Non Fund Based Business State Bank Staff CollegeHyderabadIndia

Letters of CreditFacilitates trade domestic & internationalHelps in reducing working capital requirement for buyerHelps seller to get immediate payment though credit is extended by himBank intermediates and lend its creditworthiness for which it charges the applicantTransactions are guided by UCPDC

Letter of Credit An arrangement by means of which a bank (issuing bank) acting at the request of a customer (applicant) undertakes to pay to a third party (beneficiary) a predetermined amount by a given date according to agreed stipulations and against presentation of stipulated documents

Parties to a Letter of CreditApplicant (Buyer)Issuing Bank (opening bank)Beneficiary (Seller)Advising BankConfirming BankNegotiating Bank (Paying Bank)Reimbursing Bank

Negotiating BankIMPORTEREXPORTERCONTRACTOPENINGBANKISSUE CREDITNEGOTIATINGBANKADVISINGBANKPAYDOCSNegotiating bank pays beneficiary first and claims reimbursement from the opening / confirming bank.

Mechanics of Documentary CreditIMPORTEREXPORTERCONTRACTOPENINGBANKADVISING/NEGOTIATINGBANKSHIPPINGCOMPANYGOODSDOCSGOODSDOCS

Types of LCsSecurity wise RevocableIrrevocableConfirmedPayment wisePayment / deferred payment / instalmentAcceptanceNegotiation

Types of LCsWith advance paymentRed ClauseGreen ClauseInvolving MiddlemenTransferableBack to BackOthersRevolvingStandby

Opening of LCTrade Control requirementsExchange Control requirementsCredit norms of Central Bank UCPDC ProvisionsBanks Internal Credit Policies / procedures

Appraisal / AssessmentMeans & standing of applicantApplication details authorised personPurpose, sources of payment, relationship with turnoverAssessment details & maximum expected outstandingsNature of goods marketablility, Seasonality, susceptibility to price changesImport DutyCurrency riskCrystallisation

Exercise on AssessmentAnnual Cost of Raw materials purchased under LCs Rs. 1903.85 croreImported - Rs.504.73 crore Indigenous Rs.1399.12 croreAverage usance period for Imports 30 days from shipmentLead time 3 months

Local Purchases Lead time 1mthUsance for local purchase 1 monthLocal purchase without LCs Rs.650 crore

Exercise on AssessmentMonthly purchase of imported RM = 42.06 (D)Avg usance period for imports = 1 month (E)Lead time = 3 months (F)

Total of E & F = 4 months (G)Required LC limit for imported RM = DxG= Rs.168.24 crore (L)

Exercise on AssessmentMonthly purchase of indigenous RM = Rs.116.59 crore (H)Avg usance period for local purchases = 1 month (I) Local Purchases Lead time 1mth (J)Total of (I) + (J) = 2 months (K)LC limit required for indigenous RM = (H) x (K) = Rs. 233.19 crore (M)

Exercise on AssessmentTotal LC limit required = L+M = Rs. 401.43 crore say Rs.400 crore.

Treatment of stocks covered by Usance LC Lien should be earmarked against advance value of stocks for the outstanding usance LC bills This ensures provision of margins on the stocks covered by usance LCs right from the time the stocks are bought on credit backed by the Banks commitment. Thus, it ensures that the margin is available well before the CC a/c is debited for the matured LC bill. In some cases it is quite possible that the units may not be in a position to provide margins right from the time of purchases against LCs. In such cases, based on merits, earmarking of lien for the value of usance LC bills outstanding against the aggregate market value of all the securities (including the LC stocks) may be permitted instead of against the advance value of securities.

Devolvement of LC (Precautions)The limits for demand LCs and usance LCs should be assessed separately with ample justifications. The usance period should not, generally, exceed the production cycle. In case of bulk imports, establishment of LCs for longer usance period may be considered selectively.When liability under LC is met by creating an irregularity in the Cash Credit account, the relative LC limit should not be released for opening further LCs till the account is adjusted. In other words, the liability should not be marked off in LC liability register merely because of retirement of documents. The relative liability should be marked off only after the account is regularised. In case of devolvement, if the irregularity in the account is not adjusted within 15 days, or if the LC devolved earlier is not adjusted, no further LCs should be opened without adequate margin.

Scrutiny Level of sundry creditors in the accepted projections in case of Usance LCsCompare with operating cycleMargins & security depending on track recordCash budget monitoring to track availability of fundsIrregularity to be rectified before fresh LCs are openedContinuous devolvement is a warning signal

Purchase of Bills Drawn Under LCsSales through LCs will be the basis for assessment of limitsOnly First class banks & Correspondents LCsPowers only for bills without discrepancyBills on sister concerns - actual movement of goods to be verifiedNot part of ABF For bills with discrepancy, indemnity is to be obtained.

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Bank Guarantee Guarantee is A contract to perform the promise or discharge the liability of a third person in case of his default The contract of guarantee is distinctly different from the contract of indemnity. Indemnity is

A contract by which one party promises to save the other from loss suffered by him by the conduct of the promissor himself or by the conduct of any other person

Bank GuaranteeParties to the Contract of Guarantee

Applicant : The principal debtor person at whose request the guarantee is executedBeneficiary : Person to whom the guarantee is given and who can enforce it in case of default.Guarantor : The person who undertakes to discharge the obligations of the applicant in case of his default.Thus, the guarantee is a collateral contract, consequential to a main contract between the applicant and the beneficiary.

Bank GuaranteeParties to the Contract of Indemnity

Indemnifier : person who promises to make good the loss

Indemnified : Whose loss is to be made good

Necessity for Bank GuaranteeIn lieu of security deposit / earnest money deposits for participating in tenders;Mobilisation advance/advance money before commencement of the project by the contractor and for money to be received in various stages like plant layout, design/drawings in project finance;In respect of raw material supplies or for advances by the buyers;In respect of due performance of specific contracts by the borrowers and for obtaining full payment of the billsPerformance guarantee for warranty period on completion of contract which would enable the supplier to realise the proceeds without waiting for warranty period to be over;To allow units to draw funds from time to time from the concerned indentors against part execution of contracts, etc.

Appraisal of Bank GuaranteeThe following aspects must be examined :

Purpose for genuine business requirements ?Need for BG Related to normal trade / business ?Nature of Bank Guarantee Financial / Performance ?Amount of BG needs to be specificApplicants financial strength / capacityPast record in respect of BGs issued earlier Present outstanding on account of BGs already issuedMarginCollateral Security Offered

Format for BGNormally, BG should be issued on standardised format only.If some other format is required to be used for issue of BG, it should be ensured that the BG is :a]for a definite period,b)for a definite objective enforceable on the happening of a definite event,c)for a specific amount,d)in respect of bonafide trade/commercial transactions,e)not stipulating any onerous clause, and f)not containing any clause for automatic renewal of the BG on its expiry.

Limitation ClauseNothwithstanding anything contained herein:

a)our liability under this Bank Guarantee shall not exceed Rs.___________ (Rupees __________________only);

b)this Bank Guarantee shall be valid upto __________________; andc)we are liable to pay the guaranteed amount or any part thereof under this Bank Guarantee only and only if you serve upon us a written claim or demand on or before ___________________________ (date of expiry of Guarantee).

Invocation of BGImportant pointsThe Banks liability under BG is absolute and independent and exclusive of any other contract entered into by the applicant and beneficiary. It is, therefore, obligatory on the part of the Bank to pay to the beneficiary without delay and demur the amount of BG on its invocation in accordance with the terms and conditions of the guarantee deeds. It is not necessary for the beneficiary to satisfy the Bank, about the default or the amount of actual loss suffered by him.

Types of Bank GuaranteeFinancial - Guarantees customers credit worthinessAdvance paymentRetention moneySecurity depositPerformance Guarantees obligations relating to capacity of customer to executeBid-bond, performance bondsInland , Foreign - export & import

PrecautionsShould not be open endedShould stipulate maximum liability crystallisedShould not contain onerous clausesEnsure customers ability to reimburseOther bank customer - ask why?Performance guarantee assess capacity of customer, means to carry out contract, experienceGuarantee liability to have reasonable relation to equity of borrowerCounter guarantee by authorised person

(BASED ON THE ESTIMATES AS ON 31.03.08)i.Total Purchase of raw material during 2007-08 =1200 lacsii. Monthly Purchase of RM under LC = 100 lacsiii. Av LC usance period required =60 Daysiv.Lead time & Transit =30 Daysv.Total time for which credit under LC is required (iii+iv)90 Days vi.LC limit required [(ii) (v) 365] =2.465 lacsvii.LC limit recommended =2.50 lacs