Commercial Paper Funding Program - Definition
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What is a Commercial Paper Funding Program (CPFP)?
A Commercial Paper Funding Program is a system established by the United States Federal Reserve Board to improve the markets short-term liquidity. Basically, the CPFP program provided short-term funding to the United States commercial papers issuers.
Commercial paper funding program has the following benefits:
- It can be used by credit providers to obtain liquidity by simply transferring the commercial paper to the third party.
- It allows the debtor to get short-term fund at a considerably lower price than that of bank credit.
A major drawback of a Commercial Paper Funding Program is that there is no guarantee that payment will be fulfilled. In other words, there is a possibility of a debtor defaulting to meet the payment obligation especially after the CPFP expires.
What are the types of Commercial Paper funding Program?
There are various types of Commercial Paper Funding Program. They include the following:
- Receipt: This refers to a document given by a creditor which highlights the main features of the commercial credit. For instance, the amount involved and the term/period. Note that in this type of document does not show the debtor. This means that there is no debt recognition. This makes the creditor have a small number of guarantees where he/she requires to deduction from a third party.
- Bill exchange: This is the most widely used document in business traffic when it comes to CPFP. The document is usually meant to ensure that the debtor agrees to the obligation of repaying back the loan. It is usually given out by the creditor to the debtor and can at the same time be transferred to a third party if need be. The debtor is supposed to sign the receipt to accept the responsibility. This gives provides utmost security in case the bank decides to give a discount.
- I will pay: This document is different from the two above. This is because unlike the two, the debtor is the one who issues this particular document. In this case, the payment obligation is recognized by the debtor and not the creditor. A bank promissory note is known for this purpose. It consists of the current account payment as well as the payment date.
Academic Research on Commercial Paper Funding Program
- The international propagation of the financial crisis of 2008 and a comparison with 1931, Moessner, R., & Allen, W. A. (2011). Bank for International Settelements. The authors compare the financial crisis of 1931 to 2008s. In the US, the collateral squeezed and after the Lehman Brothers failure, it became intense making other financial companies stability doubtful. The authors specify common features of these 2 crises, i.e. the flight to safety and liquidity. Central Europe accepted banks of London merchants in 1931 that became a serious issue. The commercial banks provided liquidity commitments to shadow banks in 2008. So, in both cases, the creditors valuation of assets and behaviour to debtors were highly important. However, a major difference in these crises was that the assets were regarded as safe and liquid. In 2008, the central banks with the constraint of no gold standard had an option to liquify the illiquid assets on a large scale.
- When safe proved risky: Commercial paper during the financial crisis of 2007-2009, Kacperczyk, M., & Schnabl, P. (2010). Journal of Economic Perspectives, 24(1), 29-50. Big corporations issue commercial paper which is a short time debt instrument. The market of commercial paper has been considered as a bastion of low risk and high liquidity. But during 2007 to 2009 financial crisis, the commercial paper two times dried up and ceased considering as a safe haven. To help the issuers and investors of commercial paper, the Federal Reserve interventions had to be used. The authors analyse the commercial paper market in the financial crisis by evaluating demand & supply forces and significant developments during this period. They explain the decline as; commercial paper issuers used alternative means of financing, institutional constraints in money market funds and adverse selection.
- The evolution of a financial crisis: Collapse of the assetbacked commercial paper market, Covitz, D., Liang, N., & Suarez, G. A. (2013). The Journal of Finance, 68(3), 815-848. This research is based on ABCP programs in 2007,i.e. Asset-Backed Commercial Paper. The authors note that one 3rd program faced a run within the weeks of ABCP crisis onset. The maturities, runs and yields were related to macro-financial and program level risks. These results are persistent with the asymmetric information structure that is used for describing banking panics. They have implications for risk intolerance of commercial paper investors. They inform statistical predictions of current papers on the failures of dynamic coordination.
- Did the commercial paper funding facility prevent a Great Depression style money market meltdown?, Duca, J. V. (2013). Journal of Financial Stability, 9(4), 747-758. This article makes an analysis of how risk premiums changed the commercial paper use for the bank loans meanwhile the recent financial crisis occurred. The results are consistent with the empirical and theoretical work on how risk premium surges can cause plunges in the credit funded with uninsured sources or under collateralized credit, showing that a risk premiums spike caused a plunge in the use of commercial paper during the current crisis. Also, the findings are that interventions by the Federal Reserve in the money market supported in preventing the market of commercial paper from melting down as much as observed in the early 1930s.
- Do global banks spread global imbalances? Asset-backed commercial paper during the financial crisis of 200709, Acharya, V. V., & Schnabl, P. (2010). IMF Economic Review, 58(1), 37-73. The riskless assets demand from countries having current account surplus brought fragility in countries having current account deficits, particularly in the US. This paper examines the asset-backed commercial papers setup by big commercial banks. The banks in surplus and deficit, both countries made up riskless assets, making a total of 1.2 trillion dollars, by selling short run ABCP to risk opposing investors, mainly, US market funds and making the investment of the proceeds in long run assets. A negative data about US assets revealed in Aug 2007. Banks of both the countries faced problems in rolling over ABCP thus had great losses. The findings are that international banking flows estimated the geography of the financial crisis.
- Market liquidity and funding liquidity, Brunnermeier, M. K., & Pedersen, L. H. (2008). The review of financial studies, 22(6), 2201-2238. The authors present a model linking the market liquidity of an asset funding liquidity of traders. Traders deal in market liquidity and this ability is subject to funding availability and vice versa. The authors show that margins destabilise under specific conditions. Funding liquidity and market liquidity reinforce mutually causing liquidity spirals. The model elaborates empirically documented properties that can be suddenly dried up by the market liquidity. It has common attributes across securities. It relates to volatility and depends on Flight to Quality. It moves together with the market. The authors present new testable predictions, such as the capital of speculators drives risk premiums and market liquidity.
- The role of securitization in bank liquidity and funding management, Loutskina, E. (2011). Journal of Financial Economics, 100(3), 663-684. This study explains the securitization role in bank management. The author offers a new index named bank loan portfolio liquidity. It is the potential weighted average for the securitization of loans. Weight here refers to the bank loan portfolio. When we allow banks converting illiquid loans to the liquid funds, securitization minimizes liquid securities that banks hold and enhance their lending ability. Securitization provides an extra funding source to banks. The bank lending becomes less sensitive to funds shocks cost. The ability of monetary authority becomes so weak that it cannot influence the lending activity of banks. When the market of securitization shuts down, banks become more susceptible to funding crisis and liquidity.
- US dollar money market funds and non-US banks, Baba, N., McCauley, R., & Ramaswamy, S. (2009). In this paper, the authors state that the failure of the Lehman Brothers troubled foreign exchange markets and international interbank. This is because it caused a run on the funds of the money market, the largest dollar funding suppliers to non-US banks. Policy prevented the run and made replacement of private funding with the public one.
- The changing nature of financial intermediation and the financial crisis of 20072009, Adrian, T., & Shin, H. S. (2010). The recent financial crisis has spotted the changing nature of financial institutions. It throws light on the growing role of shadow banking. It developed on the back of assets securitization and the banking integration with the growth of the capital market. This trend has mostly been noticed in the US but it has a profound impact on the overall international financial system. Capital market and banking growth cannot be separated in a financial system which is market-based. The authors discuss the changing role of financial intermediation in this system. They highlight the policy responses that the Federal Reserve and other central banks implement and counter.
- The financial crisis, systemic risk, and the future of insurance regulation, Harrington, S. E. (2009). Journal of Risk and Insurance, 76(4), 785-819. This paper explains the role of AIG (American International Group) and the financial crisis of 2007 to 2009 in the insurance sector. To investigate the reasons for the crisis, the author analyses the policies and events which contributed to the intervention of the Federal Government, preventing AIGs bankruptcy and the scope of federal support to AIG. Generally, insurance introduces systematic risk. Whether the insurers or financial institutions other than banks, desire the regulator of systematic risk. Finally, the implications of the financial crisis for federal charting have been addressed.