Strategic Management and Corporate Finance · Raising of Funds - Non Fund Based

Deferred Payment Guarantee and Other Non-Fund Based Credit Support

Updated 11 October 2026 · Fact-checked

A deferred payment guarantee (DPG) is a bank's promise to the seller of machinery that the buyer's instalments will be paid on the due dates. The bank lends no cash at the start. It only pays if the buyer defaults. Standby credit and bill acceptance work on the same non-fund based principle.

Understand Deferred Payment Guarantee and Other Credit Support

In fund based finance, the bank gives you cash, as in a cash credit or term loan. In non fund based finance, the bank gives you its name and credit. It does not part with money unless you fail to pay. The bank earns a fee or commission and carries a contingent liability.

A deferred payment guarantee is used when you buy capital goods, such as plant and machinery, and want to pay in instalments over several years. The seller may not trust your credit alone. Your bank guarantees the instalments. The seller ships the goods, and you pay on the due dates. If you miss one, the bank pays the seller and then recovers the amount from you. This is why banks treat a DPG like a loan and fix a limit, take margin or security, and appraise the project.

A standby letter of credit (SBLC) is a bank's undertaking to pay the beneficiary if you fail to perform or pay as promised. It is a back-up. If you pay on time, it is never drawn. A normal letter of credit is meant to be used for payment against shipping documents. An SBLC is used only on default, and the beneficiary claims by presenting a statement of default along with the documents the SBLC asks for.

Acceptance credit means the bank accepts a bill of exchange drawn on it by your supplier or by you. By accepting, the bank promises to pay the bill on maturity. The bill can then be discounted in the market at a fine rate because the bank's name stands behind it. In co-acceptance, the bank adds its acceptance to a bill already accepted by you, so the bill carries two names. You must put the bank in funds before maturity, or the bank pays and the amount becomes a loan to you.

Other non fund based facilities include bank guarantees (performance, financial, bid bond and advance payment guarantees) and letters of credit (inland and import). For all of them, the pattern is the same: the bank substitutes its credit for yours, you pay a commission, and the bank is exposed only if you default.

Key rules to remember

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.

How to solve Deferred Payment Guarantee and Other Credit Support questions

Most questions ask you to explain an instrument, distinguish between instruments, or apply one to a business situation. Use the same method each time.

1Identify the instrument asked about: DPG, SBLC, acceptance credit, co-acceptance, guarantee or letter of credit.
2Start with a one-line definition that says the bank gives its credit, not cash.
3Name the parties: applicant (buyer), bank, beneficiary (seller) and, for bills, the holder or discounting bank.
4Explain the flow in order: what happens at the start, on the due date, and on default.
5State how the bank protects itself: margin, security, counter-guarantee, commission and appraisal of the borrower.
6Apply to the facts given. Link the instrument to the need, such as instalment purchase of machinery or back-up for a payment obligation.
7Compare with a fund based facility or a similar instrument if the question asks for difference.
8End with a short conclusion on benefit to the customer and risk to the bank.

Quickest way: Four-line answer for any non fund based instrument

When to use it: Use when time is short or the question is worth few marks.

Line 1: define it as a bank undertaking, with no immediate cash outflow.
Line 2: who is covered, for what, and for how long.
Line 3: when the bank pays, which is on default or on maturity of the accepted bill.
Line 4: bank's protection and income, namely margin, security and commission.

Common mistakes in Deferred Payment Guarantee and Other Credit Support

Saying the bank lends money immediately under a DPG.
Students treat every bank facility as a loan.
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.
Both have similar names and similar documents.
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.
Mixing up acceptance credit and co-acceptance.
Both involve a bank signing on a bill.
Fix: In acceptance credit the bank is the acceptor of the bill. In co-acceptance the bank signs a bill already accepted by the customer.
Ignoring the bank's right of recovery.
Students stop the story at the bank paying the seller.
Fix: Always add that the bank recovers the amount from the customer, and that it takes margin or security up front.
Leaving out the commission or fee earned by the bank.
Focus is placed only on the customer's benefit.
Fix: Mention that the bank earns commission and takes on a contingent liability. Treat it as credit exposure.

Worked examples

Example 1

Explain how a deferred payment guarantee helps Sundaram Engineering Ltd. buy a machine from a supplier in instalments. Describe what happens if the company defaults.

Show the solution

Define: a DPG is a bank guarantee that the buyer's deferred instalments will be paid to the seller on due dates.
Need: Sundaram wants to pay over several years, but the supplier wants assurance of payment.
Process: the bank appraises the project and Sundaram's credit, sanctions a DPG limit, and issues the guarantee to the supplier. It may take margin and security.
Result: the supplier delivers the machine. Sundaram pays instalments on the due dates.
Default: if Sundaram misses an instalment, the supplier invokes the guarantee, the bank pays, and the bank recovers the amount from Sundaram with interest or by enforcing security.
Nature: the bank gives no cash at the start, so the facility is non fund based and shows as a contingent liability.

Answer: A DPG lets Sundaram buy on instalments without upfront cash, since the bank backs the payment promise. The bank pays the supplier only on default and then recovers from Sundaram.

Example 2

Distinguish between acceptance credit and co-acceptance facility.

Show the solution

Acceptance credit: the bank accepts a bill of exchange drawn on it, so the bank is the main acceptor and undertakes to pay at maturity.
Co-acceptance: the buyer accepts the bill first, and the bank adds its own acceptance, so the bill carries two names.
Purpose: both make the bill more acceptable and easier to discount at a finer rate.
Customer's duty: in both cases the customer must provide funds to the bank before maturity. If not, the bank pays and the amount becomes a loan to the customer.
Nature: both are non fund based, as the bank does not advance money when it accepts.

Answer: In acceptance credit the bank is the acceptor of the bill. In co-acceptance the bank signs a bill already accepted by the customer. Both give the bill the bank's credit and need the customer to fund the bank by maturity.

Exam tips

Begin each answer with a clear definition showing the bank gives credit support, not cash.
If asked to distinguish, write two columns' worth of points in short paragraphs or bullets, covering meaning, parties, when bank pays and purpose.
Use a simple example with a company name and a machine or import purchase to show application.
Mention the bank's safeguards and commission to earn the extra marks.
Link this topic to bank guarantee and letter of credit, since questions often combine them.

Practice questions from Raising of Funds - Non Fund Based

Deferred Payment Guarantee and Other Credit Support: frequently asked questions

What is a deferred payment guarantee in simple words?

It is a bank's promise to the seller that the buyer will pay the instalments for goods on the due dates. If the buyer fails, the bank pays the seller. The bank then recovers the money from the buyer.

Which are the main non fund based credit facilities offered by banks?

The main ones are letters of credit, bank guarantees, deferred payment guarantees, standby letters of credit, acceptance credit and co-acceptance of bills. In each, the bank lends its credit and takes on a contingent liability.

What is a standby letter of credit?

It is a bank's undertaking to pay the beneficiary if the applicant fails to meet a payment or performance obligation. It works as a back-up and is drawn only on default.

Does a bank charge for non fund based facilities?

Yes. The bank charges a commission or fee on the amount of the guarantee, credit or acceptance. It may also ask for margin money or security.