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Non Fund Based Business

State Bank Staff College Hyderabad India

Letters of Credit
 Facilitates trade – domestic & international  Helps in reducing working capital requirement for buyer  Helps seller to get immediate payment though credit is extended by him  Bank intermediates and lend its creditworthiness for which it charges the applicant  Transactions are guided by UCPDC

Letter of Credit
An arrangement by means of which a bank (issuing bank) acting at the request of a customer (applicant) undertakes to pay to a third party (beneficiary) a predetermined amount by a given date according to agreed stipulations and against presentation of stipulated documents

Parties to a Letter of Credit  Applicant (Buyer)  Issuing Bank (opening bank)  Beneficiary (Seller)  Advising Bank  Confirming Bank  Negotiating Bank (Paying Bank)  Reimbursing Bank .

Negotiating Bank CONTRACT IMPORTER EXPORTER D O C S P A Y OPENING BANK ISSUE CREDIT DOCUMENTS PAYMENT ADVISING BANK NEGOTIATING BANK Negotiating bank pays beneficiary first and reimbursement from the opening / confirming bank. claims .

Mechanics of Documentary Credit CONTRACT GOODS IMPORTER DOCS SHIPPING COMPANY GOODS DOCS EXPORTER OPEN CREDIT OPENING BANK ADVISING/ DOCUMENTS PAYMENT NEGOTIATING DOCUMENTS PAYMENT BANK .

Types of LCs  Security wise –  Revocable  Irrevocable  Confirmed  Payment wise  Payment / deferred payment / instalment  Acceptance  Negotiation .

Types of LCs  With advance payment  Red Clause  Green Clause  Involving Middlemen  Transferable  Back to Back  Others  Revolving  Standby .

Opening of LC  Trade Control requirements  Exchange Control requirements  Credit norms of Central Bank  UCPDC Provisions  Bank’s Internal Credit Policies / procedures .

sources of payment. Seasonality. relationship with turnover  Assessment details & maximum expected outstandings  Nature of goods – marketablility. susceptibility to price changes  Import Duty  Currency risk  Crystallisation .Appraisal / Assessment  Means & standing of applicant  Application details – authorised person  Purpose.

1903.Exercise on Assessment  Annual Cost of Raw materials purchased under LCs – Rs.504.650 crore .1399.Rs.85 crore  Imported .73 crore  Indigenous – Rs.12 crore  Average usance period for Imports 30 days from shipment  Lead time – 3 months  Local Purchases Lead time –1mth  Usance for local purchase – 1 month  Local purchase without LCs Rs.

06 (D)  Avg usance period for imports = 1 month (E)  Lead time = 3 months (F)  Total of E & F = 4 months (G)  Required LC limit for imported RM = DxG= Rs.24 crore (L) .Exercise on Assessment  Monthly purchase of imported RM = 42.168.

116.19 crore (M) .Exercise on Assessment  Monthly purchase of indigenous RM = Rs. 233.59 crore (H)  Avg usance period for local purchases = 1 month (I) Local Purchases Lead time –1mth (J) Total of (I) + (J) = 2 months (K) LC limit required for indigenous RM = (H) x (K) = Rs.

401.Exercise on Assessment  Total LC limit required = L+M = Rs.43 crore say Rs.400 crore. .

 In some cases it is quite possible that the units may not be in a position to provide margins right from the time of purchases against LCs.  Thus. earmarking of lien for the value of usance LC bills outstanding against the aggregate ‘market value’ of all the securities (including the LC stocks) may be permitted instead of against the ‘advance value’ of securities. based on merits. it ensures that the margin is available well before the CC a/c is debited for the matured LC bill. . In such cases.Treatment of stocks covered by Usance LC  Lien should be earmarked against advance value of stocks for the outstanding usance LC bills  This ensures provision of margins on the stocks covered by usance LCs right from the time the stocks are bought on credit backed by the Bank’s commitment.

establishment of LCs for longer usance period may be considered selectively. the relative LC limit should not be released for opening further LCs till the account is adjusted.Devolvement of LC (Precautions)  The limits for demand LCs and usance LCs should be assessed separately with ample justifications.  In other words.  When liability under LC is met by creating an irregularity in the Cash Credit account. . or if the LC devolved earlier is not adjusted. no further LCs should be opened without adequate margin.  In case of bulk imports. the liability should not be marked off in LC liability register merely because of retirement of documents. if the irregularity in the account is not adjusted within 15 days. exceed the production cycle.  In case of devolvement.  The usance period should not. The relative liability should be marked off only after the account is regularised. generally.

Scrutiny  Level of sundry creditors in the accepted projections in case of Usance LCs  Compare with operating cycle  Margins & security depending on track record  Cash budget monitoring to track availability of funds  Irregularity to be rectified before fresh LCs are opened  Continuous devolvement is a warning signal .

indemnity is to be obtained.Purchase of Bills Drawn Under LCs  Sales through LCs will be the basis for assessment of limits  Only First class banks & Correspondents LCs  Powers only for bills without discrepancy  Bills on sister concerns . .actual movement of goods to be verified  Not part of ABF  For bills with discrepancy.

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Indemnity is A contract by which one party promises to save the other from loss suffered by him by the conduct of the promissor himself or by the conduct of any other person .Bank Guarantee Guarantee is A contract to perform the promise or discharge the liability of a third person in case of his default The contract of guarantee is distinctly different from the contract of indemnity.

Bank Guarantee Parties to the Contract of Guarantee  Applicant : The principal debtor – person at whose request the guarantee is executed  Beneficiary : 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. . consequential to a main contract between the applicant and the beneficiary. the guarantee is a collateral contract. Thus.

Bank Guarantee  Parties to the Contract of Indemnity  Indemnifier : person who promises to make good the loss  Indemnified : Whose loss is to be made good .

Mobilisation advance/advance money before commencement of the project by the contractor and for money to be received in various stages like plant layout. design/drawings in project finance. In respect of raw material supplies or for advances by the buyers.Necessity for Bank Guarantee       In lieu of security deposit / earnest money deposits for participating in tenders. To allow units to draw funds from time to time from the concerned indentors against part execution of contracts. In respect of due performance of specific contracts by the borrowers and for obtaining full payment of the bills Performance guarantee for warranty period on completion of contract which would enable the supplier to realise the proceeds without waiting for warranty period to be over. etc. .

Appraisal of Bank Guarantee  The following aspects must be examined :          Purpose – for genuine business requirements ? Need for BG – Related to normal trade / business ? Nature of Bank Guarantee – Financial / Performance ? Amount of BG – needs to be specific Applicant’s financial strength / capacity Past record in respect of BGs issued earlier Present outstanding on account of BGs already issued Margin Collateral Security Offered .

Format for BG Normally. e) not stipulating any onerous clause. c) for a specific amount. it should be ensured that the BG is : a] for a definite period. d) in respect of bonafide trade/commercial transactions. . If some other format is required to be used for issue of BG. b) for a definite objective enforceable on the happening of a definite event. and f) not containing any clause for automatic renewal of the BG on its expiry. BG should be issued on standardised format only.

and  c) we are liable to pay the guaranteed amount or any part thereof under this Bank Guarantee only and only if you serve upon us a written claim or demand on or before ___________________________ (date of expiry of Guarantee).  b) this Bank Guarantee shall be valid upto __________________.” .Limitation Clause  “Nothwithstanding anything contained herein:  a) our liability under this Bank Guarantee shall not exceed Rs.___________ (Rupees __________________only).

 It is not necessary for the beneficiary to satisfy the Bank.  It is. therefore. about the default or the amount of actual loss suffered by him.Invocation of BG Important points  The Bank’s liability under BG is absolute and independent and exclusive of any other contract entered into by the applicant and beneficiary. obligatory on the part of the Bank to pay to the beneficiary without delay and demur the amount of BG on its invocation in accordance with the terms and conditions of the guarantee deeds. .

Foreign .  performance bonds  Inland .Types of Bank Guarantee  Financial .Guarantees customer’s credit worthiness  Advance payment  Retention money  Security deposit  Performance – Guarantees obligations relating to capacity of customer to execute  Bid-bond.export & import .

ask why?  Performance guarantee – assess capacity of customer.Precautions  Should not be open ended  Should stipulate maximum liability – crystallised  Should not contain onerous clauses  Ensure customer’s ability to reimburse  Other bank customer . experience  Guarantee liability to have reasonable relation to equity of borrower  Counter guarantee by authorised person . means to carry out contract.

Total Purchase of raw material during 2007-08 =1200 lacs ii.LC limit recommended =2.Total time for which credit under LC is required (iii+iv)90 Days vi.Lead time & Transit =30 Days v.LC limit required [(ii) х (v) ÷ 365] =2.465 lacs  vii.08)      i.(BASED ON THE ESTIMATES AS ON 31. Monthly Purchase of RM under LC = 100 lacs iii.50 lacs . Av LC usance period required =60 Days iv.03.

BG is a collateral contract. Indemnity only one contract between the indemnifier and the indemnified or beneficiary. Under BG liability of the surety is secondary and arises only when the principal debtor defaults in fulfilling his obligation or promise. . consequent to the main contract. In case of contract of indemnity the liability of the indemnifier is primary and unconditional Guarantor posses certain rights which are not available to the indemnifier ie right of subrogation or reimbursement Indemnifier cannot claim such reimbursement from anybody else.