Unit II: Banking Products and Services (Credit Facility)

Unit II: Banking Products and Services
(Credit Facility)
Syllabus Coverage:
Meaning of Credit, Types of Lending, Principles of Lending, Process & Documentation of Lending, Primary
and Secondary Collateral Securities, Modes of Creating Charges on Securities, Hypothecation, Pledge, Lien
and Assignment, Credit Cards, Consortium & Syndication, Micro Finance, Documentary Credit (Bank
Guarantee & Letter of Credit), Financing Export and Imports.
Introduction
Historically banks have preferred to make short-term loans to businesses for non-permanent additions to
their working capital. These loans usually were used to finance the inventory-raw material or finished goods
to sell. Such loans take advantage of the normal cash cycle in a business firm. While banks today make a
far wider array of business loans than just simple liquidating credits, the short-term loan- frequently displaying
many of the features of self-liquidation- continues to account for over half of bank loans to business firms.
The extension of credit is one of the major functions of banking business. Major source of income for the
bank and financial institution comes from their Loans and Advances. Credit management is the management
of loans and advances. Success of banking business depends on the efficient and effective management of
credit. Poor credit management has proved to be one of the major causes of bank failures throughout the
world. Loan uncollectible due to mismanagement, illegal manipulation of loan, misguided lending policies or
unexpected economic downturn are main reasons for a bank getting into serious problems.
Credit can be offered in a variety of types/categories as per the need of the potential market. Credit
management is always a challenging task in the banking business because there are several environmental
influences and risks associated with the credit operation and administration. Credit Risk is that risk which
arises where the borrower fails to meet the obligation on agreed terms. The volume and impact of credit risk
is very high among the various types of risk associated in the banking business (See detail in Risk
Management chapter).
Lending function is significant for every bank as it yields substantial income by means of interest on loan &
advances and fees on non-fund based credit activities. Bank lending facilitates the economic development
of a country by extending financial support to industry, agriculture, trade, commerce and other sectors. Banks
also invest a certain part of their loan in social development in the form of deprived sector lending. Banks
lending activities are generally governed by certain principles since the lending activities involve depositors'
money which is repayable on demand or on specified maturities. Bank adheres to the principle of liquidity,
safety and profitability in their lending policies and standard guidelines for operations. Nepal Rastra Bank has
also stipulated mandatory maintenance of Cash Reserve Ratio (CRR) & Statutory Liquidity Ratio (SLR) to
reinforce liquidity and safety principles. Banks also diversify their loan portfolio across a spectrum of
borrowers industries, sectors, securities as per the prudential norms and also follow other risk management
practices.
Definitions
Credit (function) can be defined as the channelization of the fund from the people/entities that have excess
funds to the people/entities that have a deficit (of funds).
UJJWAL MARAHATTA | PRESIDENCY COLLEGE 1

"Credit is a contractual agreement in which a borrower receives something of a value with the explicit
agreement to repay the lender at some date in future. The borrower pays interest as compensation (to the
lender) for allowing the use of funds.
“Credit management is the management of the credit portfolio of the bankers and financial institutions. The
expression credit refers to short term loans and advances as well as medium/long term loans and off balance
sheet transactions. Management includes within its preview pre-sanction appraisal, sanction, documentation,
disbursement and post lending supervision and control.”
- O.P. Agrawal “Principles of Banking”, (Macmillan).
A specified sum of money lent by a bank to customers usually for a specified time at specified rate of interest.
In most cases banks require some form of security for loans especially if the loan is to a commercial
enterprise.
- Oxford Dictionary of Business, second edition
From the above definitions and explanation, we can say that credit is one of the major functions of the banking
business. There are several risks inherent in the credit process. Credit management deals with minimizing
those risks which are directly or indirectly involved in a project. Credit management is no longer a "rule of
thumb" game. In a highly competitive and deregulated environment, Banks and Financial Institutions have to
evolve better systems and procedures to manage the credit needs of highly demanding customers,
particularly in the corporate and retail sectors. Credit management includes all the activities related with credit
such as; credit processing, credit marketing, portfolio management, concentration risk monitoring, risk
hedging, capital required for the risks and credit reporting etc. This chapter presents the principles and
practices in credit operation and administration.
Types of Credit
Credit can be classified on several bases. The credit products may differ as per the financing requirement of
any business. These products can be developed on the basis of terms and conditions demanded by the credit
agreement between bank and the borrower. Furthermore the credit products are determined on the basis of
borrowing cause of the customer.
For simplicity in learning, it can be classified as;

 Fund Utilization: Funded or Non-funded
 Tenure: Fixed Term or Working Capital
 Target Customer: Retail/Consumer or Corporate
Funded or Non-Funded
Funded
Funded loan refers to the loan which is disbursed in the forms cash or any other payments made on behalf
of customers. Whenever a bank disburses a loan and cash goes out of the bank immediately, then it is
classified as funded loan. Funded loans are recorded in the books of accounts and appear in the balance
sheet under the heading of loan and advances.

Some examples of funded loans are;
 Overdraft/ Cash Credit/Hypothecation Loan
 Importers' Loan/ Trust Receipt Loans
 Exporters' Loan/ Packing Credit Loan
 Short Term Loan/ Demand Loan
 Long Term Loan
 Home Loan/Hire Purchase/ Consumer/ Mortgage Loan/ Auto
 Loan
 Credit Cards
 Bills purchase
Non Funded
Bank's commitment for the future payment or any other conditional payment on behalf of its customer is
known as a non-funded facility. In non-funded facilities banks don't have to pay cash but need to commit a
conditional payment. Non funded facility involves the issuing bank's commitment to honor certain promises
as per the letter of credit or guarantee or similar documents favoring a third party, without requiring any
immediate outlay of funds by the bank at the time of making a commitment. However outlay of the may take
place in the event of development of commitment on the issuing bank. These commitments do not appear in
the banks on the balance sheet. It is presented as contingent liabilities outside the balance sheet hence they
are also known as off balance sheet items.
Some examples of non funded loans are;
 Letter of Credit
 Guarantee (Bid bond, Performance bond, Advance payment,
Retention etc.)
 Acceptance and endorsement
 Commitments
Fixed Term or Working Capital
The loans which are granted for the creation of longer term assets (Capital Expenditure) are known as fixed
term loans. These types of loans are generally for more than one year and repaid on fixed installments over
the loan tenor. These loans are secured mortgaging the specific fixed assets financed or the entire block of
fixed assets of a particular project.
Examples are;
 Project loan
 Home/house
 Hire purchase
 Other term loans
Business requires working capital for its day to day operation. Working capital loans are granted to finance
the working capital requirement of the business. The working capital requirement relates to processing,
production, sale of goods and services which are granted for bridging the financial gaps in the production
cycle of the business. Banks sanction a specified credit limit to the borrower against the security of stock,
book debts or any other assets acceptable to banks which are pledged /hypothecated. Some examples are;
 Pledge
 Hypothecation
 Overdraft
 Demand Loan
 Cash Credit

Retail/Consumer or Corporate
Retail/Consumer loans are the loans which are granted for the consumption purpose. These loans are based
on the security and the future cash flow (disposable income) of the borrower. Some examples are;
 House/Home loan
 Vehicle loan/ Auto
 Education loan
 Personal loan/Management loan
Corporate loans are the loans which are granted for big business houses. The corporate loans are appraised
on the basis of detailed analysis of the borrowers past performance, projected balance sheet, profit and loss
account, cash flow statements etc. to determine financial viability of the capacity. The technical, managerial,
commercial viabilities of the project is also critically examined by the banker before granting these loans. For
example; all the loans disbursed to the corporate sector.
Principles of Lending
Banks have to follow the basic principle of lending for minimizing risk associated. There are various
fundamental norms and principles for making good quality of loan which helps banks in honoring
commitments to the depositors and earning some profit from their lending situation.
1. Principle of Safety and Security:

The safety of funds lent is another principle of lending. Safety means that the borrower should be able to
repay the loan and interest in time at regular intervals without default. The repayment of the loan depends
upon the nature of security, the character of the borrower, his capacity to repay and his financial standing.
This principle is based on the assumptions that the bankers should lend their fund in such an area where
there are least probabilities of default. To follow this principle banks should develop an appropriate
mechanism of credit appraisal system and good credit policy. While granting a loan, the bank carefully
examines the economic financial and commercial viability of the business, quality of its management
(integrity, honesty, willingness to pay, reputation in market etc.) and the past track record. Banks should give
priority to have possession or control over a cashable security for future precaution in adverse situations.
Like other investments, bank investments involve risk. But the degree of risk varies with the type of security.
Securities of the central government are safer than those of the state governments and local bodies. And the
securities of state government and local bodies are safer than those of the industrial concerns. This is
because the resources of the central government are much higher than the state and local governments and
of the latter higher than the industrial concerns.
In fact, the share and debentures of industrial concerns are tied to their earnings which may fluctuate with
the business activity in the country. The bank should also take into consideration the debt repaying ability of
the governments while investing in their securities. Political stability and peace and security are the
prerequisites for this.
It is very safe to invest in the securities of a government having large tax revenue and high borrowing capacity.
The same is the case with the securities of a rich municipality or local body and state government of a
prosperous region. So in making investments the bank should choose securities, shares and debentures of
such governments, local bodies and industrial concerns which satisfy the principle of safety

Thus from the bank’s viewpoint, the nature of security is the most important consideration while giving a loan.
Even then, it has to take into consideration the creditworthiness of the borrower which is governed by his
character, capacity to repay, and his financial standing. Above all, the safety of bank funds depends upon
the technical feasibility and economic viability of the project for which the loan is advanced.
2 Principle of Liquidity: The banks should have the best mechanism to manage the assets and liabilities in
a sound manner. Banks have various sources of funds for conducting its lending business. During the course,
it has to attune the maturities of its assets (loan) with the maturities of liabilities (deposit). Bank should not
delay or default in making payment to its depositors or other liabilities, as this would result in loss of trust and
faith of customers. Banks must comply with various regulatory requirements regarding liquidity like CRR
(Cash reserve ratio), SLR (Statutory Liquidity ratio).
Liquidity is an important principle of bank lending. Bank lend for short periods only because they lend public
money which can be withdrawn at any time by depositors. They, therefore, advance loans on the security of
such assets which are easily marketable and convertible into cash at a short notice.
A bank chooses such securities in its investment portfolio which possess sufficient liquidity. It is essential
because if the bank needs cash to meet the urgent requirements of its customers, it should be in a position
to sell some of the securities at a very short notice without disturbing their market prices much. There are
certain securities such as central, state and local government bonds which are easily saleable without
affecting their market prices.
The shares and debentures of large industrial concerns also fall in this category. But the shares and
debentures of ordinary firms are not easily marketable without bringing down their market prices. So the
banks should make investments in government securities and shares and debentures of reputed industrial
houses.
3. Principle of Risk Diversification: There are various risks involved in lending business and banks can be
away from such risk. This principle focuses on better credit risk management through tolerable credit limits
in different sectors and parties.
This principle is based on the proverb "Do not put all eggs in a single basket". So concentration risk should
be monitored and managed through credit diversification. The credit risk can be minimized through
diversification of credit portfolio that means prevention from excessive concentration of loans into few
borrowers/industries/sectors.
In choosing its investment portfolio, a commercial bank should follow the principle of diversity. It should not
invest its surplus funds in a particular type of security but in different types of securities. It should choose the
shares and debentures of different types of industries situated in different regions of the country. The same
principle should be followed in the case of state governments and local bodies. Diversification aims at
minimising risk of the investment portfolio of a bank.
The principle of diversity also applies to the advancing of loans to varied types of firms, industries, businesses
and trades. A bank should follow the maxim: “Do not keep all eggs in one basket.” It should spread it risks
by giving loans to various trades and industries in different parts of the country.

4. Principle of Profitability:
This is the cardinal principle for making investment by a bank. It must earn sufficient profits. It should,
therefore, invest in such securities which was sure a fair and stable return on the funds invested. The earning
capacity of securities and shares depends upon the interest rate and the dividend rate and the tax benefits
they carry.
Banks are commercial organizations and profit making is their main objective. Profit is necessary for the
bank's sustainability and growth. They need to pay an adequate return to their shareholders. Banks take risk
for securing the reasonable level of return. This principle advocates that maximum possible return should be
considered while a lending decision is made.
It is largely the government securities of the centre, state and local bodies that largely carry the exemption of
their interest from taxes. The bank should invest more in such securities rather than in the shares of new
companies which also carry tax exemption. This is because shares of new companies are not safe
investments.
5. Principle of loan purpose: Banks always need to be careful about the purpose and objective of the loan.
Analysis of the borrowing cause is a very important aspect in credit analysis. If the disbursed loan from the
bank is misutilized, there will be less chances of repayment by the borrower. Lending activities should be
guided by banks' own credit policy and remain within the boundaries of the legal framework. Banks need to
be careful to prevent lending in money laundering, terrorist activities, conducting illegal business etc.
6. Principle of Stability:
Another important principle of a bank’s investment policy should be to invest in those stocks and securities
which possess a high degree of stability in their prices. The bank cannot afford any loss on the value of its
securities. It should, therefore, invest it funds in the shares of reputed companies where the possibility of
decline in their prices is remote.
Government bonds and debentures of companies carry fixed rates of interest. Their value changes with
changes in the market rate of interest. But the bank is forced to liquidate a portion of them to meet its
requirements of cash in cash of financial crisis. Otherwise, they run to their full term of 10 years or more and
changes in the market rate of interest do not affect them much. Thus bank investments in debentures and
bonds are more stable than in the shares of companies.
Credit Process
Banks and financial institutions have to pass through a predetermined process of granting loans. Well defined
processes help to minimize credit risk as well as other potential complexities of the future. In general following
steps are taken as credit processes;
 Credit appraisal;
 Credit approval;
 Credit Documentation;
 Disbursement;
 Credit monitoring;
 Credit recovery and restructuring

Credit Appraisal
Credit Appraisal is the process whereby the risks relating to the repayment of a loan are evaluated. It is the
first step in the credit process which involves analysis of the borrower's capacity to repay the loan. Good
credit appraisal may be a milestone in maintaining a good credit portfolio in the banking business. Better
credit quality may be regarded as the outcome of the better credit appraisal technique. Every lending situation
may vary from case to case. Proper credit appraisal involves the assessment of three main aspects: the
applicant, the purpose, and the security. The banks should also assess the applicant's character and capital
position (or financial capacity to repay). The Banks should also assess the economic and industry conditions
and the borrower's need for funds, including the feasibility of any proposed venture, the amount of funds
required, and the cash flow expected to liquidate the credit facility. Banks should assess the marketability
and price stability of the security offered. Moreover in case of business borrowers, financial statements and
project progress reports are normally good indicators of the state of their businesses.
A credit appraisal is generally standardized presentation demonstrating the detailed analysis of a particular
lending situation. The conclusion drawn on the analysis helps in decision making for lending. Before making
the credit appraisal it is must for the credit analyst to understand the situation of the macro environment and
the industry a firm operates in. The detail procedure and analysis technique are discussed under Credit
Appraisal Chapter.
Credit approval
The loan is approved by competent authority after completion of the credit appraisal on the basis of the
recommendation of credit analyst as well as credit risk officer. Approving authority may enquire and make
addition in terms and conditions of the credit agreement during the stage of approval. Principally the approval
process needs to be started after completion of the documentation process. But in practice, the competitive
market has developed the trend of collecting initial documents in the first stage for approval of loans. Final
and original documentation are obtained only before disbursement of loan. Approval of credit facilities should
be done only by the authorized officers of the bank within their respective authorized limits.
In practice, "Principally agreed" type of pre-approval is also granted to the borrower subject to the condition
of providing necessary documents (securities) before disbursement of loan.
Credit Documentation
Credit documentation means obtaining and executing necessary legal documents in order to protect the
interest of the Bank. As discussed earlier, credit is an agreement between the bank and the borrower. The
borrower must present the documents before being availed of the loan as specified in the agreement.
Documentation means the execution of credit documents in the proper form as required by bank's internal
policies as well prevailing legal provisions. It establishes the contractual relationship between lending bankers
and the borrowers. Documents are essential to avoid ambiguities and settlement of future disputes.
Once the approval of the credit facility is received, the job of loan documentation starts. Normally there are
two units within the credit department namely business development unit and Credit Administration unit.
Business development unit is responsible for bringing business and relationship banking. They generally
focus on marketing related jobs, making necessary credit appraisals and forwarding it to the competent

authority for approval. Credit administration unit is responsible for documentation, monitoring, follow-ups,
supervision and control of the loans and advances.
The necessity of credit documents depends on the type of loan product. There are several credit documents
which are required. Some of the documents may be compulsorily required as per bank's credit policy
guideline while others may be needed to minimize credit risk. In general, following documents are used by
banks and financial institutions.
Major Credit Documents

1. Personal Information of Borrower (Individual borrower and guarantors)
 Citizenship or other valid identification document issued by government
 Location Verification Documents
 Background, Experience, Engagements
2. Information of Borrower (Institutional)
 Registration documents
 Ownership documents
 Income tax documents (PAN)
 Financial statements
3. Income Source Documents
 Document verification of income i.e. salary, wage, rental, pension, remittance etc.,
 Financial Statements (if possible audited),
4. Collateral Security Documents
 (Ownership) Legal documents of collateral i.e. registration and/or certification
 Valuation document of collateral (if required)
5. Other legal documents (before disbursement executing at FI)

 Offer letter/Sanction letter
 Mortgage deed with all necessary legal documents.
 Loan deed
 Personal guarantee/cross guarantee/ corporate guarantee
 Promissory notes
 Hypothecation of stocks & supplementary agreement to hypothecation
 Hypothecation of book debts & power of attorney
 Insurance documents
 Transfer of ownership of vehicle
 Subordinate agreement from other creditors
 Hire purchase agreement etc.
 Approved Credit Appraisal (Memo) / Approved Credit Facility

Request (CFR)
 Offer letter/Sanction letter
 Evidence of Income Sources & Financial Statements
 Evidence of Identification and Business Incorporation Certificates & Tax Registration Certificate
 Mortgage deed with all necessary legal documents.
 Loan deed

 Personal guarantee/cross guarantee/ corporate guarantee
 Promissory notes
 Hypothecation of stocks & supplementary agreement to hypothecation
 Hypothecation of book debts & power of attorney
 Insurance documents
 Transfer of ownership of vehicle
 Subordinate agreement from other creditors
 Hire purchase agreement etc.
Loan and security documentation refers to the possession and possible use of legal documents to validate
the claim of the Bank against the borrower. The credit analyst prescribes the document to be obtained while
obtaining the approval for various facilities provided to the borrower and it is the responsibility of the Credit
Administration Division (CAD) to get the documents executed in conformity with the approval. Credit
Administration Department prepares the checklist based on terms of approval so as to confirm that all
required security documents are obtained.
After approval of the various credit facilities, CAD prepares offer letter and property valuation letter from
registered valuation of Bank. The offer letter should cover the approved credit facility, interest rate/cash
margin, commission, management fee, purpose, maturity, security arrangement and other terms and
conditions. CAD must ensure that those documents received from the customer are duly signed/stamped by
the concerned authorities.
Disbursement
After ensuring that all the documents have been obtained from the borrower, banks disburse the approved
loan limits. The disbursement may be in full or in partial amount as per the approved terms and conditions.
In case of revolving credit banks provide limit to the borrower.
Credit Recovery and Restructuring

All the borrowers may not serve interest as well as principal on time according to the agreed term and
conditions. Some of them become delinquent in payment. In such cases banks need to take recovery action.
When a borrower fails to meet obligation, banks take recovery action as per the recovery policy of the bank.
The actions regarding recovery are; issue reminder notice, 7/15/35 days notice as per prevailing laws. The
bank may go for recovery of its dues through selling of the mortgaged/ pledged/lien assets when there is no
chance of repayment by the borrower.
Sometimes borrowers may request for the continuation of credit agreement by restructuring the terms and
conditions. In such a case, if the bank is assured that the loan will be repaid once the loan is
restructured/rescheduled, a new agreement can be established which is known as restructuring of loans.
Primary and Secondary Collateral Securities
Collateral is an asset or property that an individual or entity offers to a lender as security for a loan. It is used
as a way to obtain a loan, acting as a protection against potential loss for the lender should the
borrower default in his payments. In such an event, the collateral becomes the property of the lender to
compensate for the unreturned borrowed money.

For example, if a person wants to take out a loan from the bank, he may use his car or the title of a piece of
property as collateral. If he fails to repay the loan, the collateral may be seized by the bank, based on the two
parties’ agreement. If the borrower has finished paying back his loan, then the collateral is returned to his
possession.
Collateral vs. Security
Collateral and security are two terms that often confuse people who think the terms are completely
synonymous. In fact, the two concepts are different. The differences are explained below:
 Collateral is any property or asset that is given by a borrower to a lender in order to secure a loan. It
serves as an assurance that the lender will not suffer a significant loss. Securities, on the other hand,
refer specifically to financial assets (such as stock shares) that are used as collateral. Using
securities when taking out a loan is called securities-based lending.
 Collateral can be the title of a parcel of land, a car, or a house and lot, while securities are things
such as bonds, futures, swaps, options, and stocks.
 Collateral, or at least the ownership title to it, stays with the lender throughout the time the borrower
is paying the loan. Securities, on the other hand, allow the borrower to benefit from both the loan and
the securities portfolio even while the loan is still being paid back because the securities portfolio
remains under the borrower’s control. However, the lender assumes a greater risk because the value
of the securities may fluctuate substantially.
Primary Collateral
Primary collateral is the main, or first, asset pledged to secure a loan. Sometimes a loan has secondary
collateral -- for instance, when one mortgage covers multiple pieces of real estate, as in a blanket mortgage.
When an asset acquired by the borrower under a loan is offered to the lender as security for the financed
amount then that asset is called Primary Security. In simple terms, it is the thing that is being financed.
Example: A person takes a housing loan of Rs. 50 lakh from the bank and purchases a residential loan. That
flat will be mortgaged to the bank as primary security.
Primary Collateral means all property (whether real or personal) with respect to which any security interests
have been granted (or purported to be granted) pursuant to any Primary Security Document, including,
without limitation, all Pledge Agreement Collateral, all Earnings and Insurance Collateral, all Primary
Collateral Vessels and all cash and Cash Equivalents at any time delivered as collateral thereunder or
hereunder.
Credit Facility Type Primary Collateral

Housing Loan Land & Building (Financed by Housing Loan)
Hire Purchase Loan Vehicle (Financed by Hire Purchase Loan)
Business Working Capital Loan Stock & Debtors (Financed by WC Loan)
Features of Primary Collaterals:

 Credit facility is granted to finance primary collateral and drawing power (% of lending limit calculated
based on value of collateral offered) is calculated based on it,

 This is the first collateral offered by borrower to lender,
 It can be physical property (movable & immovable) and / or personal guarantee etc.
 Value of primary collateral may or may not cover the value of credit facility,
Secondary Collateral Security

All other collateral securities offered other than primary collateral is secondary collateral. Sometime, primary
collateral value may not be adequate to cover the total credit limit or lender (bank) may feel required to add
additional collaterals or nature of credit may demand other collaterals, then secondary collaterals are offered.
Bank creates charge over secondary collateral basically to secure the credit facility.
Features of Secondary Collateral Security:

 It is other than primary collateral,
 It can be physical property (movable & immovable) and / or personal guarantee etc.
 Credit facility is not granted to finance secondary collateral and drawing power (% of lending limit
calculated based on value of collateral offered) is not calculated based on it,
Modes of Creating Charge over Collateral Securities:
In order to be useful to a banker as an enforceable security for an advance, it is necessary that the security,
in addition to having the qualities as discussed, should also be charged to a banker in a legal and a perfect
manner. The mode by which various assets are made available as securities to a banker for advance granted
is called charging of securities. In case the mode of charging is defective, a banker will not be in a position
to enforce his security in case of default by the borrower. By charging a security, the borrower does not
transfer ownership of asset to a banker but transfers certain rights and interest in the property to the banker:
In order to safeguard his interest, a banker must understand various modes of charges. The following are
modes of charges, which are very important for a bank:
 Pledge
 Hypothecation
 Mortgage
 Assignment
 Lien
Pledge
It is the bailment of goods as security for payment of a debt or performance of a promise. Bailment of goods
is the delivery of the goods by one person to another for some purpose, under a contract that the goods
shall, when the purpose is served, be returned or otherwise disposed of, according to the directions of the
person delivering them.

The person who delivers the goods are delivered is called the pledger or pawner (borrower of the bank) and
the person to whom the goods are delivered is called the pledgee or bank or Pawnee. Legal delivery- actual
or constructive- is an essential part of a contract of pledge. The contract or pledge may not be expressed in
writing. A banker, however, takes precautions in addition to taking possession of goods and securities, and
also binds the borrower by a deed of pledge, embodying the terms of agreement. Of all the methods of
charging a security, a pledge is considered to be most satisfactory by the banker, it is perfectly legal.
Documents to the title of goods and paper security, like fixed deposit receipts and stock exchange securities,
also can be pledged to a banker as security.
Pledge is a kind of bailment having the following essential elements:

o Goods must be delivered by the pledger to the pledgee. The delivery to the pledgee may be actual or
constructive. Delivery of the key of the warehouse where the pledged goods are stored is a constructive
delivery and is sufficient to create a pledge. A pledge involves a transfer of possession of the goods
pledged and not of title. The ownership of the of goods pledged remains with the pledger.
o Pledge can be made only of movable properties. Money cannot be pledged.
o A contract of pledge must be supported by a valid consideration. The goods should be offered as security
for the payment of a debt or the performance of promise.
Hypothecation
Hart describes hypothecation charge against property for an amount of debt where neither ownership nor
possession is passed to the creditor.
Hypothecation is a mode of securing a loan by creating a charge on movable goods without the surrender of
possession or ownership. It may be described as a transaction whereby money is borrowed by the debtor on
the security of the movable property without transferring either the ownership or the possession to the
creditor. It is a well settled law that mortgage of movable property unaccompanied by transfer of ownership
or possession is called hypothecation. Thus, the borrower continues to be the owner of the property by
hypothecated as in the case of pledge. But the possession is not transferred to the creditor or lender.
In hypothecation, the charge created is equitable. Under this arrangement, the movable property remains in
the possession of the borrower who undertakes to give the possession to the creditor when the latter requires
him to do so. Thus, charge of hypothecation can be converted into a pledge by the lender at any time. In
such a case, the lender will enjoy all the rights of a pledgee.
Hypothecation is a device to create a charge over movable property and is the most suitable arrangement in
circumstances where the transfer of possession of the goods is either inconvenient or impracticable. For
instance, where an industrialist provides the security of raw materials or work-in-progress for a loan, transfer
of possession will hamper the production. This difficulty can be removed by hypothecating the assets with
the bank. This will enable the borrower to utilise the raw materials or work-in-progress in the ordinary course
of his business. Now-a-days, banks also lend against hypothecation of automobiles like three wheelers, vans,
tampos and trucks. This enables the borrower to use the vehicle and earn money. Thus, hypothecation is a
floating charge on the borrower's assets, present and future. It is crystallised when the borrower makes
default in making the payment and the lender takes steps to enforce his security.
Some of the important characteristics of a charge by hypothecation are given below:

 A document called hypothecation deed is executed by the borrower, which contains a
clause that when the banker demands, the borrower agrees to convert the hypothecation
charge into a pledge by giving possession of the goods to the banker. If peaceful
possession is not given when demanded, the banker has no alternative but to file a suit for
appointment of a receiver.
 Only movable goods and commodities, movable machinery and book debts can be
hypothecated.
 It is an equitable charge to a banker, where possession as well as ownership of the property
is with the borrower.
 It is advantageous to a banker also as he is not saddled with responsibility of storing the
goods and taking care of goods' protection and preservation.
 It is advantageous to the borrower, who is in a position to retain possession and sell the
goods, and also can convert the raw material into semi-finished goods and then finished
goods. He can also sell the finished goods to realise cash or create book debts, which can
also be hypothecated with his banker.
 Possibility of double financing in case of hypothecated goods is real. A banker should be
careful in this regard. The bank's Board should be prominently displayed at the place of the
borrower to give notice to other bankers. A Board of the bank should also be affixed on the
hypothecated machinery. The borrower must bank only with one banker to avoid the
possibility of double financing.
 As the advance against security of hypothecation is a risky advance, a banker should give
this facility only to first class parties, after proper verification of their credentials. A borrower
has got every opportunity to dispose of the goods in his possession without bothering about
repayment.
 A borrower has to submit stock statements of the goods or book debts to the bank either
monthly or quarterly. Such statements should be signed by authorized officials of the borrowing
unit and should be accompanied by a certificate that the quantity, quality and price quoted are
proper and the goods and commodities are paid for by the borrower.
Mortgage
A borrower may offer immovable property as a security for a loan to be granted by the creditor or
banker. When a borrower offers his immovable property like building, land, factory premises, etc. for
a loan, a charge thereon is created by means of a mortgage.
Advance against immovable property are secured by way of charge of mortgage. A mortgage is the
transfer of an interest in specific immovable property for the purpose of securing payments of money
advanced by way of loan, existing or future debts or performance of an engagement, which may
give, rise to a pecuniary liability. The transferor is called a mortgage, the transferee or mortgagee
and the principal money and interest of which the payment is secured are called the mortgage money
and the instruments (if any) by which the transfer is effected is called a mortgage deed. The
essentials of a charge of mortgage can be summarized as under: -

 Mortgage property must be specific and identifiable.
 Ownership and possession of the property remain with the mortgagor; only some interest
in the property is transferred to the mortgage.
 Immovable property, like land and buildings, plant and embedded machinery, should be
taken by way of mortgage.
 Mortgage creates transfer of interest in property by the mortgagor to the mortgagee.
 Mortgage can be created for present as well as future debt.
Assignment
Assignment means transfer of an existing or future right, property or debt by one person to another person.
The transferor is known as the assignor and the transferee as assignee. Actionable claims are assigned by
way of security for advance. An actionable claim means a claim to any debt other than a debt security by
mortgage of immovable property or by hypothecation or pledge of movable property or to any beneficial
interest in movable property not in the possession, either actual or constructive or beneficial interest be
existent, accuring conditional or contingent. In simple words, an actionable claim is a claim for which an
action can lie in the court of law if it is not met on due date. Some of the actionable claims to be noted are
interest in the insurance policy, book debts, shares, debentures and even term deposits.
Types of Assignment:
Legal Assignment:
A legal assignment of an actionable claim must be in writing and signed by the assignor. It must be
absolute and not by way of charge only. In practice, the banker to whom debt has been assigned sends
prompt notice in writing to the debtor of the borrower.
Equitable Assignment:
When due, procedure in case of legal assignment is not followed, it is called equitable assignment. In
case of legal assignment, the assignee can sue in his name, but it is not so if it is an equitable
assignment. A legal assignee can also give a good discharge for the debt without the concurrence of
the assignor. Value of assignment will depend not only on the integrity of the borrower, who is the
assignor, but also on the integrity of the borrower’s debtors, who ultimately has to make the payment.
Lien:
A Lien is the right of a creditor to retain the properties belonging to the debtor until the debt due to him is
repaid. Lien gives a person only a right to retain the possession of the goods and not the power to sell them.
A banker’s lien is a general lien which tantamount to an implied pledge. It confers upon the banker the right
to sell the securities after serving reasonable notice to the borrower.
Lien is the right of a creditor to hold possession of the goods of the debtor till he discharges his debt. Right
of lien entitles the creditor to retain the security or goods belonging to the debtor till the payment of debt. Lien
can be either (i) a general lien, or (ii) a particular lien.

- General lien entitles the creditor in possession to retain the goods till all his claims against the owner
of the goods have been met. This is applicable in respect of all amounts due from the debtor to the
creditor.
- But a particular lien is a specific lien which confers a right to retain those goods for which the amount
is to be paid.
Difference between Pledge and Lien
Following are the points of difference between a pledge and a lien:
 Pledge is always created by a contract, whereas no contract is necessary for a right of licn. In most of
the cases, lien is createdd by law.
 Though in both the cases the possession of the goods is transferred to the creditor, yet in case of a lien,
the party in possession of the goods does not have in general any right to sell the goods. In case of
pledge, the creditor or the pledgee has right to sell the goods in his possession on the default by the
debtor.
 Right of lien is lost with the loss of the possession of the goods. But pledge is not necessarily terminated
by return of goods to the owner. The goods pledged may be redelivered to the pledger for a limited
purpose.
 Lien is purely a passive right. Lien-holder can only hold the goods till the payment is made. Lien holder
can not enforce its claim through a court of law. But a pledge enjoys the right to sue, right of sale and the
right of lien.
Difference between Mortgage and Pledge

The main difference between a mortgage and a pledge is that in case of a pledge, the possession is
transferred to the creditor, while it remains with the mortgagor in case of a mortgage unless otherwise stated
in the mortgage deed. Delivery of possession is essential in a pledge, but the pledgee has only a special
interest in the property and the general interest remains with the pledger.
Goods must be movable in case of a pledge, but mortgage is possible only in the case of specific immovable
property. Further, a mortgagee has the right of foreclosure in certain cases which is not available to the
pledgee in any case.
Credit Cards
A credit card is a payment card issued to users (cardholders) to enable the cardholder to pay
a merchant for goods and services based on the cardholder's accrued debt (i.e., promise to the card issuer to
pay them for the amounts plus the other agreed charges). The card issuer (usually a bank) creates
a revolving account and grants a line of credit to the cardholder, from which the cardholder can borrow money
for payment to a merchant or as a cash advance.
A credit card is different from a charge card, which requires the balance to be repaid in full each month or at
the end of each statement cycle. In contrast, credit cards allow the consumers to build a continuing balance
of debt, subject to interest being charged. A credit card also differs from a cash card, which can be used like
currency by the owner of the card. A credit card differs from a charge card also in that a credit card typically
involves a third-party entity that pays the seller and is reimbursed by the buyer, whereas a charge card simply
defers payment by the buyer until a later date.

Interest charges
Credit card issuers usually waive interest charges if the balance is paid in full each month, but typically will
charge full interest on the entire outstanding balance from the date of each purchase if the total balance is
not paid.
For example, if a user had a Rs. 1,000 transaction and repaid it in full within this grace period, there would
be no interest charged. If, however, even Rs. 1.00 of the total amount remained unpaid, interest would be
charged on the Rs. 1,000 from the date of purchase until the payment is received.
The precise manner in which interest is charged is usually detailed in a cardholder agreement which may be
summarized on the back of the monthly statement. The general calculation formula most financial institutions
use to determine the amount of interest to be charged is (APR/100 x ADB)/365 x number of days revolved.
Take the annual percentage rate (APR) and divide by 100 then multiply to the amount of the average daily
balance (ADB). Divide the result by 365 and then take this total and multiply by the total number of days the
amount revolved before payment was made on the account. Financial institutions refer to interest charged
back to the original time of the transaction and up to the time a payment was made, if not in full, as a residual
retail finance charge (RRFC). Thus after an amount has revolved and a payment has been made, the user
of the card will still receive interest charges on their statement after paying the next statement in full (in fact
the statement may only have a charge for interest that collected up until the date the full balance was paid,
i.e. when the balance stopped revolving).
The credit card may simply serve as a form of revolving credit, or it may become a complicated financial
instrument with multiple balance segments each at a different interest rate, possibly with a single umbrella
credit limit, or with separate credit limits applicable to the various balance segments. Usually this
compartmentalization is the result of special incentive offers from the issuing bank, to encourage balance
transfers from cards of other issuers. In the event that several interest rates apply to various balance
segments, payment allocation is generally at the discretion of the issuing bank, and payments will therefore
usually be allocated towards the lowest rate balances until paid in full before any money is paid towards
higher rate balances. Interest rates can vary considerably from card to card, and the interest rate on a
particular card may jump dramatically if the card user is late with a payment on that card or any other credit
instrument, or even if the issuing bank decides to raise its revenue.
Parties involved
 Cardholder: The holder of the card used to make a purchase; the consumer.
 Card-issuing bank: The financial institution or other organization that issued the credit card to the
cardholder. This bank bills the consumer for repayment and bears the risk that the card is used
fraudulently. American Express and Discover were previously the only card-issuing banks for their
respective brands, but as of 2007, this is no longer the case. Cards issued by banks to cardholders in a
different country are known as offshore credit cards.
 Merchant: The individual or business accepting credit card payments for products or services sold to the
cardholder.
 Acquiring bank: The financial institution accepting payment for the products or services on behalf of the
merchant.
 Independent sales organization: Re-sellers (to merchants) of the services of the acquiring bank.

 Merchant account: This could refer to the acquiring bank or the independent sales organization, but in
general is the organization that the merchant deals with.
 Card association: An association of card-issuing banks such as Discover, Visa, MasterCard, American
Express, etc. that set transaction terms for merchants, card-issuing banks, and acquiring banks.
 Transaction network: The system that implements the mechanics of the electronic transactions. May be
operated by an independent company, and one company may operate multiple networks.
 Affinity partner: Some institutions lend their names to an issuer to attract customers that have a strong
relationship with that institution, and get paid a fee or a percentage of the balance for each card issued
using their name. Examples of typical affinity partners are sports teams, universities, charities,
professional organizations, and major retailers.
 Insurance providers: Insurers underwriting various insurance protections offered as credit card perks, for
example, Car Rental Insurance, Purchase Security, Hotel Burglary Insurance, Travel Medical Protection
etc.
Credit Card Issue Process
Credit cards have become a part and parcel of our financial routine. They not only bring in convenience but
also help tide over short-term crunches.
How do you apply for a credit card?

There are multiple ways to apply for a credit card. You can apply for one online or by visiting the nearest
branch. Often, they can be applied through many promotional stalls set up at various events or through the
field service officers of the bank. If you submit an online application, a representative of the bank will visit you
to collect your documents.
What are the documents needed to apply for a credit card?

The documents you would need to submit with a filled-up application form are:
 Identity Proof
 Address Proof
 A copy of your PAN card
 Income/ Employment proof

The Processing and Verification of your Application
Once you have submitted all the necessary documents, the bank starts the process of verifying the
authenticity of your documents. They will check all the documents and may also call and talk to the references
provided in your application. Your employer may also be approached to check for the correctness
of the details that you have provided. Also, the verification may be expatiated if you operate a salary or loan
account of a fixed deposit with that bank.
Credit Score Check

Credit Score is an important determinant for your application getting accepted or rejected. A credit card is an
unsecured credit, so the issuer of your card would want to be doubly sure about your creditworthiness before
your application is accepted. The only way to do this is through your credit score. A good credit
score indicates that you behave responsibly towards credit and that makes you eligible for further credit.
The Final check

After the credit score and the initial documents check, a final check of all documents is carried out before
taking a call on either accepting or rejecting the application. If the application is accepted, the issuing bank
sets your credit limit based on your income and other deciding criteria like your credit score, etc. The
individual is intimated about the acceptance of the application. The approved credit card is then sent with
all the relevant documentation regarding the terms and conditions to the applicant.
Time taken for the approval

Generally, the entire process from submission to approval may take about 10-15 days depending upon the
kind of card you have applied, and the documents submitted.
Consortium & Syndication
Loan Syndication
A loan syndication usually occurs when multiple banks lend money to a borrower all at the same time and for
the same purpose. In a very general sense, a consortium is any group of individuals or entities that decide to
pool resources toward a given objective. A consortium is usually governed by a legal contract that delegates
responsibilities among its members. In the financial world, a consortium refers to several lending institutions
that group together to jointly finance a single borrower.
These multiple banking arrangements are very similar to a loan syndication, although there are structural and
operational differences between the two.
 Loan syndications are generally reserved for loans involving international transactions, different
currencies, and necessary banking cooperation.
 A consortium is usually governed by a legal contract that delegates responsibilities among its
members.
 Consortium financing occurs for transactions that might not take place with a single lender.
While a loan syndication also involves multiple lenders and a single borrower, the term is generally reserved
for loans involving international transactions, different currencies, and a necessary banking cooperation to

guarantee payments and reduce exposure. A loan syndication is headed by a managing bank that is
approached by the borrower to arrange credit. The managing bank is generally responsible for negotiating
conditions and arranging the syndicate. In return, the borrower generally pays the bank a fee.
Loan syndication is the most common way for European and American corporations to seek financing from
banks and other lenders. In Europe, loan syndication is primarily driven by private equity sponsors, while in
the U.S., corporate borrowers and private equity sponsors drive the loan syndication market in equal
measures.
The managing bank in a loan syndication is not necessarily the majority lender, or "lead" bank. Any of the
participating banks may act as lead or assume the responsibilities of the managing bank depending on how
the credit agreement is drawn up.
A loan syndication is similar to a consortium, although there are structural and operational differences
between the two.
Consortium
Like a loan syndication, consortium financing occurs for transactions that might not take place with a single
lender. Several banks agree to jointly supervise a single borrower with a common appraisal, documentation,
and follow-up and own equal shares in the transaction. Unlike in a loan syndication, there is not one lead
bank that manages the financing project; all of the banks play an equal role in managing the project.
Consortiums are not built to handle international transactions such as a syndication loan. Instead, a
consortium may arise because the size of the project at hand is simply too large or too risky for any single
lender to assume. While loan syndications typically work across borders and may handle financing in different
currencies, consortiums typically occur within the boundaries of a given nation.
Sometimes the participating banks form a new consortium bank that functions by leveraging assets from
each institution and disbands after the project is complete. By allowing all of the members to pool their assets,
consortiums allow smaller banks to tackle larger projects.
In consortium lending system, two or more lenders join together to finance a single borrower. The lending
banks formally join together, by way of an inter-se agreement to meet the credit needs of a borrower. Here,
the sanction of limits to a borrower is completed with common appraisal, common documentation and
monitoring the advance with joint supervision and follow-up exercises.
The borrower company gives a mandate to a bank to lead the consortium, which is commonly referred as a
consortium lead (leader) bank. The consortium leader will be responsible for holding common loan/advance
documents executed by the borrower company on behalf of consortium. The “Pari-Passu” Charge will be
created on securities offered by the borrower company against the total credit extend to the company by all
the lending institutions of consortium. “Pari Passu” charge means that when Borrower entity goes into
dissolution or the security is sold or otherwise disposed –off by the consortium, the assets over which the
charge has been created will be distributed in proportion to the creditors’ (lenders) respective holdings.
Thus, the system of consortium lending offers scope and opportunity to share risk amongst banks. The
system is considered to be mutually beneficial to the banks as well as customers.

In consortium advance, the levy of commitment charge is not mandatory and it is left to the discretion of the
financing banks/ consortium/syndicate. Accordingly, banks are free to evolve their own guidelines in regard
to commitment charge for ensuring credit discipline.
Micro Finance
Micro Finance in Nepal

The microfinance sector was served by cooperatives (1950-1960s) and normal banks (1970-1980s) until
1980, when a number of pilot projects and initiatives were implemented to introduce the financial and banking
services to help poor and women. However, few groups of poor people were benefited, but at the end these
service were found ineffective.
During the 1990s and early 2000s, the government moved further to strengthen the Microfinance Institutions
to provide financial service to poor and women, with the formation of five Regional Development Banks
(RDBs) in each Development region based of Grameen model with the sole objective to provide micro-credit
services to the poor and women. Eventually these Regional Development Banks transformed to
Microfinance Development Banks (MFDBs) after privatization and licensed as class 'D' financial Institutions.
Soon after in early 2000s, a number of private microfinance and NGOs came into existence with microfinance
programs. Under Grameen Model, NGOs such as Nirdhan Utthan Bank, Center for Self-help Development
(CDF) successfully implemented microfinance program and later transformed to Microfinance Development
Banks. Similarly other Microfinance Development Banks, Chhimek Bikas Bank Ltd. (CBB), Deprosc Bikas
Bank (DBB) and Nerude Microfinance Development Bank Ltd. (NMDB), were also formed.
During early 2000s, NGOs which were involved in community based financial activities were also legalized
and licensed by Nepal Rastra Bank (NRB) to formalize micro financing services, as a result Financial
Intermediary NGOs (FINGOs) were formed. Wholesale funding institutions were also formed during the early
2000s period. Nepal Rastra Bank formed Rural Self-Reliance Fund (RSRF) in the year 1991 to provide
financial assistance to NGOs and Cooperatives. Rural Microfinance Development Center (RMDC) is the one
such wholesale organization that was formed in 1998 under the Public Private Partnership (PPP) Program,
where Nepal Rastra Bank has 26% stake and remaining stakes hold by 13 commercial banks. Sana Kisan
Bikas Bank Ltd. (SKBBL) was formed in 2001 with the objective to finance Small Farmer Cooperatives Ltd.
(SFCLs) and the National Cooperative Development Bank (NCDB) was formed in 2003 to support and
finance the Cooperative organizations in the country. Nepal Rastra Bank, the central bank of the country
regulates the Microfinance Development Banks (MFDBs) and Financial Intermediary NGOs (FINGOs) while
the Small Farmer Cooperatives Ltd. (SFCL) and Savings and Credit Cooperatives (SACCOs) are governed
by Cooperative Laws.
All types of Microfinance services in the country are provided by Microfinance Institutions (MFIs) working as
regulated MFDBs, FINGOs, SFCL, and SACCOs.
Nirdhan Utthan Bank Ltd., Chhimek Bikas Bank Ltd., and Swabalamban Bikas Bank are the top three
Microfinance Institutions in the country.
Of the total borrowers under Microfinance Institutions, government Regional Development Banks serves
almost quarter of the total borrowers, Microfinance Development Banks (MFDBs) servers almost the half of

the borrowers and the remaining borrowers are serviced by FINGOs and Cooperatives.
There are various organizations in Nepal that regulates and supervises Microfinance Institutions, which are
listed below:
Microfinance—also called microcredit—is a way to provide small business owners and entrepreneurs access
to capital. Often these small and individual businesses don’t have access to traditional financial resources
from major institutions. This means it is harder to access loans, insurance, and investments that will help
grow their business.
Essentially, microfinance is providing loans, credit, access to savings accounts—even insurance policies and
money transfers––to the small business owner and entrepreneur. There are many such enterprises in the
developing world.
How Microfinancing Works
Microfinance, pioneered by the Nobel-Prize winner Muhammad Yunus, helps the financially marginalized by
providing them with the necessary capital to start a business and work toward financial independence. These
loans are significant because they are given even though the borrower has no collateral. However, the
interest rates for these microloans are often very high due to the risk of default.
The term microfinance encompasses microloans, micro-savings, and microinsurance. Microfinance

institutions provide small loans and other resources to business owners and entrepreneurs to help them get
their businesses off the ground. Many of the recipients are in developing countries, and could otherwise not
obtain a traditional loan.
Micro-savings accounts are also under the microfinance umbrella. They allow entrepreneurs to have a
savings account with no minimum balance. And microinsurance provides these borrowers with insurance, at
a lower rate, and with lesser premiums.

Financial Literacy
Sometimes, those who receive microloans are required to take training courses. These courses include book-
keeping, cash flow management, and other relevant skills.
Access to cell phones and wireless internet around the world has also lent itself to the prevalence of
microfinance since potential borrowers can use their cell phones as banking channels.
Why Is It Important?
Microfinance is important because it provides resources and access to capital to the financially underserved,
such as those who are unable to get checking accounts, lines of credit, or loans from traditional banks.
Without microfinance, these groups may have to resort to using loans or payday advances with extremely
high-interest rates or even borrow money from family and friends. Microfinance helps them invest in their
businesses, and as a result, invest in themselves.
Who Benefits from Microfinancing?
While microfinance can certainly benefit those stateside, it can also serve as an important resource for those
in the developing world. For example, cell phones are being used as a way to bring financial services such
as microlending to those living in Kenya.
It’s also made headway in the United States, where burgeoning entrepreneurs with no collateral are able to
take out loans of less than $50,000 to jump-start their business ventures.8
Microfinance can also help women break the cycle of poverty. Often, these loans can be as small as $60.
For example, a young single mother from Paraguay took this small investment of $60 to start an empanada
and snack stand. She continued building her business, repaying this loan and taking out larger loans to buy
a building for her stand, complete with a refrigerator and attached home for her family. This is microfinance
at its best.
In fact, women are major microfinance borrowers, making up 80% of loans in 2018, according to the 2019
Microfinance Barometer. Around 65% of total borrowers live in rural areas, which means that a large number
of female microfinance borrowers live in rural areas with limited resources.
The microfinance industry is also growing rapidly. In 2018, there were 139.9 million microfinance borrowers,
for a total of $124 billion in loans. India accounted for most of these borrows, followed by Bangladesh, and
Vietnam.
Does It Actually Work?
While some have lauded microfinance as a way to end the cycle of poverty, decrease unemployment,
increase earning power, and aid the financially marginalized, some experts say that it may not work as well
as it should, even going so far as to say it’s lost its mission.

Others argue that microfinance simply makes poverty worse since many borrowers use microloans to pay
for basic necessities, or their businesses fail, which only plunges them further into debt.
For example, in South Africa, 94% of all microfinance loans are used for consumption, meaning, the funds
are used to pay for basic necessities. This means borrowers aren’t generating new income with the initial
loan, which means they have to take out another loan to pay off that loan, and so forth and so forth. This
translates into a lot more debt.
However, other experts say that microfinance can serve as a valuable tool for the financially underserved
when used properly. They also cite the industry’s high repayment rate as proof of its effectiveness. Either
way, microfinance is an important topic in the financial realm, and if done correctly, could be a powerful tool
for many.
Documentary Credit (Bank Guarantee & Letter of Credit)
Letter of Credit (LC)

A letter of credit, or "credit letter" is 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 a payment on
the purchase, the bank will be required to cover the full or remaining amount of the purchase. It may be
offered as a facility.
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 of credit is a document sent from a bank or financial institute that guarantees that a seller will
receive a buyer's payment on time and for the full amount.
 Letters of credit are often used within the international trade industry.
 There are many different letters of credit including one called a revolving letter of credit.
 Banks collect a fee for issuing a letter of credit.
Because a letter of credit is typically a negotiable instrument, the issuing bank pays the beneficiary or any
bank nominated by the beneficiary. If a letter of credit is transferable, the beneficiary may assign another
entity, such as a corporate parent or a third party, the right to draw.
Banks also collect a fee for service, typically a percentage of the size of the letter of credit. The International
Chamber of Commerce Uniform Customs and Practice for Documentary Credits oversees letters of credit
used in international transactions. There are several types of letters of credit available.
A letter of credit (LC), also known as a documentary credit or bankers commercial credit, or letter of
undertaking (LoU), is a payment mechanism used in international trade to provide an
economic guarantee from a creditworthy bank to an exporter of goods. Letters of credit are used extensively
in the financing of international trade, where the reliability of contracting parties cannot be readily and easily
determined. Its economic effect is to introduce a bank as an underwriter, where it assumes the counterparty
risk of the buyer paying the seller for goods.

A letter of credit is a document from a bank that guarantees payment. There are several types of letters of
credit, and they can provide security when buying and selling products or services.
 Seller protection: If a buyer fails to pay a seller, the bank that issued a letter of credit must pay the
seller as long as the seller meets all of the requirements in the letter. This provides security when
the buyer and seller are in different countries.
 Buyer protection: Letters of credit can also protect buyers. If you pay somebody to provide a
product or service and they fail to deliver, you might be able to get paid using a standby letter of
credit. That payment can be a penalty to the company that was unable to perform, and it’s similar to
a refund. With the money you receive, you can pay somebody else to provide the product or service
needed.
Example
 A manufacturer receives an order from a new customer overseas. The manufacturer has no way of
knowing if this customer can (or will) pay for the goods after producing and shipping the products.
 To manage risk, the seller uses an agreement that requires the buyer to pay with a letter of credit as
soon as shipment is made.
 To move forward, the buyer needs to apply for a letter of credit at a bank in their home country. The
buyer may need to have funds on hand at that bank or get approval for financing from the bank.
 The bank will only release funds to the seller after the seller proves that the shipment happened. To
do so, the seller typically provides documents showing how goods were shipped (with details like the
exact dates, destination, and contents). In some ways, the buyer also enjoys protection under a letter
of credit: Buyers might prefer to pay a bank with a big legal department rather than send the money
directly to an unknown seller.
 If the buyer is concerned about a dishonest seller, there are additional options available for the
buyer’s protection. For example, somebody can inspect the shipment before the payment is
released.

To better understand letters of credit, it helps to know the terminology.
 Applicant: The party who requests the letter of credit. This is the person or organization that will pay
the beneficiary. The applicant is often (but not always) an importer or buyer who uses the letter of
credit to make a purchase.
 Beneficiary: The party who receives payment. This is usually a seller or exporter who has requested
that the applicant use a letter of credit (because the beneficiary wants more security).
 Issuing bank: The bank that creates or issues the letter of credit at the applicant’s request. It is
typically a bank where the applicant already does business (in the applicant’s home country, where
the applicant has an account or a line of credit).
 Negotiating bank: The bank that works with the beneficiary. This bank is often located in the
beneficiary’s home country, and it may be a bank where the beneficiary is already a customer. The
beneficiary submits documents to the negotiating bank, and the negotiating bank acts as a liaison
between the beneficiary and the other banks involved.
 Confirming bank: A bank that “guarantees” payment to the beneficiary as long as the requirements
in the letter of credit are satisfied. The issuing bank already guarantees payment, but the beneficiary
may prefer a guarantee from a bank in their home country (with which they are more familiar). This
may be the same bank as the negotiating bank.
 Advising bank: The bank that receives the letter of credit from the issuing bank and notifies the
beneficiary that the letter is available. This bank is also known as the notifying bank, and may be the
same bank as the negotiating bank and the confirming bank.
 Intermediary: A company that connects buyers and sellers, and which sometimes uses letters of
credit to facilitate transactions. Intermediaries often use back-to-back letters of credit (or transferable
letters of credit).
 Freight forwarder: A company that assists with international shipping. Freight forwarders often
provide the documents exporters need to provide in order to get paid.
 Shipper: The company that transports goods from place to place.
 Legal counsel: A firm that advises applicants and beneficiaries on how to use letters of credit. It’s
essential to get help from an expert who is familiar with these transactions.
Several categories of LC's exist which seek to operate in different markets and solve different issues. An
example of these include:
 Import/export(Commercial): — The same credit can be termed an import or export letter of credit
depending on whose perspective is considered. For the importer it is termed an Import LC and for the
exporter of goods, an Export LC.
 Revocable/ Irrevocable: — Whether a LC is revocable or irrevocable determines whether the buyer
and the issuing bank are able to manipulate the LC or make corrections without informing or getting
permissions from the seller. According to UCP 600, all LCs are irrevocable, hence in practice the
revocable type of LC is increasingly obsolete. Any changes (amendment) or cancellation of the LC
(except when expired) is done by the applicant (buyer) through the issuing bank. It must be authenticated
and approved by the beneficiary (seller).
 Confirmed/Unconfirmed: — An LC is said to be confirmed when a second bank adds its confirmation
(or guarantee) to honor a complying presentation at the request or authorization of the issuing bank.

 Restricted/ Unrestricted: — Either the one advising bank can purchase a bill of exchange from the
seller in the case of a restricted LC or; the confirmation bank is not specified, which means that the
exporter can show the bill of exchange to any bank and receive a payment on an unrestricted LC.
 Deferred / Usance: — A credit that is not paid/assigned immediately after presentation, but after an
indicated period that is accepted by both buyer and seller. Typically, seller allows buyer to pay the
required money after taking the related goods and selling them.
Additionally, a letter of credit may also have specific terms relating to the payment conditions which relate to
the underlying reference documents. Some of these include
 At Sight: — A credit that the announcer bank immediately pays after inspecting the carriage documents
from the seller.
 Red Clause: — Before sending the products, seller can take the pre-paid part of the money from the
bank. The first part of the credit is to attract the attention of the accepting bank. The first time the credit
is established by the assigner bank, is to gain the attention of the offered bank. The terms and conditions
were typically written in red ink, thus the name.
 Back to Back: — A pair of LCs in which one is to the benefit of a seller who is not able to provide the
corresponding goods for unspecified reasons. In that event, a second credit is opened for another seller
to provide the desired goods. Back-to-back is issued to facilitate intermediary trade. Intermediate
companies such as trading houses are sometimes required to open LCs for a supplier and receive Export
LCs from buyer.
 Standby Letter of Credit: (SBLC) — Operates like a Commercial Letter of Credit, except that typically
it is retained as a "standby" instead of being the intended payment mechanism. In other words, this is a
LC which is intended to provide a source of payment in the event of non-performance of contract. This
is a security against an obligation which is not performed. If you present the bank with demands of non-
payment it is not a guarantee - trigger isn't non-payment - it is presented by documentation. UCP600
article 1 provides that the UCP applies to Standbys; ISP98 applies specifically to Standby letters of
Credit; and the United Nations Convention on Independent Guarantees and Standby Letters of
Credit[16] applies to a small number of countries that have ratified the Convention.
Documents That May Be Requested for Presentation
 Financial documents — bill of exchange, co-accepted draft

 Commercial documents — invoice, packing list
 Shipping 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
 Official documents — license, embassy legalization, origin certificate, inspection
certificate, phytosanitary certificate
 Insurance documents — insurance policy or certificate, but not a cover note.

Advantages of Letter of Credit
A letter of credit enjoys various advantages in executing an international trade transaction. Some of the major
ones are below:
Safely Expand Business Internationally: A letter of credit gives the trade partners an ability to transact
with unknown partners or in newly established trade relationships. It helps in expanding their business quickly
into new geographies.
Highly Customizable: A letter of credit is highly customizable. Both the trading partners can put in terms
and conditions as per their requirements and arrive at a mutual list of clauses. It can also be customized from
one transaction to another with the same trading partners.
Seller Receives Money on Fulfilling Terms: A letter of credit makes the issuing bank independent of the
trading partners’ obligations and any disputes arising out of those obligations. The bank has to just check
whether the documents submitted by the beneficiary satisfy the terms and conditions specified in the letter
of credit, and pay the full amount.
Works as a Credit Certificate for Buyer: A letter of credit transfers the credit-worthiness from the importer
or buyer to the issuing bank. The importer can do multiple transactions at the same time when he is backed
by an established and larger institution such as a bank.
Seller is Free of Credit Risk: A letter of credit is safer for the seller or exporter in case the buyer or importer
goes bankrupt. Since the creditworthiness of the importer is transferred to the issuing bank, it is the bank’s
obligation to pay the amount as agreed in the letter of credit. Thus, a letter of credit insulates the exporter
from the importer’s business risk.
Quick to Execute for Creditworthy Parties: A letter of credit is quick to execute. As per the initial terms
and conditions, the seller or exporter has to present the proof of material type and quantity along with the
shipping documents supporting his claim that the goods have been shipped. The advising bank will verify the
documents and give the full payment.
Payment Assured in Disputable Transactions: In the case of a dispute between the trading partners, the
exporter can withdraw the fund as agreed upon in the letter of credit and resolve the disputes later in the
court. The beneficiary’s right to the full amount is described in the phrase ‘pay now, litigate later’ by the courts.
The importer cannot hold or deny the payment to the exporter by raising objections on the quality of goods
because the bank just needs to see the documents satisfying the shipping terms and conditions as put in the
letter of credit.
Timely Payments Leads to Better Cash Flow Planning: A letter of credit provides certainty to the amount
and timing of the exporter’s cash flows. He can plan his financing needs well in advance which reduces his
risk.
Pre-shipment Financing Available to Sellers: The exporter can avail pre-shipment financing against a
letter of credit. This helps him in plugging the financing gaps if any.

Bank Guarantee (BG)
In commercial transactions, bank guarantees are required as a security for due fulfillment of a contract by
the obligor, in favor of the beneficiary. The obligor's financial standing and credentials may be unknown to
the beneficiary of a commercial contract and a bank's guarantee on behalf of the obligor supports for the
transaction. These financial instruments are often used in trade financing when suppliers or vendors are
purchasing and selling goods to and from overseas customers with whom they don't have established
business relationships. The instruments are designed to reduce the risk taken by each party.
A guarantee is a promise to answer 'for the debt, default or miscarriage of another', if that person fails to meet
the obligation. Guarantees are given by banks. A bank guarantee enables the customer (debtor) to acquire
goods, buy equipment, or draw down loans, and thereby expand business activity. The guarantor incurs
secondary liability, that is, the guarantor becomes liable only if the principal debtor fails to pay. If the principal
debtor's liability to the bank is void, the guarantor will not be liable. Bank guarantees are given in the form of
tender bonds, performance guarantees and repayment guarantees in relation to projects in the same country
or another country which involves supply of goods or services or the performance of work. These guarantees
are currently an important tool of international trade.
Bank Guarantee is an irrevocable obligation in the form of written undertaking of a Bank to pay an agreed
sum, in case of default by a third party in fulfilling their obligations under the terms of the Bank Guarantee. A
guarantee from the bank ensures that the liabilities of a debtor will be met. In other words, if the debtor fails
to settle a debt, the bank will cover it.
A bank guarantee is an undertaking by the bank at the request of a party, whereby the bank in the event of
default by the principal in the fulfillment of his obligations has to make payment to the beneficiary within the
limits of specified sum of money and within the specified period of time. So, bank guarantees are usually
limited with respect to amount and time. As for as the time is concerned, usually a grace period is granted to
the beneficiary to claim under the guarantee. This is basically given for the time taken by the beneficiary to
present his claim. The bank issues the required guarantee on behalf of the obligor after making a proper
assessment of his financial standing and ability to fulfill his part of the contract.
A bank guarantee and a letter of credit are similar in many ways but they're two different things. Letters of
credit ensure that a transaction proceeds as planned, while bank guarantees reduce the loss if the transaction
doesn't go as planned. A letter of credit is an obligation taken on by a bank to make a payment once certain
criteria are met. Once these terms are completed and confirmed, the bank will transfer the funds. This
ensures the payment will be made as long as the services are performed. A bank guarantee, like a line of
credit, guarantees a sum of money to a beneficiary. Unlike a line of credit, the sum is only paid if the opposing
party does not fulfill the stipulated obligations under the contract. This can be used to essentially insure a
buyer or seller from loss or damage due to non performance by the other party in a contract. The more
common method of payment in international trade is by letter of credit rather than a bank guarantee
particularly when the seller and buyer have yet established a trade relationship. Letter of credit is primary
liability while guarantees are the secondary liability of the bank. Banks become liable only when the customer
breaches the terms and conditions specified in the contract.

A bank guarantee is for the bank to guarantee and pay their client's debt to the seller of goods in case of
default payment. However the claim is still settled primarily against the bank's client, and not the bank itself.
Hence a bank guarantee is more risky for the seller and less risky for the bank. A letter of credit is a similar
documentary arrangement, but the principal difference being that it is a claim against the bank, rather than a
bank's client. A letter of credit is therefore less risky for the seller, but more risky for a bank.
Need for a Bank Guarantee

Bank guarantee are:
 Issued by a bank on behalf of its customer in favor of another party; or
 Received by a bank as a beneficiary from another bank promising loan repayment.
Bank guarantees are issued by banks with the full assurance that the issuing institution is fully liable to pay
all responsibilities if the client/borrower fails to comply with the terms and conditions stated in the contractual
agreement between the client and the beneficiary. Every guarantee has a definite limit as regards the bank's
liability, in terms of the amount and time frame for its enforcement by the beneficiary. The issuing bank
charges commission on the basis of the amount and validity period of the guarantee.
Customers need bank guarantee;

 To provide an assurance of the intention of the principal to sign the contract
 To safeguard against the principal failing to meet his obligations
under such a contract.
 To protect interest of a party awarding the contract (beneficiary)
in respect of the repayment of payments and advances made by
him in the event of principal not fulfilling the contract terms.
Bank guarantees are normally issued for the following purposes;

 As a form of security assuring the performance of certain acts;
and
 As collateral for loan and advances
A bank guarantee might be used when a buyer obtains goods from a seller then runs into cash flow difficulties
and can't pay the seller. The bank guarantee would pay an agreed-upon sum to the seller. Similarly, if the
supplier was unable to provide the goods, the bank would then pay the purchaser the agreed-upon sum.
Essentially, the bank guarantee acts as a safety measure for the opposing party in the transaction.
Banks demand some tangible security or cash deposit to be safe in the event of enforcement of the guarantee
by the beneficiary. Documentation is of vital importance in the issuance of Bank Guarantee. Although Bank
guarantees are indirect or contingent liabilities, they may become direct liabilities. Banks examine the
implications of the terms and conditions of the contracts to be guaranteed to determine whether the customer
is capable of satisfactorily complying with the provisions. Bank Guarantee requires the same credit evaluation
criteria and guidelines normally used for the approval of other loans and advances.

Parties involved in Guarantees
 The beneficiary: Beneficiary is the Party inviting the tender or the party awarding the contract. It is
a person who wants to receive a compensatory sum of money in case another party fails to perform
Bond the contract in accordance with its terms. The beneficiary claims and receives the amount
specified in the guarantee in case the principal fails to perform the contract. Banks issue bank
guarantees in favor of the beneficiary. This party is benefited in the event of non-performance
because certainty of payment is guaranteed by the bank.
 The principal: The party tendering the contract or the party to whom the contract has been awarded.
Principal may be the contractor or buyer of the services provided by the beneficiary. Banks issue
bank guarantees on behalf of the principal.
Principal gets benefits of bank guarantee because it enables better liquidity by deferring payment
and making it contingent on non-performance.
 Guarantor: Guarantor is a party who will meet his commitment in terms of the guarantee, without
becoming involved in possible disputes between beneficiary and principal. Banks are who issue bank
guarantees. Banks get commission income from guarantee services.
Types of Bank Guarantee

Bid Bond
This type of guarantee is basically used in projects awarded through tenders. This guarantee is issued to
government, semi-government or private bodies in lieu a certain sum to be deposited with them as 'Earnest
Money' when they call for tenders. Tender Guarantee/Bid Bond is required as an indication of good faith that
the tendered is serious in tendering for the contract. Such a bank guarantee is given for the shortest of the
tenure and is returned back if in case the work is not allotted. The same can later be treated as Performance
Guarantee if in case the work is allotted A tender/bid bond is a commitment given by a bank to the beneficiary
to ensure that the principal party to whom a contract is awarded will accept the contract awarded. Failure of
the principal party to take up the contract will result in delay and financial losses to the awarding party
(beneficiary of the bank guarantee) and a claim for compensation may be made on the bank under the bid
bond. The amount of the guarantee is usually the amount of earnest money required, that
ranges from 5% to 10% of the value of the contract.
Performance Bond
It is issued on behalf of the principal in favor of the beneficiary. The contract requires the beneficiary to
provide the principal with a deposit for a nominal sum of the contract value in lieu of which a performance
bond guarantee is provided by the bank. This will act as an assurance that the principal will fulfill his obligation.
This type of guarantee gives the assurance that the principal party will perform and complete its obligations
in compliance with the terms of the contract awarded. The performance bond remains valid until the
performance of the contract has been completed. The bank commits to compensate the beneficiary in the
event of default, non-performance, non-completion, or completion of the contract. The amount of the
guarantee depends on the nature of the contract and the parties concerned.
Advance Payment Guarantee

This type of guarantee arises when the purchaser makes an advance payment to the seller before the goods
are received. In turn, the seller obtains an advance payment guarantee from the bank to assure the buyer of
the supply of the goods. The Bank issues this type of guarantee to government bodies that have granted the
contract to the customer (the contractor) or the principal. Advance Payment Guarantee allows the
governments to give advance payment to the contractor in order to our government projects according to the
terms and conditions of the contract. The advance is normally a certain percentage of the contract sum and
is usually used for cash flow purposes. The bank guarantees to refund the payment to the buyer in the event
the seller/supplier/contractor defaults in the performance of the contract.
Credit Supply Guarantee

This guarantee is issued in favor of a bank that extends credit facility to the customer. This type of guarantee
is issued by one bank favoring another bank to support a credit line extended by the letter to a customer. The
guaranteeing bank commits to make the repayment (which includes interest, if specified) in the event the
borrower fails to adhere to the terms and conditions of the credit facilities granted by the guaranteed bank. A
foreign bank lends to the subsidiary if such borrowings are supported by a guarantee from a bank. This
situation usually arises if the subsidiary is not well known to the bank or if the subsidiary does not have
sufficient collateral to secure its borrowings. This kind of guarantee provided by one bank to another is also
known as counter guarantees.
Custom Bond
This type of guarantee is only issued to the Custom Department. A custom bond is commonly issued to
facilitate the import/export of certain items. A forwarding agent is required to furnish to the Custom
Department a custom bond to guarantee its activities. The bonds are used to secure clearance of goods
pending the authorization of the tax exempt status.

Retention Money Guarantee
After execution of the work, the employer usually retains back a certain percentage of the value of total work
executed as security for quality of the work performed. This may vary from contract to contract but is usually
in range of 5-10% of the contract value. The contractor can get this money released by way of providing a
bank guarantee for equivalent amounts to the employer or the beneficiary. This guarantee or the principal is
known as Retention money Guarantee. Duration of the guarantee depends on the underlying contract terms
and may extend for a period after completion of the contract.
Documents Required for Bank Guarantees

 Application of the client specifying purpose of the guarantee.
 The contract paper signed by the client and the beneficiary stating the different terms and conditions.
 All supporting documents (details of tender, contract agreement etc.)
 Letter of indemnity duly endorsed by the customer.
 Margin deposit, fixed deposit (pledged if any)
 Renewed and updated firm registration and tax certificate, in cases where the applicant is a firm.

Advantages of Bank Guarantee
Reduction of Financial Risk: The need for bank guarantees arose because of the increased defaults by
the buyers. Sellers were not willing to supply goods to unknown buyers without having payments received.
A sense of mistrust was present. Bank guarantees solved this issue by acting as an assurer to the seller, i.e.
the beneficiary in our case. The sellers, after obtaining bank guarantees, are ready to supply goods. It brought
down their financial risk to a substantially low level.
Increased Opportunities: By having bank guarantees with itself, a business can grasp opportunities in the
market which were earlier not available to it. A public perception would be developed that a bank stands with
a particular business. Having a bank as a partner is always a sign of the inherent strength and faith towards
the business.
Small Fees: The fees charged by the banks are also very nominal. It ranges from about 0.5% – 1% of the
amount guaranteed by the bank. Due to its nominal nature, the fees do not have a significant impact on the
profits of the business.
No Need for Advance Payments: Advance payments to the sellers have become a thing of the past. It
means that the buyer can defer his cash outflow to a later date. By deferring payments, the available funds
can be utilized currently to fuel extra growth.
Increased Credibility: Banks exercise extensive credit monitoring. They have specialized staff and tools
which can accurately assess the financial health of a business. Hence, the credibility of the entity enhances
as it is backed by the banks. The banker’s trust would reflect that the performance of the business is great
and that there is no risk of default.
Less Documentation: In bank guarantees, lesser documentation is required. Only the information about the
concerned parties, the details about the transaction about which guarantee is sought, financials of the
applicant are generally demanded by the banks. The level and extent of documentation may change
depending on the lender’s policy and period of credit.
Financing Export and Imports

The world's economy is connected through global trade accords like the North American Free Trade
Agreement, the Transatlantic Trade and Investment Partnership and the litany of other agreements with
foreign countries. Growth is made possible through the open exchange of international commerce, taking full
advantage of human ingenuity to benefit societies.
While the cooperation of governments has allowed for access in the near and far reaches of the globe,
actually tapping into these international markets requires importing and exporting services. Commercial ports
are hotbeds of activity, with the busiest in California, Texas and South Carolina.
But frenetic ports would be veritable ghost towns without the financing to get equipment, products, supplies
and raw materials from here to there.
That's where import and export financing comes into play. This quick guide will give you a breakdown of
everything you need to know about import and export financing and why Comerica Bank can be your trade
financing facilitator.

What are import and export trade financing?
Import and export financing, as their titles imply, pay for the accompanying expenses associated with
receiving and shipping goods to and from companies in other parts of the world. From tariffs to freight rates,
duties and fees, capital requirements run the gamut. Import and export financing provide the funding
advances so the exchanging of goods can transpire.
How does it work?
There are at least three parties involved in the trade flow process: the customer receiving the goods
(importer); the company selling (exporter); and the lending institution that's financing the operation. Once a
sales agreement is reached between the two parties that are buying and selling, the financial institution
makes the funds available for the transaction to proceed. Where the funds go - and how they're delivered -
depends upon the nature of the loan. For export financing, where the exporter's bank is involved, the lender
sends the appropriate funds to use as a deferred payment. For import financing, it's the importer's bank that
pays the exporter, and the importer repays the lending institution the principal amount plus interest.
Countries may not always have the same monetary system, so the lender ensures that the funds align with
the local currency.
Import and export financing fund the transaction itself, but financing can also be made available before it
transpires. With pre-import financing, the lender provides the importer with a working capital loan, and
approval is based on the borrower's credit history. With pre-export financing, it's the seller that's seeking an
advance, so it can produce goods to sell, although the money may be used for other purposes, such as the
transportation of goods and warehousing. Approval of the loan is measured both on credit history and a solid
track record of buyers.
Financing Imports:
 Import Financing Method #1: Advance Payment
Also known as cash in advance, this is not strictly considered a method of import financing. Here,
the importer simply pays the exporter in advance for the goods. The upside of this method is that it
is simple and straightforward. The downside is that the importer assumes all the risk (what happens
if the goods are not up to standard?) and consumes a lot of the seller’s working capital, which can
prevent the business from scaling and even lead to cashflow problems.
In some parts of the world exporters usually demand advance payment. In China, for example, the
standard procedure is a 30% upfront deposit and the remaining 70% to be paid before shipment—

essentially a 100% advance payment. These sorts of requirements thus create the need for the other
methods of import financing below.
 Import Financing Method #2: Letters of Credit (LCs)
LCs are one of the most prevalent trade finance instruments. An LC is a legally binding, irrevocable
commitment from a financial institution, made on behalf of the importer, guaranteeing payment for
the goods so long as certain terms are met. In this way, the exporter is now assuming the credit risk
of the bank, instead of the importer.
The pros of using LCs are that they are widely accepted and highly customizable. Although
straightforward import/export transactions need no more than the ‘basic’ LC, the terms of LCs can
be varied to suit a range of transaction types. The importer can also build in safeguards in the LC,
such as stipulations on quality, delivery etc. as conditions for payment.
The cons are that they are expensive and difficult to obtain—especially for smaller import businesses
who do not have collateral to pledge—as the bank now must assume the credit risk of the importer.
Further, whatever safeguards the importer can build into the LC are solely based on documentation,
rather than actual physical inspection of the goods.
Finally, issuing LCs can also be an extremely cumbersome and time-consuming process—this is a
common complaint we have received from our clients.
 Import Financing Method #3: Cash Against Documents (CAD)
CAD is essentially another form of advance payment, whereby the importer must still pay for the
goods before receiving them. In CAD financing, a third party—such as a bank—will hold the shipping
and title documents, only releasing the goods to the importer upon full payment. An analogy would
be that of an escrow account. The advantage of this method to the importer is that it helps eliminate
some of the risk. It is also easy to implement and far cheaper compared to LCs (since the bank does
not take on the credit risk of the importer). The disadvantage is that it doesn’t do much to alleviate
the strain on the seller’s working capital. The importer must still pay for the goods before getting the
chance to sell them.

 Import Financing Method #4: Business Loans
A more straightforward method of import financing is a simple business loan. It’s obvious how it
works, so there’s not much to elaborate on in that area. The advantages are also apparent, as once
the loan is disbursed, the importer can immediately pay the exporter. And depending on the tenure
of the loan, there should be enough time to sell the goods before repayment.
The disadvantages of this method are similar to LCs—they are expensive and hard to obtain,
particularly if you are a smaller importer, such as an ecommerce or Amazon FBA business. Failure
to service these loans will also negatively impact your credit score.
And while there are specific financing options for such businesses, e.g. Amazon seller funding or
FBA loans, those can be difficult to qualify for. They also sometimes take repayments from your daily
sales, affecting your cashflow.
 Import Financing Method #5: Transigo’s Proprietary Solution
Recognizing the drawbacks of the above methods, Transigo’s proprietary solution was created to
give smaller import businesses all the advantages with none of the drawbacks. Our specialty is
providing ecommerce and Amazon FBA businesses with ecommerce funding and ecommerce seller
financing.
You only do a single repayment 60 to 120 days after you accept the goods, giving you ample time to
stock and sell them. We don’t collateralize your goods (nor do we deduct anything from your daily
sales) and charge reasonable interest rates. On top of all that, our financing solution has zero effect
on your credit score.
Export Finance
Though banks are providing different types of loans to customers, export finance is a kind of advance
by which not only the customer is benefited but also the country itself as it brings valuable foreign
exchange earnings. Hence, government has given more importance to export finance and has
simplified various procedures involved in obtaining finance. Reserve Bank of India has also given
instructions to commercial banks that they should give top priority in the sanctioning of export finance.

 Pre-shipment export finance: The exporter is provided finance even for the purchase of raw
materials and processing them into finished products but this finance can be provided only when the
exporter has firm order from the importer and the importer has also given an anticipatory Letter of
Credit from his bank. So, against the export order received from the importer, the exporter is given
finance by his bank which is called pre-shipment export finance.
 Post shipment export finance: After dispatching the goods to the importer, the exporter draws a
bill, against which the importer will make payment. But this may take a minimum period of 3 to 6
months and this time gap will affect the exporter in his continuation of production. For this purpose
after exporting, the export bill will be presented by the exporter to his bank. The bank will prefer to
purchase the bill or collect the bill or even discount the bill, which depend on the economic status of
the importing country.
Examples for Post shipment export finance

For example 1, if the export is made to USA against the Letter of Credit of the importer, the exporter’s
bank will purchase the bill and pay the full value to the exporter. Here, the bank gains as the value
of currency is bound to go up since it belongs to a developed country. The entire risk of the bill is
borne by the bank.
For example 2, if the export is made to Egypt or Philippines, the bill will be discounted for 60 or 70%
of the value as they both belong to developing countries. If the export is made to countries in Africa,
such as Namibia, Rwanda, Somalia, etc., the bill will be collected and paid to the exporter after 3 or
6 months, since the importing country happens to be a poor country.
 Export finance against collection of bills: When export is made to different countries, loan can be
obtained from the bank against the bills sent for collection. As there are institutions such as Export
Credit Guarantee Corporation, banks will come forward to provide finance to exporters. In case of a
default, the guaranteeing company will indemnify at least 80% of defaulted amount. While financing
against the export bills, the banker will take into account the FOB invoice and not CIF invoice (FOB
— Free on Board invoice — Price includes all expenses incurred until the goods are kept on board
the ship. CIF invoice includes costs, insurance and freight and so this type of an invoice will not be
taken by the banker for financing).
 Deferred export finance:

To enable the importer to purchase valuable goods, hire purchase financing or lease finance may be
arranged. There are two types of deferred export finance.
 Supplier’s finance; and
 Buyer’s finance.

Supplier’s finance in exporting: In the supplier’s finance, exporter’s bank will finance the exporter so that
he will sell the goods on installment basis to the importer. The exporter will receive the full value and the
payment made in installments by the importer will be received by the exporter’s bank.
Buyer’s Finance in exporting: In buyer’s finance, the buyer is given credit under line of credit by the
exporter’s bank and the exporter will be made to export.
Export finance against allowances and subsidies:

Exporters are given subsidies by the government so that they can sell the goods on reduced price to importer.
For example, cash compensatory support is a subsidy given to the exporter by the government whenever
there is an increase in expenditure, due to reasons beyond the control of the exporter, such as increase in
transport cost or wage of the laborers.
There are also allowances given for increasing exports. Example for this is duty drawback. Here, when a
product is imported duty is paid. After processing, it is exported at a higher value. The duty paid at the time
of import is refunded which is called duty drawback. Gold is imported and duty is paid. It is converted into
jewel and exported at a higher value and the import duty is refunded. It may take some time to receive the
refund but the bank will finance against the refund of duty.
When the exporter is faced with a sudden increase in expenditure due to reasons beyond his control, the
government comes forward to provide cash compensatory support which is a percentage of costs of his
finished product. Example: Deviation in the shipping route due to war.

Unit II: Banking Products and Services (Credit Facility)

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Unit II: Banking Products and Services

UJJWAL MARAHATTA | PRESIDENCY COLLEGE 1

For simplicity in learning, it can be classified as;

UJJWAL MARAHATTA | PRESIDENCY COLLEGE 2

UJJWAL MARAHATTA | PRESIDENCY COLLEGE 3

1. Principle of Safety and Security:

UJJWAL MARAHATTA | PRESIDENCY COLLEGE 4

UJJWAL MARAHATTA | PRESIDENCY COLLEGE 5

UJJWAL MARAHATTA | PRESIDENCY COLLEGE 6

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Major Credit Documents

5. Other legal documents (before disbursement executing at FI)

 Approved Credit Appraisal (Memo) / Approved Credit Facility

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Credit Recovery and Restructuring

Primary and Secondary Collateral Securities

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Credit Facility Type Primary Collateral

Features of Primary Collaterals:

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Secondary Collateral Security

Features of Secondary Collateral Security:

Modes of Creating Charge over Collateral Securities:

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Pledge is a kind of bailment having the following essential elements:

Some of the important characteristics of a charge by hypothecation are given below:

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Difference between Mortgage and Pledge

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Credit Card Issue Process

How do you apply for a credit card?

What are the documents needed to apply for a credit card?

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Credit Score Check

The Final check

Time taken for the approval

Consortium & Syndication

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Micro Finance in Nepal

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How Microfinancing Works

The term microfinance encompasses microloans, micro-savings, and microinsurance. Microfinance

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Who Benefits from Microfinancing?

Does It Actually Work?

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Documentary Credit (Bank Guarantee & Letter of Credit)

Letter of Credit (LC)

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Documents That May Be Requested for Presentation

 Financial documents — bill of exchange, co-accepted draft

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Need for a Bank Guarantee

Customers need bank guarantee;