Treasury Talk & Forex Factor: Volume-3 (Fund/Non-fund based limits)

Fund-based and non-fund-based limits are two primary categories of credit facilities offered by banks and financial institutions to businesses and individuals. These limits play a crucial role in managing working capital and financing various business operations. Here’s a detailed explanation of each, including examples, features, and benefits.

Fund-Based Limits

 Fund-based limits involve the actual disbursement of funds to the borrower. These facilities directly impact the borrower's cash flow, as they provide immediate access to funds that can be used for various business purposes.

 Types of Fund-Based Limits

1. Cash Credit (CC):

    - Description: A short-term financing facility that allows businesses to borrow against their inventory and receivables.

   - Usage: Primarily used for working capital needs like purchasing raw materials, managing operational expenses, and bridging the gap between sales realization and inventory costs.

   - Features:

     - Revolving Limit: Businesses can borrow, repay, and borrow again up to the sanctioned limit.

     - Interest: Charged on the amount utilized, not on the entire limit.

     - Collateral: Typically secured against stock, receivables, or other assets.

   - Example: A manufacturing company uses a cash credit facility of INR 1 crore to purchase raw materials, and as it sells products, it repays the amount, making it available for future use.

2. Overdraft (OD):

    - Description: Similar to cash credit, an overdraft allows account holders to withdraw more money than what is available in their bank account up to a specified limit.

   - Usage: Used for short-term liquidity needs and cash flow management.

   - Features:

     - Revolving Credit: Can be reused as repayments are made.

     - Interest: Charged only on the overdrawn amount.

     - Collateral: May require collateral, often a fixed deposit or other assets.

   - Example: A business with an overdraft limit of INR 50 lakh uses the facility to cover payroll expenses during a lean sales month and repays it when revenue improves.

3. Working Capital Demand Loan (WCDL):

    - Description: Short-term loans aimed at meeting working capital requirements, usually offered for a tenure of 3 to 12 months.

   - Usage: Used for managing daily business operations and expenses.

   - Features:

     - Fixed Amount: Unlike revolving credit, it is a one-time loan disbursement.

     - Interest: Charged on the entire loan amount.

     - Repayment: Typically in installments or as a lump sum at maturity.

   - Example: A retailer takes a WCDL of INR 20 lakh to stock up on inventory ahead of a festive season and repays it from sales proceeds.

4. Term Loans:

    - Description: Long-term loans used for acquiring fixed assets, capital expenditure, or business expansion.

   - Usage: Suitable for purchasing equipment, infrastructure development, and large capital investments.

   - Features:

     - Fixed Tenure: Loan tenure ranges from 1 to 10 years or more.

     - Interest: Fixed or variable interest rates based on the agreement.

     - Repayment: Regular installments over the loan period.

   - Example: A construction company secures a term loan of INR 5 crore to purchase new machinery for a major project, repaid over 7 years.

5. Bill Discounting:

    - Description: The bank purchases trade bills (invoices) at a discounted rate before their maturity date, providing immediate funds to the seller.

   - Usage: Used to finance sales transactions by converting trade receivables into cash.

   - Features:

     - Immediate Cash Flow: Converts sales invoices into instant cash.

     - Discount Rate: The bank charges a discount fee on the invoice amount.

     - Recourse or Non-Recourse: May involve recourse to the seller in case of default by the buyer.

   - Example: An exporter receives immediate payment for an invoice of INR 10 lakh by discounting it with the bank at an 8% annual interest rate.

6. Packing Credit (PC):

    - Description: A pre-shipment credit facility offered to exporters for financing the purchase of raw materials, processing, and packing of goods meant for export.

   - Usage: Provides working capital for preparing goods for shipment.

   - Features:

     - Short-Term Credit: Typically available for 180 days, extendable as needed.

     - Interest: Often lower rates due to export promotion incentives.

     - Collateral: Usually secured against export orders or letters of credit.

   - Example: An exporter uses packing credit to finance the production of garments for a foreign buyer, repaid from the export proceeds.

7. Export Credit in Foreign Currency (ECFC):

    - Description: Pre-shipment and post-shipment credit facilities provided in foreign currency to exporters.

   - Usage: Mitigates foreign exchange risk and provides access to foreign currency at competitive rates.

   - Features:

     - Currency Denomination: Available in major currencies like USD, EUR, etc.

     - Interest Rates: Often lower due to international lending rates.

     - Repayment: Aligned with export proceeds realization.

   - Example: An exporter avails of ECFC in USD to finance raw material purchases for an international order, repaid from the export payments received in USD.

Benefits of Fund-Based Limits

 - Immediate Access to Funds: Provides liquidity for daily operations and capital needs.

- Flexible Usage: Allows businesses to manage cash flow efficiently.

- Interest Cost Efficiency: Interest is charged only on the utilized portion, offering cost savings.

- Tailored Solutions: Can be customized to meet specific business requirements and objectives.

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 Non-Fund-Based Limits

 Non-fund-based limits do not involve the direct disbursement of cash but rather provide guarantees or assurances on behalf of the borrower. These facilities help manage risk and facilitate trade transactions.

 Types of Non-Fund-Based Limits

1. Letter of Credit (LC):

    - Description: A bank guarantee provided on behalf of an importer to ensure payment to the exporter upon fulfillment of specified terms and conditions.

   - Usage: Commonly used in international trade to mitigate payment risk for exporters.

   - Features:

     - Types: Can be revocable or irrevocable, sight or usance, and confirmed or unconfirmed.

     - Collateral: May require collateral or margin money.

     - Coverage: Ensures payment upon presentation of compliant documents.

   - Example: An Indian importer opens an LC for USD 100,000 in favor of a Chinese supplier, ensuring payment upon delivery of goods as per the contract.

2. Bank Guarantee (BG):

    - Description: A promise by the bank to cover a loss if the borrower defaults on a financial obligation. It is commonly used in business transactions and contracts.

   - Usage: Used in project bidding, contract performance, and financial guarantees.

   - Features:

     - Types: Performance guarantees, financial guarantees, advance payment guarantees, etc.

     - Collateral: Often requires collateral or a margin.

     - Validity: Typically has a defined expiry date.

   - Example: A construction company obtains a performance bank guarantee for INR 5 crore to assure a client of project completion as per the contract terms.

3. Deferred Payment Guarantee:

    - Description: A guarantee that covers installment payments over a period, commonly used in machinery and equipment purchases.

   - Usage: Facilitates purchase transactions with deferred payment terms.

   - Features:

     - Installment Coverage: Ensures payment to the seller over the agreed schedule.

     - Collateral: May require collateral or other security arrangements.

   - Example: A manufacturing company acquires machinery with deferred payment terms and obtains a bank guarantee to assure the supplier of installment payments.

4. Standby Letter of Credit (SBLC):

    - Description: Similar to a bank guarantee, an SBLC serves as a safety net, ensuring payment if the borrower fails to fulfill the contractual obligation.

   - Usage: Used in international trade and as a security for loans and contracts.

   - Features:

     - On-Demand Payment: Provides assurance of payment on demand if the underlying obligation is not met.

     - Collateral: Requires collateral or cash margins.

     - Usage Scenarios: Can be used as a backup to traditional payment methods.

   - Example: A U.S. company obtains an SBLC for USD 200,000 to guarantee payment for a supplier in case of non-performance of a contract.

5. Advance Payment Guarantee:

    - Description: A guarantee provided to the buyer by the seller's bank, ensuring repayment of advance payments if the seller fails to deliver goods or services.

   - Usage: Used in contracts requiring upfront payments for goods or services.

   - Features:

     - Risk Mitigation: Protects the buyer's advance payments.

     - Collateral: Often backed by collateral or performance bonds.

   - Example: A buyer in the construction industry requires an advance payment guarantee before paying a supplier 30% of the contract value upfront for equipment.

 Benefits of Non-Fund-Based Limits

 - Risk Management: Provides assurance and mitigates risk in trade transactions and contracts.

- No Immediate Cash Outflow: Does not impact cash flow until obligations arise.

- Enhanced Credibility: Improves the borrower’s standing with suppliers and clients.

- Facilitates Trade: Enables smoother transactions in international and domestic trade.

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