FEE-BASED

SERVICES

Presented by

Dr.S.C.Bihari
 INTRODUCTION

•Deregulation and new technology have eroded banks’ comparative advantages

and margins and made it easier for non-bank competitors to enter these markets.

•The banks’ response to dwindling margins has been

•to cut costs and focus on profitable niches .

•They have shifted their sales mix towards non-interest income.

with bouquets of And non-fund based

Offers which include activities like
fee based facilities Bank Guarantee, L/C etc.
 BANK GUARANTEES

•As per Section 126 of the Indian

Contracts Act 1872 : “A contract to
perform the promise or discharge the
DEFINITION liability of a third person in case of
default.”

•The person who gives the guarantee

is called the surety;
•The person in respect of whose
default the guarantee is given is
called the principal debtor and
THE PARTIES •The person to whom the guarantee is
given is called the creditor.
 ESSENTIAL FEATURES
•The liability of a guarantor comes into
existence upon the failure of a debtor.

If the guarantor extinguishes the liability of a debtor

then it will acquire all the rights of the creditor,
which is known as Right of Subrogation

•Banks extend guarantees on behalf of their clients.

•These guarantees are classified as

financial guarantees and performance guarantees.
 Financial Guarantees
•The bank guarantees
its customer’s credit-
•Financial guarantees
worthiness and his or
her capacity to take up are typically issued for
financial risks. the following purposes:

•In lieu of
Earnest • Issued to Government
Money/Tender departments for releasing
deposit/Retenti disputed claim money like
on money. excise duty/customs duty etc.
 EXAMPLE OF FIN. GUARANTEE
For example, if a contractor wants to bid for a
tender, he or she needs to deposit a specified
sum of money known as Earnest Money
Deposit (EMD).
This amount will be This involves blocking
refunded to him or of funds for a specified
her if the work is not period which varies
allotted to him or her. depending on the
nature of contract.
• This can be avoided by submitting a bank
guarantee in the place of EMD.
• The bank undertakes to pay the money if the
contractor is awarded the work but fails to pay
the EMD.
 Performance Guarantees
The bank guarantees obligations that relate to
the technical, managerial, administrative
experience and capacity of the customer.

The liabilities under the performance guarantees

are reduced to monetary terms.
Performance guarantees typically
cover the following areas:
For performance of machinery/goods supplied
For satisfactory performance of Turnkey projects-
for a specific period, for releasing disputed
claim money like excise duty/customs duty, etc.
 ESSENTIALLY FINANCIAL
•Notwithstanding the classification of guarantees into
financial and performance, the liability of a bank
will always be determined in financial terms and banks
are obliged to pay the amount demanded by the beneficiary
subject to the limit up to which the bank
agreed to make itself liable under a guarantee.

•While these guarantees do serve as non-fund based services

serving the purpose of working capital management,
there are also instances where banks may issue
guarantees for financing capital equipment.
 Deferred Payment Guarantee
This guarantee is issued for guaranteeing
payment of specified amount over a period of time.

In cases of equipment financing by banks, the

manufacturer by himself or herself or through
a financing tie-up offers credit to the buyers
at very attractive terms to generate
additional demand for his or her products.
•However, the manufacturer may not be willing to assume
the risk of default by the buyer and consequently demand
a guarantee from the buyer’s bankers that
the terms of such financing would be met.
 Under Deferred Payment Guarantee
The bank does not directly extend
a loan to a unit for acquiring equipment.
Instead, it extends a guarantee to
the equipment manufacturer on behalf of
its client that the finance extended by
the manufacturer would be repaid
as per the terms agreed upon.
The advantage to the buyer here is that it benefits
to the extent of savings in interest charges
accruing on account of opting for equipment
financing, minus the guarantee charges paid to the bank.
 DOCUMENTATION
Counter guarantee in favour of the bank
affixed with required stamp duty from the borrower
on whose behalf the guarantee is given.

In case it is a partnership, all the

partners should sign the said document.

In case of a limited company, necessary resolution

passed by the Board of Directors of the company
is obtained in advance and the officials authorized
thereon execute the counter-guarantee
on behalf of the company.
Invocation of Guarantee and Payment of Claim
In the event of default by the customer on whose behalf
guarantee is given, the beneficiary will invoke the guarantee
and demand payment of the sum undertaken by
the guaranteeing banker after ensuring that:-
There is a letter from the beneficiary advising the banker
of the default of the principal debtor (customer) .
The letter demands the payment of
the sum undertaken in the guarantee.
The authority invoking the guarantee is
the beneficiary in own right and capacity
Guarantee has not expired or the invocation period
given in the guarantee bond is not over yet.
 Cancellation of a Bank Guarantee
•Bank guarantees issued can be canceled
on production and surrender of original guarantee bond,
when the applicant (principal debtor) requests for cancellation.

No guarantee commission needs to be

refunded if the purpose for which the
guarantee was issued is already over

Otherwise, a banker may refund a part of the

commission in respect of the prospective
period deducting three months
COMMISSION ON BANK GUARANTEES
•A banker may collect guarantee commission
at the prescribed rate for the entire period of
guarantee including the claim/invocation period
mentioned in the guarantee in advance.

Concessional charge is allowed on

guarantees fully secured by cash deposits

Concessional charge is also allowed for

guarantees issued by the Bank against
counter guarantee of State / Central
Government / Prime Bank
LETTERS OF CREDIT It is a document
Issued by a bank
2
0
0
Guaranteeing a client’s
2

ability to pay for

goods or services

A bank issues
a letter of credit
Authorizing the exporter
On behalf of an
importer or buyer or seller to obtain payment
within a specified time frame
once the terms and conditions
outlined in the
letter of credit are met.
 Parties to Letters of Credit

There are four

parties to a letter
of credit
Applicant (the
Beneficiary, who is the
importer who
exporter and in whose
approaches the bank
favuor the letter of
for opening a letter of
credit is opened
credit)

Beneficiary’s bank, which

Issuing bank, which informs the exporter about
opens the letter of the letter of credit being
credit for the applicant opened in favour of the
exporter
 HOW DOES IT WORK
 The letter of credit acts like an insurance contract for
both the buyer and seller and practically eliminates
the credit risk for both parties, while
at the same time reduces payment delays.

A letter of credit provides the exporter or seller

with the greatest degree of safety when extending credit

It is useful when the importer or buyer

is not well known and when exchange
restrictions exist or are possible.
TWO TYPES OF LETTER OF CREDIT
Letters of credit accomplish their purpose
by substituting the credit of the bank for
that of the customer, for the
purpose of facilitating trade.

There are basically two types of LCs:

commercial and standby

The commercial letter of credit is the primary

payment mechanism for a transaction, whereas the
standby letter of credit is a secondary payment
mechanism
 SIGNIFICANCE OF LETTER OF CREDIT
Letters of credit are not the most common means
of small business financing, but they are
important financing tools for companies
that engage in international trade.
A customer is granted a LC only if
he or she has an adequate
line of credit established with the banker
On behalf of the trader (and for a fee), his or her
bank promises (via the LC) to pay the purchase
price to a seller (or his or her appointed bank) if the
stipulated and highly detailed conditions are met
The conditions might include :

Complete, on-board, ocean bills of lading

Commercial invoice, original, six copies

Packing slip, original, six copies

Insurance certificates
Inspection certificates

Strict date limitations

Precise name, and address of the beneficiary (seller)

References to mode of transport etc.

 REVOCABLE LETTER OF CREDIT
A revocable letter of credit allows for amendments,
modifications and cancellation of the terms outlined
in the letter of credit at any time and without
the consent of the exporter or beneficiary
Because this places the exporter at risk, revocable
letters of credit are not generally accepted.

A revocable Letter of Credit can be

canceled or revoked by the issuing bank
at the request of the applicant, without
the consent of the beneficiary
IRREVOCABLE LETTER OF CREDIT
An irrevocable letter of credit requires the
consent of the issuing bank, the beneficiary
and applicant before any amendment,
modification or cancellation
to the original terms can be made.

This type of letter of credit is commonly

used and preferred by the exporter or beneficiary
because payment is always assured, provided
the documents submitted comply
with the terms of the letter of credit.
Irrevocable letters of credit can be
confirmed, unconfirmed and back-to-back
 Confirmed Letter of Credit
A letter of credit that is confirmed or guaranteed
by another bank in addition to the issuing bank

A confirmed letter of credit is when a second

guarantee is added to the document by another bank.
The advising bank, the branch or the correspondent
through which the issuing bank routes the letter of credit,
adds its undertaking and commitment to pay to the L/C.

This confirmation means that the seller/beneficiary

may also look to the creditworthiness of the
confirming bank for payment assurance.
 Unconfirmed Letter of Credit
When a letter of credit is not confirmed by
any bank other than the issuing bank,
it is called an unconfirmed letter of credit

An unconfirmed letter of credit is the document,

which bears a guarantee of the issuing bank alone

The advising bank merely informs the exporter

of the terms and conditions of the letter of credit
without adding its obligation to pay
The exporter assumes the payment risk
of the issuing bank, which is typically
located in a foreign country.
 Back-to-Back Letters of Credit
A back-to-back credit or a countervailing credit
is a letter of credit, which is opened with
another letter of credit as the security.

In such an agreement, two individual

letters of credit together offer an
alternative to a transferable letter of credit
This allows exporters (sellers or middlemen) who do
not qualify for unsecured bank credit to use a letter
of credit as security for a second letter of credit in
favour of a supplier
 DEFERRED PAYMENT LETTER OF
CREDIT
Deferred payment letters of credit allows
the issuing bank to make the payment
to the beneficiary in installments

The timing and the amounts of

these installments are predetermined
The buyer accepts the documents and agrees to pay
the issuing bank on a fixed maturity date; thus, the
buyer gets a grace period for payment
 REVOLVING LETTER OF CREDIT
With a Revolving letter of credit, the issuing bank
commits to restore the credit to the original amount
once it has been used or drawn down
The credit also states the number of times
it can be used and its period of validity
The credit can be cumulative, meaning
sums can be added to the next installment,
or non-cumulative, meaning partial amounts
expire if not used in the time stated
A revolving credit may be limited
by the overall credit available, or the time period
in which such credit may be utilized, or both
TRANSFERABLE LETTER OF
CREDIT
A transferable letter of credit is one
where the beneficiary can transfer
his or her rights to a third party

The third party is usually the manufacturer

of the goods utilizing the services of the
beneficiary as a marketer or a middleman

An irrevocable letter of credit

may also be transferable
ANTICIPATORY LETTER OF CREDIT
It is a letter of credit under which
payment is made to the beneficiary
even at the pre-shipment stage

There are two kinds of anticipatory letters of credit

Under the red clause credit, advance is given

for purchase of raw material,
processing and/or packing of goods

Under the green clause credit, advance is

also given for warehousing
and insurance charges at port
 CLEAN LETTER OF CREDIT
This credit is mainly used for encashment
against the beneficiary’s approval
by way of counter-signing the invoices
STANDBY LETTER OF CREDIT
Unlike a commercial letter of credit,
which is basically a payment mechanism,
a standby letter of credit is a form of bank guarantee
Banks issue them to stand behind monetary
obligations, to ensure the refund of
advance payment, to support performance
and bid obligations, and to ensure
the completion of a sales contract