A Bank by definition is a financial establishment which accepts deposits from its depositors and uses this money for making investments and granting loans to its clients.
Hence by its very nature, the bank has to deploy the funds received from its depositors in a manner that not only it earns profit on the lending however the lending it makes has to be safe and secure since they have to repay their depositors as and when they demand. While I will mention the various methods employed by the bank for ensuring the safety and security of its lending in my further posts, this post is primarily dedicated on understanding the various types of facilities that a bank generally provides to its asset customers.
Types of facilities provided by Bank
· Fund Based Facilities
o These facilities involve outflow of funds from the bank to the borrower. These facilities generally earn interest income to the bank
o These facilities include products like
· Cash Credit/ Overdraft
· Term Loans
· Non Fund Based Facilities
o These are credit facilities given by the banks where actual bank funds are not involved. Banks generally earns Commission income from these facilities.
o These facilities include products like
· Letter of Credit
· Bank Guarantees
Banking Asset Products in detail
· Cash Credit/ Overdraft
o These facilities are provided by the banks to meet the day to day operation of their borrowers and hence are known as Working Capital facilities in banking parlance as they lend liquidity to the borrowers businesses.
o Almost all the businesses require working capital facilities for seamless operations.
o Under this facility the bank based on its assessment sanctions a limit upto which the borrower can draw the facilities. Based on the utilization made by the borrower interest is charged to the borrowers account on a monthly basis.
For Eg - If a business has a simple current account they can draw money only to the extent of credit balance reflecting in their account, however say if they have a Cash Credit/ Overdraft limits sanctioned of say Rs. 1 crores they can utilize the account to the extent of debit balance of Rs. 1 crores. The interest calculated will be on a daily basis but payable at the end of the month.
o The only difference between Cash Credit and Overdraft is that while in Overdraft the entire limits sanctioned is available to the borrower for utilization, in Cash Credit these limits are available subject to the availability of Drawing Power which is calculated on a monthly basis.
o Drawing Power is a formula set the by the bank for ensuring that the limits utilization is commensurate to the working capital requirement of the borrower. Generally it would be a percentage of (Current Assets less Current Liabilities) of the company.
o It helps the bank in ensuring that the funds are not diverted by the borrower to any other use except for working capital purpose.
· Term Loans
o Loan provided by a bank which is to be repaid by a borrower in a specified period of time with a specific repayment schedule. These loans fund the capital assets of the client.
o Term Loans are provided for financing the asset purchased/ constructed by the borrower. Examples of Term Loan include Home / Car/ Personal Loan for individuals and Machinery/ Infrastructure Loans for businesses.
o The tenure of these loans may vary from 1 year to 30 years depending on the type of Term Loan.
o For sanctioning a Term Loan the bank assesses the repayment capacity of the borrower wrt to income generated by them in the past vis-a-vis the size of loan applied.
o Term loan provides long term liquidity to the purchaser of asset and allows him to own the asset by paying the bank obligations in installments.
· Letter of Credit
o It is a written commitment from a bank guaranteeing that a buyer's payment to a seller will be received on time and for the specified amount provided that the seller provides all the documentary evidence as mentioned in the LC issued by the bank.
o It provides comfort to the seller that in case of any eventuality it’s the bank who would be paying off them their receivables and thereby increases the credit strength of the purchaser of goods.
o LC’s on the basis of payment methodology can be divided into two
§ Sight LC - Under this LC, payment is due by the bank upon presentation by the seller and only post its payment the bank can hand over the transaction documents to the buyer of the goods.
§ Usance LC – Along with the documents the seller sends a Bill of Exchange to the bank and post acceptance of the Bill, the documents are handed over to the buyer. The Bank post acceptance is liable to honour the bill on the due date.
o Practically only Confirmed and Irrevocable LC’s issued by the bank are accepted by the market.
· Bank Guarantee
o It is a commitment given by a banker to a third party, assuring her/ him to honour the claim against the guarantee in the event of the non- performance by the bank’s customer.
o Major Types of Bank Guarantee issued by Banks are
§ Financial Guarantee - The guarantee issued in lieu of receipt of any money from its clients customers in advance/ caution deposit needed to made for a contract by the banks client etc. In case the client doesn’t execute the contract the bank will be liable to pay the advance money/ caution deposit to the beneficiary.
§ Performance Guarantee – Guarantee issued by the bank guaranteeing the execution of project taken by its client is called as Performance Guarantee. This guarantee can be invoked if the client doesn’t perform the project to the satisfaction of the beneficiary. The payment amount in this case will be as determined between the client and the beneficiary and accepted by the bank at the time of issuance of guarantee.
o The major difference between LC and Bank Guarantee is the bank is under LC the bank is liable to make the payment if all the conditions in the LC are complied by the seller of the goods and under bank guarantee the bank is liable if the conditions mentioned in the Guarantee is not complied by the banks client.
- CA Sandeep Hoskeri
