Bank finance of different types

(This posts elucidates different types of credit facilities extended by the banks)

You may be aware that banks lend various types of credit facilities to their customers  viz.Demand Loans,  consumer loans, home loans, education loans, term lending,  working capital finance,  export credit, Bank Guarantee, Letter of credit, etc.

Bank finance to their customers is not only in the form of loans, there are other types of credit facilities provided by banks. The other types of bank finance are tailor made to suit the needs of customers. The loans and advances wherein immediate flow of funds available to borrowers, are called funds based facility. In non-fund based facilities like issuance of letter of guarantee, letter of credit etc., banks get fee income and there is no immediate outflow of funds from bank. The nature of credit facilities which are different from loans are described here-under.

Overdrafts: Overdraft means allowing the customer to draw cheques over and above credit balance in his account.  Overdraft is normally allowed to Current Account Customers and in exceptional cases SB A/c holders are also allowed to overdraw their account.  High rate of interest is charged on daily debit balance of overdraft account.  There are two types of overdraft accounts are prevalent in Banks i.e. (i) Temporary overdraft or clean overdraft (ii) Secured overdraft. Temporary overdrafts are allowed purely on personal credit of the party and it is for party to meet some urgent commitments on rare occasions. Allowing a customer to draw against his cheques sent in clearing also falls under this category.  Secured overdraft is allowed up to a certain limit against some tangible security like bank deposits, LIC policies, National Saving Certificates, shares and other similar assets. Secured overdraft is most popular with traders as   lesser operating cost, simple application and document formalities are involved in this facility.

Cash Credit Account (CC A/C): A cash credit facility is a short-term finance to a borrower company, having a tenure of up to one year which can be renewed for further period by the bank on the basis of projected sales and satisfactory  operation in the account during the period of finance. Cash credit facility is extended in two forms viz. Open Cash Credit and Key Cash Credit.  Open Cash credit account is a running account just like a current account where the borrower is allowed to maintain debit balance in the account up to a sanctioned limit or drawing power whichever is lower.   The Cash Credit facility is offered to a borrowers normally either against pledge (Key Cash Credit) or hypothecation of stocks of raw materials, semi finished goods and finished goods and Book Debts (Receivables).

In KCC, the borrower lodges the stocks in his godown and the key of the godown will be handed over to the bank. The goods lodged in the godown are pledged to the bank and they are allowed to be removed by the borrower on remitting into his CC account the amount equivalent to value of the goods. The bank would release further funds to the borrower within the Drawing Power (DP)/sanctioned limit on borrower depositing (pledge) more stock in the godown.  Therefore, such facility is called Key Cash Credit.

Cash Credit limits are also sanctioned to a borrower against security of term deposits, LIC policies, NSCs or Gold Jewels. This type of limit offered mainly to traders who find it difficult to maintain stock register and submitting periodic stock statements. When the security for the CC facility is jewels, life policies, NSC, Term Deposits; there is no need to submit periodic stock statements. In case of manufacturing units this facility is required for purchase of raw materials, processing and converting them into finished goods. In case of traders, the limit is allowed for purchase of goods which they deal.

Bills Finance: Bills finance is short term and self liquidating finance in nature. The bills can be classified as Demand Bills and Usance Bills. Demand Bill is purchased and Usance bill is discounted by the banks. The credits available to the seller against the bills drawn under Letter of Credit either on sight draft or usance draft are called bills negotiated by the banks. The advantage of bills finance is that the seller of goods (borrower) gets immediate money from the bank for the goods sold by him irrespective of whether it is a purchase, discount or negotiation by the bank.

The ‘Demand Bills’ can be documentary or clean. Usually banks accept only documentary bills for purchase. However, clean bills from good parties also purchased by the banks. The ‘Documentary Bills’ may be drawn on D/P (Delivery against payment) or D/A (Delivery against Acceptance) terms. In case of D/P terms the documents of title to goods are delivered to the buyer of the goods (drawee) against payment of bill amount. In case of D/A bills, the documents to the title of goods are to be delivered to the drawee (Buyer) against acceptance of bills. These types of bills are called “Usance Bills’ which means bills are maturing on a future date and payment will be made on due date. In case of ‘Usance Bills’ bills become clean after it is delivered to drawee on acceptance.  Therefore banks take into consideration the credit worthiness not only of the borrower but also of the drawee.

Leasing Finance: A lease is a contract between the owner (lessor) and the user (lessee). There is various type of lease viz. operating lease, finance lease etc. In terms of lease agreement the lessor pays money to the supplier who in turn delivers the article to the lessee. The lessee (hirer of the article) makes periodical payment to the lessor. At the end of lease period the asset is restored to the lessor. Commercial banks in India have been financing the activities of leasing companies, by providing overdraft/Cash credit account/Demand loan against fully paid new machinery or equipment by hypothecation of security. The repayment should be from rentals of machinery/ equipment leased out.  The maximum period of repayment is five years or economic life of the equipment which ever is lower. The bank is allowed to periodical inspection of the asset. Lease contracts are only for productive purpose and not for consumer durable.

Hire-Purchase finance: Hire-Purchase transactions are very similar to leasing transactions. In the Hire-purchase finance takes place predominantly in automobile sector.  Like Leasing Finance, the ownership of the vehicle continues to remain with the Leasing Company till the agreement period ends. However, at the end of the stipulated period, the hirer (lessee) has options either to return the asset to leasing company while terminating the agreement or purchase the asset upon terms set out in the hire-purchase agreement. Since hire-purchase finance takes place predominantly in automobile sector, banks have started direct finance to transport operator as the nature of advance being classified as priority sector lending.

Related article: Different Types of Bank Borrowers