Pre-Joining Assignment

Commercial Banking

Submitted to: Ms Bhavna Ranjan

Submitted by: Saqib Iqbal Lone MBA (Gen) B-29 A0101911142

The various trade finance options available to him in order to decide the most optimal approach to meet his trade requirements(in detail).
a)

Trade finance is more than regular lending. It refers to innovative financial products and services that assist importers and exporters to fulfill their financing needs. Trade Finance is a source of working capital for many traders in need of financing to procure process or manufacture products before sale in future. Trade finance is also important for individual traders and firms trading internationally, because it can shape competitiveness of their contract terms. Trade finance is therefore important for any country as it facilitates international trade. As international trade increases, so does the importance of trade finance.

Various trade finance options available to MR X in order to decide the most optimal approach to meet his trade requirements: Letters of Credit Bank Guarantees Pre and Post shipment finance loan facilities Buyers and Sellers credit Structured Finance Leasing Factoring and Forfaiting Countertrade

Letter of credit:
A Letter of Credit is a written undertaking by the Importers bank, known as the Issuing Bank, on behalf of its customer, the Importer (Applicant), promising to effect payment in favor of the Exporter (Beneficiary) up to a stated sum of money, within a prescribed time limit and against stipulated documents. A key principle underlying Letters of Credit is that banks deal only in documents and not in goods. The decision to pay under a Letter of Credit will be based entirely on whether the documents presented to the bank appear on their face to be in accordance with the terms and conditions of the Letter of Credit. It would be prohibitive for the banks to physically check whether all merchandise has been shipped exactly as per each letter of Credit.

The documentary credit---letter of credit, documentary letter of credit, or commercial letter of credit--- is an arrangement whereby the applicant (the importer) requests and instructs the issuing bank (the importer's bank) or the issuing bank acting on its own behalf Pays the beneficiary (the exporter) or accepts and pays the draft (bill of exchange) drawn by the beneficiary, or authorizes the advising bank or the nominated bank to pay the beneficiary or to accept and pay the draft drawn by the beneficiary, or authorizes the advising bank or the nominated bank to negotiate

Types of Letter Of Credit : Irrevocable versus Revocable Letters of Credit

Irrevocable Letter of Credit An irrevocable letter of credit cannot be amended or cancelled without the consent of the issuing bank, the confirming bank, if any, and the beneficiary. The payment is guaranteed by the bank if the credit terms and conditions are fully met by the beneficiary. The words "irrevocable documentary credit" or "irrevocable credit" may be indicated in the L/C. In some cases, an irrevocable L/C received by the beneficiary may become invalid without the amendment or cancellation of such L/C, for example, when the trade between importing and exporting countries is suspended such as in a trade sanction, or when the issuing bank has ceased operation. There have been cases of an irrevocable L/C being amended without the consent of the beneficiary in the OEM arrangements. The beneficiaries affected were export-manufacturers from a developing country. The importers were able to convince and instruct the issuing bank to amend the latest date for shipment in the L/C, changing to a date earlier than the agreed upon date, at which time the beneficiary would not be able to ship the OEM products. The importers used sneaky tactics that aimed to cause the beneficiaries to default in the delivery. The intention of the importers was to cancel the orders from the existing OEM suppliers and buy from other suppliers in another developing country where the prices had become lower. In the event of an amendment like the above-mentioned case, the beneficiary must give notification of rejection of amendment to the bank that advised the amendment at once.

Irrevocable and Without Recourse Letter of Credit A revocable letter of credit can be amended or cancelled by the issuing bank at any time without the consent of the beneficiary, often at the request and on the instructions of the applicant. There is no security of payment in a revocable letter of credit (L/C). The words "this credit is subject to cancellation without notice", "revocable documentary credit" or "revocable credit" usually are indicated in the L/C.

Revocable Letter of Credit : A revocable letter of credit can be amended or cancelled by the issuing bank at any time without the consent of the beneficiary, often at the request and on the instructions of the applicant. There is no security of payment in a revocable letter of credit (L/C). The words "this credit is subject to cancellation without notice", "revocable documentary credit" or "revocable credit" usually are indicated in the L/C. The revocable L/C was not uncommon in the 1970's and earlier when dealing with less developed countries. It is rarely seen these days in international trade. Confirmed Irrevocable versus Unconfirmed Irrevocable Letters of Credit : Confirmed Irrevocable Letter of Credit An irrevocable letter of credit (L/C) opened by an issuing bank whose authenticity has been confirmed by the advising bank and where the advising bank has added its confirmation to the credit is known as confirmed irrevocable letter of credit. The words "we confirm the credit and hereby undertake ..." or "we add our confirmation to this credit and hereby undertake ..." normally are included in the L/C. An exporter whose method of payment is a confirmed irrevocable L/C is assured of payment even if the importer or the issuing bank defaults. The confirmed irrevocable L/C is particularly important from buyers in a country which is economically or politically unstable. In a confirmed letter of credit, the exporter or the importer pays an extra charge called the confirmation fee, which may vary from bank to bank within a country. The fee usually is added to the exporter's account. The exporter may indicate in the sales contract that the confirmation fee and other charges outside the seller's country are on the buyer's account. Unconfirmed Irrevocable Letter of Credit An irrevocable letter of credit (L/C) opened by an issuing bank in which the advising bank does not add its confirmation to the credit is known as an unconfirmed irrevocable letter of credit. The promise to pay comes from the issuing bank only, unlike in a confirmed

irrevocable L/C where both the issuing bank and the advising bank promise to pay the beneficiary. Restricted Negotiable versus Freely Negotiable Letters of Credit :

Restricted Negotiable Letter of Credit In a restricted negotiable letter of credit, the authorization from the issuing bank to pay the beneficiary is restricted to a specific nominated bank. Freely Negotiable Letter of Credit In a freely negotiable letter of credit, the authorization from the issuing bank to pay the beneficiary is not restricted to a specific bank, any bank can be a nominated bank as long as the bank is willing to pay, to accept draft(s), to incur a deferred payment undertaking, or to negotiate the L/C. The words this credit is not restricted to any bank for negotiation or this credit may be negotiated at any bank or similar words, may be indicated on the L/C. Revolving Letter of Credit When a letter of credit (L/C) is specifically designated revolving letter of credit the amount involved when utilized is reinstated, that is, the amount becomes available again without issuing another L/C and usually under the same terms and conditions. The revolving L/C may be used in shipments of a wide range of goods to a buyer within a period of time (several months to one year usually).

BANK GUARANTEE: 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 nonperformance by the other party in a contract. For example a letter of credit could be used in the delivery of goods or the completion of a service. The seller may request that the buyer obtain a letter of credit before the transaction occurs. The buyer would purchase this letter of credit from a bank and forward it to the seller's bank. This letter would substitute the bank's credit for that of its client, ensuring correct and timely payment. 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. 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. Types of Bank Guarantee Bank provides guarantee facilities to its customers that can be divided into the following categories: Financial guarantee:- These are guarantees provided by banks to discharge financial obligations of the customers, for example a customer having some financial obligation towards the electricity board and is asked by Electricity board to get a guarantee from his bank. Performance guarantee:- These guarantees are issued by banks for due performance of a contract and do not involve a financial commitment but in case of default by the customer, the financial loss incurred by the principal creditor will have to be borne by the bank. Bid Bond:- Also known as Tender bond, the purpose of a tender bond is to prevent a company from submitting a tender, winning the contract and then declining to accept it. Tender bonds offer buyers security against dubious or unqualified bids.

Pre and Post shipment finance loan facilities Pre -Shipment Finance is issued by a financial institution when the seller wants the payment of the goods before shipment. The main objectives behind pre-shipment finance or pre export finance is to enable exporter to:

Procure raw materials. Carry out manufacturing process. Provide a secure warehouse for goods and raw materials. Process and pack the goods. Ship the goods to the buyers. Meet other financial cost of the business.

Types of Pre Shipment Finance

Packing Credit Advance against Cheques/Draft etc. representing Advance Payments.

Pre shipment finance is extended in the following forms :

Packing Credit in Indian Rupee Packing Credit in Foreign Currency (PCFC)

Requirement for Getting Packing Credit This facility is provided to an exporter who satisfies the following criteria

A ten digit importer exporter code number allotted by DGFT. Exporter should not be in the caution list of RBI. If the goods to be exported are not under OGL (Open General License), the exporter should have the required license /quota permit to export the goods.

Packing credit facility can be provided to an exporter on production of the following evidences to the bank: 1. Formal application for release the packing credit with undertaking to the effect that the exporter would be ship the goods within stipulated due date and submit the relevant shipping documents to the banks within prescribed time limit. 2. Firm order or irrevocable L/C or original cable / fax / telex message exchange between the exporter and the buyer. 3. Licence issued by DGFT if the goods to be exported fall under the restricted or canalized category. If the item falls under quota system, proper quota allotment proof needs to be submitted. The confirmed order received from the overseas buyer should reveal the information about the full name and address of the overseas buyer, description quantity and value of goods (FOB or CIF), destination port and the last date of payment.

Post Shipment Finance is a kind of loan provided by a financial institution to an exporter or seller against a shipment that has already been made. This type of export finance is granted from the date of extending the credit after shipment of the goods to the realization date of the exporter proceeds. Exporters dont wait for the importer to deposit the funds. Basic Features The features of post shipment finance are:

Purpose of Finance Postshipment finance is meant to finance export sales receivable after the date of shipment of goods to the date of realization of exports proceeds. In cases of deemed exports, it is extended to finance receivable against supplies made to designated agencies.

Basis of Finance Postshipment finances is provided against evidence of shipment of goods or supplies made to the importer or seller or any other designated agency.

Types of Finance Postshipment finance can be secured or unsecured. Since the finance is extended against evidence of export shipment and bank obtains the documents of title of goods, the finance is normally self liquidating. In that case it involves advance against undrawn balance, and is usually unsecured in nature. Further, the finance is mostly a funded advance. In few cases, such as financing of project exports, the issue of guarantee (retention money guarantees) is involved and the financing is not funded in nature.

Quantum of Finance As a quantum of finance, postshipment finance can be extended up to 100% of the invoice value of goods. In special cases, where the domestic value of the goods increases the value of the exporter order, finance for a price difference can also be extended and the price difference is covered by the government. This type of finance is not extended in case of preshipment stage. Banks can also finance undrawn balance. In such cases banks are free to stipulate margin requirements as per their usual lending norm.

Period of Finance Postshipment finance can be off short terms or long term, depending on the payment terms offered by the exporter to the overseas importer. In case of cash exports, the maximum period allowed for realization of exports proceeds is six months from the date of shipment. Concessive rate of interest is available for a highest period of 180 days, opening from the date of surrender of documents. Usually, the documents need to be submitted within 21days from the date of shipment.

Financing For Various Types of Export Buyer's Credit Postshipment finance can be provided for three types of export :

Physical exports: Finance is provided to the actual exporter or to the exporter in whose name the trade documents are transferred.

Deemed export: Finance is provided to the supplier of the goods which are supplied to the designated agencies.

Capital goods and project exports: Finance is sometimes extended in the name of overseas buyer. The disbursal of money is directly made to the domestic exporter.

Supplier's Credit Buyer's Credit is a special type of loan that a bank offers to the buyers for large scale purchasing under a contract. Once the bank approved loans to the buyer, the seller shoulders all or part of the interests incurred. Types of Post Shipment Finance The post shipment finance can be classified as : 1. Export Bills purchased/discounted. 2. Export Bills negotiated 3. Advance against export bills sent on collection basis. 4. Advance against export on consignment basis 5. Advance against undrawn balance on exports 6. Advance against claims of Duty Drawback. 1. Export Bills Purchased/ Discounted.(DP & DA Bills) Export bills (Non L/C Bills) is used in terms of sale contract/ order may be discounted or purchased by the banks. It is used in indisputable international trade transactions and the proper limit has to be sanctioned to the exporter for purchase of export bill facility. 2. Export Bills Negotiated (Bill under L/C) The risk of payment is less under the LC, as the issuing bank makes sure the payment. The risk is further reduced, if a bank guarantees the payments by confirming the LC. Because of the inborn security available in this method, banks often become ready to extend the finance against bills under LC. However, this arises two major risk factors for the banks: The risk of nonperformance by the exporter, when he is unable to meet his terms and conditions. In this case, the issuing banks do not honor the letter of credit. The bank also faces the documentary risk where the issuing bank refuses to honor its commitment. So, it is important for the for the negotiating bank, and the lending bank to properly check all the necessary documents before submission. 3. Advance against Export Bills Sent on Collection Basis:-

Bills can only be sent on collection basis, if the bills drawn under LC have some discrepancies. Sometimes exporter requests the bill to be sent on the collection basis, anticipating the strengthening of foreign currency.

Banks may allow advance against these collection bills to an exporter with a concessional rates of interest depending upon the transit period in case of DP Bills and transit period plus usance period in case of usance bill. The transit period is from the date of acceptance of the export documents at the banks branch for collection and not from the date of advance. 4. Advance Against Export on Consignments Basis:Bank may choose to finance when the goods are exported on consignment basis at the risk of the exporter for sale and eventual payment of sale proceeds to him by the consignee. However, in this case bank instructs the overseas bank to deliver the document only against trust receipt /undertaking to deliver the sale proceeds by specified date, which should be within the prescribed date even if according to the practice in certain trades a bill for part of the estimated value is drawn in advance against the exports. In case of export through approved Indian owned warehouses abroad the times limit for realization is 15 months. 5. Advance against Undrawn Balance:It is a very common practice in export to leave small part undrawn for payment after adjustment due to difference in rates, weight, quality etc. Banks do finance against the undrawn balance, if undrawn balance is in conformity with the normal level of balance left undrawn in the particular line of export, subject to a maximum of 10 percent of the export value. An undertaking is also obtained from the exporter that he will, within 6 months from due date of payment or the date of shipment of the goods, whichever is earlier surrender balance proceeds of the shipment. 6. Advance against Claims of Duty Drawback:Duty Drawback is a type of discount given to the exporter in his own country. This discount is given only, if the in-house cost of production is higher in relation to international price. This type of financial support helps the exporter to fight successfully in the international markets. In such a situation, banks grants advances to exporters at lower rate of interest for a maximum period of 90 days. These are granted only if other types of export finance are also extended to the exporter by the same bank. After the shipment, the exporters lodge their claims, supported by the relevant documents to the relevant government authorities. These claims are processed and eligible amount is disbursed after making sure that the bank is authorized to receive the claim amount directly from the concerned government authorities.

Crystallization of Overdue Export Bills Exporter foreign exchange is converted into Rupee liability, if the export bill purchase / negotiated /discounted is not realize on due date. This conversion occurs on the 30th day after expiry of the NTP in case of unpaid DP bills and on 30th day after national due date in case of DA bills, at prevailing TT selling rate ruling on the day of crystallization, or the original bill buying rate, whichever is higher.

Structured Finance
Structured finance is the art of transferring risks in trade financing from parties less able to bear those risks to those more equipped to bear them in a manner that ensures automatic reimbursement of advances from the underlying assets.

Typical examples of structured finance include:

Inventory/Ware house financing

Receivable financing

Leasing
It is more useful for long term financing needs, e.g. for acquisition of equipment or machinery requiring large sum of cash outlay. Under leasing such can be acquired without having to make a large one-time cash outlay. Usually a leasing company will purchase and lease to a company in need against monthly rental fee.

Factoring and Forfaiting

Factoring and Forfaiting are both forms of receivables discounting. A specialized financial firm pays company cash up-front for the amounts due to them by their customers. While Forfaiting is mostly used for international transactions, Factoring is mostly used for domestic trade. Factoring is the assignment by a supplier of receivables arising from contracts of sale of goods made between the supplier and its customers (debtors) to a factor. The factor can pay for the accounts receivable (invoices)in different ways: Advance-based factoring Maturity-based factoring Collection-based factoring

Forfaiting is the term generally used to denote the purchase of obligations falling due at some future date, arising from deliveries of goods and services-mostly export transactions-without recourse to any previous holder of the obligation. In a forfaiting transaction, an exporter/seller remits guaranteed debt, which results from a sale on credit, to forfeiting company. The forfaiting company pays him cash, up-front, the face value of the debt minus a discount. The debt has to be enhanced through an avail or guarantee from a bank or other financially strong institution. Once the debt has been accepted by the forfaiter, the exporter is no longer liable for a failure of the buyer to pay-the forfaiter ,except where there was element of fraud.

Countertrade
Countertrade involves the exchange of goods and/or services as condition of purchase, or as financing of purchases. Under such arrangements valued goods are exchanged at an agreed value without cash or credit terms. It is particularly valuable in markets where there is a shortage of foreign exchange reserves, where the currency is not freely convertible, or where there is difficulty in obtaining export credits. It is an umbrella term for a range of reciprocal or compensatory trade mechanisms including barter, compensation, counter purchase, buyback, and offset, switch trading and tolling.

B) The various fund based and non fund based options available with MR X: FUND BASED: Working Capital Finance - Cash Credit -Working Capital Demand Loan Overdraft Term Loan Export Finance Bill Discounting

NON FUND BASED Letter of Credit (L/Cs), Bank Guarantees (B/Gs)

Working Capital Finance: Working capital is defined as the total amount of funds required for day to day operations of a business unit. It is often classified as gross Working capital and net working capital. Gross working capital refers to the fund required for financing total current assets whereas NWC refers to the difference between the total current assets and current liabilities and this difference can be positive or negative. The assessment of the working capital requirements can be done through 3 different methods depending on the turnover of the company. These methods are: 1. Nayak Committee which states that of an acceptable sales turnover, 25% of total sales would be the required working capital, of which 20% would be financed by the bank and the remaining 5% would have to be the margin that is to be brought by the owner. 2. CMA data, which is provided by the concern in a prescribed format. This CMA data involves the analysis of balance sheet in order to find out the working capital requirements of the company and the maximum mount of permissible bank finance. This method is the most widely used method and requires a great deal of understanding in order to prepare a CMA data of the company.

Cash Budget method, which is used specially for industries where availability of raw materials is seasonal such as sugar industry. In this method, a cash budget is prepared for the next 12 months. The cash requirements for each month are calculated and the highest value of cash required during any month becomes the working capital of the company. Cash Credit Cash credit is the issuance of a short term cash loan to a business. A cash loan of this type if often used to meet the expenses associated with a specific task or project, with repayment expected within a period of one year or less. Cash credit works in a manner that is very similar to that of a line of credit. The difference is that it establishes a cash account with the lender institution that can be drawn upon by the debtor. This is different from a conventional loan, in that the debtor does not have to receive the entire amount of the loan at one time. It's also different from a line of credit, as the amount of resources extended are pre-approved and the repayment schedule is the same whether the debtor is actively using the cash or not.

Capital Demand Loan A borrower may sometimes require ad hoc or temporary accommodation in excess of sanctioned credit limit to meet unforeseen contingencies. Banks provide such accommodation through a demand loan account or a separate non-operable cash credit account. The borrower is required to pay a higher rate of interest above the normal rate of interest on such additional credit. KPTL has to pay rate of interest on WCDL not exceeding 9% irrespective of bankers BPLR.

Overdraft Loan arrangement under which a bank extends credit up to a maximum amount (called overdraft limit) against which a current (checking) account customer can write checks or make withdrawals. The most common form of business borrowing, an overdraft is a type of revolving loan where deposits (credits) are available for re-borrowing, and interest is charged only on the daily overdraft (debit) balance. It is, however, also a demand loan: the facility can be cancelled (and entire outstanding amount 'called') at any time by the lender at its discretion, without any warning notice or explanation. If the overdraft is secured by an asset or property, the lender has the right to foreclose on the collateral in case the account holder does not pay. Calls happen usually where the (1) borrower's credit rating falls, (2) lender has reason to believe the borrower may go into default, or (3) borrower has not 'revolved' the

overdraft in a satisfactory manner and has turned it into a hardcore debt. An overdraft is approved only for a fixed period (usually one year) after which it is must be renegotiated. Term Loan A loan from a bank with a floating interest rate, the total amount of which must be paid off in a certain period of time. An example of a term loan is a loan to a small business to buy fixed assets, such as a factory, in order to operate. The length of a term loan varies between one and 10 years, depending on the loan agreement. Export Finance: Export financing can be defined as to provide credit for export trade. Export financing is very much encouraged by Govt. as exports show the economic strength of the country and it is by exports only that more money from outside comes into the country and as such the value of economy also increases. Govt. and RBI has extended vast concessions to boost exports. Some of the concessions include: 1. Cheap credit to exporters. 2. Minimum of 12% of net credit should go to exports. 3. Refinance to Banks on eligible portion of export credit outstanding. 4. ECGC guarantee for export credits 5. No margin requirements for advance against export receivables. 6. Flexible approach to export lending and norms of lending. 7. Time norms for disposal of application for export credit. 8. Rejection with the concurrence of next higher authority 9. Bifurcation of WC limits into loan and cc component after excluding export limits. 10. Issue of Gold Card to exporters with good track record. Export credit can be broadly classified into Pre-shipment finance and post shipment finance. Pre-shipment finance refers to finance extended to purchase, processing or packing of goods meant for exports. Financial assistance extended after the shipment of exports falls within the scope of post shipment finance.

Bill Discounting Bank credit is being made available through discounting of usance bills by banks. The RBI envisaged the progressive use of bills as an instrument of credit as against the prevailing practice of using the widely-prevalent cash credit arrangement for financing working capital. The amount made available under this arrangement is covered by the cash credit and overdraft limit. Before discounting the bill, the bank satisfies itself about the creditworthiness of the drawer and the genuineness of the bill.