Study of call money market

Introduction - Money Market

Money market refers to the market where money and highly liquid marketable securities are bought and sold having a maturity period of one or less than one year. It is not a place like the stock market but an activity conducted by telephone. The money market 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, call money, repurchase agreements etc.

The major player in the money market are Reserve Bank of India (RBI), Discount and Finance 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 the gap of short-term liquidity problems or to deploy the short-term surplus to gain income on that.

Definition of Money Market:

According to the McGraw Hill Dictionary of Modern Economics, "money market is the term designed to include the financial institutions which handle the purchase, sale, and transfers of short term credit instruments. The money market includes the entire machinery for the channelizing of short-term funds. Concerned primarily with small business needs for working capital, individual's borrowings, and government short term obligations, it differs from the long term or capital market which devotes its attention to dealings 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 requirements of borrowings and provides liquidity or cash to the lenders. It is the place where short term surplus investible funds at the disposal of financial and other institutions and individuals are bid by borrowers' agents comprising institutions and individuals and also the government itself."

According to the Geoffrey, "money market is the collective name given to the various firms and institutions that deal in the various grades of the near money."

So after analyzing the above definitions, we can easily conclude with the following features of MONEY MARKET.

  • Short-term funds are borrowed and lent.
  • No fixed place for conduct of operations, the transactions being conducted even over the phone and therefore, there is an essential need for the presence of well developed 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 and with 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, bill rediscounting, 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 and deficits.
  • Providing a focal point for central bank intervention for the influencing liquidity in 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 and deficits.
  • Providing a focal point for central bank intervention for the influencing liquidity in the economy.
  • Providing access to users of short-term money to meet their requirements at a reasonable 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 planned economic development that commenced in the year 1951 market an important beginning in the annals of the Indian money market. The nationalization of banks in 1969, setting up of various committees such as the Sukhmoy Chakraborty Committee (1982), the Vaghul working group (1986), the setting up of discount and finance house of India ltd. (1988), the securities trading corporation of India (1994) and the commencement of liberalization and globalization process in 1991 gave a further fillip for the integrated and efficient development of India money market.

Money Market Instruments

Money market instruments are generally characterized by a high degree of safety of principal and are most commonly issued in units of $1 million or more. Maturities range from one day to one year; the most common are three months or less. Active secondary markets for most of the instruments allow them to be sold prior to maturity. Unlike organized securities or commodities exchanges, the money market has no specific location.

Available from financial institutions, money markets give the smaller investor the opportunity to get in on treasury securities. The institution buys a variety of treasury securities with the money you invest. The rate of return changes daily, and services such as check writing may be offered. The major participants in the money market are commercial 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. Money market instrument meets short term requirements of the borrowers and provides liquidity to the lenders. Common Money Market Instruments are as follows:

  1. Treasury Bills
  2. Repurchase Agreements (Repo/Reverse Repo)
  3. Call Money
  4. Commercial paper
  5. Certificate of Deposits
  6. Bankers Acceptance
  7. Eurodollar

Review of Literature

Article: India call money ends near reverse repo rate, cash ample

Reuters, 2/9/2009, Indian overnight money rates brought down to near the reverse repo rate of 3.25% on Wednesday as this cash surplus in the system will help banks meet their reserve needs comfortably. Cheaper money available at the collateralised borrowing and lending obligation (CBLO) also eased pressure on the inter-bank cash rates. 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 the central bank may start rolling back the liquidity as early as December 2009, as the already pressured consumer prices could pose significant inflationary threat to the economy, amid easy cash conditions Overnight rates are supported around the reverse repo rate because banks holding surplus funds could also deploy the same with central bank at that rate in its daily liquidity adjustment auctions.

Article: Money Market Integration in India: A Time Series Study

Rastogi Nikhil, Says Indian financial markets have come a long way from the highly controlled pre-liberalization era. He signifies that the main focus is on achieving efficiency, which is the hallmark of any developed financial market. This research paper tests the efficiency and extent of integration between financial markets empirically at the 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 have achieved 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 other market (forex market).

Article: Market efficiency and financial markets integration in India

Prusty Sadananda, June, 2007 The author explored the impact of economic reforms on the 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 findings were: (i) various segments of the financial market in India have achieved market efficiency, (ii) the 91-day Treasury bill rate is the appropriate 'reference rate' of the financial sector in India, (iii) the financial markets in India are largely integrated at the short-end of the market, and (iv) the long-end of the market is integrated with the short-end of the market. The above findings suggest that monetary policy should rely more 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 of intervening holidays) is "Call Money". When money is borrowed or lent for more than a day and up to 14 days, it is "Notice Money". No collateral security is required to cover these 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 notice money market; funds are transacted for the period between 2 days and 14 days. The most active segment of the money market has been the call money market, where the day to day imbalances in the funds position of scheduled commercial banks are eased out. The call notice money market has graduated into a broad and vibrant institution.

Participants in call/notice money market currently include banks (excluding RRBs) and Primary dealers both as borrowers and lenders. Non Bank institutions are not permitted in the call/notice money market with effect from August 6, 2005. The regulator has prescribed limits on the banks and primary dealers operation in the call/notice money market.

Call money market is for very short term funds, known as money on call. The rate at which funds are borrowed in this market is called `Call Money rate'. The size of the market for these funds in India is between Rs 60,000 million to Rs 70,000 million, of which public sector banks account for 80% of borrowings and foreign banks/private sector 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 call money 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/notice and term money market was operationalized with effect from September 18, 2006. This system has been developed by Clearing Corporation of India Ltd. on behalf of the Reserve Bank of India. The NDS -CALL system provides an electronic dealing platform with features like Direct one to one negotiation, real time quote and trade information, preferred counterparty setup, online exposure limit monitoring, online regulatory limit monitoring, dealing in call, notice and term money, dealing facilitated for T+0 settlement type for Call Money and dealing facilitated for T+0 and T+1 settlement type for Notice and Term Money. Information on previous dealt rates, ongoing bids/offers on re al time basis imparts greater transparency and facilitates better rate discovery in the call money market. The system has also helped to improve the ease of transactions, increased operational efficiency and resolve problems associated with asymmetry of information. However, participation on this platform is optional and currently both the electronic platform and the telephonic market are co-existing. After the introduction of NDS-CALL, market participants have increasingly started using this new system more so during 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 the demand for funds in the call market is mainly governed by the banks' need for resources to meet their statutory reserve requirements, it also offers to some participants a regular funding source for building up short -term assets. However, the demand for funds for reserve requirements dominates any other demand in the market. Figure 4.1 displays the average daily volumes in the call markets.

Committee Recommendation on Call Money Market:

The Sukhumoy Chakravarty Committee:

The call money market for India was first recommended by the Sukhumoy Chakravarty Committee, 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 not dilute the strength of monetary regulation by the RBI, as resources from non-bank participants do not represent any additional resource for the system as a whole, and their participation in call money market would only imply a redistribution of existing resources from one participant to another. In view of this, the Chakravarty Committee recommended that additional nonbank participants may be allowed to participate in call money market.

The Vaghul Committee Report:

The Vaghul Committee (1990), while recommending the introduction of a number of money market instruments to broaden and deepen the money market, recommended that the call markets should be restricted to banks. The other participants could choose from the new money market instruments, for their short -term requirements. One of the reasons 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 were regulated, while call rates were market determined.

The Narasimham Committee II Report:

The Narasimham Committee II (1998) also recommended that call money market in India, like in most other developed markets, should be strictly restricted to banks and primary dealers. Since non- bank participants are not subject to reserve requirements, the Committee felt that such participants should use the other money market instruments, 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 money market 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 on lending by nonbanks were progressively reduced along with the operationalisation of negotiated dealing system (NDS) and CCIL until their complete withdrawal in August 2005. In order to create avenues for deployment of funds by non-banks following their phased exit from the call money market, several new instruments were created such as market repos and CBLO.

Various reform measures have imparted stability to the call money market. With the transformation of the call money market into a pure inter-bank market, the turnover in the call/notice money market has declined significantly. The activity has migrated to other 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 commercial banks, both Indian and foreign, State Bank of India, Cooperative Banks, Discount and Finance House of India ltd. (DFHL) and Securities Trading Corporation of India (STCI).
  • As lenders: Life Insurance Corporation of India (LIC), Unit Trust of India (UTI), General Insurance Corporation (GIC), Industrial Development Bank of India (IDBI), National Bank for Agriculture and Rural Development (NABARD), specified institutions already operating in bills rediscounting market, and entities/corporate/mutual funds.

The participants in the call markets increased in the 1990s, with a gradual opening up of the call markets to non-bank entities. Initially DFHI was the only PD eligible to participate in the call market, with other PDs having to route their transactions through DFHI, and subsequently STCI. In 1996, PDs apart from DFHI and STCI were allowed to end and borrow directly in the call markets. Presently there are 18 primary dealers participating in the call markets. Then from 1991 onwards, corporates were allowed to lend in the call markets, initially through the DFHI, and later through any of the PDs. In order to be able to lend, corporates had to provide proof of bulk lendable resources to the RBI and were not suppose to have any outstanding borrowings with the banking system. The minimum amount corporates had to lend was reduced from Rs. 20 crore, in a phased manner to Rs. 3 crore in 1998. There were 50 corporates eligible to lend in the call markets, through the primary dealers. The corporates which were allowed to route their transactions through PDs, were phased out by end June 2001.

Banks and PDs technically can operate on both sides of the call market, though in reality, only the P Ds borrow and lend in the call markets. The bank participants are divided into two categories: banks which are pre- dominantly lenders (mostly the public sector banks) and banks which are pre- dominantly borrowers (foreign and private sector banks). Currently, the participants in the call/notice money market currently include banks (excluding RRBs) and Primary Dealers (PDs) both as borrowers and lenders.

Call Money Rates:

The rate of interest on call funds is called money rate. Call money rates are characteristics in that they are found to be having seasonal and daily variations requiring intervention by RBI and other institutions.

The concentration in the borrowing and lending side of the call markets impacts liquidity in the call markets. The presence or absence of important players is a significant influence on quantity as well as price. This leads to a lack of depth and high levels of volatility in call rates, when the participant structure on the lending or borrowing side alters.

Short-term liquidity conditions impact the call rates the most. On the supply side the call rates are influenced by factors such as: deposit mobilization of banks, capital flows, and banks' reserve requirements; and on the demand side, call rates are influenced 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 integrated treasuries that hold short term positions in both rupee and forex markets, deploying and borrowing funds through call markets.

During normal times, call rates hover in a range between the repo rate and the reverse repo rate. The repo rate represents an avenue for parking short -term funds, and during periods of easy liquidity, call rates are only slightly above the repo rates. During periods of tight liquidity, call rates move towards the reverse repo rate. Table provides data on the 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 the market. Call rates touched a peak of about80% in March 2006-07, reflecting tight liquidity on account of high levels of statutory pre-emptions and withdrawal of all refinance facilities, barring export credit refinance.

Prudential Limits:

The prudential limits in respect of both outstanding borrowing and lending transactions in call/notice money market for banks and PDs are as follows:-

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 is mandatory for all Negotiated Dealing System (NDS) members to report their call/notice money market deals (other than those done on NDS-CALL) on NDS. Deals should be reported within 15 minutes on NDS, irrespective of the size of the deal or whether the counterparty is a member of the NDS or not. In case there is repeated non-reporting of deals by an NDS member, it will be considered whether non-reported deals by that member should be treated as invalid.

The reporting time on NDS is up to 5.00 pm on weekdays and 2.30 pm on Saturdays or as decided by RBI from time to time.

With the stabilisation of reporting of call/notice money transactions over NDS as also to reduce reporting burden, the practice of reporting of call/notice/term money transactions 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 the Financial 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 OF LYQUIDITYin funds on any given day. There are mainly two reasons why a bank may face such a shortfall. Banks normally lend out of the deposits that they mobilize. But there are temporary gaps, or mismatches. The call money market is used to manage these gaps.

The second reason is to meet the cash reserve ratio (CRR) which is the cash reserves it must 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 economic conditions) of all their borrowings from the public (in the form of savings and term deposits) and other banks with RBI. The CRR is calculated on the basis of the bank's borrowing or net time and demand liabilities (NDTL), broadly its deposit base, every alternate Friday. This day is also called the reporting Friday, on which the banks report their 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 can borrow these funds for one day up to 14 days. Normally, funds are borrowed for one day, 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 an annualized one. Once the deal is struck the funds are immediately available to the borrowing bank and are returned with interest the next day. The funds are lent and paid back through a banker's pay order which is cleared by the special high value banker's clearing cell in the RBI.

Can the RBI lend in the call market? What does intervention by the central bank mean?

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. The STCI lends funds against the government securities that a bank holds with an offer to sell back the security (called repurchases or repos), while the DFHI lends funds that it receives from the central bank against repos of certain securities specified as eligible for them. The RBI also allows banks to rediscount proceeds of export bills of exchange.

Why do rates fluctuate? What does this indicate?

The rates fluctuate in the market depending on the demand and supply of money in the market. High rates indicate a tightness of liquidity position. In India, rates in the call market are prone to fluctuations and are unidirectional. This is due to the fact that it has a limited number of players whose needs are similar.

Commercial Papers:

Commercial Paper (CP) is an unsecured money market instrument issued in the form of a promissory note. It was introduced in India in 1990 with a view to enabling highly rated corporate borrowers/ to diversify their sources of short-term borrowings and to provide an additional instrument to investors. Subsequently, primary dealers and satellite 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 banks and corporations in the form of promissory note, negotiable and transferable by endorsement and delivery with a fixed maturity period to meet the short-term financial requirement. 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 rated corporates.

Depending upon the issuing company, a commercial paper is also known as "Financial paper, 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 by a credit rating agency to diversify their sources of short term borrowings at a rate which was 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. Effective from 6th September 1996 and 17th June 1998, primary dealers and satellite dealers were also permitted to issue commercial paper to access greater volume of funds to help increase their activities in the secondary market. It can be issued to individuals, banks, and companies and other registered Indian corporate bodies and unincorporated bodies. It is issued at a discount determined by the issuer company. The discount varies with the credit rating of the issuer company and the demand and the supply position in the money market. In India, the emergence of commercial paper has added a new dimension to the money market.

Salient Features

  • They are unsecured debts of corporates and are issued in the form of promissory notes, redeemable at par to the holder at maturity.
  • Only corporates who get an investment grade rating can issue CPs, as per RBI rules.
  • 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. Amount invested 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 one year from the date of issue.

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 requirement especially those that are short-term, is promptly met through flotation of commercial paper. Directly accessing market by issuing short-term promissory notes, backed by stand-by or underwriting facility enables the corporate to leverage its rating to save on interest costs.

Typically commercial paper is sold at a discount to its face value and is redeemed at face value. Hence, the implicit interest rate is function of the size of discount and the period of maturity. Scheduled commercial banks are major investors in commercial paper and their investment is determined by bank liquidity conditions. Banks prefer commercial paper as an investment avenue rather than sanctioning bank loan. These loans involve high transaction costs and money is locked for a longer time period whereas a commercial paper is an attractive short-term instrument for banks to park funds during times of high liquidity. Some banks fund commercial papers by borrowing from the call money market. Usually, the call money market rates are lower than the commercial paper rates. Hence, banks book profits through arbitraged between the two money markets. Moreover, the issuance of commercial papers has been generally observed to be invested related to the money market rates.

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 institutions are 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 latest balance sheet.
    2. Working capital limit is obtained from banks/ all India financial institutions, and
    3. Its borrowable account is classified as standard asset by banks/ all India financial institutions.
  • Credit rating should be obtained by all eligible participants in cp issue from the specified credit rating agencies like CRISIL, ICRA, CARE, and FITCH. The minimum rating shall be equivalent to P-2 of CRISIL.
  • Commercial paper can be issued for maturities between a minimum of 15 days and a maximum of up to one year from the date of issue.
  • The maturity date of commercial paper should not exceed the date beyond the date 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 (face value).
  • A company can issue commercial paper to an aggregate amount within the limit approved 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 limits duly taking into account the resource pattern of company's financing including commercial papers.
  • The total amount of commercial paper proposed to be issued should be raised within a period of two weeks from the date on which the issuer opens the issue for subscription.
  • Commercial paper may be issued on a single date or in parts on different dated provided that in the latter case, each commercial paper shall have the same maturity date.
  • Every commercial paper should be reported to RBI through issuing and paying agent (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 dematerialised form.
  • 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 the commercial paper by means of a crossed account payee cheque to the account of the issuer through IPA.
  • On maturity, if commercial paper is held in physical form, the holder of commercial paper shall present the investment for payment to the issuer through IPA.
  • When the commercial paper is held in De-mat form, the holder of commercial paper will have to get it redeemed through depository and received payment from the IPA.
  • Commercial paper is issued as a 'stand alone' product. It would not be obligatory for banks and financial institutions to provide stand-by facility to issuers of commercial paper.
  • Every issue of commercial paper, including renewal, should be treated as a fresh issue.

Growth in the Commercial Paper Market:

Commercial paper was introduced in India in January 1990, in pursuance of the Vaghul Committee's recommendations, in order to enable highly rated non-bank corporate borrowers to diversify their sources of short term borrowings and also provide an additional instrument to investors. Commercial paper could carry on an interest rate coupon but is generally sold at a discount. Since commercial paper is freely transferable, banks, financial institutions, insurance companies and others are able to invest their short-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 market took place when the 'stand by' facility* of the restoration of the cash credit limit and guaranteeing 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 of the commercial paper market, the issuance of commercial paper was delinked from the cash credit limit in October 1997. It was converted into a standalone product from October 2000 so as to enable the issuers of the service sector to meet short-term working capital requirements.

Banks are allowed to fix working capital limits after taking into account the resource pattern of the company's finances, including commercial papers. Corporates, PDs and all-India financial institutions (FIs) under specified stipulations have permitted to raise short term resources by the Reserve Bank through the issue of commercial papers. There is no lock in period for commercial papers. Furthermore, guidelines were issued permitting investments in commercial papers which has enabled a reduction in transaction cost.

In order to rationalize the and standardize wherever possible, various aspects of processing, settlement and documentation of commercial paper issuance, several measures were undertaken with a view to achieving the settlement on T+1 basis. For further deepening the market, the Reserve Bank of India issued draft guidelines on securitisation 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 the commercial paper market reflects the state of market liquidity as its issuances tend to rise amidst ample liquidity conditions when companies can raise funds through commercial 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 the commercial paper rate works out higher than the call rate. Table shows the trends in commercial papers rates and amounts outstanding.

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

Issuers

Initially, only highly rated corporate borrowers were allowed to issue CP to diversify their short-term borrowings. Primary Dealers (PDs) were allowed in this market, subject to fulfilling the eligibility criteria, on April 15, 1997. Thereafter, all-India financial institutions (FIs) that have been permitted to raise short-term resources under umbrella 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 and nonfinancial issuers are allowed to issue CP. In France, CPs are mainly issued by investment firms, public companies, community institutions and international organisations of which France is a member.

Maturity Period

Initially, corporates were permitted to issue CP with a maturity between a minimum of three months and a maximum of upto six months from the date of issue. Since October 18, 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 and since May 25, 1998, it was reduced to 15 days. Presently, CP can be issued for maturity period between a minimum of 15 days and a maximum upto one year from the date of issue.

As against this, in USA, there is no prescription of minimum and maximum maturity period 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 the CP market. In UK also, there is no restriction but in France, initial maturity ranges from 1 day to up to 1 year.

Credit Ratings

All eligible participants are required to obtain credit rating for issuance of CP from either the Credit Rating Information Services of India Ltd. (CRISIL) or such other credit rating 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 at P1+ of CRISIL. It was softened to P1 of CRISIL or such equivalent rating by other agencies 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 generally have the rating of A1/P1 (the highest category) for generating investor interest.

Limits and the Amount of Issue of CP

The entry criteria for issuance of CP have been relaxed considerably over the years. In 1990, a corporate was eligible to issue CP provided the tangible net worth of the company, as per the latest audited balance sheet, was not less than Rs.10 crore. This was 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 (fund based) 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 enable more corporates to issue CP, the amount to be carved out of the working capital limit for issuance of CP was also increased over the years for facilitating the growth of this market. Accordingly, while the working capital (fund based) limit was reduced to "not less than Rs.4" crore on October 18, 1993, the amount of CP that could be issued out of the working capital was also raised upto 100 per cent of the companies' working capital limit 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 was severed 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 as approved by its Board of Directors or the quantum indicated by the credit rating agency for the specified rating, whichever is lower. Banks and FIs, however, have the flexibility to 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 fixed by 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 exceed 100 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.

Denomination

At the time of introduction, with effect from January 1, 1990, it was stipulated that CP may be issued in multiple of Rs.25 lakh and the amount to be invested by a single investor 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 invested by a single investor was also reduced to Rs.50 lakh. At present, CP can be issued in denominations of Rs.5 lakh or multiple thereof and amount invested by a single investor should not be less than Rs.5 lakh (face value).

Internationally, in USA, there is no required minimum size of issue. However, it is usually issued in minimum denomination of $1,00,000. In France, the minimum amount stands at EUR 1,50,000 and in UK, it stands at EUR 40,000.

Investors in the CP Market

Initially, it was stipulated that CP can be issued to and held by individuals, banks, companies, other corporate bodies registered or incorporated in India and unincorporated 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, Foreign Institutional Investors (FIIs) were added as eligible investors in CP market in October 2000. However, investment by FIIs would be within the limits set for their investments by SEBI.

In USA, investors include money market mutual funds, banks, insurance companies and pension funds.

Dematerialisation

With effect from June 30, 2001, banks, FIs and PDs have been encouraged to make fresh investments and hold CP only in dematerialised form. Outstanding investments in scrip form in the books of banks, FIs and PDs were to be converted into dematerialised form by October 31, 2001.

Internationally, in USA and France, CPs are issued in dematerialized form. In UK, fully dematerialized system does not exist though by market convention, Euro CP is issued in the form of an immobilized global certificate lodged with a central depository e.g., Euroclear/Clearstream.

Factors Hampering Growth of CP Market

Some of the factors which have hampered active growth of CP market in India are as follows:

  1. The linking of CP to working capital limits. Market participants have suggested that CP should be made a "stand alone" product.
  2. At present, for issuance of CP approval or NOC is required from the Financing Banking Company. This NOC/approval is valid for a period of two weeks from the date of its issuance. Furthermore, rating for the issuance of CP has to be current and not more than 2 months old. Market participants perceive these stipulations as impediments to the development of CP market.
  3. The difference in stamp duty rates as between banks and other entities has created operational difficulties. There is at present, inter-state disparities as also investor-wise differences in stamp duty rates. Further, there is tenor-wise slab structure of stamp duty as given below:
  4. Secondary market transactions in CP, however, do not attract any stamp duty. This divergence in stamp duty for banks and non-banks has created some distortions in the market and also encouraged some mal-practices. All primary issues of CP are almost exclusively subscribed to by banks and non-banks buy CP from banks in the secondary market. Further, CP issues with maturity of less than 90 days are generally not preferred.

  5. Procedure to issue CP in physical form is quite cumbersome. The concerned corporates have to arrange for stamping of all the certificates, which is time consuming. Furthermore, copies of all the documents have to be given to all the investors along with the CP certificate.
  6. No reliable bench mark is available in the market for pricing CP.

References

  1. Article 1: http://www.livemint.com/2009/09/02141025/India-call-money-ends-near-rev.html
  2. Article3: http://findarticles.com/p/articles/mi_m1TSD/is_1_6/ai_n25012617/
  3. Ghosh and Bhattacharyya, Spread, Volatility and Monetary Policy: Emprical Evidences from the Indian Overnight Money Market,pg1

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