Non – Fund Based Credit Facilities

Definition

Non- fund based facilities are such facilities extended by banks which do not involve outgo of funds from banks when the customer avails the facilities but may at a later date crystallise into financial liabilities if the customer fails to honour the commitment made by availing these facilities.

Banker undertakes a risk to the amount on happening of a contingency.

Advantages of NFB Facilities to Banks

-No immediate outlay of funds

-Future or contingent deployment of funds

-Earnings by way of Up Front commission, fee and exchange income

-Costs less to the bank

-Low probability of default

Types of NFB Facilities

Letter of Credit

-Inland LC

-Foreign (Import) LC

Bank guarantee

-Inland Bank guarantee

-Foreign Bank Guarantee

Letter  of  Credit or Documentary Credit

Letter of Credit is an undertaking issued by a Bank (Issuing Bank), on behalf of the buyer (importer), to the seller (exporter) to pay for goods and services provided that the seller presents documents which comply with the terms and conditions of the Letter of Credit

As per UCPDC – 600 Edition effective from 1st July 2007:-

“Documentary Credit means any arrangement that is irrevocable and thereby constitutes a definite undertaking  of the issuing bank to honor a complying presentation.”

“Complying presentation” means:-

- A presentation that is in accordance with the terms and conditions of the credit and also 

  the applicable provisions of  rules (UCP 600) & international standard banking practice.

“Honor” means

-to pay at sight if the credit is available by sight payment.

-to incur a deferred payment undertaking and pay at maturity if the credit is available by deferred    

  payment.

-to accept a bill of exchange ("draft") drawn by the beneficiary and pay at maturity if the credit is  

  available by acceptance.

Three main contracts underlying LC are:-

 - Sale Contract between Buyer & Seller

- Application-cum-Guarantee between   Applicant(Buyer) and Issuing Bank

- LC  itself (contract between Issuing  Bank and Beneficiary/Seller)

        ( LC is independent of other two contracts)

Parties to Letter of Credit

-Opener/Buyer

-Issuing Bank

-Advising Bank

-Beneficiary/Seller

-Nominated Bank/Negotiating Bank

-Confirming Bank

-Reimbursing Bank

Types of Letter of credit

As per Security to beneficiary:-

-Confirmed Letter of Credit

As per Mode of settlement:-

-Payment/ deferred payment

-Acceptance

-Negotiation

Involving middlemen:-

-Transferable

-Back to back

Involving advances:-

-Red Clause Credit

-Green Clause Credit

Involving repeated transactions:-

-Revolving

-Stand by

While opening LC, Banks to follow guidelines of institutions:-

-Foreign Trade Policy requirements.

-FEMA requirements.

-Credit norms of RBI.

-UCPDC 600 Provisions.

-Bank’s Internal Credit Policies/ procedures.

-Public notices issued by DGFT

-Uniform Rules for bank-to-bank reimbursements 525

-Inco-terms 2010

Bank Guarantee

Section 126 of Indian Contract Act, 1872 defines guarantee:

“A contract to perform the promise or discharge the liability of a third person in case of his default”

Parties Involved in BG

-Applicant : Principal Debtor: The person at whose request the guarantee is executed

-Beneficiary: The person to whom the guarantee is given and who can enforce it in case of default

-Guarantor: The person who undertakes to discharge the obligations of the applicant in case of his default

Thus, a contract of guarantee is a collateral contract, consequential to a main contract between the applicant and the beneficiary

BG issued must be unconditional and for:-

-Definite Period

-Definite Amount

-Definite Purpose

BG may be based on location of beneficiary, Purpose and Currency.

Types of Bank Guarantee

-Financial Bank Guarantee

-Performance Bank Guarantee

-Deferred Payment Guarantee

Financial BG is issued in lieu of customer’s requirement to :-

-Deposit a cash security or earnest money for the contract

-Deposit of excise / Custom duties in dispute

-Cover payments for supplies / services

Performance BG is issued :-

-On behalf of customer who enters into contract to do certain things on or before a given date

-Bank assures the third party that the customer will perform the contract as per condition stipulated in

  the contract

Deferred Payment Bank Guarantee is issued:-

-when goods or machinery are purchased on long term credit and payment is made through cheques and bills of different dates

-Bank issues guarantee of payment of installments on due date in the event of default by the buyer.