Module 1

Introduction To Credit
 Types of Credit Facilities
• Fund based: This is a direct form of lending in which a loan with an actual cash
outflow is given to the borrower by the Bank. In most cases, such a loan is
backed by primary and/or collateral security. The loan can be to provide for
financing capital goods and/or working capital requirements etc.
• Non-fund based: These are services, where there is no outlay of funds by the
bank when the commitment is made. At a later stage however, the bank may
have to make funds available. Since there is no fund outflow initially, it is not
reflected in the balance sheet. However, the bank may have to pay. Therefore,
it is reflected as a contingent liability in the Notes to the Balance Sheet.
Therefore, such exposures are called Off Balance Sheet Exposures. When the
commitment is made, the bank charges a fee to the customer. Therefore, it is
also called fee-based business.
 Fund-based Limits for Business
• Working Capital Finance: Working capital finance is utilized for
operating purposes, resulting in creation of current assets (such as
inventories and receivables). Banks carry out a detailed analysis of
borrowers' working capital requirements. Credit limits are established in
accordance with the process approved by the board of directors. The
limits on Working capital facilities are primarily secured by inventories
and receivables (chargeable current assets). Working capital finance
consists mainly of cash credit facilities, short term loan and bill
discounting.
• Project Finance: Project finance business consists mainly of extending
medium-term and long-term rupee and foreign currency loans to the
manufacturing and infrastructure sectors. Banks also provide financing
by way of investment in marketable instruments such as fixed rate and
floating rate debentures. Lending banks usually insist on having a first
charge on the fixed assets of the borrower. The project finance approval
process entails a detailed evaluation of technical, commercial, financial
and management factors and the project sponsor's financial strength
and experience.
 Fund-based Limits for Business
• Loans to Small and Medium Enterprises: A substantial quantum
of loans is granted by banks to small and medium enterprises
(SMEs). While granting credit facilities to smaller units, banks often
use a cluster-based approach, which encourages financing of small
enterprises that have a homogeneous profile such as leather
manufacturing units, chemical units, or even export oriented units
• Bank Overdraft : A facility where the account holder is permitted
to draw more funds that the amount in his current account.
 Fund-based Limits for Business
• Bill Purchase / Discount – When Party A supplies goods to Party B, the payment terms may provide for a Bill
of Exchange (traditionally called hundi). A bill of exchange is an unconditional written order from one person
(the supplier of the goods) to another (the buyer of the goods), signed by the person giving it (supplier),
requiring the person to whom it is addressed (buyer) to pay on demand or at some fixed future date, a certain
sum of money, to either the person identified as payee in the bill of exchange, or to any person presenting the
bill of exchange.
• When payable on demand, it is a Demand Bill
• When payable at some fixed future date, it is a Usance Bill.
• The supplier of the goods can receive his money even before the buyer makes the payment, through a Bill
Purchase / Discount facility with his banker.
• It would operate as follows:
• The supplier will submit the Bill of Exchange, along with Transportation Receipt to his bank.
• The supplier’s bank will purchase the bill (if it is a demand bill) or discount the bill (if it is a usance bill) and pay
the supplier.
• The supplier’s bank will send the Bill of Exchange along with Transportation Receipt to the buyer’s bank, who is
expected to present it to the buyer:
• For payment, if it is a demand bill
•• For
The acceptance, if it is athe
buyer will receive usance bill.
Transportation Receipt only on payment or acceptance, as the case may be.
•
Fund-based Limits for Individuals
Credit Card : The customer swipes the credit card to make his purchase. His seller will then
submit
and paythe details
the toThe
seller. the bank
card issuing
will bankthe
recover to collect
full the payment.
amount from theThe bank will
customer deductThe
(buyer). its margin
margin
deducted from the seller’s payment thus becomes a profit for the card issuer.
• Personal Loans: These are often unsecured loans provided to customers who use these funds
for various purposes such as higher education, medical expenses, social events and holidays.
Sometimes collateral security in the form of physical and financial assets may be available for
securing the personal loan.
• Vehicle Finance : This is finance which is made available for the specific purpose of buying a car
or a two-wheeler or other automobile. The interest rate for used cards can go close to the
personal loan rates. However, often automobile manufacturers work out special arrangements
with the financiers to promote the sale of the automobile. This makes it possible for vehicle-buyers
to get attractive financing terms for buying new vehicles.
• Home Finance: Banks extend home finance loans, either directly or through home finance
subsidiaries. Such long term housing loans are provided to individuals and corporations and also
given as construction finance to builders. The loans are secured by a mortgage of the property
financed. These loans are extended for maturities generally ranging from five to fifteen years and
a large proportion of these loans are at floating rates of interest
Non-Fund based Limits for Business
• Letter of Credit : When Party A supplies goods to Party B, the
payment terms may provide for a Letter of Credit.
• In such a case, Party B (buyer, or opener of L/C) will approach his
bank (L/C Issuing Bank) to pay the beneficiary (seller) the value of
the goods, by a specified date, against presentment of specified
documents. The bank will charge the buyer a commission, for
opening the L/C.
• The L/C thus allows the Party A to supply goods to Party B, without
having to worry about Party B’s credit-worthiness. It only needs to
trust the bank that has issued the L/C. It is for the L/C issuing bank
to assess the credit-worthiness of Party B. Normally, the L/C
opener has a finance facility with the L/C issuing bank.
• The L/C may be inland (for domestic trade) or cross border (for
international trade).
Non-Fund based Limits for Business
• Guarantee: In business, parties make commitments. The
beneficiary of the commitment wants to be sure that the party
making the commitment (obliger) will live up to the commitment.
This comfort is given by a guarantor, whom the beneficiary trusts.
• Banks issue various guarantees in this manner, and recover a
guarantee commission from the obliger. The guarantees can be of
different kinds, such as Financial Guarantee, Deferred Payment
Guarantee and Performance Guarantee, depending on how they
are structured
• Loan Syndication: This investment banking role is performed by a
number of universal banks
Non-Fund based Limits for Individuals
• Sale of Financial Products such as mutual funds and
insurance is another major service offered by universal
banks.
• Financial Planning and Wealth Management are offered
by universal banks.
• Executors and Trustees: a department within banks –
help customers in managing succession of assets to the
survivors or the next generation.
• Lockers: a facility that most Indian households seek to
store ornaments and other valuables
Thank You

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