Commercial Papers, History, Types, Uses, Challenges

Commercial Papers (CPs) are unsecured, short-term debt instruments issued by corporations, Financial institutions, and Primary dealers to meet their short-term funding needs. Introduced in India in 1990, CPs typically have maturities ranging from 7 days to 1 year and are issued at a discount to face value. Since they are not backed by collateral, only companies with high credit ratings from recognized credit rating agencies can issue them. CPs offer higher returns than Treasury Bills, making them attractive to institutional investors like mutual funds and banks. They are regulated by the Reserve Bank of India (RBI) and play a vital role in India’s money market by providing an alternative to bank borrowing, thereby improving liquidity and cost-efficiency for issuers.

History Commercial Papers in India:

Commercial Papers (CPs) were introduced in India in 1990 by the Reserve Bank of India (RBI) as part of financial sector reforms aimed at developing the Indian money market and reducing the dependency of corporates on bank credit. Prior to the introduction of CPs, companies primarily relied on banks for working capital requirements. The launch of CPs provided an alternative source of short-term financing for companies with strong credit ratings, allowing them to raise funds directly from the market at competitive rates.

Initially, CPs were allowed to be issued by corporates with a tangible net worth of at least ₹4 crore, a sanctioned working capital limit, and a good track record. Over time, eligibility norms were relaxed, and the CP market expanded to include financial institutions, non-banking financial companies (NBFCs), and primary dealers. The CP market grew steadily with the support of regulatory improvements, increased investor participation, and growing awareness among corporates.

The RBI introduced various measures to enhance the transparency and liquidity of the CP market, including dematerialization of CPs and reporting requirements through platforms like F-TRAC. Today, CPs play a crucial role in India’s money market, serving as a flexible, cost-effective tool for short-term funding and liquidity management by top-rated entities and financial institutions.

Types of Commercial Papers:

• Promissory Note-Based Commercial Papers

These are the most common type of CPs and are structured as unsecured promissory notes issued by companies to investors at a discount and redeemed at face value upon maturity. They are typically issued in denominations of ₹5 lakh or more and are used to meet working capital needs. Only companies with a high credit rating can issue these instruments. They are traded in the secondary market and offer better returns than bank deposits for short-term investors.

• Asset-Backed Commercial Papers (ABCPs)

Asset-Backed Commercial Papers are short-term instruments backed by financial assets such as receivables or loans. Issued typically by Special Purpose Vehicles (SPVs), ABCPs are used by companies to raise funds by securitizing a pool of assets. Though less common in India than in developed markets, ABCPs offer a means of off-balance-sheet financing. The credit quality of ABCPs depends not just on the issuer but also on the underlying assets, making them more complex and risk-sensitive compared to standard CPs.

Uses of Commercial Papers:

• Short-Term Working Capital for Companies

Commercial Papers are a popular tool for companies to raise short-term working capital. Instead of relying on bank loans, highly rated firms can issue CPs to quickly obtain funds at lower interest rates. This helps meet immediate expenses such as inventory purchases, salary payments, or operational costs. Since CPs are flexible and unsecured, they offer a cost-effective alternative to traditional financing, especially when market conditions are favorable and interest rates are lower than those of bank credit.

• Efficient Cash Flow Management

Firms use CPs to smoothen cash flow mismatches between receivables and payables. During periods of temporary liquidity shortfall, issuing CPs allows companies to maintain operations without disturbing long-term funding arrangements. Conversely, companies with surplus funds may invest in CPs to earn higher returns than bank deposits. This dual role—borrowing and investing—makes CPs an effective cash flow management tool for both issuers and investors, helping to optimize short-term liquidity without compromising creditworthiness.

• Alternative to Bank Credit

Commercial Papers offer a market-based alternative to traditional bank loans, especially for companies with strong credit ratings. By accessing funds directly from investors, firms can reduce dependency on banks, diversify their funding sources, and potentially negotiate better terms. This enhances a company’s financial flexibility and reduces borrowing costs. Moreover, during periods of tight bank credit or high interest rates, CPs can be a more accessible and affordable option for short-term funding requirements.

• Short-Term Investment for Institutions

Banks, mutual funds, insurance companies, and corporate treasuries invest in CPs as low-risk, short-duration instruments that offer better returns than savings accounts or Treasury Bills. CPs are ideal for parking idle funds for short periods due to their liquidity, safety (in case of top-rated issuers), and fixed maturity. Since CPs are traded in the secondary market, they also offer exit opportunities before maturity, making them a flexible and attractive investment option for institutional investors with short-term surplus capital.

• Liquidity Management by Financial Institutions

Financial institutions and Non-Banking Financial Companies (NBFCs) issue CPs to bridge liquidity gaps or manage short-term funding needs. For example, NBFCs often use CPs to finance loan disbursements while awaiting repayments. Similarly, housing finance companies may use them to manage staggered inflows and outflows. CPs help institutions maintain operational continuity and manage timing mismatches between assets and liabilities. Given their short tenures and quick issuance process, CPs are an efficient tool for tactical liquidity planning.

• Supporting Monetary Policy Operations

Commercial Papers contribute to the broader money market infrastructure, aiding the Reserve Bank of India (RBI) in liquidity and interest rate management. A vibrant CP market reflects real-time borrowing costs and helps the RBI assess credit flow in the economy. CP rates can act as a benchmark for other short-term instruments. As CP issuance responds to changes in repo rates and market liquidity, it indirectly supports the RBI’s monetary policy objectives, including inflation control and economic growth stabilization.

Challenges of Commercial Papers:

• Limited Access for Lower-Rated Firms

Commercial Papers are typically issued by companies with high credit ratings, making them inaccessible to small or medium enterprises (SMEs) or those with lower ratings. Since CPs are unsecured instruments, investors demand strong creditworthiness. This limits the participation of many firms that may need short-term funds but cannot meet the eligibility criteria. As a result, CPs are dominated by large corporates, reducing the depth and inclusiveness of the CP market in India.

• Credit Risk for Investors

Since Commercial Papers are unsecured, investors face credit risk, especially during economic downturns. If the issuing company defaults, investors have no collateral to recover their investment. Credit rating downgrades after issuance can also affect the market value of CPs. While only highly rated firms are allowed to issue CPs, unexpected financial or operational issues can arise. Therefore, institutional and retail investors must carefully evaluate creditworthiness and monitor issuer performance throughout the CP’s life cycle.

• Limited Retail Participation

Retail investor participation in the CP market is extremely low due to a lack of awareness, high entry barriers (e.g., ₹5 lakh minimum denomination), and complex documentation. Most CPs are bought by mutual funds, banks, or institutional investors, limiting the market’s reach. Additionally, CPs are not listed on popular retail trading platforms, making them inaccessible for individual investors. Increasing financial literacy and improving retail-friendly issuance platforms are necessary to expand retail participation in India’s CP market.

• Secondary Market Illiquidity

The secondary market for Commercial Papers is underdeveloped, with most investors holding CPs until maturity. This limits liquidity for those who need to exit before the maturity date. The absence of active market-making and low transparency in pricing make it difficult to trade CPs easily. As a result, investors face challenges in adjusting portfolios or responding to market changes. Strengthening the secondary market infrastructure is vital to improve flexibility and transparency for CP investors.

• Interest Rate Volatility

Commercial Paper yields are sensitive to changes in interest rates set by the Reserve Bank of India. Sudden increases in repo or reverse repo rates can raise borrowing costs for issuers, reducing CP issuance. Conversely, rate cuts may lower investor returns, making CPs less attractive compared to other instruments. This volatility creates uncertainty for both issuers and investors, particularly for those with tight liquidity schedules or rigid return expectations, and can destabilize short-term financial planning.

• Regulatory Constraints and Compliance

CP issuers must comply with strict SEBI and RBI regulations, including eligibility norms, credit ratings, and disclosure requirements. While these norms ensure market integrity, they can be burdensome for smaller companies. Additionally, frequent regulatory updates or procedural delays may discourage companies from using CPs as a short-term funding tool. Complying with multiple agencies and ensuring transparency through platforms like F-TRAC also demands time and resources, which can be a challenge for entities with limited financial infrastructure.