Debt Funding – Indian Non-Fund Based – Corporate Funding and Listings in Stock Exchanges Important Questions
Question 1.
Distinguish between the following: Letter of Guarantee and Bank
Answer:
“Letter of Guarantee”:
Letter of Guarantee (also known as “Letter of Credit”) referred to as a documentary credit acts as a promissory note from a bank. Letter of Guarantee represents an obligation taken on by a bank to make a payment once certain criteria are met. Once these terms are completed and confirmed, the bank will transfer the funds. The letter of credit ensures the payment will be made as long as the services are performed.
Letters of credit are especially important in international trade due to the distance involved and potentially differing laws in the countries of the businesses involved. In these transactions, it is not always possible for the parties to meet in person. The bank issuing the letter of credit holds payment on behalf of the buyer until it receives confirmation that the goods in the transaction have been shipped.
“Bank Guarantee”:
Bank Guarantees insure both parties in a contractual agreement from credit risk. For instance, a construction company and its cement supplier may enter into a new contract to build a mall. Both parties may have to issue bank guarantees to prove their financial stance and capability. In a case where the supplier fails to deliver cement within a specified time, the construction company would notify the bank, which then pays the company the amount specified in the bank guarantee.
Bank guarantees represent a more significant contractual obligation for banks than letters of credit do. A bank guarantee, like a letter of credit, guarantees a sum of money to a beneficiary unlike a letter of credit the sum is only paid if the opposing party does not fulfil the stipulated obligations under the contract. This can be used to essentially insure a buyer or seller from loss or damage due to non-performance by the other party in a contract.
While letters of credit are used mostly in international trade agreements, bank guarantees are often used in real estate contracts and infrastructure projects. Both bank guarantees and letters of credit work to reduce financial risk.
Question 2.
Explain the conditions under which a bank can grant non-funded facilities to customers, (not availing facility from any bank in India)
Answer:
Banks can grant non-funded facilities including partial credit enhancement to customers, not availing fund based facility from any bank in India under following conditions:
- Banks are to ensure that the borrower has not availed any fund based facility from any bank operating in India. At the time of granting non-funded facilities, bank to obtain declaration from the customer about the non-funded credit facilities already enjoyed by them from other banks.
- Banks are to undertake similar credit appraisal as for fund based facilities.
- Credit information relating to such facility shall be mandatorily be furnished to the Credit Information Companies.
Question 3.
Y Ltd, an Indian Company opened irrevocable letter of credit for 6 Million Swedish Kroner in favour of Z Ltd. for import of two pulsed rectifiers. Z Ltd. the Swedish Company shipped only one pulsed rectifier but invoiced for two pulsed rectifiers. Bill of Lading also stated that the packing contains two pulsed rectifiers. Based on the documents the Indian Bank remitted the amount to the Banker of Z Ltd. and debited the account of Y Ltd. Y Ltd. wants to hold the Indian Banker responsible for wrong payment against the short shipment. Will Y Ltd. succeed?
Give your assessment with reasons.
Answer:
The foreign Letter of Credit is subject to Uniform Customs and Prac-tices for Documentary Credit (UCPDC 600) as per the guidelines of International Chamber of Commerce (ICC). According to which LC is not payment against goods but only payment against documents.
As far as the Bank is concerned, the documents as called for in the Letter of Credit have been presented by the seller and there is no internecine discrepancy among the documents. Because of this he will not be held liable for short shipment of the goods physically.
Therefore, Indian Company will not succeed.
Question 4.
On the basis of following information, calculate the limit for Letter of Credit (LC) for the financial year 2019-2020 of M/s Madhukar Enterprises:
| (i) Estimated Raw Material purchase for the FY 2019 – 20 INR | 172.64 Crore |
| (ii) Estimated purchase under Letter of Credit for FY 2019 – 20 (LC) | INR 69.41 Crore |
| (iii) Lead time i.e. time from order placement to shipment | 10 days |
| (iv) Transit Time | 20 days |
| (v) Credit (Usance) Period available | 3 months |
Answer:
| Particulars | Amount (INR in Crore) |
| (i) Annual Consumption of Raw Material (RM) to he purchased under Letter of Credit (LC) | 69.41 |
| (ii) Average monthly purchase of Raw’ Material | = 69.41/12 = 5.78 |
| (iii) Lead time i.e. time from order placement to shipment | 10 days |
| (iv) Transit Time | 20 days |
| (v) Credit (Usance) Period available | 3 months |
| (vi) Total Period [(iii) + (iv) + (v)] | 4 months |
| (vii) Requirement of LC [(ii) X (vi)] i.e. ₹ 5.78 × 4 i.e. LC limit recommended
|
= 23.14 Crore. = 23 Crore. |
Question 5.
Discuss any five types of letter of credit?
Answer:
Following are various types of Letter of Credit:
1. sight Credit: In this Letter of credit, documents are payable at sight/upon presentation, Le., Payment is made to the seller immediately (maximum within 7 days) after the required documents have been submitted.
2. Confirmed Credit: A confirmed letter of credit is one when a banker other than the Issuing bank, adds its own confirmation to the credit. In case of confirmed letter of credits, the benehciary’s bank would forward the LC to the confirming banker with a request to add their confirmation. The liability of the confirming bank is same as the issuing bank.
Note: Only Irrevocable letter of credit can be confirmed
3. Transferable Credit: A Transferable letter of credit is one in which a benehciary can transfer his rights to third party/parties in whole or in part (in that case the unused portion can be transferred back to the original benehciary). Such letter of credit should clearly indicate that it is a ‘Transferable’ letter of credit. Transferable Letter of Credit is transferrable only once.
4. Red Clause Letter of Credit: In case of red clause letter of credit, the issuing bank will make an advance payment to the exporter Le. the seller before the seller ships the goods to the importer Le. buyer. This is usually done to provide aid to the seller in the form of working capital to purchase raw material, processing and packaging of goods, etc.
Note: Red clause letter of credit is an advance payment letter of credit.
5. Green Clause Letter of Credit: Green Clause Letter of Credit provides the advance not only for the purchase of raw materials, processing and packaging of goods, etc. but also for pre-shipment warehousing at the port of origin and insurance expense.
In normal situations, the advance under this letter of credit is granted only after the purchased goods are stored in bonded warehouses. This type of letter of credit is usually used in transactions related to commodity market such as wheat, rice, gold, etc.
Note: Green clause letter of credit is an extension of red clause letter of credit.
Question 6.
What are the various types of Bank Guarantee?
Answer:
Three types of Bank Guarantee discussed below:
1. Financial Guarantee helps the bank’s customer to bid for the contract without depositing actual money. In case, the contractor does not take up the awarded contract, then the government department would invoke the guarantee and claim the money from the bank.
Example: Banker issues guarantee in favour of a government department against caution deposit or earnest money to be deposited by bank’s client. At the request of his customer, in lieu of a caution deposit/earnest money, the banker issues a guarantee in favour of the government department
2. Performance Guarantee
Performance Guarantees are issued by banks on behalf of their clients. In performance guarantee bank issue on behalf of his client to assure the third party to complete some work on time or as per the terms of contact between the parties.
If the work is not completed as per the term of contract then the third party can request the bank to invoke the bank guarantee and make payment for default.
3. Deferred Payment Guarantee (DPG)
It is clear from the name of the Bank guarantee that under this guarantee, the banker guarantees payments of instalments spread over a period of time.
The banks undertake to make payment of instalments payable by the buyer of capital goods such as machinery, on long term credit given by the supplier.
Question 7.
Write Short Note on: “Standby Letter of Credit (SLOC)”.
Answer:
“Standby Letter of Credit (SLOC)”:
- Standby letter of credit is a lender’s guarantee of payment to an interested third-party in the event the client defaults on an agreement.
- Standby letters of credit are formal documents that specify the duties and obligations of each party and serve as an act of good faith. The bank issuing the SLOC performs general underwriting duties to ensure the financial credibility of the party seeking the letter of credit. Afterwards, it sends a notification to the bank of the party requesting the letter of credit (typically a seller or creditor).
Example: An exporter sells goods to a foreign buyer who guarantees pay-ment in 30 days. When no payment is received by the deadline, the exporter presents the SLOC to the buyer’s bank to receive payment.
Question 8.
Explain any two documents handled under Letter of Credit?
Answer:
Two important documents handled under Letter of Credit are broadly classified as:
- Bill of Exchange: Bill of exchange is drawn by the beneficiary (exporter) on the LC issuing bank. When the bill of exchange is not drawn under a LC, the drawer of the bill of exchange (exporter), draws the bill of exchange on the drawee (importer). In such a case, the exporter takes credit risk on the importer.
- Bill of Lading (B/L): The B/L is the shipment document, evidencing the movement of goods from the port of acceptance (in exporter’s country) to the port of destination (in importer’s country). It is a receipt, signed and issued by the shipping company or authorized agent. It should be issued in sets (as per the terms of credit).
Question 9.
Discuss about five parties involved in Letter of Credit Finance?
Answer:
Following five parties involved in letter of credit finance:
- Applicant: The buyer/importer of goods: This person has to make payment of letter of credit to the issuing bank if the documents are in accordance with the terms and conditions of LC.
- Issuing Bank: Importer’s or buyer’s bank who lends its name or credit, is issuing Bank. It is liable for payment of LC in case the documents are received by it from the nominated or negotiating bank and the documents are in terms of letter of credit. This bank gets 5 days to check the documents.
- Beneficiary: The party to whom the credit is addressed i.e. seller or the exporter or the supplier of the goods. It gets payment against documents as per LC from the nominated bank within validity period of negotiation maximum 21 days from date of shipment.
- Reimbursing Bank: Third bank which repays settle or funds the negotiating bank at the request of its principal, the issuing bank.
- Confirming Bank: The bank adding confirmation to the credit, which undertakes the responsibility of payment by the issuing bank and on his failure, to pay. The confirmation is added on request of the opening bank.
Question 10.
When application for the issue of bank guarantee is received then what aspects are examined and satisfied by Bank?
Answer:
Whenever an application for the issue of bank guarantee is received bank examines & satisfy about the following aspects:
- Margin.
- Need of the bank guarantee & whether it is related to the applicant’s normal trade/business.
- Whether the requirement is one time or on the regular basis.
- Nature of bank guarantee (Le. financial or performance).
- Applicant’s financial strength/capacity to meet the liability/obligation under the bank guarantee in case of invocation.
- Past record of the applicant in respect of bank guarantees issued earlier.
- Present outstanding on account of bank guarantees already issued.
- Collateral security offered.
Question 11.
Illustrate the specimen for assessment of Limit of Bank Guarantee (without financial figures)?
Answer:
The Specimen Illustration for assessment of Limit of Bank Guarantee is as follows:
| S. No. | Particulars |
| 1. | Outstanding Bank Guarantee as per Audited Balance Sheet. |
| 2. | Add: Bank Guarantee required during the period |
| 3. | Less: Estimated maturity or cancellation of Bank Guarantee during the period |
| 4. | Requirement of Bank Guarantee (4 = 1 +2 – 3) |
Question 12.
What is the purpose of issuing Performance Bank Guarantee?
Answer:
Following are purpose of issuing Performance Bank Guarantee:
- For securing any claims by the buyer on the seller arising from default in delivery or performance of the terms of the contract (example construction, assembly, execution).
- For Execution of Long Term Infrastructure Projects such as Seaports, Airports, Road Construction, Bridges, Sanitation and Sewerage Projects, Telecommunication Services, Construction of Educational Institutions and Hospitals, Generation/Transmission/Distribution of Power, etc.
- For Due performance of a specific contract undertaken by a customer in favour of Government Bodies/Others.
Example: Construction of Roads, Buildings Dams, Civil Work, etc. - For Due performance of an equipment/project after completion for a specific period due to possible defects appearing after delivery during warranty period of the equipments.