Regulation of Bank Finance^387
Basically, the issue of CPs is an important step in financial disintermediation bringing
the borrower and the investor in touch with each other, without the intervention of the
banking system as financial intermediary. However, to the extent CPs substitute the
working capital loan, the banking system would lose its loan portfolio and probably
would losts its deposits as well, if the funds were with the banking system before
investment in CP. The banks end up losing both the asset and the liability through this
disintemediation process and the profit margin earned on the march would vanquish.
Theory suggests that the CPs would be predominantly funded by the short-term surplus
of the corporate sector. This is unlikely to be true in India, especially when the market
expands. The corporate sector will continue to the issue of CPs, intercorporate loans
and portfolio management scheme for employing their surplus and in the long run, it is
the money in the banks that will find its way to the CP market. Further CP facilitates
securitisation of loans resulting in creation of a secondary market for the paper and
efficient movement of money providing cash surpluses to cash deficit entities. In
international context, securitisation of debt paves way to globalisation of loan assets.
Potentiality of Commercial Paper as a
Source of Corporate FinanceCommercial paper serves as a very useful instrument for meeting working capital needs
of firms. However, only large and well established business enterprises with a track
record of high creditworthiness can make use of CP as a means of financing their
short-term needs because CP is an unsecured promissory note and does not carry any
tangible security. Basic reason for popularity of CP as a means of financing is that it is
usually less expensive than short-term bank credit by about 1 to 2 per cent and cost
differential increases in periods of easy money. Since no compensating balance
requirements are associated with the issuing of CP, cost of its issue would further be
lower than that of the bank credit. Another reason for the usefulness of CP as a source
of financing is that by means of this instrument firms can raise large amount of funds
which they cannot take from a single bank. CP provides sufficient flexibility in business
financing in as much as issuing firm may decide the quantum of CP and its maturity on
the basis of its future cash flows. Financially, use of CP adds to the prestige of the
issuing company, it seems more likely that the prestige was there before the paper was
sold.
A significant drawback of this source of financing is that it is less reliable source of
credit than bank loans. Because of the impersonal nature of the market, a buyer of
commercial paper feels no obligation ìto see the borrower throughî a period of hard
times or tight money. Buyers of CP simply look for the best yield possible for a short-
term investment at a minimum risk. Thus, alacrity with which buyers of CP will switch
to more attractive investments leaves firms high and dry in hard days when money
market condition becomes tight forcing the management to seek funds from banks. It is