Raising of Funds - Non Fund Based: formula sheet

Key formulas

Core test

Fund based = cash released by the bank; Non-fund based = commitment given by the bank, no cash released

Use this one line to classify any facility in an exam question.

Bank's income

Bank's income = commission or fee on the amount of the facility

Fund based facilities earn interest on the amount drawn. Non-fund based earn commission.

Nature of liability

Bank's liability = contingent, becomes actual when the commitment is invoked

Shown off the main balance sheet as a contingent liability until invoked.

Commission amount

Commission = Facility amount × Rate % × Period in years

Use only when the question gives a rate. Rates are usually quoted per annum.

Core principle of an LC

Bank pays if: documents presented are complying, within expiry date and presentation period

Banks deal in documents, not goods, services or performance.

Irrevocability under UCP 600

A credit is irrevocable even if it does not say so

Amendment or cancellation needs agreement of issuing bank, confirming bank (if any) and beneficiary.

Presentation period under UCP 600

Presentation within 21 calendar days after shipment date, and not later than LC expiry

Applies unless the LC states a different period.

Examination time for banks

Maximum 5 banking days following the day of presentation

Bank decides whether the presentation complies or is to be refused.

Types in one line

Sight / Usance, Revocable-type not used / Irrevocable, Confirmed / Unconfirmed, Transferable, Revolving, Back-to-back, Red clause, Standby

Be ready to define each in two lines.

Parties to a guarantee

Applicant (principal) + Bank (issuer) + Beneficiary

Always name all three. The bank's liability is to the beneficiary, up to the guaranteed amount and within the validity period.

Bank's reimbursement right

Bank pays beneficiary → recovers from applicant under counter-indemnity, margin and security

Payment under the BG creates a debt of the applicant to the bank.

Bank's income and exposure

Guarantee commission = guaranteed amount × commission rate per annum × period in years

Use the rate given in the question. Pro-rate for months.

Margin money

Margin = guaranteed amount × margin %

The bank holds this from the applicant as cash cover. Exposure net of margin = amount − margin.

BG versus LC (core test)

LC: bank pays against compliant documents in the ordinary course. BG: bank pays only on default of the applicant.

This single line answers most compare questions.

Nature of exposure

Non fund based limit = contingent liability of the bank, not a cash outlay

Cash goes out only if the customer defaults and the bank honours the commitment.

DPG flow

Seller supplies goods → buyer pays instalments on due dates → bank pays if buyer defaults → bank recovers from buyer

Use this chain when asked to explain how a DPG works.

Bank's earnings

Commission = rate % p.a. × amount guaranteed or accepted × period ÷ 12 (months)

Rates are fixed by the bank. Use the rate given in the question.

Co-acceptance

Bill accepted by buyer + bank's co-acceptance = bill with two names

Makes the bill easier to discount at a lower rate.

Advance by factor

Advance = Invoice value × Advance percentage

The balance is the factor's reserve, released on collection.

Factoring commission

Commission = Invoice value × Commission rate

Charged for administration and credit protection; usually deducted from the invoice value.

Finance charge (discount)

Interest = Advance × Rate × Days ÷ 365 (or 360, if the question says so)

Charged only on the amount actually advanced, for the period it is outstanding.

Net cost of factoring

Effective annual cost = (Commission + Interest − Savings, all for one credit period) ÷ Net funds received × (Days in year ÷ Days in credit period)

Keep everything on the same period basis. Commission, interest and savings in the numerator must all be for one credit period (one cycle). Net funds received = Advance − Commission − Interest for that period, if charges are deducted upfront. Savings, such as collection costs and bad debts avoided, are subtracted from the charges when asked; convert an annual saving to one cycle first (for example, divide by 6 for a 60-day cycle). Use the day basis stated in the question (360 or 365) in the annualising factor. Alternatively, use annual charges and annual savings against the average net funds, which stay constant, and do not annualise again.

Forfaiting discount

Proceeds = Face value − (Face value × Discount rate × Days ÷ 360)

Use the day-count basis given in the question; forfaiting often uses 360 days.

Key rule on recourse

Recourse: client bears bad debt. Non-recourse: factor or forfaiter bears it.

Forfaiting is always without recourse to the exporter.

Margin money

Margin = Margin % × Amount of LC or BG

This is the amount you must fund. The bank's net exposure is the amount minus the margin.

Net bank exposure

Net exposure = Amount of LC or BG − Margin money

Use this when asked how much risk the bank actually carries.

Guarantee commission

Commission = Amount × Rate % p.a. × Period in years

Commission is usually charged on the full guarantee amount, not on the net exposure. Take the period as the question states.

Limit sizing for LCs

LC limit ≈ Monthly purchases through LC × (Usance period + Transit and processing time in months)

A working rule used in practice. The bank may adjust it. State this as an approach, not a fixed regulation.

Rating and terms (principle)

Better rating → lower margin, lower commission, easier limit

A general principle. Exact terms are the bank's own decision.

Quick revision

• Non-fund based financing means the bank gives a commitment, not cash, at the time of the facility.
• The bank earns a fee or commission for lending its credit standing.
• A letter of credit is a bank's undertaking to pay the seller if the stated documents are presented in compliance.
• The main LC parties are the applicant, the issuing bank and the beneficiary.
• A bank guarantee obliges the bank to pay the beneficiary if the customer fails to meet an obligation.
• An LC works on documents; a guarantee works on default of the customer.
• A deferred payment guarantee supports purchases where the buyer pays in instalments over time.
• Factoring is the sale of trade receivables to a factor, who provides finance and often collects the debts.
• Forfaiting is the purchase of export receivables, usually without recourse to the exporter.
• Credit rating helps lenders judge the borrower's ability to meet obligations and set limits.
• Write a flow of parties and steps for each instrument in your answers.

Common mistakes

• Saying non-fund based finance carries no risk for the bank. Fix: Write that the risk is contingent. If the customer defaults, the bank must pay and then recover.
• Listing cash credit or overdraft as non-fund based. Fix: Cash credit, overdraft, term loans and bill discounting are fund based. Letters of credit and guarantees are non-fund based.
• Saying the advising bank guarantees payment. Fix: The advising bank only authenticates and forwards the LC. Payment assurance comes from the issuing bank, or from a confirming bank that has added its confirmation.
• Saying the bank checks the quality of goods. Fix: Write that banks examine documents on their face against LC terms. Quality disputes are settled under the sale contract.
• Treating a bank guarantee as a loan that gives cash to the applicant. Fix: Say that no funds move at issue. The bank pays only if the guarantee is invoked, and then recovers from the applicant.
• Confusing a performance guarantee with a financial guarantee. Fix: Performance guarantee covers failure to perform a contract. Financial guarantee covers failure to pay money.
• Saying the bank lends money immediately under a DPG. Fix: Write that the bank gives a promise and pays only on default. Cash outflow is contingent.
• Confusing a standby letter of credit with an ordinary letter of credit. Fix: State that an ordinary LC is meant to be drawn against documents in the normal course, while an SBLC is a back-up drawn only on default.
• Treating factoring as a plain bank loan. Fix: Say factoring is an assignment of receivables with services, not just a loan. Mention administration and credit protection.
• Saying recourse factoring removes bad debt risk. Fix: Only non-recourse factoring shifts credit risk to the factor for approved debtors. In recourse, the client bears it.

Exam tips

• Open every answer with the one-line cash or promise test. It scores the definition mark quickly.
• In a difference question, give at least four points with a matching example on each side.
• In case questions, name the beneficiary and state who pays if there is a default.
• Use the words contingent liability and commission. Examiners look for them.
• Attempt a short link to letters of credit and bank guarantees, as these are studied next in the chapter.
• Draw or list the parties first. Many case questions are solved once roles are clear.
• Write the process as numbered steps. Examiners reward sequence.
• For comparison questions, use two or three points: purpose, trigger for payment and use case.