Basel III F: Callable Commercial Paper

Abstract

One of the Basel Committee on Banking Supervision’s responses to the global financial crisis of 2007-2009 was to introduce the Liquidity Coverage Ratio (LCR), a short-term measure that evaluates whether a bank has enough liquidity to meet expected cash outflows during a 30-day stress scenario. One area in which this incentive has already resulted in changed practices is in the market for commercial paper. Banks often provide backup liquidity facilities to the issuers of commercial paper that the issuers can draw upon to repay a maturing issue of commercial paper if they are unable to sell a new issue to do so. To avoid such draws occurring within the 30-day LCR window, banks have developed commercial paper that features a call provision enabling issuers to redeem the commercial paper prior to the start of the window. This case considers the implications of the emergence of callable commercial paper and whether this development introduces additional risk into the financial system.