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Non Fund Based Credit Facility by Banks

IMPORTANT POINTS FOR LETTER OF CREDIT AND BANK GUARANTEE


WHO IS?
APPLICANT:
The buyer /importer of goods: This person has to make payment of letter of credit to the
issuing bank if the documents are in accordance with the terms and conditions of LC.
1. ISSUING BANK:
Importers or buyers bank who lends its name or credit is issuing Bank. It is liable for
payment of LC in case the documents are received by it from the nominated or negotiating
bank and the documents are in terms of letter of credit. This bank gets 5 days to check the
documents.
2. Advising Bank
Issuing bank branch or correspondent in exporter country to whom the letter of credit is sent
for onward transmission to the seller or beneficiary, after authentication of genuineness of the
credit. Where it is unable to verify he authenticity, it can seek instructions from the opening
bank or can advise the LC to the beneficiary, without any liability on its part. This bank has
no obligation to negotiate the document.
3. Beneficiary:
The party to whom the credit is addressed i.e. seller or the exporter or the supplier of the
goods. It gets payment against documents as per LC from the nominated bank within validity
period of negotiation maximum 21 days from date of shipment.
4. Negotiating bank:
The bank to whom the beneficiary presents the documents for negotiation. It claims payment
from the reimbursing bank or opening bank and gets 5 banking days to check the documents.
5. Reimbursing Bank:
Third bank which repays, settle or funds the negotiating bank at the request of its principal,
the issuing bank.
6. Confirming Bank:
The bank adding confirmation to the credit, which undertakes the responsibility of payment
by the issuing bank and on his failure to pay the confirmation, is added on request of the
opening bank.

7. RED CLAUSE LC:


It refers to a packing or anticipatory credit where in a clause is incorporated in LC permitting
the correspondence Bank in the exporters country to grant advance to beneficiary at the
issuing banks responsibility. The PCL shall be adjusted out of the proceeds of the bill
negotiated.
A GREEN CLAUSE LC:
It permits the advances for storage of goods in a warehouse in addition to pre-shipment
credit. It is an extension of the red clause LC.
PRECAUTIONS TO BE TAKEN
BACKGROUND
The monitoring of non-fund based facilities is as important as the monitoring of fund-based
facilities for controlling and monitoring of the credit risk of the borrower on whose behalf the
non-fund based facilities are granted.
GUIDELINE
The important points to be observed and complied with in regard to monitoring of non-fund
based facilities are outlined below:
LETTERS OF CREDIT
RESTRICTIONS ON OPENING OF LETTERS OF CREDIT
Some of the important restrictions that have to be kept in mind while opening LCs are listed
below for ready reference:
a. Branches should not open LCs bearing the without recourse clause.
b. No LC shall be opened to facilitate drawing of accommodation bills.
c. Branches should not open LCs on behalf of the frontal firms/ companies floated in the
name of employees of the promoters or opening LCs in favour of such firms.
d. Letter of credit should not normally be opened for customers who do not enjoy credit
facilities with the Bank.
e. LC facility sanctioned for working capital should not be used for opening LC for import of
capital goods. Letter of Credit (Inland/ Import), for capital goods should be considered only if
funds are arranged for retirement by sanction of Term loans wither by our own bank OR
against Term loans sanctioned by other financial Institutions provided the concerned FIs
issues Letter of Comfort in favour of our Bank i.e. they undertake to remit the amount
directly to the Bank to honour the obligations.

f. No onerous clause detrimental to the interest of the Bank shall be incorporated in the Letter
of Credit.
PRECAUTIONS TO BE OBSERVED WHILE OPENING LETTERS OF CREDIT
a. The commodity for which the LC is being opened should be consistent with the known
trade practice of the borrower.
b. Opening of LCs for commodities which have hitherto been not dealt by the customer
should be with the consent of the respective sanctioning authority only.
c. Verification of underlying commercial transactions such as sale/purchase contract, the
quantity and value of transaction, payment terms, the mode of transport, etc.
d. Details of the beneficiary of the LC must be ascertained such as
i. In case of frequent LCs being opened in favour of single beneficiary or in case of large
value LC, CR from the beneficiarys banker/CIBIL report should be obtained.
ii. Whether the beneficiary is regularly dealing in the items for which LC is being opened
iii. Whether the beneficiary is related to the opener or its subsidiary/front company.
iv. LCs in favour of sister concerns should not be normally opened by the Branches and
wherever the same are required to be opened for genuine trade transactions, necessary
approval should be obtained from the respective sanctioning authority.
v. In case LC facility is sanctioned under delegated powers of Branch Incumbent, approval
for opening LC favouring sister concern should be obtained from Regional Office.
e. The entire cycle from opening of LC by Bank to the negotiation of the bills by the
beneficiarys banker and advising of the due date by our Bank should have a reasonable time
lag. Special attention should be paid so as to have time for the execution of the intermediate
stages between opening of the LC and negotiation of documents so as to ensure the
genuineness of the transaction in all such cases.
f. In case of DA LCs, the cash flow of the transaction must be studied closely. The LC opener
gets sufficient time to process/sell the goods and realize the sale proceeds thereof. As such, it
must be ensured that sufficient funds are available for retirement of bills on the due date
without devolving on the Bank. This could be either by way of
i. Banking arrangement for fund based working capital facilities duly assessed and sanctioned
either from our Bank or other bank.
ii. Build up of margin by progressively depositing sale proceeds regularly in their accounts
with us.
- Where a customer enjoys working capital credit facilities with some other bank, the reasons
for his approaching the bank for sanctioning L/C limits have to be clearly stated. A reference
to the existing banker of the customer should invariably be made.

- The request of customer for sanctioning and opening of letter of credit should be properly
scrutinised to establish the genuine need of the customer. The customer may be, required to
submit a complete loan proposal including financial statements to satisfy our bank about his
needs and also his financial resources, to ensure retirement of bills on the due date.
- Branches must satisfy themselves about retirement of bills received under LC by stipulating
adequate margin or by a back up support of the credit facility approved in their favour.
Liquidity aspect of resources available for retirement of bills must be kept in mind.
- LCs should not be issued for amounts out of proportion to the borrowers' genuine
requirements. These may be opened only after ensuring that the borrowers have made
adequate arrangements for retiring the bills received under LCs out of their own resources or
from the existing borrowing arrangements;
- The branches shall obtain an undertaking from the borrower(s) that in respect of
transactions relating to the import LCs, the borrower will undertake to bear exchange
fluctuations risk, if any, and will arrange for necessary forward cover, whenever called upon
to do so by the bank.
- The branches shall obtain an undertaking from the borrower(s) to comply with all the
exchange / import trade control regulations of RBI in respect of the imports under the import
LC limit.
- LCs should be issued under joint signatures of the Banks authorised officials in the
approved format only.
PRECAUTIONS FOR OPENING REVOLVING LC
a. In case of Revolving LC, reinstatement clause be suitably worded and in no case it should
be automatic.
b. No revolving LC be issued without re-instatement clause.
c. The reinstatement should only be permitted after a written confirmation from LC opening
branch is received and liability against bills already negotiated is cleared by the applicant.
BANK GUARANTEE
MONITORING OF PERFORMANCE BANK GUARANTEESISSUED BY THE
BRANCHES ON BEHALF OF OUR BORROWERS/CLIENTS
Purpose of issuing Performance Bank Guarantees
a. Performance Bank Guarantees are issued guaranteeing due performance of contract or
obligation of the Borrower under the contract. In the event of non-performance of obligation
in terms of contract the bank assumes monetary liability upto the amount specified in the
Guarantee. Some of the purposes for which Bank Guarantees are issued are:

i. Due performance of a specific contract undertaken by a customer in favour of Govt.


bodies / Others - for e.g. supply of materials, Construction of Roads, Buildings Dams, Civil
Work, etc.
ii. To secure any claims by the buyer on the seller arising from default in delivery or
performance of the terms of the contract (e.g. construction, assembly, execution).
iii. Due performance of an equipment/project after completion for a specific period due to
possible defects appearing after delivery during warranty period of the equipments.
iv. Execution of Long Term Infrastructure Projects such as Seaports, Airports, Road
Construction, Bridges, Sanitation and Sewerage Projects, Telecommunication Services,
Construction of Educational Institutions and Hospitals, Generation/ Transmission/
Distribution of Power, etc.
b. Monitoring of Performance Bank Guarantees issued
c. It is very important that Performance Bank Guarantees issued by the Branches are
monitored closely. The action to be taken would depend on the circumstances and gravity of
the case.
SOME OF THE STEPS ARE BEING DETAILED HEREUNDER:
Area of Monitoring

Action to be taken by Branches and ROs


a. Branch should scrutinize the Contract for which the Bank
Guarantee has been issued regarding the time lines specified and
Bank
Guaranteesconditions laid in the contract by the beneficiary whose fulfilment by
issued in case ofthe borrower is crucial.
Infrastructure Projects
for
executing
theb. Performance by our Borrower in executing the Contract / Job has to
project
for
longbe tracked so that on a periodic basis it can be ascertained that the
duration beyond 3borrower is performing the job as per schedule
years
c. Confirmation reports from the borrower regarding the progress in
execution of the contract may be obtained at quarterly intervals
a. In case any delay is noticed the reasons for the same should be
immediately ascertained and the chances of the Bank Guarantee being
invoked should be assessed.
Delay
noticed
inb. Discussions should be held with the borrower for corrective course
executing the project. of action. Detailed letter should be obtained from the borrower about
the same.
c. The branch should immediately report the delay noticed to the
Sanctioning authority and appraise the progress from time to time.
In case of Consortiuma. Other Co-lenders should be kept apprised.
Banking / Multiple
Banking
b.In case Bank Guarantees have been invoked with other Co-lenders
the same should be taken on record and informed to the sanctioning

authority.
c. Periodic exchange of information as prescribed for Consortium
Banking / Multiple Banking should be ensured
In case the Banka. The utilization of funds by the borrower should be tracked along
Guarantee
is
forwith the billing for the work done by them.
Mobilisation advance b. Quarterly progress reports should be obtained from the Borrower
Issuance of further
The sanctioning authority shall decide on this based on the
guarantees on behalf of
circumstances and gravity of each case
the client

Source : BANKS' POLICY AND RBI GUIDELINES -