Published Apr 7, 2024 ### Definition of Eligible Paper Eligible paper refers to financial documents that are accepted for discounting or purchase by a financial institution, especially during lending operations. It is mainly used in the context of central banking where commercial banks are allowed to borrow funds from the central bank, using certain types of securities or financial instruments as collateral. These documents typically include promissory notes, bills of exchange, and other short-term debt securities that meet specific criteria set by the lending institution in terms of credit quality, maturity, and liquidity. ### Example Let’s consider a scenario involving a commercial bank that needs to increase its short-term liquidity to meet unexpected deposit withdrawals. The bank decides to approach the central bank to borrow money. To secure this loan, the bank needs to provide collateral that qualifies as eligible paper. Among its assets, it has several promissory notes that are due to mature in 90 days with high credit ratings. These promissory notes meet the central bank’s requirements for eligible paper due to their short maturity and strong credit quality. Hence, the bank can use these notes as collateral to obtain the necessary funds from the central bank. ### Why Eligible Paper Matters The concept of eligible paper is crucial in the banking and financial system for several reasons. First, it provides a clear framework for secure lending between financial institutions and central banks. By defining specific criteria for acceptable collateral, central banks can manage the risk associated with their lending activities. For commercial banks and other financial institutions, having assets that qualify as eligible paper gives them access to liquidity in times of need, which is essential for maintaining stability in the financial system. This is particularly important during periods of economic stress when cash flows might be constrained. Furthermore, the market for eligible paper, including the trading of these securities, contributes to the overall liquidity and efficiency of the financial markets. It allows financial institutions to manage their short-term funding needs and investment opportunities effectively. ### Frequently Asked Questions (FAQ) #### How does eligible paper support monetary policy implementation? Eligible paper plays a pivotal role in the implementation of monetary policy. By adjusting the criteria for what constitutes eligible paper or by changing the interest rates on loans secured by such papers, central banks can influence the liquidity conditions in the banking system. This, in turn, impacts the interest rates, lending activities, and economic growth. #### What determines the eligibility of a paper? The eligibility of a paper is determined by several factors including the creditworthiness of the issuer, the maturity of the paper, and its market liquidity. Central banks and other financial institutions set specific criteria that these securities must meet to qualify as eligible, such as minimum credit ratings, maximum maturity periods, and acceptable types of issuers. #### Can the list of eligible paper change over time? Yes, the list of securities that qualify as eligible paper can change over time. Central banks may adjust their criteria in response to changing economic conditions, the health of the financial system, or their monetary policy objectives. For example, during a financial crisis, a central bank might decide to broaden the range of eligible paper to provide greater liquidity support to the banking system. This dynamic aspect of eligible paper underscores its significance in the financial ecosystem, offering a mechanism through which central banks can adapt their strategies to support economic stability and growth.
Economics