Why companies use commercial papers as a source of funds: 

Why companies use commercial papers as a source of funds: 

Context

Commercial papers have become one of the popular routes for corporates to raise funds when compared with loans from banks in recent times.

What is a commercial paper?

• Commercial papers have become one of the popular routes for corporates to raise funds when compared with loans from banks in recent times.
• A commercial Paper (CP) is an unsecured loan raised by firms in money markets through instruments issued in the form of a promissory note.
• CPs can be issued for maturities between a minimum of 7 days and a maximum of up to one year from the date of issue.

What is the current scenario in the banking system?

• ICRA pointed out that the glut in bank deposits post demonetisation has resulted in surplus liquidity in the banking system being parked by banks under reverse repo with RBI the during September 2017.
• While the deposit inflows have been strong, credit growth has remained weak for banks.

Why is CPs popular?

Because of the following reasons

• Surplus liquidity
• Short-term borrowing rates in money markets have significantly declined post demonetisation and are much lower than the lowest benchmark lending rates of the banks
• banks cannot lend below the benchmark lending rates, firms with good ratings have preferred to meet short-term working capital requirements

Will this spike in commercial papers be sustained?

• Issuance of commercial papers will continue to remain strong till there is surplus liquidity in banks and short-term rates continue to be significantly lower than benchmark lending rates of the banks
• He also noted that a bank or mutual fund with surplus temporary liquidity will prefer to subscribe to commercial papers and earn a slightly higher return in the short-term than parking funds under reverse repo.
• Roughly 33% of outstanding commercial papers have been subscribed to by banks.

What are the advantages of issuing CPs?

• Apart from being a cheaper source of funds, it helps meet funding requirements relatively quickly for better rated corporates.
• Procedural requirements for securing bank facilities and charge creation on assets is not required.

What are the key challenges with CPS?

• As the CP is an unsecured loan, the investor in commercial papers largely prefers highly-rated corporates or public sector entities in terms of credit rating.
• Lender appetite is limited to better rated companies.
• Commercial paper markets can be seasonal and vulnerable to liquidity conditions.
• Within the year, liquidity conditions can become tight in certain months such as the end of a quarter, because of advance payment of taxes and the like.