New lending system to make CPs popular

Commercial papers, the money market instruments to raise funds of less than a year, are set to gain popularity with banks shifting to the new base rate regime.

In the prime lending rate (PLR) system, which ended on Wednesday, banks were allowed to lend below PLR. In the new regime, banks cannot lend below the base rate. CPs, as commercial papers are popularly known, offer five-seven per cent, depending on the tenor.

State Bank of India, India’s largest lender, has fixed its base rate at 7.5 per cent. Bank of Baroda, Union Bank of India and Punjab National Bank have pegged their base rates at 8 per cent. This will affect borrowing by companies that borrow from banks for less than a year. “The window for shorter duration loans at banks will now get closed,” said Rajesh Verma, senior vice-president, Development Credit Bank (DCB), explaining that companies would not look for such loans from banks any more. “In one way, it will make the treasury more active,” he said, explaining that banks would invest their surplus money in money market instruments.

According to an estimate, companies raise about Rs 1 lakh crore through CPs in a year. This is likely to rise. However, traders of these papers declined to put an estimate to the expected rise in the CP business.

The flip side of the larger interest in the CP market is that it may increase rates since “there will be more demand for CP than ever before”, said Prabal Banerji, group chief financial officer, Hinduja Group.

“The other impact will be that tenors will become longer, since corporates will want to enjoy low-cost funds as much as possible,” he said. The trend could see more demand for CPs of six to 12 months in comparison to CPs of one to three months. The rise in CP demand may also affect banks’ earnings from overdraft lending as it becomes a high-cost source.

Another instrument that can gain popularity is non-convertible debentures (NCDs) of over 90 days. “NCDs will definitely get popular, along with CPs,” said Seshagiri Rao, director, finance, JSW Steel.