Commercial Paper

Indian Economy glossary

Also called: CP · Topic: Financial Markets, Instruments, Insurance and Pensions · NCERT: Beyond NCERT

Meaning

Commercial Paper (CP) is an unsecured short-term promissory note (a written promise to repay a fixed sum on a fixed date). It is issued at a discount for 7 days to 1 year by eligible, credit-rated companies, NBFCs, AIFIs and similar bodies to raise short-term money, mainly for working capital.

  • It lets strong borrowers raise short-term money straight from investors, without going to a bank for a loan.
  • Its yield (return) moves with the RBI's policy rate, so it is one of the links through which monetary policy reaches companies.
  • Discount yield formula: Yield (%) = [(Face value − Price) ÷ Price] × (365 ÷ Days to maturity) × 100

Explanation

How a CP works

  • Unsecured: the issuer pledges no collateral (no security, such as property or bonds, is kept aside for the lender). The investor depends only on the issuer's ability to repay. That is why a credit rating is compulsory.
  • Discount instrument: a CP pays no interest coupon (no regular interest payment).
  • It is sold below face value. Face value is the amount repaid on maturity.
  • On maturity, the investor gets the full face value.

  • The gap between the two amounts is the investor's return.

  • Money-market instrument: its tenor (how long it lasts) is 7 days to 1 year. So it belongs to the money market (borrowing and lending for up to one year), not the capital market.

  • Purpose: working capital, meaning money for day-to-day business, such as buying raw material and paying wages.

Worked example

  • A company issues a 90-day CP. Face value = ₹5,00,000. Issue price = ₹4,90,000.
  • Investor's gain = ₹10,000.
  • Yield = (10,000 ÷ 4,90,000) × (365 ÷ 90) × 100 ≈ 8.28% a year.

What makes CP yields rise or fall

  • Price and yield move in opposite directions.
  • The amount repaid at maturity is fixed.

  • So if investors want a higher return, they pay a lower price today, and the yield rises.

  • RBI policy rate:

  • repo rate (the rate at which the RBI lends to banks for a short time) goes up → overnight call and TREPS rates go up → CP yields follow.

  • Issuer's credit quality: a weaker rating means more risk, so investors ask for a higher yield.

  • Investor appetite: mutual funds are the biggest buyers of CP. If they stop buying, as they did in 2018, issuers cannot sell new CP easily and yields shoot up.

In India

  • Regulator: the RBI, through the Master Direction – RBI (Commercial Paper and Non-Convertible Debentures) Directions, 2024. It was issued on 3 January 2024 and took effect on 1 April 2024 [1].
  • Tenor: "not less than seven days or more than one year" [1].
  • Eligible issuers: companies, NBFCs, InvITs, REITs, AIFIs and other body corporates [1].
  • They must meet a minimum net-worth test [1].

  • All their fund-based bank facilities must be classified Standard (not in default) when the CP is issued [1].

  • Minimum rating: 'A3' from a SEBI-registered credit rating agency [1].

  • Denomination: at least ₹5 lakh, and then in multiples of ₹5 lakh [1].
  • Pricing: CPs "shall be issued at a discount to the face value" [1].
  • Form and settlement: demat only (held electronically, not on paper). Primary issues settle within T+4 working days. Secondary trades settle on T+0 or T+1 [1].
  • Investors: all residents. Non-residents may invest under FEMA. No one may invest in a CP issued by a related party (for example, a group company) [1].
  • IL&FS crisis (2018)
  • IL&FS (Infrastructure Leasing & Financial Services) defaulted in 2018.
  • Mutual funds, the biggest CP buyers, got scared and stopped buying CP.
  • NBFCs could not roll over their CPs, meaning they could not repay old paper by issuing new paper.
  • Result: NBFC lending slowed. The crisis showed the danger of asset-liability mismatch, which here meant funding long-term loans with short-term CP.

Don't confuse with

  • Certificate of Deposit (CD): a CD is issued by banks (Scheduled Commercial Banks, RRBs, Small Finance Banks). A CP is issued by companies, NBFCs, AIFIs, InvITs, REITs and similar bodies. A CD may also carry a fixed or floating rate [2]. A CP must be issued at a discount [1].
  • Treasury bill (T-bill): a T-bill is debt of the Government of India. It has zero default risk and tenors of 91, 182 and 364 days. A CP is private corporate debt, so it carries credit risk.
  • Call money: call money is an interbank loan, open only to banks and primary dealers. A CP is a tradable instrument that corporates issue and many kinds of investors buy.
  • Bonds / debentures (capital market): these are debt that lasts longer than one year. A CP's maximum tenor is one year.

Prelims Hooks

  • CP = unsecured, issued at a discount, tenor 7 days to 1 year. It is a money-market instrument [1].
  • Minimum denomination ₹5 lakh (then in multiples of ₹5 lakh). Minimum rating 'A3' from a SEBI-registered credit rating agency [1].
  • Regulator is the RBI, not SEBI. Current rules: CP and NCD Directions, 2024, effective 1 April 2024 [1].
  • Trap: eligible issuers include InvITs and REITs. The issuer's fund-based bank facilities must be Standard at the time of issue [1].
  • Trap: a CP can be held only in demat form. No investment is allowed in a CP issued by a related party [1].
  • Trap: CP is a company's instrument and CD is a bank's. Both have a minimum of ₹5 lakh.

Mains Points

  • Short-term funding risk (the IL&FS lesson, 2018):
  • NBFCs used cheap short-term CP to fund long-term loans.
  • When mutual funds stopped buying, NBFCs could not roll over their CP, and a liquidity problem turned into a solvency scare.

  • The policy answer: asset-liability management rules for NBFCs, scale-based regulation of NBFCs, and stricter CP issuer tests such as the 'Standard' asset-classification condition [1].

  • Monetary transmission (GS-III):

  • RBI changes the repo rate → call and TREPS rates move → CP yields follow → companies' borrowing costs change.

  • A deep CP market makes RBI policy reach firms faster, and this supports inflation targeting.

  • Access versus safety:

  • Allowing more issuers (InvITs, REITs) gives more firms a cheaper option than a bank loan [1].
  • But CP is unsecured, and one investor group (mutual funds) buys most of it. So the rating, net-worth and related-party rules are needed to keep this risk from spreading to the whole financial system [1].

Related concepts

Read more

Sources

  1. 1Master Direction – Reserve Bank of India (Commercial Paper and Non-Convertible Debentures) Directions, 2024rbi.org.in · tier 1
  2. 2Master Direction – Reserve Bank of India (Certificate of Deposit) Directions, 2021rbi.org.in · tier 1