Bank Guarantees

It helps to have a third partys vetting for your business.

When running a business, you might come across a situation that your client may ask you to provide a
financial guarantee from a third party.
In such circumstances, approach your bank and ask it to stand as a guarantor on your behalf. This
concept is known as bank guarantee (BG).
This is usually seen when a small company is dealing with much larger entity or even a government
across border. Let us take an example of a company XYZ bags a project from, say, the Government to
build 200 power transmission towers.
In this case, companies all over the world would have applied. The selection would be made on the basis
of lowest cost and track record as submitted in the proposal form.
However, the government has limited ability to assess all companies for financial stability and credit
worthiness.
To ensure the project is done satisfactorily and on time, the government puts a condition that company
XYZ will have to furnish a guarantee given by one or more banks.
In banking nomenclature, company XYZ is an applicant, its bank is the issuing bank and the Government
of Ethiopia is the beneficiary.
Usually, the BG is for a specified amount, which is a percentage of the total money required for the
contract.
Obviously, the bank will not just issue such guarantee with its own due diligence. The bank does its own
thorough analysis of the financial well being of company XYZ to assess the amount of guarantee it can
issue. After all, the bank is at a risk too, in case the client defaults. This amount is called a limit.
Here too there is a catch. The bank will issue guarantee provided the company has not exceeded its
overall limit for BGs. And if the Government of Ethiopia is not satisfied with the performance of the
contract at a later date, it can invoke the BG.
In this situation, the bank will have to immediately release the amount of the BG to the government.
BGs can be broadly classified into Performance and Financial BGs. As the name suggests, Performance
BGs are the ones by which the issuing bank, also known as the Guarantor, guarantees the ability of the
applicant to perform a contract, to the satisfaction of the beneficiary.
VARIATIONS
Let us continue with our earlier example, to understand the different types of performance BGs. XYZ
might need to give a BG that guarantees it has the capability to do the project, on winning the bid. This
ensures only serious bidders are in the fray for the project. This is called a bid-bond guarantee. XYZ also
might be getting an advance payment for buying materials, etc. Again, it will have to furnish a BG to the
extent of the advance, called an advance payment BG. To secure the project even further, the
Government of Ethiopia might insist on stage payment guarantees. This would have milestones like 20
per cent, 40 per cent, etc and a period in which these have to be done. As and when XYZ does that part
of the work, the BG would expire, thus freeing its limits with the bank (banks also charge for these
services, typically as a small percentage of the BG amount, even as little as 0.05 per cent).
Another interesting use of the performance BG is in importing materials into the country. In this case, an
importer might want to contest the amount of duty levied by the customs and until the duties are paid,
the goods are not released. The importer can, in this case, present a BG for the amount of the duty (also
known as customs guarantee) and get his goods released. Once the final decision is taken, the import
duty is paid and the BG released.
The other broader types of BGs are financial guarantees. These are used to secure a financial
commitment such as a loan, a security deposit, etc. For example, guarantees of margin money for stock
exchanges. These are issued on behalf of brokers, in lieu of the security deposit that needs to be paid at
the time of becoming a member of the exchange.
The applicant, XYZ, has to prove credit worthiness only to one party, his bank, and can bid for projects
across the world. The beneficiary, Government of Ethiopia, does not have to analyse how financially
sound the companies are and knows that in case something goes wrong, the bank will pay him.

External Commercial Borrowing (ECB)
External Commercial borrowing (ECB) refers to commercial loans availed by companies from non-
resident lenders in the form of bank loans, buyers credit, suppliers credit, securitized instruments (e.g.
floating rate notes and fixed rate bonds). A company is allowed to raise ECB from internationally
recognized source such as banks, export credit agencies, suppliers of equipment, foreign collaborators,
foreign equity-holders, international capital markets etc. However, offers from unrecognized sources are
not entertained. External Commercial Borrowings (ECBs) include bank loans, suppliers and buyers
credits, fixed and floating rate bonds (without convertibility) and borrowings from private sector
windows of multilateral Financial Institutions such as International Finance Corporation. In India,
External Commercial Borrowings are being permitted by the Government for providing an additional
source of funds to Indian corporate and PSUs for financing expansion of existing capacity and as well as
for fresh investment, to augment the resources available domestically. ECBs can be used for any
purpose (rupee-related expenditure as well as imports) except for investment in stock market and
speculation in real estate.
What it includes:-
Commercial bank loans, buyers credit, suppliers credit, securitized instruments such as floating rate
notes, fixed rate bonds etc., credit from official export credit agencies, commercial borrowings from the
private sector window of multilateral financial institutions such as IFC, ADB, AFIC, CDC etc. and
Investment by Foreign Institutional Investors (FIIs) in dedicated debt funds. The government has been
streamlining and liberalising the ECB procedures in order to enable the Indian corporate to have greater
access in the financial markets. The RBI has been empowered to regulate the ECBs. ECB provide
additional sources of funds for the corporate and allows them to supplement the domestic available
resources and take advantage of the lower interest rates prevailing in the international financial
markets.
Purpose:-
ECBs are being permitted by the government as an additional source of financing for expanding the
existing capacity as well as for fresh investments. The policy of the government also seeks to emphasize
the priority of investing in the infrastructure and core sectors such as Power, telecom, Railways, Roads,
Urban infrastructure etc. Another priority being addressed is the need of capital for Small and Medium
scale enterprises.
Modes of raising ECBs: -
ECB constitutes the foreign currency loans raised by residents from recognised lender. The ambit of ECB
is wide. It recognizes simple form of credit as suppliers credit as well as sophisticated financial products
as securitization instruments. Basically ECB suggests any kind of funding other than Equity (considered
foreign direct investment) be it Bonds, Credit notes, Asset Backed Securities, Mortgage Backed
Securities or anything of that nature, satisfying the norms of the ECB regulations. The different
borrowings and loans that come under the ECB roof are:-
Commercial Bank Loans: These loans constitute the term loans taken by companies from banks
outside India
Buyers Credit: Buyers credit is the credit availed by the importers of goods/services from
overseas lenders such as Banks and Financial Institutions for payment of their Imports on the
due date. This lending is usually based on the letter of Credit (a Bank Guarantee) issued by the
importers bank, i.e., the importers bank acts as a broker between the Importer and the
Overseas lender for arranging buyers credit by issuing its Letter of Comfort for a fee.
Suppliers Credit: Securitized instruments such as Floating Rate Notes (FRNs), Fixed Rate Bonds
(FRBs), Syndicated Loans etc.
Credit from official export credit agencies: Commercial borrowings from the private sector
window of multilateral financial institutions such as International Finance Corporation
(Washington), ADB, AFIC, CDC,
Loan from foreign collaborator/equity holder, etc and corporate/institutions: with a good credit
rating from internationally recognized credit rating agency
Lines of Credit from foreign banks and financial institutions
Financial Leases
Import Loans
Investment by Foreign Institutional Investors (FIIs) in dedicated debt funds
External assistance, NRI deposits, short-term credit and Rupee debt Foreign Currency
Convertible Bonds
Non convertible or optionally convertible or partially convertible debentures
What is not included under ECBs:
Investment made towards core capital of an organization viz. Investment in equity shares Convertible
preference shares Convertible debentures Instruments which are fully and mandatorily convertible into
equity within a specified time are to be reckoned as part of equity under the FDI Policy Equity capital
Retained earnings of FDI companies Other direct capital (inter-corporate debt transactions between
related entities)
Advantages of ECBs:-
Benefits to the borrower:
Foreign currency funds: Companies need funds in foreign currencies for many purposes such as,
paying to suppliers in other countries etc that may not be available in India.
Cheaper Funds: The cost of funds borrowed from external sources works out to be cheaper as
compared to the cost of Rupee funds. Diversification of investors base: Another advantage is
the addition of more investors thus diversifying the investor base
Satisfying Large requirements: The international market is a better option in case of large
requirements, as the availability of the funds is huge when compared to domestic market.
Corporate can raise ECBs from internationally recognised sources such as banks, export credit
agencies, suppliers of equipment, foreign collaborators, foreign equity holders, international
capital markets etc.
Benefits to the Economy:
As can be seen from the policies formed to regulate the ECB, these borrowings have some apparent
benefits for the economy. The government through these policies is trying to nourish 2 sectors:-
Infrastructure
SME
The policies do not require any approval for investment under a limit in these 2 sectors. Thus it is easy to
acquire foreign loans for such enterprises. Apart from that, the low cost of funds in the global market
provides the small and medium enterprises funds at low costs thus bringing in more money in these
sectors.
Benefits to the Investor: ECB is for specific period, which can be as short as three years Fixed Return,
usually the rates of interest is fixed. The interest and the borrowed amount are repatriable (recoverable
i.e. there is no owners risk).
Note that: ECB works in the same manner as term loan works. The difference is:-
It is in foreign currency.
It carries lower rate of interest (2% int rate).
If not hedged the borrower is exposed to foreign currency risk.
Bankers do not give limit to companies having small limits (We can think of giving companies
ECB only if Total WC limits enjoyed by the Co is 50crores or more).
Generally banks gives ECB only to large players & when the company has got very good profile.
Even if all the criterias of companies are descent still bank may not give ECB. It is very much
within their discretion.
Bank gives ECB generally for high funding amount only.
It is not necessary that for getting ECB, you have to import anything. It is just a foreign currency
loan which helps the companies by having cheaper rate of interest.
Pre-shipment & Post-shipment Credit
There are two types of facilities offered by the banks to the exporters. They are:-
1) Pre shipment credit facility
2) Post shipment credit facility
Pre shipment credit facility
This is the credit facility known as packing credit loan which means the credit limit provided by the bank
to the exporters till the packing of the finished materials. This facility is basically given to the exporters
to enable them to purchase the required raw materials and for processing the same i.e. for the payment
of labour charges.
This facility can be availed in the following manner either as:-
PCFC (Packing credit in Foreign Currency) or
Rupee PC (Export Packing Credit).
P.C.F.C. (Packing credit in Foreign Currency)
In the case of PCFC, the bankers have their own line of credit with their foreign banks and the interest is
charged at LIBOR' rate i.e. London Inter Bank Offered Rate plus the interest spread that is mutually
agreed upon between the bankers and the exporter subject to a minimum of 1.0%, till the due date. This
is denominated in a foreign currency.If the payment is not received after 30 days from the due date, the
Packing credit will be crystallised. It means that the bankers will convert the balance PCFC, at the TT
selling inter bank rate into Indian Rupees and the interest will be charged on the entire amount at
commercial rate of interest from day one of availing the PCFC.
Rupee PC (Export Packing Credit)
This is taken in Indian Rupees and is given to the exporter in the form of the Rupee Loan and the interest
is charged at the rate as per RBI directives. When any export proceeds are realized, the packing credit is
automatically adjusted. If it becomes overdue the rate of interest will be charged at the rate determined
by the individual bank.
Post shipment credit facility
The post shipment credit limit is allowed after the shipments are effected for bills drawn on a client
through the bankers or shipments directly addressed to the consignee. Out of this post shipment the
bankers allow a sub-limit for availing loans against direct shipments. The bankers obtain the confidential
reports about the foreign clients of their exporter customers through their overseas
correspondents/their branches/approved international agencies. The bankers update the confidential
reports once in a year. Once the documents are submitted to the bank, the exporter can avail the post
shipment credit limits.
The post shipment credit limits can be availed in any of the following manners:-
Rupee Loan
Discounting of Export bills
Loan in Foreign Currency
Rupee Loan
It is granted for 90% of the export bill value. The normal rate of interest till the due date and the
overdue interest are charged at the rate determined by the respective banks as per Reserve Bank of
India's directives. Once the payment is received 90% will be adjusted towards the loan availed under
post shipment credit and the balance will be credited to current account or packing credit account after
deducting the charges like, interest and commission.
Discounting of Export bills
The exporter after submission of the export documents, requests the bankers to purchase / discount the
export bill. The bankers will convert the entire bill amount taking the spot buying rate prevalent on the
date of purchase and the premium for the tenor and the transit period of the bill and the total bill
amount will be adjusted to the packing credit account if there is any outstanding in the packing credit
account or will be credited to the exporter's current account.
The rate of interest is determined by the respective bankers, as per RBI directives.
In this case, if the payment is not received within the due date, the overdue interest will be charged at
the determined rate of the bankers. If the payments are not received within 30 days after the due date,
the bill will be crystallised at the TT selling rate prevalent on the date of crystallization and commercial
rate of interest will be charged to the exporter from the date of crystallization till the date of the
payment.
PSFL/EBR (Post Shipment Foreign Loan/Export Bill Rediscounting Facility)
This is the facility granted in foreign currency only and is not converted into Indian Rupees. This foreign
currency loan is basically granted to liquidate the packing credit loan availed in foreign currency. The
rate of interest charged will depend upon the LIBOR' rate i.e. London Inter Bank offered rate plus the
interest spread that is mutually agreed upon between the bankers and the exporter subject to a
minimum of 1.0%.
After 30 days of the due date if the bill is still not realized the bankers will crystallise the bill and charge
commercial rate of interest from day one of availing the facility.

Dropline OD
This is a new generation overdraft facility in which both the features of Term Loans & Overdraft Facility
are available. These limits can be for a period of 10 years where the drawing power of the borrower is
reduced on month on month basis. These limits do not have a yearly renewal charge but it has a
onetime processing fees. These are only offered to self employed persons or companies. DOD is best for
Manufactures, traders & retailers. Funding amount is determined as a percentage of collateral.
Percentage funding on collateral is similar to LAP.

DODs dont require a charge to be made on your stocks book debts; it also not requires any quarterly or
half yearly audits of the stock.
Example:-
Say client has taken DOD of Rs 60 lakhs for 5years (60 months). Here every month he has to pay Rs 1
lakh towards repayment of principal which is fixed & Interest is calculated daily on the fluctuating
outstanding balance and is normally charged at the end of each month. The limit gets reduced by the
end of that month. At the end of 4 months the limit will be 56 lakhs i.e. in 5
th
month he can utilize
maximum Rs 56 lakhs only.
FCNR (B)
What is FCNR (B)
FCNR (B) means Foreign Currency Non Resident. The letter B in FCNR (B) stands for the word Bank. An
account that can be opened with an Indian bank by a Non Resident Indian or a Person of Indian Origin in
foreign currency is FCNR (B) account. It is an account that allows the NRI to keep his deposits in foreign
currency. The account is maintained in foreign currency. Pound sterling, Australian dollar, Canadian
dollar, Japanese Yen, Euro, United States dollar are few currency types in which an FCNR account can be
opened today. The account can be opened by a Non Resident Indian or Person of Indian origin and only
an NRI or PIO can be joint holder to this account. Only term deposit schemes are available to this
account type and the period can be more than a year and a maximum of 5 years. If the account holder
so wishes these accounts can also be transferred to other NRE/FCNR accounts before maturity period.
Such transfers are subjected to penalties that are charged for premature withdrawals of the deposit.
What is the use of FCNR (B) to Indian Companies
Since banks have this money deposited with them by NRI on which they have to pay lesser rate of
interest as it is in foreign currency, banks can give companies having very good parameters, working
capital facility at interest rate of around 9-10% (where normal CC rates are around 13-14%). Banks
compulsorily ask such companies to hedge against this loan bcoz this loan is in INR for companies,
however bank has dollar exposure. Actually companies get it at around 4-5% & around 6% is hedging
cost. Therefore total cost to the companies comes to around 10-11%. The banks will review every
quarter whether the limit can be renewed; banks decide this on the basis of dollar availability. If they
dont have dollar availability, then it is converted to normal CC and interest rates are charged which are
applicable on CC.
Letter of Credit (LC)
Where there is a mutual distrust between a buyer & a seller, letter of credit is issued. It is a
written commitment to pay, by a buyer's or importer's bank (called the issuing bank) to
the seller's or exporter's bank (called the accepting bank, negotiating bank, or paying bank).
A letter of credit guarantees payment of a specified sum in a specified currency, provided the seller
meets precisely-defined conditions and submits the prescribed documents within a fixed timeframe.
These documents almost always include a clean bill of lading or air waybill, commercial invoice,
and certificate of origin. To establish a letter of credit in favor of the seller or exporter (called
thebeneficiary) the buyer (called the applicant or account party) either pays the specified sum
(plus service charges) up front to the issuing bank, or negotiates credit. Letters of credit
are formal trade instruments and are used usually where the seller is unwilling to extend credit to the
buyer. In effect, a letter of credit substitutes the creditworthiness of a bank for the creditworthiness of
the buyer. Thus, the international banking system acts as an intermediary between far flung exporters
and importers. However, the banking system does not take on any responsibility for
the quality of goods, genuineness of documents, or any other provision in the contract of sale.
Letters of credit are often used in international transactions to ensure that payment will be received.
Due to the nature of international dealings including factors such as distance, differing laws in each
country and difficulty in knowing each party personally, the use of letters of credit has become a very
important aspect of international trade. A letter from a bank guaranteeing that a buyer's payment to a
seller will be received on time and for the correct amount. In the event that the buyer is unable to make
payment on the purchase, the bank will be required to cover the full or remaining amount of the
purchase. The bank also acts on behalf of the buyer (holder of letter of credit) by ensuring that the
supplier will not be paid until the bank receives a confirmation that the goods have been shipped. The
letter of credit can also be used to ensure that all the agreed upon standards and quality of goods are
met by the supplier, provided that these requirements are reflected in the documents described in the
letter of credit.
A letter of credit is a document issued by a financial institution, or a similar party, assuring payment to a
seller of goods and/or services provided certain documents have been presented to the bank. These are
documents that prove that the seller has performed the duties under an underlying contract (e.g., sale
of goods contract) and the goods (or services) have been supplied as agreed. In return for these
documents, the beneficiary receives payment from the financial institution that issued the letter of
credit. Almost all letters of credit are irrevocable, i.e., cannot be amended or canceled without the
consent of the beneficiary, issuing bank, and confirming bank, if any.
The parties to a letter of credit are:-
supplier, usually called the beneficiary
the issuing bank, of whom the buyer is a client, and
sometimes an advising bank, of whom the beneficiary is a client.
{Note :-Who is an Advising Bank - An advising bank (also known as a notifying bank) advises
a beneficiary(exporter) that a letter of credit (L/C) opened by an issuing bank for anapplicant (importer)
is available. Advising Bank's responsibility is to authenticate the letter of credit issued by the issuer to
avoid fraud. The advising bank is not necessarily responsible for the payment of the credit which it
advises the beneficiary of. The advising bank is usually located in the beneficiary's country. It can be (1) a
branch office of the issuing bank or a correspondent bank, or (2) a bank appointed by the beneficiary.
Important point is the beneficiary has to be comfortable with the advising bank.
In case (1), the issuing bank most often sends the L/C through its branch office or correspondent bank to
avoid fraud. The branch office or the correspondent bank maintains specimen signature(s) on file where
it may counter-check the signature(s) on the L/C, and it has a coding system (a secret test key) to
distinguish a genuine L/C from a fraudulent one (authentication) .
In case (2), the beneficiary can request the applicant to specify his/her bank (the beneficiary's bank) as
the advising bank in an L/C application. In many countries, this is beneficial to the beneficiary, who may
avail the reduced bank charges and fees because of special relationships with the bank. Under normal
circumstances, advising charges is standard and minimal. In addition, it is more convenient to deal with
the beneficiary's own bank over a bank with which the beneficiary does not maintain an account.}
Flow of transaction when LC is issued


After a contract is concluded between a buyer and a seller, the buyer's bank supplies a letter of credit to
the seller.


Seller consigns the goods to a carrier in exchange for a bill of lading.




Seller provides bill of lading to bank in exchange for payment. Seller's bank exchanges bill of lading for
payment from buyer's bank. Buyer's bank exchanges bill of lading for payment from the buyer.



Buyer provides bill of lading to carrier and takes delivery of goods.


Documents that can be presented for payment
To receive payment, an exporter or shipper must present the documents required by the letter of credit.
Typically, the payee presents a document proving the goods were sent instead of showing the actual
goods. The Original Bill of Lading (BOL) is normally the document accepted by banks as proof that goods
have been shipped. However, the list and form of documents is open to negotiation and might contain
requirements to present documents issued by a neutral third party evidencing the quality of the goods
shipped, or their place of origin or place. Typical types of documents in such contracts might include:
Financial Documents
Bill of Exchange, Co-accepted Draft
Commercial Documents
Invoice, Packing list
Shipping Documents
Transport Document, Insurance Certificate, Commercial, Official or Legal Documents
Official Documents
License, Embassy legalization, Origin Certificate, Inspection Certificate, Phytosanitary certificate
Transport Documents
Bill of lading (ocean or multi-modal or Charter party), Airway bill, Lorry/truck receipt, railway
receipt, CMC Other than Mate Receipt, Forwarder Cargo Receipt, Deliver Challan...etc
Insurance documents
Insurance policy, or Certificate but not a cover note.


Types of Letter of Credit
Import/export Letter of Credit
The same credit can be termed as import and export LC depending on whose perspective it is being
looked upon. For the importer it is termed as Import LC and for the Exporter of goods, Export LC.
Revocable Letter of Credit
In this type of credit, buyer and the bank which has established the LC are able to manipulate the letter
of credits or make any kinds of corrections without informing the seller and getting permissions from
him. Currently all LCs are Irrevocable, hence this type of LC used no more.
Irrevocable LC
In this type of LC, Any changes (amendment) or cancellation of the LC (except it is expired) is done by
the Applicant through the issuing Bank. It must be authenticated by the Beneficiary of the LC. Whether
to accept or reject the changes depends on the beneficiary.
Confirmed LC
An LC is said to be confirmed when another bank adds its additional confirmation (or guarantee) to
honor a complying presentation at the request or authorization of the issuing bank.
Unconfirmed LC
This type of letter of credit, does not acquire the other bank's confirmation.
Transferrable LC
A Transferable Credit is the one under which the exporter has the right to make the credit available to
one or more subsequent beneficiaries. Credits are made transferable when the original beneficiary is a
middleman and does not supply the merchandise himself but procures goods from the suppliers and
arrange them to be sent to the buyer and does not want the buyer and supplier to know each other. The
middleman is entitled to substitute his own invoice for the one of the supplier and acquire the
difference as his profit in transferable letter of credit mechanism.
Important Points of Consideration:
A letter of credit can be transferred to the second beneficiary at the request of the first beneficiary only
if it expressly states that the letter of credit is "transferable". A bank is not obligated to transfer a credit.
A transferable letter of credit can be transferred to more than one second beneficiary as long as credit
allows partial shipments.
The terms and conditions of the original credit must be indicated exactly in the transferred credit.
However, in order to keep the workability of the transferable letter of credit below figures can be
reduced or curtailed.
Letter of credit amount any unit price of the merchandise (if stated) the expiry date the
presentation period or the latest shipment date or given period for shipment.
The first beneficiary may demand from the transferring bank to substitute his name for that of the
applicant. However, if a document other than invoice required in the transferable credit must be issued
in a way to show the applicant's name, in such a case that requirement must be indicated in the
transferred credit.
Transferred credit cannot be transferred once again to any third beneficiary according to the request of
the second beneficiary.
Untransferable LC
It is said to the credit that seller cannot give a part or completely right of assigned credit to somebody or
to the persons he wants. In international commerce, it is required that the credit will be untransferable.
Deferred / Usance LC
It is kind of credit that won't be paid and assigned immediately after checking the valid documents but
paying and assigning it requires an indicated duration which is accepted by both of the buyer and seller.
In reality, seller will give an opportunity to the buyer to pay the required money after taking the related
goods and selling them.
At Sight LC
It is a kind of credit that the announcer bank after observing the carriage documents from the seller and
checking all the documents immediately pays the required money.
Red Clause LC
In this kind of credit assignment, the seller before sending the products can take the pre-paid or part of
the money from the bank. The first part of the credit is to attract the attention of the acceptor bank. The
reasoning behind this is the first time this credit is established by the assigner bank, it is to gain the
attention of the offered bank. The terms and conditions were written by red ink, going forward it
became famous with that name.
Back to Back LC
This type of LC consists of two separated and different types of LC. First one is established in the benefit
of the seller that is not able to provide the corresponding goods for any reasons. Because of that reason
according to the credit which is opened for him, neither credit will be opened for another seller to
provide the desired goods and sends it.
Back-to-back L/C is a type of L/C issued in case of intermediary trade. Intermediate companies such as
trading houses are sometimes required to open L/Cs by supplier and receive Export L/Cs from buyer.
SMBC will issue a L/C for the intermediary company which is secured by the Export L/C (Master L/C).
This L/C is called "Back-to-back L/C".

Price of LC
All the charges for issuance of letter of credit, negotiation of documents, reimbursements and other
charges like courier are to the account of applicant or as per the terms and conditions of the letter of
credit. If the Letter of Credit is silent on charges, then they are to the account of the Applicant. The
description of charges and who would be bearing them would be indicated in the letter of credit.

Risk Situations in LC Transactions
Fraud Risks
The payment will be obtained for nonexistent or worthless merchandise against presentation by the
beneficiary of forged or falsified documents.
Credit itself may be funded.
Sovereign and Regulatory Risks
Performance of the Documentary Credit may be prevented by government action outside the
control of the parties.
Legal Risks
Possibility that performance of a Documentary Credit may be disturbed by legal action relating
directly to the parties and their rights and obligations under the Documentary Credit
Force Majeure and Frustration of Contract
Performance of a contract including an obligation under a Documentary Credit relationship is
prevented by external factors such as natural disasters or armed conflicts
Risks to the Applicant
Non-delivery of Goods
Short shipment
Inferior Quality
Early /Late Shipment
Damaged in transit
Foreign exchange
Failure of Bank viz Issuing bank / Collecting Bank
Risks to the Issuing Bank
Insolvency of the Applicant
Fraud Risk, Sovereign and Regulatory Risk and Legal Risks
Risks to the Reimbursing Bank
No obligation to reimburse the Claiming Bank unless it has issued a reimbursement undertaking.
Risks to the Beneficiary
Failure to Comply with Credit Conditions
Failure of, or Delays in Payment from, the Issuing Bank

EDFS (Electronic Dealer Financing Scheme)
It is a funding arrangement for the first stage dealers (i.e. sub dealers are not entertained) who are
authorized dealers of branded companies like Maruti Suzuki, Tata Motors, ITC, etc. Only those branded
automobile dealers & other brands which routes their sales through authorized dealers can only be
considered under this scheme. However if the original manufacturer has not entered into master
agreement with that particular bank, then dealers of that particular brand cannot obtain EDFS facility
from that particular bank. For example, if Tata motors have not entered into master agreement with
SBI, then authorized dealers of Tata motors cannot avail EDFS facility from SBI.A master agreement is an
agreement between original manufacturer & the bank containing terms of finance to be provided by
bank to dealers of such manufacturer. The terms & conditions mentioned in the agreement are very
lucrative (for example SBI may offer 10.5% interest on WC facility & without collateral to Tata dealers). It
is important to note that terms of agreement will differ from manufacturer to manufacturer even if it is
with same bank (for example terms offered by SBI to Tata Motors and that to TVS will be different).In
this scheme dealers are highly benefitted bcoz of low interest interest rate or no collateral or both. Here
the bank requires comfort letter from original manufacturer wrt that particular dealer who wants to
avail the facility. The bank will provide only such amount of facility & only such period of credit to
dealers as mentioned by original manufacturer in letter of comfort. Banks provide such facility without
collateral also bcoz the original manufacturer for example Tata Motors gives assurance to the bankers of
the following things:-
If the dealers fails to pay the bank loan, then Tata motors will help the bank to sell the cars of
the dealers which is now in banks custody (as banks had created primary charge on cars)
Tata motors will also stop supplying cars to such dealers.
The benefit to the manufacturer is that they will force more sales to dealers by stating to dealers that
they are getting this facility at reduced rate bcoz of them.

Mortgage Dealer Financing Scheme (MDFS)
It is similar to EDFS. The only differences are:-
Collateral is necessary mostly around 150%.
Letter of comfort is not required.
Rate of interest will be higher than EDFS but lesser than CC limits.
Credit period offered will be higher than CC & EDFS (mostly around 120 days credit period).

Inventory Financing
It is a type of Working Capital Finance secured by the inventory purchased. Separate collateral is not
required. The inventory acts as a primary as well as collateral security for banks in this case unlike CC
limits where Stock & Debtors are considered as primary security & separate immovable property is
taken as collateral. Inventory financing is useful, especially, for the businesses that must pay their
suppliers in a shorter time period than what is taken in selling the inventory to customers. It also
provides a solution to seasonal fluctuations in cash flows in addition to helping a business reach a higher
sales volume. Generally, inventory financing is taken by dealers of automobiles as they cannot afford to
keep 300-500 cars in their showroom from their own funds. Lenders may view inventory financing as a
type of unsecured loan because if the business can't sell its inventory, the bank may not be able to
either.
How does Inventory Financing works?
Maruti (Mfr)

HDFC pays directly to
Supplies Cars Maruti mfr on supply of car


Maruti (Auth Dealer) HDFC bank

Here Maruti Co supplies cars to dealers & bank pays directly to Maruti (mfr) for cars supplied. Around
85-100% is financed for these inventories. Only Commission is paid by Maruti Co to dealer & dealer pays
interest to bank. Dealer will need a good credit record, a compelling business plan, and a list of the
inventory you want to finance, along with values. The lender will give you an estimate of how much you
can borrow on the inventory.

Lease Rental Discounting (LRD)
Lease Rental Discounting (LRD) is a term loan offered against rental receipts derived from lease
contracts with corporate tenants. The loan is provided to the lessor based on the discounted value of
the rentals and the underlying property value.LRD is typically offered against commercial property.
Rent receipts are payable by the tenant directly to an escrow account with the lending bank. Rental
income is credited in this account and EMI is deducted of it.
The underlying tenanted property, which may be commercial property or quasi commercial property will
be taken as collateral. No plot, self construction or under construction properties will be allowed.
This product is typically useful for people who have significant rental incomes but at the same time may
not be able to leverage their property directly and avail a loan against it. This could be because the
property may already have a loan against it.
Most institutions discount upto 90% of the value of the remaining lease, provided the borrower can
demonstrate the ability to pay the installment for such a loan.

Working Capital Demand Loan (WCDL)
A borrower may sometimes require ad hoc or temporary accommodation in excess of sanctioned credit
limit to meet unforeseen contingencies. Banks provide such accommodation through a demand loan
account or a separate non-operable cash credit account. The borrower is required to pay a higher rate of
interest above the normal rate of interest on such additional credit.

Working Capital Term Loan (WCTL)
Write from notebook and
The other use of WCTL is if client ka drawing power nahi baith raha hain toh WCTL can be given to him.

Foreign Currency Term Loan (FCTL)
Write from notebook

Buyers Credit
Buyer's credit is short term credit availed to an importer (buyer) from overseas lenders such
asbanks and other financial institution for goods they are importing. The overseas banks usually lend the
importer (buyer) based on the letter of comfort (a bank guarantee) issued by the importer's bank. For
this service the importer's bank or buyer's credit consultant charges a fee called an arrangement fee.
Buyer's credit helps local importers gain access to cheaper foreign funds that may be closer
toLIBOR rates as against local sources of funding which are more costly.
The duration of buyer's credit may vary from country to country, as per the local regulations. For
example in India, buyer's credit can be availed for one year in case the import is for tradeable goods and
for three years if the import is for capital goods. Every six months, the interest on buyer's credit may get
reset.
Benefits to Importer
1. The exporter gets paid on due date; whereas importer gets extended date for making an import
payment as per the cash flows
2. The importer can deal with exporter on sight basis, negotiate a better discount and use the
buyers credit route to avail financing.
3. The funding currency can be USD, GBP, EURO, JPY etc., depending on the choice of the
customer.
4. The importer can use this financing for any form of trade; open account, collections, or LCs.
5. The currency of imports can be different from the funding currency, which enables importers to
take a favourable view of a particular currency.

Steps Involved
1. The customer will import the goods either under LC, collections or open account
2. The customer requests the Buyer's Credit Arranger to arrange the credit before the due date of
the bill
3. Arrange to request overseas bank branches to provide a buyer's credit offer letter in the name
of the importer. Best rate of interest is quoted to the importer
4. Overseas bank to fund Importer's bank Nostro account for the required amount
5. Importer's bank to make import bill payment by utilizing the amount credited (if the borrowing
currency is different from the currency of Imports then a cross currency contract is utilized to
effect the import payment)
6. Importer's bank will recover the required amount from the importer and remit the same to
overseas bank on due date.
7. It helps importer in working capital management.
Cost Involved
1. Interest cost: is charged by overseas bank as a financing cost
2. Letter of Comfort / Undertaking: Your existing bank would charge this cost for issuing letter of
comfort / Undertaking
3. Forward Booking Cost / Hedging cost
4. Arrangement fee: Charged by person who is arranging buyer's credit for buyer.
5. Risk premium: Depending on the risk perceived on the transaction.
6. Other charges: A2 payment on maturity, For 15CA and 15CB
[clarification needed]
on maturity,
Intermediary bank charges.
7. WHT (Withholding tax): The customer may have to pay WHT on the interest amount remitted
overseas to the local tax authorities depending on local tax regulations. In case of India, the
WHT is not applicable where Indian banks arrange for buyer's credit through their offshore
offices.
Indian Regulatory Framework
Banks can provide buyers credit up to USD 20 million per import transactions for a maximum maturity
period of one year from date of shipment. In case of import of capital goods, banks can approve buyers
credits up to USD 20 million per transaction with a maturity period of up to three years. No rollover
beyond that period is permitted.
RBI has issued directions under Sec 10(4) and Sec 11(1) of the Foreign Exchange Management Act, 1999,
stating that authorized dealers may approve proposals received (in Form ECB) for short-term credit for
financingby way of either suppliers' credit or buyers' creditof import of goods into India, based on
uniform criteria.
All applications for short-term credit exceeding $20 million for any import transaction are to be
forwarded to the Chief General Manager, Exchange Control Department, Reserve Bank of India, Central
Office, External commercial Borrowing (ECB) Division, Mumbai.

Documents at the time of taking Fresh / Rollover of Buyers Credit
A1 Form (Principal amount)
ECB Form
Offer Letter from overseas bank, Letter of Undertaking format & Swift Address
Import Documents & Bill of Entry (In Case of Direct Documents)
Request Letter and along with it authority to debit charges



Documents at the time of Repayment of Buyers Credit
A2 Form (for Interest payment)
Form 15CA and Form 15CB (Incase of Foreign Bank)

Term Loan
Fixed-term business loan with a maturity of more than one year, providing an organization funds to
acquire assets or inventory, or to finance plant and equipment generating cash flow. The term loan is
the most common form of intermediate-term financing arranged by commercial banks, and there is
wide diversity in how it is structured. Maturities range from one year to 15 years, although most term
loans are made for one- to five-year periods. Term loans are paid back from profits of the business,
according to a fixed amortization schedule. Term Loans interest rate is linked to base rate. Loan interest
normally is payable monthly, quarterly, semiannually, or annually.
Term loans are usually given before purchase or construction of fixed asset. However in many cases
where construction of factory shed or expansion of factory or construction of any other things are
concerned, term loan reimbursement can also be provided for i.e. in such cases when after construction
is over, term loan is provided in the form of reimbursement. However, it is worthwhile to note that
Term Loan reimbursement is not a preferred product for the banker & therefore becomes very
subjective call of banker whether to give term loan reimbursement.
Unsecured Loan
A loan that is issued and supported only by the borrower's creditworthiness, rather than by a type of
collateral. An unsecured loan is one that is obtained without the use of property as collateral for the
loan. Borrowers generally must have high credit ratings to be approved for an unsecured loan. Also
called signature loans.
Because an unsecured loan is not guaranteed by any type of property, these loans are bigger risks for
lenders and, as such, typically have higher interest rates than secured loans. An unsecured loan may be
a good option for individuals who do not have enough equity in their homes to be approved for a home
equity loan.
Hundi
Hundis refer to financial instruments evolved on the Indian sub-continent used in trade and credit
transactions. They were used
as remittance instruments (to transfer funds from one place to another),
as credit instruments (to borrow money [IOUs]),
for trade transactions (as bills of exchange).
Technically, a Hundi is an unconditional order in writing made by a person directing another to pay a
certain sum of money to a person named in the order. Hundis, being a part of the informal system have
no legal status and are not covered under the Negotiable Instruments Act, 1881. Though normally
regarded as bills of exchange, they were more often used as equivalents of cheques issued by
indigenous bankers.
History
Hundis have a very long history in the sub-continent. Written records show their use at least as far back
as the sixteenth century. The merchant Banarasi Das, born 1586, received a hundi for 200 rupees from
his father to enable him to borrow money to start trading.[2]
During the colonial era, the British government regarded the hundi system as indigenous or traditional,
but not informal. They were reluctant to interfere with it as it formed such an important part of the
Indian economy and they also wished to tax the transactions taking place within the system.[3] Official
hundi forms were produced incorporating revenue stamps bearing the image of British monarchs,
including Queen Victoria, and disputes between merchants often entered the court system, so in no way
was the system an underground one even though it did not take place through normal banking
channels.

Types of Hundi
Sahyog Hundi: This is drawn by one merchant on another, asking the latter to pay the amount to a
third merchant. In this case the merchant on whom the hundi is drawn is of some 'credit
worthiness' in the market and is known in the bazaar. A sahyog hundi passes from one hand to
another till it reaches the final recipient, who, after reasonable enquiries, presents it to the drawee
for acceptance of the payment. Sahyog means co-operation in Hindi and Gujrati, the predominant
languages of traders. The hundi is so named because it required the co-operation of multiple parties
to ensure that the hundi has an acceptable risk and fairly good likelihood of being paid, in the
absence of a formalized credit monitoring and reporting framework.
Darshani Hundi: This is a hundi payable on sight. It must be presented for payment within a
reasonable time after its receipt by the holder. Thus, it is similar to a demand bill.
Muddati Hundi: A muddati or miadi hundi is payable after a specified period of time. This is similar
to a time bill.
There are few other varieties; the Nam-jog hundi, Dhani-jog hundi, Jawabee hundi, Jokhami hundi,
Firman-jog hundi, etc.
Nam-jog hundi - such a hundi is payable only to the person whose name is mentioned on the Hundi.
Such a hundi cannot be endorsed in favour of any other person and is akin to a bill on which a
restrictive endorsement has been made.
Furman-jog Hundi - such a hundi can be paid either to the person whose name is mentioned in the
hundi or to any person so ordered by him. Such a hundi is similar to a cheque payable on order and
no endorsement is required on such a hundi.
Dhani-jog Hundi - when the hundi is payable to the holder or bearer,it is known as a dhani jog hundi.
It is similar to an instrument payable to bearer.
Jokhim-Hundi - normally a hundi is unconditional but a jokhim hundi is conditional in the sense that
the drawer promises to pay the amount of the hundi only on the satisfaction of a certain condition.
Such a hundi is not negotiable, and the prevalence of such hundis is very rare these days because
banks and insurance companies refuse to accept such hundis.
Jawabi Hundi - if money is transferred from one place to another through the hundi and the person
receiving the payment on is to give an acknowledgement (jawab) for same, then such a hundi is
known as a Jawabi Hundi.
Khaka Hundi - a hundi which has already been paid is known as a Khaka Hundi.
Khoti Hundi - In case there is any kind of defect in the hundi or in case the hundi has been forged,
then such a hundi is known as a khoti hundi.



Bill Discounting & Purchase Bill Discounting
An accepted draft or bill of exchange sold for early payment to a bank or credit institution at less
than face value after the bank deducts fees and applicable interest charges. The bank or credit
institution then collects full value on the draft or bill of exchange when payment comes due.

A foreign bill discounting is the act of giving credit facility against a foreign bill that is unpaid and
sometimes not yet due. The bank assesses the authenticity of the bill before awarding a credit facility to
the client.
Purchase bills discounting means finance taken from the Banks / FI's on the bills/invoices issued by the
supplier whereas Bills discounting means finance availed from Banks / FIs on the invoices raised on the
customers.
Factoring
Introduction
Factoring is a financial transaction in which a business sells its accounts receivable (i.e., invoices) to a
third party (called a factor) at a discount.[1]
In "advance" factoring, the business owner sells his receivables in the form of invoice to the factor, who
makes an advance of 70-85% of the purchase price of the receivable amount. The factor collects the full
amount from the customer in due course and pays the balance amount due to the business owner after
deducting his commission and other charges. In "maturity" factoring, the factor makes no immediate
advance on the purchased accounts, but sees to it that the customer pays the invoiced amount within
the stipulated time i.e. on maturity. However, if the customer fails to make payment within the
stipulated time e.g. 30 days, the factor makes payment to the client and proceeds to collect the
payment from the customer.
Overview
The three parties directly involved are: the one who sells the receivable, the debtor (the account debtor,
or customer of the seller), and the factor. The receivable is essentially a financial assetassociated with
the debtor's liability to pay money owed to the seller (usually for work performed or goods sold). The
seller then sells one or more of its invoices (the receivables) at a discount to the third party, the
specialized financial organization (aka the factor), often, in advance factoring, to obtain cash.Factoring is
a process of fulfilling the credit requirement by lending of material or asset to another person. This
process is very popular In manufacturing industries. When the manufacturing Unit. Needs raw material
and do not have sufficient amount then they borrow it and whenever the credit is available they pay it
back. In the same way when the suppliers of raw material need any material from manufacturing unit
and they too have credit shortage similar method is adopted.
The sale of the receivables essentially transfers ownership of the receivables to the factor, indicating the
factor obtains all of the rights associated with the receivables.[2][3] Accordingly, the factor obtains the
right to receive the payments made by the debtor for the invoice amount and, in nonrecourse factoring,
must bear the loss if the account debtor does not pay the invoice amount due solely to his or its
financial inability to pay. Usually, the account debtor is notified of the sale of the receivable, and the
factor bills the debtor and makes all collections; however, non-notification factoring, where the client
(seller) collects the accounts sold to the factor, as agent of the factor, also occurs.
There are three principal parts to "advance" factoring transaction: (a) the advance, a percentage of the
invoice face value that is paid to the seller at the time of sale, (b) the reserve,[4] the remainder of the
purchase price held until the payment by the account debtor is made and (c) the discount fee, the cost
associated with the transaction which is deducted from the reserve, along with other expenses, upon
collection, before the reserve is disbursed to the factor's client. Sometimes the factor charges the seller
(the factor's "client") both a discount fee, for the factor's assumption of credit risk and other services
provided, as well as interest on the factor's advance, based on how long the advance, often treated as a
loan (repaid by set-off against the factor's purchase obligation, when the account is collected), is
outstanding.[5] The factor also estimates the amount that may not be collected due to non-payment,
and makes accommodation for this in pricing, when determining the purchase price to be paid to the
seller. The factor's overall profit is the difference between the price it paid for the invoice and the
money received from the debtor, less the amount lost due to non-payment
Accounts Receivable Discounting
Non-recourse factoring is not a loan. A lender decides to extend credit to a company based on assets,
cash flows, and credit history. An interesting example of factoring is the credit card. Factoring is like a
credit card where the bank (factor) is buying the debt of the customer without recourse to the seller; if
the buyer doesn't pay the amount to the seller the bank cannot claim the money from the seller or the
merchant, just as the bank in this case can only claim the money from the debt issuer (Farag, I. 2013).
Factoring is different from invoice discounting, which usually doesn't imply informing the debt issuer
about the assignment of debt, whereas in the case of factoring the debt issuer is usually notified in what
is known as notification factoring. One more difference between the factoring and invoice discounting is
that in case of factoring the seller assigns all receivables of a certain buyer(s) to the factor whereas in
invoice discounting the borrower (the seller) assigns a receivable balance, not specific invoices. A factor
is therefore more concerned with the credit-worthiness of the company's customers.[2][3] The factoring
transaction is often structured as a purchase of a financial asset, namely the accounts receivable. A non-
recourse factor assumes the "credit risk" that an account will not collect due solely to the financial
inability of account debtor to pay.
It is different from forfaiting in the sense that forfaiting is a transaction-based operation involving
exporters in which the firm sells one of its transactions,[6] while factoring is a financial transaction that
involves the sale of any portion of the firm's receivables.
Factoring is a word often misused synonymously with invoice discounting. factoring is the sale of
receivables, whereas invoice discounting is borrowing where the receivable is used as collateral.
Services
Factors often provide their clients four key services: information on the creditworthiness of their
prospective customers domestic and international, and, in nonrecourse factoring, acceptance of the
credit risk for "approved" accounts; maintain the history of payments by customers (i.e., accounts
receivable ledger); daily management reports on collections; and, make the actual collection calls. The
outsourced credit function both extends the small firms effective addressable marketplace and insulates
it from the survival-threatening destructive impact of a bankruptcy or financial difficulty of a major
customer. A second key service is the operation of the accounts receivable function.
Invoice Payers (Debtors)
Large firms and organizations such as governments usually have specialized processes to deal with one
aspect of factoring, redirection of payment to the factor following receipt of notification from the third
party (i.e., the factor) to whom they will make the payment. Many but not all in such organizations are
knowledgeable about the use of factoring by small firms and clearly distinguish between its use by small
rapidly growing firms and turnarounds.
Distinguishing between assignment of the responsibility to perform the work and the assignment of
funds to the factor is central to the customer/debtors processes. Firms have purchased from a supplier
for a reason and thus insist on that firm fulfilling the work commitment. Once the work has been
performed however, it is a matter of indifference who is paid. For example, General Electrichas clear
processes to be followed which distinguish between their work and payment sensitivities. Contracts
direct with US Government require an Assignment of Claims which is an amendment to the contract
allowing for payments to third parties (factors).
Risks
Risks to a factor include:
Counter party credit risk related to clients and risk covered debtors. Risk covered debtors can be
reinsured, which limit the risks of a factor. Trade receivables are a fairly low risk asset due to their
short duration.
External fraud by clients: fake invoicing, mis-directed payments, pre-invoicing, not assigned credit
notes, etc. A fraud insurance policy and subjecting the client to audit could limit the risks.
Legal, compliance and tax risks: large number of applicable laws and regulations in different
countries.
Operational risks, such as contractual disputes.
Uniform Commercial Code (UCC-1) securing rights to assets.
IRS liens associated with payroll taxes etc.
ICT risks: complicated, integrated factoring system, extensive data exchange with client.
Reverse Factoring
In reverse factoring or supply chain finance the buyer sells their debt to the factor. That way, the buyer
secures the financing of the invoice, and the supplier gets a better interest rate.