The Non-Fund based Credit Facilities are nature of promises made by Banks in favour of a third party to provide monetary compensation on behalf of their clients, where the lending bank does not commit any physical outflow of funds. The funds position of the lending bank remains intact. It is majorly done in three forms namely Bank Guarantee, Letter of Credit and Co-acceptance of bills.

Bank Guarantee
A Bank Guarantee (BG) is a contract to perform or discharge the liability of a third person in case of default. Thus, there are three parties involved in a contract of guarantee i.e.
(i) Applicant – the client on whose behalf the guarantee is being issued
(ii) Beneficiary – to whom the guarantee is issued and
(iii) Guarantor – the issuing bank

This facility enables the customer to acquire goods and expand business activity. This is usually seen when a smaller company is dealing with a much larger entity or a government across border.

For example, Company A and Company B are two companies unknown to each other in which Company A wants to purchase material from Company B. Since Company B does not know Company A and needs assurance for the payment of the purchase of the goods, Company B asks Company A to provide a financial guarantee from a third party, essentially the Bank wherein Company A holds its ash accounts. Bank of Company A opens the Bank Guarantee in favour of Company B. Basically, in this scenario, the Bank undertakes the responsibility to make the payment to Company B, if Company A fails to make payments. In this way, interests of Company B are protected as it is assured to get the payment either from Company A or from its Bank. As such, it becomes a non-fund based lending for the Bank as it does not commit any outflow of funds.

Additionally, Enterprises participating in tenders, auctions, etc are generally required to submit Bank Guarantee for a minimum specified amount as a Security Deposit.

There are different types of Bank Guarantees issued on basis of either the Nature or the Purpose.
BG on basis of Nature:
– Financial Guarantee – Performance Guarantee
– Credit conversion
BG on basis of Purpose:
– Bid Bonds
– Advance Payment Guarantee
– Retention Money Guarantee
– Maintenance bond
– Deferred Payment Guarantee

Letter of Credit
Another important segment of the non-fund based credit facilities for commercial banks is Letter of Credit (LC). LC is a facility that initiates trade between two parties, whether at domestic or international level.

A Letter of Credit or a Documentary Credit is an undertaking issued by a Bank, on behalf of the Buyer to the Seller to pay for the goods and services, provided that the seller presents documents which comply with the terms and conditions stipulated in Letter of Credit. Transaction in letter of credit may involve several parties at different stages such as:
(i) Applicant
(ii) Beneficiary
(iii) Issuing opening bank
(iv) Advising bank
(v) Confirming Bank
(vi) Nominated Bank
(vii) Reimbursing Bank

As a rule, documentary credit limits are sanctioned as a part of work capital package and not in isolation. This is because the Issuing Bank must ensure the availability of funds at the time of retirement of bills drawn under LC, which is possible when the working capital requirements and liquidity position of the customer have been properly assessed.

Co-acceptance of Bills
Co-acceptance is a means of non-fund based import finance whereby a Bill of Exchange drawn by an Exporter on the Importer is co-accepted by a Bank. Once the Bill of Exchange is accepted, the Bank undertakes to make payments to the Exporter in case if the Importer fails to make the payment on due date.

The co-acceptance by the Importer’s Bank acts as a guarantee for the Exporter for timely receipt of proceeds from the Importer. For the Bank, it is a non-fund based exposure on the Importer. It is an increasingly used form of import finance offered by many Banks across the world.

This form of finance is beneficial to the customers in different ways. For an Importer, Co-acceptance is a considerably cheap option than a Letter of Credit since the commission for LC is payable from the date of opening of the LC whereas in case of the Co-acceptance, commission is payable only after the shipment of goods and the documents to tile reach the Importer’s Bank which is the Co-acceptor Bank.

In terms of RBI regulations, Co-acceptance limits should be need based and should be extended only to customers who enjoy other limits with the bank. Only genuine trade bills should be co-accepted and the Banks should ensure that the goods towards the bills that are co-accepted are actually received in stock of the Importer.