Guidelines on Commercial Paper for Banks

Commercial Paper: Risks and Mitigants

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Presented by:Md. Shah Naoaj

Assistant DirectorBanking Regulation and Policy Department

Bangladesh BankHead Office

Bangladesh Bank

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PRESENTATION FRAMEWORK

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Background

early stage of development in Bangladesh

Eastern Bank Limited is the pioneer of CP in the country;

• it raised Tk. 500 million for ACI Limited in 2013.

Since then, this market is growing very fast in our country with approximate growth of 593.10 per cent in 2015.

The amount of current outstanding CPs is close to Tk. 1500 million.


Background: Global Perspective

• Commercial paper is a short-term debt instrumentissued by large corporations.– For issuers, commercial paper is a way of raising capital

cheaply at short-term interest rates.– For investors, commercial paper offers returns slightly

higher than Treasury bills in exchange for taking onminimal credit risk.

• At the beginning of 2007, commercial paper was thelargest U.S. short-term debt instrument with morethan $1.97 trillion outstanding.

• Most of the commercial paper was issued by thefinancial sector, which accounted for 92 percent ofall commercial paper outstanding.

Financial Crisis: role of CP

• Commercial paper played a central role during the financial crisis of 2007-2009. Before the crisis, market participants used to regard commercial paper as a safe asset due to its short maturity and high credit rating.

• Two events changed this perception. – Case of BNP Paribas– Case of Lehman Brothers

• The news triggered the modern-day equivalent of a bank run, leading to about $172 billion worth of redemptions from the $3.45 trillion worth money market fund sector.

Role of Fed

• To stop the sudden decline in commercialpaper, the Federal Reserve decided— for thefirst time in its history—to purchasecommercial paper directly.

• By early January 2009, the Federal Reservewas the single largest purchaser ofcommercial paper and owned paper worth$357 billion, or 22.4% of the market,through a variety of lending facilities.

Why did CP market fail?

Lack of policies and regulations

Lack of supervision

Extreme credit driven growth in housing sector


Guidelines on Commercial Paper for Banks in Bangladesh

Banks can play three major roles:

However, Banks shall not issue CP in any form or provide any guarantee for CPs.


invest in CPs

provide credit enhancements to CP issuers

act as an IPA of CPs.

General Instructions to the Banks

• The net worth of the issuer shall not be less than BDT 30 crore as per the latest audited balance sheet and the net profit after tax shall be positive for the last three (3) years.

• The current status shown in the Credit Information Bureau (CIB) report of the issuer company shall be ‘standard’ and have no track record of classified status for last two (2) years.

• The issuer shall have credit rating from an ECAI. The minimum credit rating of the issuer shall not be lower than BB Rating Grade-“2” and “S2” (short-term) as per Risk Based Capital Adequacy (in line with Basel III) guidelines.


Specific Guidelines for Issuing And Paying Agent (IPA)

• In the offering document, it shall be clearly stated that the payment will be made to the investors provided that the issuer has made the funds available to IPA.

• IPA shall not invest in the respective CP.


Specific Guidelines for investment in CP by banks

• The current ratio of the issuer must be at least 1:1 as per latest audited balance sheet;

• The debt-equity ratio of the issuer must be maximum 70:30 as per latest audited balance sheet;

• Banks investment in a single issue of CP shall not exceed 20% of the respective issue.

• Banks aggregate investment in commercial papers at any point of time cannot exceed 10% of its Tier 1 capital.

• Rollover of CP shall be treated as a fresh issue and require complying with all the applicable clauses. Rollover is limited to maximum one time.


Provision requirements

• Banks shall maintain provision against outstanding balance of the defaulted CPs at the following rates:

• If it is past due/overdue for 03 (three) months or beyond but less than 06 (six) months, the provision requirement is 20%.

• If it is past due/overdue for 06 (six) months or beyond but less than 09(nine) months, the provision requirement is 50%.

• If it is past due/overdue for 09 months or beyond the provision requirement is 100%.


• Banks shall follow the BRPD Circular No. 02/2014 on Single Borrower Exposure Limit and any amendments thereafter for providing such credit enhancements.


Specific Guidelines for providing credit enhancement

Thank you!

10/3/2016 14Bangladesh Bank

Guidelines on Commercial Paper for Banks

Economy & Finance