Commercial Papers explained

Updated on Dec. 9, 2022, 2:37 p.m.

So, the concept of Commercial paper is very simple to the layman, it is an unsecured promissory note issued by the banks and other affiliated financial establishments ranging from 90 days to 270 days.

We have seen tremendous growth taking place in the financial markets and commercial papers is one of the major components taking place in the banking segment. No banks or financial establishment in India and around the world can work without the use of Commercial Papers.

Let us break down the tougher concept of Commercial Papers and these are unsecured short period debit equipment issued by the company and the validity is valid up to 270 days. These are like the promissory notes offered at huge price and also exchangeable between various banks and financial institutions.

If you look at the broader picture most of the investors in the Commercial Paper segment are from Corporates, Individuals, Non-Resident Indians, and Foreign Institutional Investors and from various financial segments of our economy. Furthermore, the foreign institutional investors can only invest as per the guidelines given by the SEBI (Securities and Exchange Board of India).

The oldest commercial paper launch was when Marcus Goldman of the Goldman Sachs got the Commercial paper in 1889.

Example of Commercial Paper

Take a scenario where in you went to have lunch in a restaurant like Hotel Empire and the bill came down to INR 900. You are giving INR 2000 rupees note however the cashier does not have money to give back the amount.

At this juncture he or she will give you a paper stating that “We are to give Mr. Roshan INR 1100 in cash in the coming days or Mr. Roshan can go to any branch of our restaurant and have a meal of INR 1100 from one of the branches within a month. The person signs the bill with the letter head and stamp of Hotel Empire.

As a customer Mr. Roshan will definitely accept it with both hands.

Commercial Paper in India

Most of the Commercial Paper rolled out in India is done by paying for the old issued notes from the revenue generated by the issue of the new issued cards and notes. So, it becomes a regular source of financing the assistance to the concerned individual.

If you look at the Commercial Paper in India it started in 1989 as a short-term financial instrument and RBI started it in the Indian Capital Markets. This form of          instrument was implemented by theVaghul Working Group on the basis of certain standards and they are given below as follows:

  • The companies having INR 5 Crores and above as net worth of money and also having fine dividend payment records.
  • Most of the markets must follow the CAS (Consolidated Account Statements), We must also take into account various parts like the Market Entry, Consolidated Paper Amount, Total amount to be upgraded every year and others.
  • There are no restrictions on the Commercial Paper markets apart from the size of the notes. The size of the notes must be not less than INR 1 Crores and INR 5 Lakhs.
  • Establishment using the Commercial Notes must have INR 5 Crores as net worth and Debt ratio of 105, Debt Servicing Ratio closer to 2, Current Minimum Ratio of 1033 and must be recorded in the Stock Exchanges.
  • The Commercial papers is created in terms of the interest or at a discounted rate to the face value as well.
  • This exercise must not be levied the stamp duty while issuing the commercial paper and transferring them.

Features of Commercial Papers

There are various features of the Commercial Papers and they are given below as follows:

  • This is a short-term debt instrument having a definite maturity period.
  • This instrument acts as a certificate showing the unsecured debt.
  • This can be subscribed at a reasonable rate and can be issued at a reasonable interest rate.
  • An establishment can directly issue the Commercial paper to the investors and it is done using various banks and its branches.
  • This instrument is used as a certificate of Unsecured Debts in India.

Advantages of Commercial Papers

The Advantages of the Commercial papers are given below as follows:

  • The assets of the company are not on risk as they are said to be unsecured in nature.
  • This is the best way to raise the working capitals and is very cost effective in nature.
  • The range of maturity of these papers always are different compared to other financial instruments.
  • The Commercial papers are very secured compared to others and do not require any restrictions while using.
  • Companies having extra finance can transfer them into ones having good returns and save more money in the years to come.
  • The Commercial papers can be personalised as per the company’s requirements and the existing matured Commercial paper can be paid by selling new Commercial papers in a logical manner.

Disadvantages of Commercial papers

The Disadvantages of the Commercial papers are given below as follows:

  • The amount used for the Commercial paper is very high and only recognised and big companies can subscribe to this instrument.
  • The continuous usage of the Commercial paper can bring down the credit limit of the banks.
  • You will generally see a huge level of control on the issuance of the Commercial papers by establishments in India.
  • It will always demand a good stand by credits in India.
  • Commercial Paper is a unique method of financing and most of the companies are not in a position to renew it due to financial restrictions.

Types of Commercial Papers

Some of the Commercial papers as per the Uniform Commercial Code given by the Government of India are given below as follows:

  • Note: A person is promised some amount that is given in this piece of paper, where in he or she will make payment to bank or another person specified amount.
  • Drafts: This is one of the written rules and policies given by the individual to another person, wherein she or he will have to pay specified amount to the third party.
  • Cheque: A document that orders bank to give specified money from a person’s account to the person in whose name the cheque has been issued.
  • Certificate of Deposits: It is a unique certificate given by a bank to another person depositing the amount for a specified time at a certain rate of interest. The bank guarantee payment of interest towards that person and complete amount at the end of the specified term.

Commercial Papers are an inseparable instrument of Indian Banking Systems and have a major role in the present world scenario. In India the Commercial Paper began in 1989 but within short duration the impact it created is vast as you can settle the short term and unsecured debts with the greatest comfort.

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