Commercial Paper and Certificate of Deposit - Article

Introduction

Commercial Paper and Certificate of Deposit are important instruments of the Indian money market.

Both help transfer short-term funds from investors having surplus money to entities requiring funding. However, they serve different issuers.

The simplest distinction is:

Commercial Paper → short-term market borrowing by eligible issuers such as companies, NBFCs and specified institutions

Certificate of Deposit → negotiable money-market instrument issued by eligible banks against funds deposited with them

The current IIBF CAIIB BFM syllabus includes Money Market Products under Module C – Treasury Products.

The current regulatory frameworks are principally:

• Master Direction – RBI (Commercial Paper and Non-Convertible Debentures of original or initial maturity up to one year) Directions, 2024, effective 1 April 2024; and

• Master Direction – RBI (Certificate of Deposit) Directions, 2021, effective 7 June 2021.

These current rules are particularly important because some older study material contains requirements that have since changed.

Learning Objectives

After studying this topic, you should be able to:

• explain Commercial Paper and Certificate of Deposit;

• distinguish their issuers and purposes;

• understand their maturity and denomination requirements;

• identify important regulatory conditions for CP and CD;

• understand their primary and secondary-market operation;

• compare their credit and liquidity characteristics; and

• avoid common CAIIB traps arising from outdated rules.

What Is Commercial Paper?

RBI defines Commercial Paper, or CP, as an unsecured money-market instrument issued in the form of a promissory note.

The important words are:

Unsecured + Money Market + Promissory Note

CP enables eligible issuers to raise short-term funds directly from investors through the money market.

Because CP is unsecured, investors rely substantially on the issuer's creditworthiness rather than specific collateral.

Why Do Entities Issue Commercial Paper?

An eligible issuer may require short-term funds for purposes such as:

• financing current assets;

• meeting operating expenses;

• managing working-capital requirements;

• bridging temporary cash-flow gaps; or

• other disclosed purposes permitted under the regulatory framework.

Under the current RBI Directions, CP proceeds should ordinarily finance current assets and operating expenses. If used for another purpose, the specific end-use must be disclosed in the offer document.

Thus, CP provides an alternative to relying entirely on bank borrowing for short-term finance.

Eligible CP Issuers

Under the RBI's 2024 Directions, CP may be issued by eligible categories including:

• companies;

• NBFCs, including Housing Finance Companies;

• Infrastructure Investment Trusts;

• Real Estate Investment Trusts;

• All India Financial Institutions;

• qualifying body corporates with minimum net worth of ₹100 crore; and

• other entities specifically permitted by RBI.

Co-operative societies and LLPs with minimum net worth of ₹100 crore may also issue CP subject to specified conditions.

A key condition is that fund-based facilities, if any, availed from banks, AIFIs or NBFCs must be classified as Standard at the time of issue.

Important Update from Older Rules

Older CP material may mention conditions such as a specific ₹4 crore tangible net-worth requirement or a sanctioned working-capital limit.

Those should not automatically be applied to a current CP question.

The 2024 RBI Directions now prescribe the current issuer framework.

Credit Rating for Commercial Paper

CP is unsecured. Credit quality is therefore particularly important.

Under the current RBI framework, the minimum credit rating for issuance of CP is:

A3

as per the rating symbols and definitions prescribed by SEBI.

The rating must be obtained from an eligible Credit Rating Agency under the applicable framework.

A rating does not guarantee repayment. It represents an assessment of credit risk based on the rating methodology and information available.

Tenor of Commercial Paper

Under the current RBI Directions:

Minimum tenor = 7 days

Maximum tenor = 1 year

Therefore, CP is clearly a short-term money-market instrument.

Denomination and Form of CP

CP must currently be:

• issued in dematerialised form; and

• held with a SEBI-registered depository.

The minimum denomination is:

₹5 lakh

and thereafter in multiples of:

₹5 lakh.

Pricing of Commercial Paper

Under the current framework, CP is issued at a discount to face value.

Conceptually:

Investor pays less today → receives face value at maturity

The difference represents the investor's return.

The actual yield depends on:

• issue price;

• maturity;

• issuer's credit quality;

• market interest rates;

• liquidity conditions; and

• investor demand.

Issuing and Paying Agent for CP

Each CP issue must have an Issuing and Paying Agent, commonly called the IPA.

Under the RBI framework, the IPA is a Scheduled Commercial Bank performing prescribed responsibilities relating to the issue.

Its responsibilities include checking:

• issuer authority;

• compliance with RBI requirements;

• relevant documents;

• issue information; and

• required reporting.

The subscription to a primary CP issue must also be routed through the IPA.

What Is a Certificate of Deposit?

A Certificate of Deposit, or CD, is defined by RBI as a negotiable, unsecured money-market instrument issued by a bank as a Usance Promissory Note against funds deposited with the bank for a maturity period up to one year.

The key words are:

Negotiable + Unsecured + Bank-issued + Money Market Instrument

Why Do Banks Issue CDs?

A bank can use CDs as an additional source of market funding.

Suppose a bank requires funds for several months because:

• loan demand has increased;

• deposit flows are temporarily insufficient;

• liquidity requirements have changed; or

• treasury wants to diversify short-term funding.

Instead of relying only on ordinary deposits or interbank borrowing, the bank may raise eligible funds through CDs.

Therefore:

For the issuing bank, CD is a funding instrument.

For the investor, CD is an investment instrument.

Eligible Issuers of CDs

Under the RBI Certificate of Deposit Directions, CDs may be issued by:

• Scheduled Commercial Banks;

• Regional Rural Banks; and

• Small Finance Banks.

CDs issued by All India Financial Institutions are governed by the separate applicable RBI resource-raising framework.

This is a fundamental difference from CP.

A normal corporate cannot issue a CD merely because it has a strong credit rating.

Eligible CD Investors

Under the RBI CD Directions, CDs may be issued to persons resident in India.

This should be distinguished from the current CP framework, under which residents may invest and non-residents may invest to the extent permitted under FEMA and the relevant rules and regulations.

Tenor of Certificate of Deposit

A CD at issuance must have:

Minimum tenor = 7 days

Maximum tenor = 1 year

Notice the important similarity:

Therefore, maturity alone may not tell you whether an instrument is CP or CD.

The issuer is a major distinguishing factor.

Denomination and Form of CD

Like CP, CDs must currently be:

• issued only in dematerialised form; and

• held with a SEBI-registered depository.

The minimum denomination is:

₹5 lakh

and thereafter in multiples of:

₹5 lakh.

This similarity is frequently useful in exam questions.

Interest Structure of CDs

A particularly important current rule is that CDs are not restricted only to discount instruments.

Under the RBI 2021 Directions, CDs may be:

• issued at a discount to face value;

• issued on a fixed-rate basis; or

• issued on a floating-rate basis, subject to the prescribed benchmark requirements.

This differs from CP under the current 2024 framework, which is issued at a discount to face value.

CP vs CD – Core Comparison

The issuer distinction should be your first test in most CAIIB questions.

Primary-Market Operation

The primary market is where the instrument is newly issued.

CP

Broadly:

Issuer → Credit Rating → IPA → Offer/Issue → Investors → Funds to Issuer

The 2024 Directions require CP primary issuance to settle within a period not exceeding T+4 working days, where T is the deal date.

CD

The issuing bank raises funds directly through the CD issue.

Under the CD Directions, primary issuance is on a T+1 basis, where T represents the date of closure of the offer period.

Secondary-Market Trading

Both CPs and CDs are negotiable instruments capable of being traded in the secondary market under the applicable RBI framework.

CP

CP can be traded:

• in OTC markets, including approved electronic platforms; or

• on recognised stock exchanges approved for the purpose.

OTC secondary trades settle on:

T+0 or T+1

and are subject to the prescribed DvP settlement framework.

CD

CDs may similarly trade:

• OTC, including on electronic trading platforms; or

• on recognised stock exchanges with RBI approval.

OTC CD trades also settle on:

T+0 or T+1

and secondary transactions are settled on a Delivery versus Payment basis through the prescribed mechanism.

What Is DvP?

Delivery versus Payment means that securities and funds are exchanged in a coordinated manner.

The purpose is to reduce the risk that:

• one party delivers the security; but

• does not receive the corresponding payment.

Reporting Through F-TRAC

The F-TRAC platform of CCIL plays an important reporting role.

Under the applicable frameworks:

• primary issuances are reported;

• secondary-market transactions are reported;

• buybacks are reported; and

• prescribed information is made available for market transparency.

For both CP and CD, secondary-market transactions are generally required to be reported with a timestamp on F-TRAC within 15 minutes of execution.

Buyback

Both current frameworks permit issuer buyback before maturity, subject to conditions.

CP Buyback

CP can be bought back only after:

7 days from the issue date

The offer must be made to all investors in that issue on identical terms, and buyback occurs at the prevailing market price. Bought-back CP is extinguished.

CD Buyback

The issuing bank can also buy back a CD only after:

7 days from issue

with similar requirements relating to identical terms, investor choice, prevailing market price and extinguishment.

No Grace Period

Another useful common feature is:

There is no grace period for repayment.

This applies under the respective current RBI frameworks for both CP and CD.

Therefore, maturity obligations must be met according to the prescribed terms.

Can a Bank Give a Loan Against a CD?

Under the RBI CD Directions:

Banks are not allowed to grant loans against CDs unless specifically permitted by RBI.

This is a useful direct examination point.

Do not assume that because a CD is a bank-issued financial instrument, the holder can automatically pledge it to obtain a bank loan.

Credit Risk

Both CP and CD are unsecured instruments, but their credit-risk sources differ.

CP Credit Risk

The investor bears exposure to the CP issuer.

Because CP may be issued by corporates, NBFCs and other eligible entities, the investor must evaluate:

• issuer financial strength;

• rating;

• cash flows;

• market conditions; and

• repayment capacity.

This helps explain why the minimum A3 rating is significant.

CD Credit Risk

The investor is exposed to the issuing bank.

A CD is not a Government security merely because it is issued by a regulated bank.

Therefore:

CD ≠ sovereign security

and

CP ≠ secured corporate borrowing

Both are unsecured instruments.

Practical Banking Application

Situation 1: Large Company Needs Short-Term Working Funds

An eligible company wants market funding for six months to finance operating requirements.

The relevant instrument may be:

Commercial Paper

Situation 2: Bank Needs Short-Term Market Funding

A bank expects strong credit demand over the next three months and wishes to raise market funds.

The relevant instrument may be:

Certificate of Deposit

Situation 3: Investor Wants to Exit Before Maturity

Because both instruments are negotiable and tradable under their respective frameworks, the investor may sell the instrument in the secondary market, subject to market liquidity and applicable rules.

Situation 4: Company Wants to Issue a CD

Incorrect.

A company does not become eligible to issue a Certificate of Deposit simply because it needs short-term funding.

The company may examine CP if it satisfies the relevant eligibility requirements.

Advantages from a Treasury Perspective

Commercial Paper

For eligible issuers, CP can:

• diversify short-term funding;

• provide market-based borrowing;

• reduce exclusive dependence on bank finance; and

• match short-term funding requirements.

For investors, it can provide:

• short-term investment opportunities;

• varying issuer credit exposures; and

• potentially higher returns than sovereign instruments, depending on market conditions and credit risk.

Certificate of Deposit

For banks, CDs can:

• diversify funding sources;

• raise funds for a known maturity;

• support liquidity management; and

• provide flexibility beyond ordinary deposits.

For investors, CDs provide:

• a negotiable short-term bank instrument;

• a defined maturity;

• secondary-market tradability; and

• market-linked investment opportunities.

Risks and Limitations

Credit Risk

Both instruments are unsecured.

The investor bears issuer credit risk.

Market Risk

If an investor sells before maturity, the market price may differ from the original acquisition price.

Liquidity Risk

Negotiability does not guarantee that an instrument can always be sold immediately at the desired price.

Refinancing Risk for Issuer

An issuer that repeatedly depends on short-term instruments may face difficulty if market conditions deteriorate at maturity.

Interest-Rate Risk

Changes in market yields can affect secondary-market prices.

CAIIB Exam Focus

CP is an unsecured promissory-note money-market instrument.

CD is a negotiable unsecured bank-issued money-market instrument.

Issuer is the fastest distinction.

CP → eligible corporate/institutional issuers.

CD → eligible banks.

Both presently have a minimum tenor of 7 days and maximum tenor of one year.

Both presently have a minimum denomination of ₹5 lakh and multiples of ₹5 lakh thereafter.

Both are issued in dematerialised form.

CP must have at least A3 credit rating under the current RBI framework.

CP is issued at a discount.

CD may be issued at discount or on a fixed/floating-rate basis.

Both are unsecured.

Both can be traded in the secondary market.

Current CP rules are governed by the RBI 2024 Directions effective 1 April 2024.

This last point is important when older textbook conditions differ from current regulations.

Common Exam Traps

Trap 1: Commercial Paper Is Secured by Company Assets

Incorrect.

RBI defines CP as an unsecured money-market instrument.

Trap 2: Only Manufacturing Companies Can Issue CP

Incorrect.

The current RBI framework permits several categories of eligible issuers, including companies, NBFCs, AIFIs, InvITs, REITs and certain other entities.

Trap 3: Every CP Issuer Must Still Satisfy the Old ₹4 Crore Net-Worth Rule

Incorrect as a general current statement.

The RBI 2024 Directions prescribe the present eligibility framework. Older eligibility conditions should not be automatically applied to current questions.

Trap 4: CDs Are Issued by Companies

Incorrect.

CD is fundamentally a bank funding instrument under the RBI CD framework.

Trap 5: CP and CD Are Secured Because They Are Money-Market Instruments

Incorrect.

Both are unsecured.

Trap 6: CP and CD Must Have Different Tenors

Incorrect.

Under current RBI rules, both may have an issue tenor from 7 days to one year.

Trap 7: Every CD Must Be Issued Only at a Discount

Incorrect under the current framework.

CDs may also be issued on fixed or floating-rate bases.

Trap 8: CP Does Not Require a Credit Rating

Incorrect.

The current minimum rating for CP issuance is A3.

Trap 9: CD Carries the Same A3 Minimum Rating Requirement as CP

Incorrect.

The specific minimum A3 requirement appears in the current CP framework; the CD Directions do not prescribe an equivalent minimum credit-rating requirement.

Trap 10: Negotiable Means Risk-Free

Incorrect.

Negotiability means the instrument can be transferred or traded. It does not eliminate:

• credit risk;

• market risk; or

• liquidity risk.

Trap 11: Banks Can Freely Give Loans Against CDs

Incorrect.

Loans against CDs are not permitted unless specifically allowed by RBI.

Trap 12: Old CP Rules Are Always Correct for Current CAIIB Questions

Incorrect.

Regulatory rules change. Current questions should be read with the RBI 2024 CP framework where applicable.

Memory Technique

Remember:

CP = Corporate/Permitted issuer Paper

CD = Deposit-based bank Certificate

For common features, remember 7–1–5:

• 7 days minimum maturity

• 1 year maximum maturity

• ₹5 lakh minimum denomination

Then remember the key difference:

CP → A3 + Discount

CD → Bank + Discount/Fixed/Floating