate of bonds.Banks also prefer investing in commercial papers during credit downswing as thecommercial paper rate works out higher than the call rate. Table shows the trends incommercial papers rates and amounts outstanding.


Table Commercial Papers - Trends in Volumes and Discount Rates.

Characteristics of CP Market in India vis-à-vis Other Major CP Markets in theWorld

IssuersInitially, only highly rated corporate borrowers were allowed to issue CP to diversifytheirshort-term borrowings. Primary Dealers (PDs) were allowed in this market, subject tofulfilling the eligibility criteria, on April 15, 1997. Thereafter, all-India financialinstitutions (FIs) that have been permitted to raise short-term resources underumbrella limit fixed by RBI were permitted to issue CP since October 10, 2000.Internationally, there is no restriction on issuers in UK. In USA, both financial andnonfinancial issuers are allowed to issue CP. In France, CPs are mainly issued byinvestment firms, public companies, community institutions and internationalorganisations of which France is a member.


Maturity PeriodInitially, corporates were permitted to issue CP with a maturity between a minimum ofthree months and a maximum of upto six months from the date of issue. Since October18, 1993, the maximum maturity period of CP was increased to less than one year.Subsequently, the minimum maturity period had been reduced from time to time andsince May 25, 1998, it was reduced to 15 days. Presently, CP can be issued for maturityperiod between a minimum of 15 days and a maximum upto one year from the date ofissue.As against this, in USA, there is no prescription of minimum and maximum maturityperiod of CP but for practical matter, it is limited upto 270 days. However, 1-day to 7-day CPs is very popular of which 1-day CP constitutes the substantial component of theCP market. In UK also, there is no restriction but in France, initial maturity ranges from1 day to up to 1 year.Credit RatingsAll eligible participants are required to obtain credit rating for issuance of CP fromeither the Credit Rating Information Services of India Ltd. (CRISIL) or such other creditrating agency (CRA) as approved by the Securities and Exchange Board of India (SEBI)from time to time for the purpose. Initially, the minimum credit rating was stipulated atP1+ of CRISIL. It was softened to P1 of CRISIL or such equivalent rating by otheragencies on April 24, 1990 and further to P2 of CRISIL or its equivalent on May 13,1992. As of now, the minimum credit rating shall be P2 of CRISIL or its equivalent.In UK, France and USA, rating is not compulsory. However, in US, CPs should generallyhave the rating of A1/P1 (the highest category) for generating investor interest.Limits and the Amount of Issue of CPThe entry criteria for issuance of CP have been relaxed considerably over the years. In1990, a corporate was eligible to issue CP provided the tangible net worth of thecompany, as per the latest audited balance sheet, was not less than Rs.10 crore. Thiswas reduced to Rs.5 crore on April 24, 1990 and further to Rs.4 crore on October 18,1993. Also, initially, issuance of CP had to be carved out of the working capital (fundbased) limit. Accordingly, in 1990, a company could issue CP upto 20 per cent of its


working capital (fund based) limit which was stipulated to be not less than Rs.25 crore.Thereafter, while the working capital limit had been reduced progressively to enablemore corporates to issue CP, the amount to be carved out of the working capital limit forissuance of CP was also increased over the years for facilitating the growth of thismarket. Accordingly, while the working capital (fund based) limit was reduced to "notless than Rs.4" crore on October 18, 1993, the amount of CP that could be issued out ofthe working capital was also raised upto 100 per cent of the companies' working capitallimit of Rs.20 crore or more since June 20, 1996.The organic link of issuance of CP in relation to working capital (fund based) limit wassevered on October 10, 2000 when CP was allowed to be issued as a "stand alone"product.The aggregate amount of CP from an issuer, however, has to be within the limit asapproved by its Board of Directors or the quantum indicated by the credit rating agencyfor the specified rating, whichever is lower. Banks and FIs, however, have the flexibilityto fix working capital limits duly taking into account the resource pattern of companies’financing needs including CPs. An FI can issue CP within the overall umbrella limit fixedby the RBI i.e., issue of CP together with other instruments viz., term money borrowings,term deposits, certificates of deposit and inter-corporate deposits should not exceed100 per cent of its net owned funds, as per the latest audited balance sheet.In USA and UK, there is no limit on the amount of CP that the entities may issue.DenominationAt the time of introduction, with effect from January 1, 1990, it was stipulated that CPmay be issued in multiple of Rs.25 lakh and the amount to be invested by a singleinvestor should not to be less than Rs.1 crore (face value). Subsequently, on April 24,1990, the minimum denomination was reduced to Rs.10 lakh and amount to be investedby a single investor was also reduced to Rs.50 lakh. At present, CP can be issued indenominations of Rs.5 lakh or multiple thereof and amount invested by a single investorshould not be less than Rs.5 lakh (face value).


Internationally, in USA, there is no required minimum size of issue. However, it isusually issued in minimum denomination of $1,00,000. In France, the minimum amountstands at EUR 1,50,000 and in UK, it stands at EUR 40,000.Investors in the CP MarketInitially, it was stipulated that CP can be issued to and held by individuals, banks,companies, other corporate bodies registered or incorporated in India andunincorporated bodies. CP may be issued to a non-resident Indian (NRI) on a non-repatriation basis and that those CPs shall not be transferable. Also, ForeignInstitutional Investors (FIIs) were added as eligible investors in CP market in October2000. However, investment by FIIs would be within the limits set for their investmentsby SEBI.In USA, investors include money market mutual funds, banks, insurance companies andpension funds.DematerialisationWith effect from June 30, 2001, banks, FIs and PDs have been encouraged to make freshinvestments and hold CP only in dematerialised form. Outstanding investments in scripform in the books of banks, FIs and PDs were to be converted into dematerialised formby October 31, 2001.Internationally, in USA and France, CPs are issued in dematerialized form. In UK, fullydematerialized system does not exist though by market convention, Euro CP is issued inthe form of an immobilized global certificate lodged with a central depository e.g.,Euroclear/Clearstream.Factors Hampering Growth of CP MarketSome of the factors which have hampered active growth of CP market in India are asfollows:(i) The linking of CP to working capital limits. Market participants havesuggested that CP should be made a "stand alone" product.(ii) At present, for issuance of CP approval or NOC is required from theFinancing Banking Company. This NOC/approval is valid for a period of


two weeks from the date of its issuance. Furthermore, rating for theissuance of CP has to be current and not more than 2 months old. Marketparticipants perceive these stipulations as impediments to thedevelopment of CP market.(iii) The difference in stamp duty rates as between banks and other entitieshas created operational difficulties. There is at present, inter-statedisparities as also investor-wise differences in stamp duty rates. Further,there is tenor-wise slab structure of stamp duty as given below:Tenor Rate for

Banks Non-banks

Upto 90 days 0.05 0.125

91 - 180 days 0.15 0.375

181 - 364 days 0.20 0.50Secondary market transactions in CP, however, do not attract any stamp duty.This divergence in stamp duty for banks and non-banks has created some distortionsin the market and also encouraged some mal-practices. All primary issues of CP arealmost exclusively subscribed to by banks and non-banks buy CP from banks inthe secondary market. Further, CP issues with maturity of less than 90 days aregenerally not preferred.(iv) Procedure to issue CP in physical form is quite cumbersome. Theconcerned corporates have to arrange for stamping of all the certificates,which is time consuming. Furthermore, copies of all the documents haveto be given to all the investors along with the CP certificate.(v) No reliable bench mark is available in the market for pricing CP.


References

Research Paper:

Ghosh and Bhattacharyya, Spread, Volatility and Monetary Policy: Emprical

Evidences from the Indian Overnight Money Market,pg1

Books

Vshaley & Mittal, Call Money Market, p1.90Internet

http://www.rbi.org.in/scripts/NotificationUser.aspx?Id=254&Mode=0 http://www.rbi.org.in/scripts/NotificationUser.aspx?Id=254&Mode=0 http://www.rbi.org.in/scripts/PublicationReportDetails.aspx?UrlPage=&ID=179 http://www.rbi.org.in/scripts/PublicationReportDetails.aspx?UrlPage=&ID=179 http://www.livemint.com/2009/09/02141025/India-call-money-ends-near-rev.html?d=1 http://findarticles.com/p/articles/mi_m1TSD/is_1_6/ai_n25012617/

http://www.rbi.org.in/scripts/NotificationUser.aspx

http://www.rbi.org.in/scripts/NotificationUser.aspx

http://www.rbi.org.in/scripts/PublicationReportDetails.aspx

http://www.rbi.org.in/scripts/PublicationReportDetails.aspx

http://www.livemint.com/2009/09/02141025/India-call-money-ends-near-

http://findarticles.com/p/articles/mi_m1TSD/is_1_6/ai_n25012617/

Study on Call Money & Commercial Paper Market

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