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

Non-Fund Based Financing: Meaning and Features

Updated 11 October 2026 · Fact-checked

Non-fund based financing is a bank facility where the bank gives no cash upfront. It gives a promise, such as a letter of credit or guarantee, to pay a third party if the customer defaults or a condition is met. Cash moves only if the commitment is invoked.

Understand Non-Fund Based Financing: Meaning and Features

Start with a simple question. When a company goes to a bank, does it always need cash? Not always. Often it needs the bank's credibility. A supplier may not trust the company, but will trust the bank.

Fund based finance means the bank lends money. Cash is released to the borrower. Examples are cash credit, overdraft, term loans and bill discounting. The bank's funds are used from day one, and interest is charged on the amount drawn.

Non-fund based finance means the bank lends its name, not its money. It gives a commitment to a third party (the beneficiary) that it will pay if the customer fails to perform or pay. The main forms are letters of credit, bank guarantees and similar credit support. No cash goes out when the facility is issued. It becomes a cash outflow only if the bank has to honour the commitment. Then it is a contingent liability of the bank.

Banks charge a commission or fee for this, not interest. The risk is lower at the start, but real. If the customer defaults, the bank pays and recovers from the customer. So banks still assess creditworthiness, take margin money or security, and set a limit for the customer.

Companies use these facilities to buy goods on credit, to win contracts that need performance security, to import goods, and to preserve cash. For exams, always link the meaning to the contrast with fund based finance and to the contingent nature.

Key rules to remember

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.

How to solve Non-Fund Based Financing: Meaning and Features questions

Use this order for any theory or case question on non-fund based financing.

1Define the term in one line: a bank facility where the bank gives a commitment, not cash.
2Name the parties: the customer (applicant), the bank (issuer) and the beneficiary (third party).
3State the main features: no cash outflow upfront, contingent liability, commission income, credit substitution, a sanctioned limit and security or margin.
4Give the instruments: letter of credit, bank guarantee, and other credit support such as deferred payment guarantee.
5Compare with fund based finance on cash flow, income, risk and examples. Use a short table-like list of points.
6Apply to the facts: say which facility suits the company's need and why.
7Conclude with the risk: if invoked, the bank pays and recovers from the customer.

Quickest way: Cash or promise test

When to use it: Use when you must classify a facility or answer a short difference question fast.

Ask: does the borrower receive money from the bank now?
If yes, it is fund based. If no, and the bank only promises to pay a third party, it is non-fund based.
Write four contrast points: cash flow, income (interest vs commission), nature of liability, examples.
Add one line on why companies use it: credibility without cash outlay.

Common mistakes in Non-Fund Based Financing: Meaning and Features

Saying non-fund based finance carries no risk for the bank.
Because no cash leaves the bank at the start, students assume nothing can be lost.
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.
Students link all working capital facilities together.
Fix: Cash credit, overdraft, term loans and bill discounting are fund based. Letters of credit and guarantees are non-fund based.
Saying the bank earns interest on non-fund based facilities.
Students carry over the idea of lending from fund based finance.
Fix: Say the bank earns commission or fee for the commitment.
Leaving out the third party.
Students describe it as a two-party loan.
Fix: Always mention the beneficiary. The promise is made to someone other than the customer.
Giving a bare definition with no application in a case question.
Students rush to recall notes.
Fix: Follow the order: meaning, features, comparison, then apply to the facts and conclude.

Worked examples

Example 1

Distinguish between fund based and non-fund based financing. (Short answer style)

Show the solution

Meaning: in fund based finance the bank releases money to the borrower. In non-fund based finance the bank gives a commitment to a third party and releases no money at the start.
Cash flow: fund based creates an immediate cash outflow for the bank. Non-fund based creates an outflow only if the commitment is invoked.
Income: fund based earns interest. Non-fund based earns commission or fee.
Liability: fund based is an actual asset (loan) in the bank's books. Non-fund based is a contingent liability.
Examples: cash credit, overdraft and term loan are fund based. Letter of credit and bank guarantee are non-fund based.

Answer: Fund based finance gives the borrower cash and earns interest. Non-fund based finance gives a bank commitment to a third party, earns commission and creates a contingent liability.

Example 2

Sunrise Textiles Ltd wants to import machinery from a foreign supplier who does not know the company and wants assurance of payment. The company has no spare cash. Which type of bank facility suits it, and what are its features? Also compute the bank's commission if the facility is ₹50,00,000 at 1.5% per annum for 6 months.

Show the solution

Need: the supplier wants payment assurance and the company wants to conserve cash. The bank's credibility is needed, not its money.
Suitable facility: a non-fund based facility, most suitably a letter of credit, where the bank promises to pay the supplier on compliance with the stated documents.
Features: no cash is released to the company at issue, the bank's liability is contingent, a limit is sanctioned, and margin money or security may be taken.
Commission: ₹50,00,000 × 1.5% × 6/12.
₹50,00,000 × 1.5% = ₹75,000 per year.
For 6 months: ₹75,000 × 6/12 = ₹37,500.
Risk: if the company fails to pay on the due date, the bank pays the supplier and recovers from the company.

Answer: A letter of credit, which is a non-fund based facility, suits the company. The bank's commission is ₹37,500.

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.

Practice questions from Raising of Funds - Non Fund Based

Non-Fund Based Financing: Meaning and Features: frequently asked questions

What is non-fund based financing in simple words?

It is a bank facility where the bank gives a promise instead of money. The bank commits to pay a third party if the customer fails to pay or perform. Cash goes out only if the promise is invoked.

What are examples of non-fund based facilities?

The common examples are letters of credit and bank guarantees. Deferred payment guarantees are another form of credit support. These are covered as separate topics in this chapter.

Why do banks charge commission and not interest on these facilities?

Because the bank does not lend money at the start. It lends its name and takes on a contingent risk. The fee pays for that risk and for the credit assessment.

Is a non-fund based limit really free of cost for the company?

No. The company pays commission and may need to keep margin money or give security. If the bank has to pay on its behalf, the company must reimburse it, and that can turn into a fund based exposure.