WHAT ARE TYPES OF CREDIT FACILITIES ?

Credit facilities are essential for economic growth of a country. Banks grant various types of credit facilities to customers as per their requirements. Credit facilities can be broadly classified in Fund Facility and Non-fund facility.

FUND BASED CREDIT FACILITIES

Fund based credit facilities are such facilities which involve outflow of funds from Bank to the customers. Cash Credit, Term Loan etc. are types of Fund Based Credit facility.

What is Cash Credit Facility ?

Cash Credit Facility is a facility wherein a banker allows customer to borrow money up to a certain limit. Cash credit facility has various advantages as a company/firm can draw such amount as per its requirement. A company/firm generally avails Cash Credit facility for working capital requirement.

What is Term Loan ?

Term Loan Facility is such credit based facility which is granted in lump sum and are repaid over a period in installments. Such loans are generally granted for capital expenditure. Term loan can be short term loan, medium term loan or long term loan. Generally short term loan is payable over a period of  one year, medium term loan is payable over a period of  seven years and long term loan is repayable over a period more than seven years.

NON-FUND BASED FACILITIES

Non fund based facilities are such facilities wherein there is no immediate outflow of funds. The Banker undertakes to take risk on happening of a contingency. Bank Guarantee, Letter of Credit etc.  are non-fund facilities.

What  is Bank Guarantee ?

Under a Bank Guarantee the Bank undertakes to discharge liability of a borrower to third parties. Banks issue Bank Guarantees against certain securities. Bank guarantee can be in nature of Financial Bank Guarantee, Performance Bank Guarantee, Deferred Payment Guarantee etc. Financial Guarantee are generally issued on behalf of Contractors dealing with Government Departments. Such guarantees are also issued in place of earnest money.  In case of performance guarantee, Bank has to pay compensation for delay in performance or non-performance of a contract. Deferred Payment Guarantee are issued by Banks in case of goods or machinery are purchased by a customer on long term credit which have to be paid in installments. If the customer fails in payment of installments, the Bank has to make the payment.

Contract of guarantee is independent of underlying contract. A banker is dutybound to honor the bank guarantee in case of its invocation.

What is Letter of Credit facility ?

Letter of credit is such facility wherein the Banker undertakes to pay on presentation of documents as specified in the Letter of Credit. Letter of credit is generally issued in export business. Various parties are involved in issuance of Letter of Credit. An importer generally applies for Letter of Credit in favour of an exporter. Issuing Bank opens letter of credit on the request of the Importer. An Advising Bank in the exporting country forwards the Letter of Credit to the exporter. Negotiating Bank makes the payment and accepts the documents. Reimbursing Bank makes payment to the negotiating bank.

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