Lending Notes

Chapter 1. Lending ProductsFORMS OF LENDING

Many there are two types of advances:

Short-term (maturity within one year)

Long term (maturity with the period of more than one year

a. Categories of borrowersi. Corporate Borrowers

Borrowing by businesses rather than by individuals.

Type of products

Short-term Lending- Working Capital Financing

Running Finance- Advanced Merchandise/Demand Finance

Receivable Financing- Factoring, Invoice Discounting

Inventory Financing

Trade Finance (L/c)

1. RUNNING FINANCE

This form of finance was previously known as “overdraft”. When a customer

requires the t e m p o r a r y a c c o m m o d a t i o n , h i s b a n k a l l o w s w i t h d r a w a l h i s

a c c o u n t i n e x c e s s o f c r e d i t  balance, which the customer has in its account, a running

finance occurs. The accommodations t h u s a l l o w e d c o l l a t e r a l s e c u r i t y . W h e n i t i s

a g a i n s t c o l l a t e r a l s e c u r i t i e s , i t i s c a l l e d a “ S e c u r e d R u n n i n g F i n a n c e ”

a n d w h e n t h e c u s t o m e r c a n n o t o f f e r a n y c o l l a t e r a l s e c u r i t y e x c e p t h i s

p e r s o n a l s e c u r i t y , a c c o m m o d a t i o n i s c a l l e d a “ C l e a n R u n n i n g F i n a n c e . ”

T h e customer is in advantageous position in running finance because he has to

pay the mark-up only the balance outstanding against him on daily product basis.

Overdraft is one sort of offering credit by the account providers, in that withdrawals are

permitted exceeding available balance of the bank account. It is nothing but an over-drawing

leading to a negative balance. The situation is more common with the credit card offerings by the

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banks. For enjoying overdraft facility, there should be some agreement or approval in advance

with the account provider. Generally, the over-draft facility is offered by the banks for some

maximum amount and the same is required to be returned to them (in the respective account)

within some specified time limit.

Demand Finance

T h i s i s c o m m o n f o r m o f f i n a n c i n g t o c o m m e r c i a l a n d i n d u s t r i a l

c o n c e r n s a n d i s m a d e a v a i l a b l e e i t h e r a g a i n s t p l e d g e o r h y p o t h e c a t i o n

o f g o o d s p r o d u c e o r m e r c h a n d i s e . I n D e m a n d F i n a n c e t h e p a r t y i s

f i n a n c e d u p t o a c e r t a i n l i m i t e i t h e r a t o n c e o r a s a n d w h e n required. The

party due to facility of paying mark-up only on the amount it actually

utilizes prefers this form of financing

1. Ordinary Shares

2. Preferred Shares

3. Quoted or Unquoted

4. Registered

5. Bearer 

6. Inscribed

2. Receivable Financing

Receivable financing, also known as factoring is a method used by businesses to convert sales on

credit terms for immediate cash flow. Financing accounts receivable has become the preferred

financial tool in obtaining flexible working capital for businesses of all sizes. The receivable

credit line is determined by the financial strength of the customer (Buyer), not the client (The

seller of the receivables).

Accounts Receivable Financing

Accounts receivable financing--also known as accounts receivables funding--is a way for small

businesses to obtain fast working capital without the need for a loan or repayment. A company's

accounts receivable--invoices sent to clients for goods, or services rendered--are listed on a

balance sheet as an asset. The small business can then sell these invoices to a larger company,

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which then takes on the risks of collecting the money owed by clients and provides the small

business with immediate funds.

A small business will usually be required to "age" its invoices before receiving accounts

receivable financing. For accounts less than 30 days old, a provider may pay around 75 percent

of the value of the invoice. But for accounts that have been outstanding for a longer amount of

time, the provider will typically pay less. Some providers are unwilling to take on accounts that

have been outstanding for longer than 90 days.

Invoice factoring:

Invoice factoring, accounts receivable factoring, and factoring freight are effective ways to

secure small business financing without the debt of a small business loan. As your factoring

company, we'll provide working capital for payroll funding, business growth and day-to-day

expenses. Factoring brokers refer their clients to Riviera Finance.

Factoring is a financial transaction whereby a business sells its accounts receivable (i.e.,

invoices) to a third party (called a factor) at a discount.

In "advance" factoring, the factor provides financing to the seller of the accounts in the form of a

cash "advance," often 70-85% of the purchase price of the accounts, with the balance of the

purchase price being paid, net of the factor's discount fee (commission) and other charges, upon

collection. In "maturity" factoring, the factor makes no advance on the purchased accounts;

rather, the purchase price is paid on or about the average maturity date of the accounts being

purchased in the batch.

Factoring differs from a bank loan in several ways. The emphasis is on the value of the

receivables (essentially a financial asset), whereas a bank focuses more on the value of the

borrower's total assets, and often considers, in underwriting the loan, the value attributable to

non-accounts collateral owned by the borrower also, such as inventory, equipment, and real

property,[1][2] i.e., matters beyond the credit worthiness of the firm's accounts receivables and of

the account debtors (obligors) thereon. Secondly, factoring is not a loan – it is the purchase of a

financial asset (the receivable). Third, a nonrecourse factor assumes the "credit risk", that a

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purchased account will not collect due solely to the financial inability of account debtor to pay.

In the United States, if the factor does not assume credit risk on the purchased accounts, in most

cases a court will recharacterize the transaction as a secured loan

Invoice discounting

Invoice discounting is a form of short-term borrowing often used to improve a company's

working capital and cash flow position.

Invoice discounting allows a business to draw money against its sales invoices before the

customer has actually paid. To do this, the business borrows a percentage of the value of its sales

ledger from a finance company, effectively using the unpaid sales invoices as collateral for the

borrowing.

Although the end result is the same as for debt factoring (the business gets cash from its sales

invoices earlier than it otherwise would) the financial arrangement is somewhat different.

Features

When a business enters into an invoice discounting arrangement, the finance company will allow

the business to draw down a percentage of the outstanding sales invoices - usually in the region

of 80%. As customers pay their invoices, and new sales invoices are raised, the amount available

to be advanced will change so that the maximum drawdown remains at 80% of the sales ledger.[1]

The finance company will charge a monthly fee for the service, and interest on the amount

borrowed against sales invoices. In addition, the finance company may refuse to lend against

some invoices, for example if it believes the customer is a credit risk, sales to overseas

companies, sales with very long credit terms, or very small value invoices. The lender will

require a floating charge over the book debts (trade debtors) of the business as security for the

funds it lends to the business under the invoice discounting arrangement.

Responsibility for raising sales invoices and for credit control stays with the business, and the

finance company will often require regular reports on the sales ledger and the credit control

process.

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Invoice discounting is targeted at larger companies with established systems and an expected

annual sales turnover in excess of £500,000; providers will need to be satisfied that the client can

manage their own sales ledger administration and credit control facilities.

Benefits

By receiving cash as soon as a sales invoice is raised, the business will find that its cash

flow and working capital position is improved.

The business will only pay interest on the funds that it borrows, in a similar way to an

overdraft, which makes it more flexible than debt factoring.

Invoice financing can be arranged confidentially, so that customers and suppliers are

unaware that the business is borrowing against sales invoices before payment is received.

Drawbacks

In some industries, financing debts can be associated with a company that is in financial

distress. This can result in suppliers becoming reluctant to offer credit terms, which will

reverse many of the benefits of the arrangement.

Invoice discounting is an expensive form of financing compared to an overdraft or bank

loan.

As the finance company takes a legal charge over the sales ledger, the business has fewer

assets available to use as collateral for other forms of lending - this may make taking out

other loans more expensive or difficult.

Once a business enters into an invoice discounting arrangement, it can be difficult to

leave as the business becomes reliant on the improved cash flow.

3. Inventory Financing:

Inventory financing is bank line of credit secured by the company's inventory. This type of

financing can help to free up some of the cash you have tied up in inventory for more pressing

needs. Although not really available to pure startups as a track record of sales is required by the

lender, the startup founder should be aware of this type of financing for later down the road.

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So why is it difficult to locate?

For a retailer, wholesaler, or manufacturer, inventory financing has to largely be funded with

equity financing (your own money). Due to the movable nature of most inventory and the

potential fluctuations in price, inventory is a difficult item for a lender to secure.

Which Companies Should Use It?

Startups which can use inventory financing include:

those with tangible inventory (in other words, service business need not apply),

those with a proven sales history and good credit since lenders aren't really interested in taking

possession of your inventory if you can't make your loan payments. For this reason startups need

not apply.

Tips for Getting Approved

Demonstrate to lenders that you have a proper inventory management system in place which

provides accurate and timely information on its size and cost.

Ensure that the inventory is protected from damage and shrinkage by either the elements or

people, respectively.

Make sure your assets are maintained in good shape; your lender may require to inspect the

inventory from time-to-time;

Demonstrate to lenders that the inventory is actually selling by showing sales order.

Show that you are managing your inventory as efficiently as possible by keeping the bare

minimum on hand while maximizing the turnover rate.

Inventory Financing Models

There is essentially three inventory financing model, each with its own variations according to

the specific business parameters involved.

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Unlike other types of financing, inventory financing programs tend to be molded to a particular

business application as there is too much variability for a one size fits all financing product. This

is yet another reason why most lenders are not interested in financing inventory.

The first type of inventory financing model is one where the lender has complete control over the

inventory, usually through the use of a third party warehouse. Under this model, inventory is

purchased with the lenders funds and stored in a third party warehouse. Depending on the lender,

the inventory may be owned by you or it may actually be owned by the lender. But in both cases,

the lender has full control.

The lender will release inventory to you as you pay for it. For example, say you purchased

$100,000 worth of inventory and had it financed under this model. You then make a sale and

have to deliver $25,000 worth of the inventory. You would have to pay the lender $25,000 plus

the financing costs, and the lender would release that amount of inventory for delivery. This

process would be repeated for each inventory draw down until all units are paid for.

The key to making this model work is having enough free cash flow to pay for the

inventory as you need it.

The major benefit to you is that you can get inventory in a saleable position without having to

self finance the purchase. In many cases where this model is used, the inventory financer has to

pay a manufacturer 50% of the order cost on order placement or booking and the remaining 50%

of the order cost on shipment from the factory. This capital outlay can be for several months,

especially if the manufacturing is done over seas.

Again, depending on the model, the financing usually ranges between 70% and 100% of the

inventory cost.

The second type of inventory financing involves purchase orders. This is most common with

wholesalers and brokers trying to facilitate buy and sell block orders.

If you have a purchase order for a commodity based product (easy to liquidate) from a well

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established purchaser, an inventory lender can potentially finance the purchase of the inventory

required to complete the sale provided that it is directly shipped to your customer and provided

the customer agrees to pay the inventory lender directly (basically, you don’t touch the inventory

or the payment). Once payment is received, the inventory lender will deduct the cost of the

inventory and the financing costs and forward the balance (margin) to you.

The third most common inventory financing model is an asset based loan. In this model, the

lender has first claim on all accounts receivable and inventory, and all incoming funds for the

business are deposited into the asset based lenders account.

Effectively, the asset based lender has complete control over the cash flow. This allows the

lender to manager their risk more effectively through weekly monitoring of cash coming in and

going out.

The net effect of asset based financing is that the lender is prepared to free up the equity held in

inventory and receivables so that more inventory can be purchased to meet demand. The amount

of financing provided is based on the lender’s margining equation which determines how much

financing can be made available for each dollar of inventory and receivables held by the

business.

Margining is influenced by the age of receivables and the liquidity of the inventory among other

things.

Each of these three models has numerous variations, but has some basic things in common:

1. The inventory lender reduces risk by controlling a combination of assets and cash flow.

2. The more certain and predictable the purchase and sale cycle the, the higher the probability of

acquiring inventory financing.

3. Inventory to be financed must be easy to liquidate and have enough retail margin to pay for

fast liquidation.

Drawbacks to Inventory Financing

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Lenders will most likely need additional security in place to make sure that you are not disposing

of the collateral improperly.

Most banks are not familiar with inventory financing which means that you will have to put in

extra effort to find a banker who is comfortable with it.

The line of credit may have to be paid off in full every 12 months and then not used at all for one

month.

If sales suddenly decline, two problems arise:

you may have to unload your inventory at a loss, thereby undermining your ability to stay current

on your line of credit, and

the interest on the loan may sap your ability to keep production on schedule.

High interest rates and other fees.

4. Trade finance

What is trade finance?

Trade finance is related to international trade.

While a seller (the exporter) can require the purchaser (an importer) to prepay for goods shipped,

the purchaser (importer) may wish to reduce risk by requiring the seller to document the goods

that have been shipped. Banks may assist by providing various forms of support. For example,

the importer's bank may provide a letter of credit to the exporter (or the exporter's bank)

providing for payment upon presentation of certain documents, such as a bill of lading. The

exporter's bank may make a loan (by advancing funds) to the exporter on the basis of the export

contract.

Trade services and supply chain

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Building on what I have termed traditional trade finance, there are a number of ways in which

banks can help corporate clients trade (both domestically and cross-border) for a fee.

A typical service offering from a bank will include:

Letters of credit (LC), import bills for collection, shipping guarantees, import financing,

performance bonds, export LC advising, LC safekeeping, LC confirmation, LC checking and

negotiation, pre-shipment export finance, export bills for collections, invoice financing, and all

the relevant document preparation.

Despite this focus on the LC, over the years the term trade finance has been shifting away from

this sometimes cumbersome method of conducting business. It is now estimated that over 80%

of global trade is conducted on an open account basis.

Factoring & Forfaiting

Factoring, or invoice discounting, receivables factoring or debtor financing, is where a

company buys a debt or invoice from another company. In this purchase, accounts receivable are

discounted in order to allow the buyer to make a profit upon the settlement of the debt.

Essentially factoring transfers the ownership of accounts to another party that then chases up the

debt.

Factoring therefore relieves the first party of a debt for less than the total amount providing them

with working capital to continue trading, while the buyer, or factor, chases up the debt for the

full amount and profits when it is paid. The factor is required to pay additional fees, typically a

small percentage, once the debt has been settled. The factor may also offer a discount to the

indebted party.

Forfaiting (note the spelling) is the purchase of an exporter's receivables – the amount

importers owe the exporter – at a discount by paying cash. The purchaser of the receivables, or

forfaiter, must now be paid by the importer to settle the debt.

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As the receivables are usually guaranteed by the importer's bank, the forfaiter frees the exporter

from the risk of non-payment by the importer. The receivables have then become a form of debt

instrument that can be sold on the secondary market as bills of exchange or promissory notes.

Structured Commodity Finance

Structured commodity finance (SCF) as covered by Trade Finance is split into three main

commodity groups: metals & mining, energy, and soft commodities (agricultural crops). It is a

financing technique utilised by commodity producers and trading companies conducting

business in the emerging markets.

SCF provides liquidity management and risk mitigation for the production, purchase and sale

of commodities and materials. This is done by isolating assets, which have relatively predictable

cash flow attached to them through pricing prediction, from the corporate borrower and using

them to mitigate risk and secure credit from a lender. A corporate therefore borrows against a

commodity’s expected worth.

If all proceeds to plan then the lender is reimbursed through the sale of the assets. If not then the

lender has recourse to some or all of the assets. Volatility in commodity prices can make SCF a

tricky business. Lenders charge interest any funds disbursed as well as fees for arranging the

transaction.

SCF funding techniques include pre-export finance, countertrade, barter, and inventory

finance. These solutions can be applied across part or all of the commodity trade value chain:

from producer to distributor to processor, and the physical traders who buy and deliver

commodities.

As a financing technique based on performance risk, it is particularly well-suited for emerging

markets considered as higher risk environments.

Export & Agency Finance

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This part of Trade Finance’s remit covers the roles of the export credit agencies, the

development banks, and the multilateral agencies. Their traditional role is complement lending

by commercial banks at interest by guaranteeing payment.

These agencies have once again become of vital importance to the trade finance market due to

the role that they play in facilitating trade, insuring transactions, promoting exports, creating

jobs, and increasingly through direct lending. All are important in the current global downturn.

ECAs are private or governmental institutions that provide export finance, or credit insurance

and guarantees, or both. ECAs can have very different mandates which we will not delve into

here (please refer to Trade Finance’s annual World Official Agency Guide). As the global

economic crisis continues we are seeing a trend towards a liberalisation of these agencies’

remits.

The development banks, sometimes referred to as DFIs (development finance institutions), and

the multilaterals similarly have different mandates depending on their ownership or regional

remit. Most will have a form of trade facilitation programme that promotes trade through the

provision of guarantees.

ECAs and multilaterals are becoming a crucial part of the financing of large infrastructure

projects around the world as credit from commercial banks remains scarce.

And the rest…

It doesn’t stop there, Trade Finance also follows: the trade credit insurance and political risk

insurance markets – an important part of doing business in developing economies; the

syndications market as banks and agencies lend funds to enable the trade finance activities of

other institutions; Islamic trade finance through its increasing popularity and expansion beyond

its historic markets; and finally Trade Finance follows the changes in global regulations and

tracks the law firms and in-house legal teams that contribute to making deals happen.

…………………..

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What are Long-Term Business Loans?

Bank term loans usually carry fixed maturities and interest rates as well as a monthly or quarterly

repayment schedule. The long-term loan usually has a maturity of 3-10 years although long-term

bank loans can stretch out as far as 20 years depending on its purpose.

Long-term bank loans are always supported by a company's collateral, usually in the form of the

company's assets

For example, the bank may specify that the company cannot take on more debt during the life of

the long-term loan. Long-term loans are usually repaid by the company's cash flow over the life

of the loan or by a certain percentage of profits that are set aside for this purpose.

Types of long term lending:

1. Term loan

2. Trade finance/ Letter of credit

1.Term Loan:

A bank loan to a company, with a fixed maturity and often featuring amortization of principal. If

this loan is in the form of a line of credit, the funds are drawn down shortly after the agreement is

signed. Otherwise, the borrower usually uses the funds from the loan soon after they become

available. Bank term loans are very a common kind of lending.

First Steps

What do banks look for when making decisions about term loans? Well, the "five C's" continue

to be of utmost importance.

Character: How have you managed other loans (business and personal)? What is your

business experience? "If a corporate executive wants to open a restaurant, then he'd better

have restaurant experience," says Rob Fazzini, senior vice president at Busey Bank in

Illinois.

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Credit capacity: The bank will conduct a full credit analysis, including a detailed review

of financial statements and personal finances to assess your ability to repay.

Collateral: This is the primary source of repayment. Expect the bank to want this source

to be larger than the amount you're borrowing.

Capital: What assets do you own that can be quickly turned into cash if necessary? The

bank wants to know what you own outside of the business-bonds, stocks, apartment

buildings-that might be an alternate repayment source. If there is a loss, your assets are

tapped first, not the bank's. Or, as one astute businessman puts it, "Banks like to lend to

people who already have money." You will most likely have to add a personal guarantee

to all of that, too.

Comfort/confidence with the business plan: How accurate are the revenue and expense

projections? Expect the bank to make a detailed judgment. What is the condition of the

economy and the industry: "Are you selling buggy whips or computers?" Fazzini asks.

What is the purpose of term loans

There are various purposes for which a bank will provide a term loan. There is a list of reasons why this is done and the borrower has to ensure that the reason that they seek a loan for is one of it. Some of the common reasons listed by the banks include:

* To help retire high cost debt for a business* To provide an impetus to the research and development activities within an entity* To shore up the net worth of a business* To build assets for a business* To help grow a business through strategic investments* To strengthen the asset base

Term loans basics

Term loans are one of the most common routes used by entities to raise funds. These funds are then used for the business in various ways. One big area of lending in case of term loans is the loans given to small-scale enterprises and businesses that are typically run by individuals or even firms and companies. Term loans form a significant part of the lending process of an entity and this is the reason why it requires attention.

What distinguishes term loans from other borrowings is its tenure. Various other loan options available are short term where the time period is usually around a year and has to be renewed thereafter. But term loans have slightly longer time period. It is common to find term loans for a period of 3 years. This is the time frame that will help a business to make proper use of the funds made available.

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2. Trade Finance/ Letter of Credit

Trade Finance: The science that describes the management of money, banking, credit,

investments and assets for international trade transactions

A letter of credit is the most widely used trade finance instrument in the world. It has been used

for the last several hundred years and is considered a highly effective way for banks to transact

and finance export and import trade. The letter of credit is a formal bank letter, issued for a

bank's customer, which authorizes an individual or company to draw drafts on the bank under

certain conditions. It is an instrument through which a bank furnishes its credit in place of its

customer's credit. The bank plays an intermediary role to help complete the trade transaction.

The bank deals only in documents and does not inspect the goods themselves.

Role of Banks in Documentary Letters of Credit

Compared to other payment forms, the role of banks is substantial in documentary Letter of

Credit transactions.

The banks provide additional security for both parties in a trade transaction by playing

the role of intermediaries. The issuing bank working for the importer and the advising

bank working for the exporter.

The banks assure the seller that he would be paid if he provides the necessary documents

to the issuing bank through the advising bank.

The banks also assure the buyer that his money would not be released unless the shipping

documents evidencing proper and accurate shipment of goods are presented.

Types of Letters of Credit - 1

A letter of credit may be of two forms: Revocable or Irrevocable

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Revocable L/C

This is one that permits amendments or cancellations any time by the issuing bank. This means

that the exporter can not count on the terms indicated on the initial document until such a time as

he is paid. This form is rarely in use in modern day trade transactions.

Irrevocable L/C

Such a letter of credit cannot be changed unless both buyer and seller agree to make changes.

Usually an L/C is regarded as irrevocable unless otherwise specified. Therefore, in effect, all the

parties to the letter of credit transaction, i.e. the issuing bank, the seller and the buyer, must agree

to any amendment to or cancellation of the letter of credit. Irrevocable letters of credit are

attractive to both the seller and the buyer because of the high degree of involvement and

commitment by the bank(s). By the 1993 revision of the UCP, credits are deemed irrevocable,

unless there is an indication to the contrary.

Types of Letters of Credit - 2

A letter of credit may be of two forms: Confirmed or Unconfirmed.

Confirmed L/C

If the exporter is uncomfortable with the credit risk of the issuing bank or if the country where

the issuing bank is situated is less developed or politically unstable, then as an extra measure, the

exporter can request that the L/C to be confirmed. This would add further comfort to the

transaction; an exporter may request that the L/C be confirmed. This is generally by a first class

international bank, typically the advising bank (now the Confirming Bank). This bank now takes

the responsibility of making payments if no remittance is received from the issuing bank on due

date.

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Unconfirmed L/C

In contrast, an unconfirmed credit does not require the advising bank to add its own payment

undertaking. It therefore leaves the liability seller with the issuing bank. The advising bank is

merely as a channel of transmission of documents and payment.

Methods of Settlement

The documentary letters of credit can be opened in two ways:

1. Sight Letter of Credit: A Sight Letter of Credit is a credit in which the seller obtains

payment upon presentation of documents in compliance with the terms and conditions.

2. Time Draft or Usance Letter of Credit: A Time Draft or Usance Letter of Credit is a

credit in which the seller will be paid a fixed or determinable future time. A time Draft or

usance letter of credit calls for time or usance drafts to be drawn on and accepted by the

buyer, provided that documents are presented in good order. The buyer is obligated to

pay the face amount at maturity. However, the issuing bank's obligation to the seller

remains in force until and unless the draft is paid.

Financing Importers through Letters of Credit

While the L/C can be used as a payment mechanism, it can also be used to provide financing to

the applicant (importer). Deferred and Acceptance credits (i.e. term credits) are considered to be

financing instruments for the importer/buyer. Both payment structures provide the

importer/buyer the time opportunity to sell the goods and pay the amount due with the proceeds.

Under the Deferred Payment structure payment is made to the seller at a specified future date, for

example 60 days after presentation of the documents or after the date of shipment (i.e. the date of

the bill of lading).

Under the Acceptance structure the exporter is required to draw a draft (bill of exchange) either

on the issuing or confirming bank. The draft is accepted by the bank for payment at a negotiated

future fixed date. This gives the importer the potential time needed to sell the product and pay off

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the Acceptance at due date. For example, payment date under an acceptance credit may be at

sight or after 90 days from presentation of the documents or from the shipment of goods.

Special Note on Documentary Letters of Credit

Documentary Letters of Credit hinge much on the appropriateness of documents. Banks involved

in the transaction do not need to know about the physical state of the goods in question but

concern themselves only with documents. If proper documents are presented, banks will make

payment whether or not the actual goods shipped comply with the sales contract.

Thus, special care needs to be taken in preparation of the documents since a slight omission or

discrepancy between required and actual documents may cause additional costs, delays and

seizures or even total abortion of the entire deal.

(1) Documents associated with an L/C

Documents are the key issue in a letter of credit transaction. Banks deal in documents, not in

goods. They decide on the basis of documents alone whether payment, negotiation, or acceptance

is to be effected. A single transaction can require many different kinds of documents. Most letter

of credit transactions involve a draft, an invoice, an insurance certificate, and a bill of lading.

Transactions can culminate in sight drafts or acceptances. Because letter of credit transactions

can be so complicated and can involve so many parties, banks must ensure that their letters are

accompanied by the proper documents, that those documents are accurate, and that all areas of

the bank handle them properly.

The four primary types Documents associated with an L/C are as follows:

Transfer documents

Insurance documents

Commercial documents

Other documents

Transfer documents are issued by a transportation company when moving the merchandise from

the seller to the buyer. The most common transfer document is the Bill of lading. The bill of

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lading is a receipt given by the freight company to the shipper. A bill of lading serves as a

document of title and specifies who is to receive the merchandise at the designated port (as

specified by the exporter). It can be in nonnegotiable form (straight bill of lading) or in

negotiable form (order bill of lading). In a straight bill of lading, the seller (exporter) consigns

the goods directly to the buyer (importer). This type of bill is usually not desirable in a letter of

credit transaction, because it allows the buyer to obtain possession of the merchandise without

regard to any bank agreement for repayment. A straight bill of lading may be more suitable for

prepaid or open account transactions. With an order bill of lading the shipper can consign the

goods to the bank, which retains title until the importer acknowledges liability to pay. This

method is preferred in documentary or letter of credit transactions. The bank maintains control of

the merchandise until the buyer completes all the required documentation. The bank then

releases the bill of lading to the buyer, who presents it to the shipping company and gains

possession of the merchandise.

Insurance documents, normally an insurance certificate, cover the merchandise being shipped

against damage or loss. The terms of the merchandise contract may dictate that either the seller

or the buyer obtain insurance. Open policies may cover all shipments and provide for certificates

on specific shipments.

Commercial documents, principally the invoice, are the seller's description of the goods shipped

and the means by which the buyer gains assurances that the goods shipped are the same as those

ordered. Among the most important commercial documents are the invoice and the draft or bill

of exchange. Through the invoice, the seller presents to the buyer a statement describing what

has been sold, the price, and other pertinent details. The draft supplements the invoice as the

means by which the seller charges the buyer for the merchandise and demands payment from the

buyer, the buyer's bank, or some other bank. Although a draft and a check are very similar, the

writer of a draft demands payment from another party's account.

In a letter of credit, the draft is drawn by the seller, usually on the issuing, confirming, or paying

bank, for the amount of money due under the terms of the letter of credit. In a collection, this

demand for payment is drawn on the buyer. The customary parties to a draft, which is a

negotiable instrument, are the drawer (usually the exporter), the drawee (the importeror a bank),

Anam Rauf (GCUF) 19

Lending Notes

and the payee (usually the exporter), who is also the endorser. A draft can be "clean" (an order to

pay) or "documentary" (with shipping documents attached).

A draft that is negotiable:

Is signed by the maker or drawer

Contains an unconditional promise to pay a certain sum of money

Is payable on demand or at a definite time

Is payable to order or to bearer

Is two-name paper

May be sold and ownership transferred by endorsement to the "holder in due course."

The holder in due course has recourse to all previous endorsers if the primary obligor (drawee)

does not pay. The seller (drawer) is the secondary obligor if the endorser does not pay. The

secondary obligor has an unconditional obligation to pay if the primary obligor and the endorser

do not, therefore the term "two-name paper."

Other documents include certain official documents that may be required by governments in

order to regulate and control the passage of goods through their borders. Governments may

require inspection certificates, consular invoices, or certificates of origin. Transactions can entail

notes and advances collateralized by trust receipts or warehouse receipts.

Purpose of borrowing

The money being borrowed can be used for number different reasons. For example, you can use

this money to purchase new equipment that is needed, purchasing additional inventory or

materials, hiring employees, covering payday, etc.

For example, think about how you are going to use the funds borrowed:

-Are you looking to start your business and get things going?

-Do you have a business but are now looking to expand?

Anam Rauf (GCUF) 20

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-Do you just need a little help with this months payroll?

-Have you considered other financing to cover the funds you need?

Classification of loan:

Secured, unsecured/clean, asset-backed

Funded and non-funded facilities/direct and contingent

Size-Corporate, Commercial, SME

Secured loan:

A secured loan is a loan in which the borrower pledges some asset (e.g. a car or property) as

collateral for the loan, which then becomes a secured debt owed to the creditor who gives the

loan. The debt is thus secured against the collateral — in the event that the borrower defaults, the

creditor takes possession of the asset used as collateral and may sell it to regain some or all of the

amount originally lent to the borrower, for example, foreclosure of a home. From the creditor's

perspective this is a category of debt in which a lender has been granted a portion of the bundle

of rights to specified property. If the sale of the collateral does not raise enough money to pay off

the debt, the creditor can often obtain a deficiency judgment against the borrower for the

remaining amount. The opposite of secured debt/loan is unsecured debt, which is not connected

to any specific piece of property and instead the creditor may only satisfy the debt against the

borrower rather than the borrower's collateral and the borrower. Generally speaking, secured debt

may attract lower interest rates than unsecured debt due to the added security for the lender,

however, credit history, ability to repay, and expected returns for the lender are also factors

affecting rates

Purpose

There are two purposes for a loan secured by debt. In the first purpose, by extending the loan

through securing the debt, the creditor is relieved of most of the financial risks involved because

it allows the creditor to take the property in the event that the debt is not properly repaid. In

exchange, this permits the second purpose where the debtors may receive loans on more

Anam Rauf (GCUF) 21

Lending Notes

favorable terms than that available for unsecured debt, or to be extended credit under

circumstances when credit under terms of unsecured debt would not be extended at all. The

creditor may offer a loan with attractive interest rates and repayment periods for the secured

debt.

Types of secured loan.

A mortgage loan is a secured loan in which the collateral is property, such as a home.

A nonrecourse loan is a secured loan where the collateral is the only security or claim

the creditor has against the borrower, and the creditor has no further recourse against the

borrower for any deficiency remaining after foreclosure against the property.

A foreclosure is a legal process in which mortgaged property is sold to pay the debt of

the defaulting borrower.

A repossession is a process in which property, such as a car, is taken back by the creditor

when the borrower does not make payments due on the property. Depending on the

jurisdiction, it may or may not require a court order.

Unsecured debt

In finance, unsecured debt refers to any type of debt or general obligation that is not

collateralized by a lien on specific assets of the borrower in the case of a bankruptcy or

liquidation or failure to meet the terms for repayment.

In the event of the bankruptcy of the borrower, the unsecured creditors will have a general claim

on the assets of the borrower after the specific pledged assets have been assigned to the secured

creditors, although the unsecured creditors will usually realize a smaller proportion of their

claims than the secured creditors.

In some legal systems, unsecured creditors who are also indebted to the insolvent debtor are able

(and in some jurisdictions, required) to set-off the debts, which actually puts the unsecured

creditor with a matured liability to the debtor in a pre-preferential position.

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Loan Scheme for Corporate

The Bank finances the corporate sector for its business activity and for setting up units,

modernisation, diversification and upgradation.

Such finance is extended in the form of

Funded facilities

Non Funded facilities

Funded facilities

1. Term Loans :

Repayment in instalments over a fixed time.

Purpose : For acquisition of fixed assets / machinery or for financing projects.

Amount of Loan : Generally 75% of the cost of maintaining a margin of 25%.

Rate of Interest : check current interest rate

Security : Charge on assets.

2. Cash Credit :

Running account facility.

Purpose :To meet working capital requirements.

Amount of facility : Based upon the Bank's assessment of the working capital

requirement.

Rate of Interest : ….

Security : Charge on current assets, collaterals if required.

3. Bill Discounting :

In the nature of post sales limit.

Amount of facility : Generally upto a specified percentage of the value of the bill.

Discounting under : L/C or firm order.

Rate of Interest :

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4.

5. Security : Charge on the Bill, Collateral if required.

Non Funded facilities

Letter of Credit facility to facilitate purchase of material / goods.

Letter of Guarantor facility for the issuance of Guarantee in the nature of bid bonds,

performance bonds, etc.

For finance of International trade, the Bank provides Working Capital facility to

Exporters

Importers

For Exporters

Working Capital finance can be availed at

Pre-shipment stage

Post shipment stage

At the pre-shipment stage finance is provided in the form of Packing Credit Purpose

For procuring / manufacturing of goods meant for export.

Amount of Packing Credit : Upto 90% of FOB value of goods.

Rate of Interest : Click here to view the Interest Rate

Security : Charge on assets created out of finance.

Repayment: From Export proceeds, Proceeds of negotiation / Discounting of Export

Bills.

At the post shipment stage export finance is provided by way of

Negotiation / Discounting of Export Bills,

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Rupee advances against collection bills,

Advance against Export incentive.

The advances are repayable from Export proceeds or receivable and carry interest rate in

conformity with RBI guidelines.

Export finance is also provided in foreign currency at internationally competitive interest

rates. Interest Rates is linked to LIBOR and is subject to maximum LIBOR + 1.5% . Finance

in foreign currency is extended by way of Pre shipment Credit in foreign currency at the

preshipment stage and Discounting of Export Bill in foreign currency at the post shipment

stage.

For Importers

For Importers Funded Working Capital finance by way of cash credit facility and non funded

Working Capital finance by way of Import Letter of Credit facility is provided to corporate

who are importers.

Foreign Currency Lending

The Bank also extends short term foreign currency loans to importers / Resident

Constituents. This enables accessing of finance at internationally competitive interest rate

linked to LIBOR.

Direct loan: a loan by a lender to a customer without the use of a third party; direct lending

gives the lender greater discretion in making loans

Contingent loan: A contingent loan is a loan that depends on financial ability to pay it back

--------------------------

Anam Rauf (GCUF) 25

Lending Notes

Individual/Consumer Borrower:

Type of products

Overdrafts, loans, revolving credit

Credit Cards

Leasing

Mortgage

Overdraft

An overdraft occurs when money is withdrawn from a bank account and the available balance

goes below zero. In this situation the account is said to be "overdrawn". If there is a prior

agreement with the account provider for an overdraft, and the amount overdrawn is within the

authorized overdraft limit, then interest is normally charged at the agreed rate. If the negative

balance exceeds the agreed terms, then additional fees may be charged and higher interest rates

may apply.

Reasons for overdrafts

Overdrafts occur for a variety of reasons. These may include:

Intentional short-term loan - The account holder finds themselves short of money and

knowingly makes an insufficient-funds debit. They accept the associated fees and cover

the overdraft with their next deposit.

Failure to maintain an accurate account register - The account holder doesn't

accurately account for activity on their account and overspends through negligence.

ATM overdraft - Banks or ATMs may allow cash withdrawals despite insufficient

availability of funds. The account holder may or may not be aware of this fact at the time

of the withdrawal. If the ATM is unable to communicate with the cardholder's bank, it

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Lending Notes

may automatically authorize a withdrawal based on limits preset by the authorizing

network.

Temporary Deposit Hold - A deposit made to the account can be placed on hold by the

bank. This may be due to Regulation CC (which governs the placement of holds on

deposited checks) or due to individual bank policies. The funds may not be immediately

available and lead to overdraft fees.

Unexpected electronic withdrawals - At some point in the past the account holder may

have authorized electronic withdrawals by a business. This could occur in good faith of

both parties if the electronic withdrawal in question is made legally possible by terms of

the contract, such as the initiation of a recurring service following a free trial period. The

debit could also have been made as a result of a wage garnishment, an offset claim for a

taxing agency or a credit account or overdraft with another account with the same bank,

or a direct-deposit chargeback in order to recover an overpayment.

Security

There are a wide variety of securities that banks will accept to sanction the overdraft facility. One point is that the securities and the details of applicability will vary across banks, depending upon what each bank has decided. Also, each borrower has to carefully look at what is applicable to them

Overdraft basics

Taking a loan every time there is a requirement of funds is not an easy task as far as any business is concerned. This calls for the presence of some security which on being deposited with the bank, will the funds be made available for the business. Instead of looking for loans and expecting to raise money in this manner, there is a better way for dealing with this kind of situation. Here, an investor can earn returns on his/her investment just like a normal investment and at the same time use this investment as a means to raise funds that can be used for the business.

An overdraft facility calls for using some investment of the borrower as a security and then providing a facility to borrow against this amount. There is a specific amount that is allowed as the borrowing. The security earns the normal rate of return for the investor and at the same time provides additional finance facility. The good part of the entire exercise is that the borrowers will pay interest only for the time period for which they have borrowed the amount and that too for the specific amount for which they have overdrawn the account.

Revolving credit

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Revolving credit is a type of credit that does not have a fixed number of payments, in contrast to

installment credit. Examples of revolving credits used by consumers include credit cards.

Corporate revolving credit facilities are typically used to provide liquidity for a company's day-

to-day operations. They were first introduced by the Strawbridge and Clothier Department Store.[1]

Characteristics of revolving credit:

A revolving loan facility provides a borrower with a maximum aggregate amount of capital,

available over a specified period of time. However, unlike a term loan, the revolving loan facility

allows the borrower to drawdown, repay and re-draw loans advanced to it of the available capital

during the term of the facility. Each loan is borrowed for a set period of time, usually one, three

or six months, after which time it is technically repayable. Repayment of a revolving loan is

achieved either by scheduled reductions in the total amount of the facility over time, or by all

outstanding loans being repaid on the date of termination. A revolving loan made to refinance

another revolving loan which matures on the same date as the drawing of the second revolving

loan is known as a "rollover loan", if made in the same currency and drawn by the same

borrower as the first revolving loan. The conditions to be satisfied for drawing a rollover loan are

typically less onerous than for other loans.[2]

A revolving loan facility is a particularly flexible financing tool as it may be drawn by a

borrower by way of straightforward loans, but it is also possible to incorporate different types of

financial accommodation within it - for example, it is possible to incorporate a letter of credit

facility, swingline facility or overdraft facility within the terms of a revolving credit facility. This

is often achieved by creating a sublimit within the overall revolving facility, allowing a certain

amount of the lenders' commitment to be drawn in the form of these different facilities.

Credit card:

A credit card is a small plastic card issued to users as a system of payment. It allows its holder

to buy goods and services based on the holder's promise to pay for these goods and services.[1]

The issuer of the card creates a revolving account and grants a line of credit to the consumer (or

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Lending Notes

the user) from which the user can borrow money for payment to a merchant or as a cash advance

to the user.

A credit card is different from a charge card : a charge card requires the balance to be paid in full each month.[2] In contrast, credit cards allow the consumers a continuing balance of debt, subject to interest being charged. A credit card also differs from a cash card, which can be used like currency by the owner of the card. Most credit cards are issued by banks or credit unions, and are the shape and size specified by the ISO/IEC 7810 standard as ID-1. This is defined as 85.60 × 53.98 mm (33/8 × 21/8 in) in size.[3]

How credit cards work

Credit cards are issued by a credit card issuer, such as a bank or credit union, after an account has been approved by the credit provider, after which cardholders can use it to make purchases at merchants accepting that card. Merchants often advertise which cards they accept by displaying acceptance marks – generally derived from logos – or may communicate this orally, as in "We take (brands X, Y, and Z)" or "We don't take credit cards".

When a purchase is made, the credit card user agrees to pay the card issuer. The cardholder indicates consent to pay by signing a receipt with a record of the card details and indicating the amount to be paid or by entering a personal identification number (PIN). Also, many merchants now accept verbal authorizations via telephone and electronic authorization using the Internet, known as a card not present transaction (CNP).

Electronic verification systems allow merchants to verify in a few seconds that the card is valid and the credit card customer has sufficient credit to cover the purchase, allowing the verification to happen at time of purchase. The verification is performed using a credit card payment terminal or point-of-sale (POS) system with a communications link to the merchant's acquiring bank. Data from the card is obtained from a magnetic stripe or chip on the card; the latter system is called Chip and PIN in the United Kingdom and Ireland, and is implemented as an EMV card.

For card not present transactions where the card is not shown (e.g., e-commerce, mail order, and telephone sales), merchants additionally verify that the customer is in physical possession of the card and is the authorized user by asking for additional information such as the security code printed on the back of the card, date of expiry, and billing address.

Each month, the credit card user is sent a statement indicating the purchases undertaken with the card, any outstanding fees, and the total amount owed. After receiving the statement, the cardholder may dispute any charges that he or she thinks are incorrect (see 15 U.S.C. §   1643 , which limits cardholder liability for unauthorized use of a credit card to $50, and the Fair Credit Billing Act for details of the US regulations). Otherwise, the cardholder must pay a defined minimum proportion of the bill by a due date, or may choose to pay a higher amount up to the entire amount owed. The credit issuer charges interest on the amount owed if the balance is not paid in full (typically at a much higher rate than most other forms of debt). In addition, if the credit card user fails to make at least the minimum payment by the due date, the issuer may

Anam Rauf (GCUF) 29

Lending Notes

impose a "late fee" and/or other penalties on the user. To help mitigate this, some financial institutions can arrange for automatic payments to be deducted from the user's bank accounts, thus avoiding such penalties altogether as long as the cardholder has sufficient funds.

Parties involved

Cardholder: The holder of the card used to make a purchase; the consumer.

Card-issuing bank: The financial institution or other organization that issued the credit

card to the cardholder. This bank bills the consumer for repayment and bears the risk that

the card is used fraudulently. American Express and Discover were previously the only

card-issuing banks for their respective brands, but as of 2007, this is no longer the case.

Cards issued by banks to cardholders in a different country are known as offshore credit

cards.

Merchant: The individual or business accepting credit card payments for products or

services sold to the cardholder.

Acquiring bank : The financial institution accepting payment for the products or services

on behalf of the merchant.

Independent sales organization : Resellers (to merchants) of the services of the

acquiring bank.

Merchant account : This could refer to the acquiring bank or the independent sales

organization, but in general is the organization that the merchant deals with.

Credit Card association: An association of card-issuing banks such as Discover, Visa,

MasterCard, American Express, etc. that set transaction terms for merchants, card-issuing

banks, and acquiring banks.

Transaction network: The system that implements the mechanics of the electronic

transactions. May be operated by an independent company, and one company may

operate multiple networks.

Affinity partner: Some institutions lend their names to an issuer to attract customers that

have a strong relationship with that institution, and get paid a fee or a percentage of the

balance for each card issued using their name. Examples of typical affinity partners are

sports teams, universities, charities, professional organizations, and major retailers.

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Insurance providers: Insurers underwriting various insurance protections offered as

credit card perks, for example, Car Rental Insurance, Purchase Security, Hotel Burglary

Insurance, Travel Medical Protection etc.

Transaction steps

Authorization : The cardholder presents the card as payment to the merchant and the

merchant submits the transaction to the acquirer (acquiring bank). The acquirer verifies

the credit card number, the transaction type and the amount with the issuer (Card-issuing

bank) and reserves that amount of the cardholder's credit limit for the merchant. An

authorization will generate an approval code, which the merchant stores with the

transaction.

Batching: Authorized transactions are stored in "batches", which are sent to the acquirer.

Batches are typically submitted once per day at the end of the business day. If a

transaction is not submitted in the batch, the authorization will stay valid for a period

determined by the issuer, after which the held amount will be returned to the cardholder's

available credit (see authorization hold). Some transactions may be submitted in the batch

without prior authorizations; these are either transactions falling under the merchant's

floor limit or ones where the authorization was unsuccessful but the merchant still

attempts to force the transaction through. (Such may be the case when the cardholder is

not present but owes the merchant additional money, such as extending a hotel stay or car

rental.)

Clearing and Settlement: The acquirer sends the batch transactions through the credit

card association, which debits the issuers for payment and credits the acquirer.

Essentially, the issuer pays the acquirer for the transaction.

Funding: Once the acquirer has been paid, the acquirer pays the merchant. The merchant

receives the amount totaling the funds in the batch minus either the "discount rate," "mid-

qualified rate", or "non-qualified rate" which are tiers of fees the merchant pays the

acquirer for processing the transactions.

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Chargebacks: A chargeback is an event in which money in a merchant account is held

due to a dispute relating to the transaction. Chargebacks are typically initiated by the

cardholder. In the event of a chargeback, the issuer returns the transaction to the acquirer

for resolution. The acquirer then forwards the chargeback to the merchant, who must

either accept the chargeback or contest it.

Credit cards in ATMs

Many credit cards can also be used in an ATM to withdraw money against the credit limit

extended to the card, but many card issuers charge interest on cash advances before they do so on

purchases. The interest on cash advances is commonly charged from the date the withdrawal is

made, rather than the monthly billing date. Many card issuers levy a commission for cash

withdrawals, even if the ATM belongs to the same bank as the card issuer. Merchants do not

offer cashback on credit card transactions because they would pay a percentage commission of

the additional cash amount to their bank or merchant services provider, thereby making it

uneconomical.

3. Leasing

Leasing is a process by which a firm can obtain the use of a certain fixed assets for which it must

pay a series of contractual, periodic, tax deductible payments.

The lessee is the receiver of the services or the assets under the lease contract and the lessor is

the owner of the assets. The relationship between the tenant and the landlord is called a tenancy,

and can be for a fixed or an indefinite period of time (called the term of the lease). The

consideration for the lease is called rent. A gross lease is when the tenant pays a flat rental

amount and the landlord pays for all property charges regularly incurred by the ownership from

lawnmowers and washing machines to handbags and jewellry.[1]

A lease is an agreement between two parties, the "lessor" and the "lessee". The lessor owns a

capital asset, but allows the lessee to use it. The lessee makes payments under the terms of the

lease to the lessor, for a specified period of time.

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The lease finance facilities are available for a variety of assets (imported/local) conforming but not limited to the following categories:

1. Vehicles (Private & Commercial) 

2. Plant, Machinery and equipment 

3. CNG Equipment 

4. Generators(Industrial & Commercial)

Leasing is, therefore, a form of rental. Leased assets have usually been plant and machinery, cars

and commercial vehicles, but might also be computers and office equipment. There are two basic

forms of lease: "operating leases" and "finance leases".

Operating leases

Operating leases are rental agreements between the lessor and the lessee whereby:

a) the lessor supplies the equipment to the lessee

b) the lessor is responsible for servicing and maintaining the leased equipment

c) the period of the lease is fairly short, less than the economic life of the asset, so that at the end of the lease agreement, the lessor can either

i) lease the equipment to someone else, and obtain a good rent for it, orii) sell the equipment secondhand.

Finance leases

Finance leases are lease agreements between the user of the leased asset (the lessee) and a provider of finance (the lessor) for most, or all, of the asset's expected useful life.

Suppose that a company decides to obtain a company car and finance the acquisition by means of a finance lease. A car dealer will supply the car. A finance house will agree to act as lessor in a finance leasing arrangement, and so will purchase the car from the dealer and lease it to the company. The company will take possession of the car from the car dealer, and make regular payments (monthly, quarterly, six monthly or annually) to the finance house under the terms of the lease.

Other important characteristics of a finance lease:

a) The lessee is responsible for the upkeep, servicing and maintenance of the asset. The lessor is not involved in this at all.

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Lending Notes

b) The lease has a primary period, which covers all or most of the economic life of the asset. At the end of the lease, the lessor would not be able to lease the asset to someone else, as the asset would be worn out. The lessor must, therefore, ensure that the lease payments during the primary period pay for the full cost of the asset as well as providing the lessor with a suitable return on his investment.

c) It is usual at the end of the primary lease period to allow the lessee to continue to lease the asset for an indefinite secondary period, in return for a very low nominal rent. Alternatively, the lessee might be allowed to sell the asset on the lessor's behalf (since the lessor is the owner) and to keep most of the sale proceeds, paying only a small percentage (perhaps 10%) to the lessor.

Why might leasing be popular

The attractions of leases to the supplier of the equipment, the lessee and the lessor are as follows:

The supplier of the equipment is paid in full at the beginning. The equipment is sold to the

lessor, and apart from obligations under guarantees or warranties, the supplier has no further

financial concern about the asset.

The lessor invests finance by purchasing assets from suppliers and makes a return out of the

lease payments from the lessee. Provided that a lessor can find lessees willing to pay the amounts

he wants to make his return, the lessor can make good profits. He will also get capital allowances

on his purchase of the equipment.

Leasing might be attractive to the lessee:

i) if the lessee does not have enough cash to pay for the asset, and would have difficulty

obtaining a bank loan to buy it, and so has to rent it in one way or another if he is to have the use

of it at all; or

ii) if finance leasing is cheaper than a bank loan. The cost of payments under a loan might

exceed the cost of a lease.

Operating leases have further advantages:

The leased equipment does not need to be shown in the lessee's published balance sheet, and so

the lessee's balance sheet shows no increase in its gearing ratio.

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The equipment is leased for a shorter period than its expected useful life. In the case of high-

technology equipment, if the equipment becomes out-of-date before the end of its expected life,

the lessee does not have to keep on using it, and it is the lessor who must bear the risk of having

to sell obsolete equipment secondhand.

The lessee will be able to deduct the lease payments in computing his taxable profits.

Hire purchase

Hire purchase is a form of instalment credit. Hire purchase is similar to leasing, with the

exception that ownership of the goods passes to the hire purchase customer on payment of the

final credit instalment, whereas a lessee never becomes the owner of the goods.

Hire purchase agreements usually involve a finance house.

i) The supplier sells the goods to the finance house.

ii) The supplier delivers the goods to the customer who will eventually purchase them.

iii) The hire purchase arrangement exists between the finance house and the customer.

The finance house will always insist that the hirer should pay a deposit towards the purchase

price. The size of the deposit will depend on the finance company's policy and its assessment of

the hirer. This is in contrast to a finance lease, where the lessee might not be required to make

any large initial payment.

An industrial or commercial business can use hire purchase as a source of finance. With

industrial hire purchase, a business customer obtains hire purchase finance from a finance house

in order to purchase the fixed asset. Goods bought by businesses on hire purchase include

company vehicles, plant and machinery, office equipment and farming machinery.

5. Mortgage:

A mortgage loan is a loan secured by real property through the use of a mortgage note which

evidences the existence of the loan and the encumbrance of that realty through the granting of a

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Lending Notes

mortgage which secures the loan. However, the word mortgage alone, in everyday usage, is most

often used to mean mortgage loan.

The word mortgage is a Law French term meaning "death contract," meaning that the pledge

ends (dies) when either the obligation is fulfilled or the property is taken through foreclosure.[1]

A home buyer or builder can obtain financing (a loan) either to purchase or secure against the

property from a financial institution, such as a bank, either directly or indirectly through

intermediaries. Features of mortgage loans such as the size of the loan, maturity of the loan,

interest rate, method of paying off the loan, and other characteristics can vary considerably.

In many jurisdictions, though not all (Bali, Indonesia being one exception[2]), it is normal for

home purchases to be funded by a mortgage loan. Few individuals have enough savings or liquid

funds to enable them to purchase property outright. In countries where the demand for home

ownership is highest, strong domestic markets have developed.

Basic concepts

Property: the physical residence being financed. The exact form of ownership will vary

from country to country, and may restrict the types of lending that are possible.

Mortgage : the security interest of the lender in the property, which may entail

restrictions on the use or disposal of the property. Restrictions may include requirements

to purchase home insurance and mortgage insurance, or pay off outstanding debt before

selling the property.

Borrower : the person borrowing who either has or is creating an ownership interest in

the property.

Lender : any lender, but usually a bank or other financial institution. Lenders may also be

investors who own an interest in the mortgage through a mortgage-backed security. In

such a situation, the initial lender is known as the mortgage originator, which then

packages and sells the loan to investors. The payments from the borrower are thereafter

collected by a loan servicer.[3]

Principal: the original size of the loan, which may or may not include certain other costs;

as any principal is repaid, the principal will go down in size.

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Interest : a financial charge for use of the lender's money.

Foreclosure or repossession: the possibility that the lender has to foreclose, repossess or

seize the property under certain circumstances is essential to a mortgage loan; without

this aspect, the loan is arguably no different from any other type of loan.

Mortgage loan types

There are many types of mortgages used worldwide, but several factors broadly define the

characteristics of the mortgage. All of these may be subject to local regulation and legal

requirements.

Interest: interest may be fixed for the life of the loan or variable, and change at certain

pre-defined periods; the interest rate can also, of course, be higher or lower.

Term: mortgage loans generally have a maximum term, that is, the number of years after

which an amortizing loan will be repaid. Some mortgage loans may have no

amortization, or require full repayment of any remaining balance at a certain date, or even

negative amortization.

Payment amount and frequency: the amount paid per period and the frequency of

payments; in some cases, the amount paid per period may change or the borrower may

have the option to increase or decrease the amount paid.

Prepayment: some types of mortgages may limit or restrict prepayment of all or a

portion of the loan, or require payment of a penalty to the lender for prepayment.

The two basic types of amortized loans are the fixed rate mortgage (FRM) and adjustable-rate

mortgage (ARM) (also known as a floating rate or variable rate mortgage).

In many countries (such as the United States), floating rate mortgages are the norm and will

simply be referred to as mortgages. Combinations of fixed and floating rate are also common,

whereby a mortgage loan will have a fixed rate for some period, and vary after the end of that

period.

In a fixed rate mortgage, the interest rate, and hence periodic payment, remains fixed for

the life (or term) of the loan. Therefore the payment is fixed, although ancillary costs

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(such as property taxes and insurance) can and do change. For a fixed rate mortgage,

payments for principal and interest should not change over the life of the loan,

In an adjustable rate mortgage, the interest rate is generally fixed for a period of time,

after which it will periodically (for example, annually or monthly) adjust up or down to

some market index. Adjustable rates transfer part of the interest rate risk from the lender

to the borrower, and thus are widely used where fixed rate funding is difficult to obtain or

prohibitively expensive. Since the risk is transferred to the borrower, the initial interest

rate may be from 0.5% to 2% lower than the average 30-year fixed rate; the size of the

price differential will be related to debt market conditions, including the yield curve.

Value: appraised, estimated, and actual

Since the value of the property is an important factor in understanding the risk of the loan,

determining the value is a key factor in mortgage lending. The value may be determined in

various ways, but the most common are:

1. Actual or transaction value: this is usually taken to be the purchase price of the

property. If the property is not being purchased at the time of borrowing, this information

may not be available.

2. Appraised or surveyed value: in most jurisdictions, some form of appraisal of the value

by a licensed professional is common. There is often a requirement for the lender to

obtain an official appraisal.

3. Estimated value: lenders or other parties may use their own internal estimates,

particularly in jurisdictions where no official appraisal procedure exists, but also in some

other circumstances.

Foreclosure and non-recourse lending

In most jurisdictions, a lender may foreclose the mortgaged property if certain conditions -

principally, non-payment of the mortgage loan - occur. Subject to local legal requirements, the

property may then be sold. Any amounts received from the sale (net of costs) are applied to the

original debt. In some jurisdictions, mortgage loans are non-recourse loans: if the funds recouped

from sale of the mortgaged property are insufficient to cover the outstanding debt, the lender

Anam Rauf (GCUF) 38

Lending Notes

may not have recourse to the borrower after foreclosure. In other jurisdictions, the borrower

remains responsible for any remaining debt.

In virtually all jurisdictions, specific procedures for foreclosure and sale of the mortgaged

property apply, and may be tightly regulated by the relevant government. There are strict or

judicial foreclosures and non-judicial foreclosures, also known as power of sale foreclosures. In

some jurisdictions, foreclosure and sale can occur quite rapidly, while in others, foreclosure may

take many months or even years. In many countries, the ability of lenders to foreclose is

extremely limited, and mortgage market development has been notably slower.

Islamic concept:

Islamic Sharia law prohibits the payment or receipt of interest, meaning that Muslims cannot use

conventional mortgages. However, real estate is far too expensive for most people to buy

outright using cash: Islamic mortgages solve this problem by having the property change hands

twice. In one variation, the bank will buy the house outright and then act as a landlord. The

homebuyer, in addition to paying rent, will pay a contribution towards the purchase of the

property. When the last payment is made, the property changes hands.[citation needed]

Typically, this may lead to a higher final price for the buyers. This is because in some countries

(such as the United Kingdom and India) there is a Stamp Duty which is a tax charged by the

government on a change of ownership. Because ownership changes twice in an Islamic

mortgage, a stamp tax may be charged twice. Many other jurisdictions have similar transaction

taxes on change of ownership which may be levied. In the United Kingdom, the dual application

of Stamp Duty in such transactions was removed in the Finance Act 2003 in order to facilitate

Islamic mortgages.[15]

An alternative scheme involves the bank reselling the property according to an installment plan,

at a price higher than the original price.

Both of these methods compensate the lender as if they were charging interest, but the loans are

structured in a way that in name they are not, and the lender shares the financial risks involved in

the transaction with the homebuyer.

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Purpose of borrowing (see detail in your internship report) Personal use- running finance Property Automobile

Classification

Secured, unsecured/clean, asset-backed

Secured & unsecured loan ( as described above)

Asset backed loan:

An asset-backed security is a security whose value and income payments are derived from and

collateralized (or "backed") by a specified pool of underlying assets. The pool of assets is

typically a group of small and illiquid assets that are unable to be sold individually. Pooling the

assets into financial instruments allows them to be sold to general investors, a process called

securitization, and allows the risk of investing in the underlying assets to be diversified because

each security will represent a fraction of the total value of the diverse pool of underlying assets.

The pools of underlying assets can include common payments from credit cards, auto loans, and

mortgage loans, to esoteric cash flows from aircraft leases, royalty payments and movie

revenues.

b. Regulations and Practices

Relevant SBP laws for lending including: lending limits, exposure calculation, disclosure

and Reporting requirements

Prevalent market practices and bank policies with respect to lending products

Read following articles:

PRUDENTIAL REGULATIONS FOR CONSUMER FINANCING(Updated on January 31, 2011) (Page 1 to 25)

PRUDENTIAL REGULATIONS FOR CORPORATE /COMMERCIAL BANKING. (Updated on January 31, 2011) (page 1 to 73)

(For exposure/lending limit etc. study page 1 to 20)

Anam Rauf (GCUF) 40

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SBP SME Financing Products (For Lending product detail … see page 1 to 40, but Definition page 1 to 2 are most important)

----------------------

c. Pricing1. Calculation of pool rates and internal cost of funds

2. Structuring floating mark-up rates and their impact during change of interest rates

3. The basis for floating mark-up rates using:

Karachi Inter-bank Offer Rates (KIBOR), SBP Discount Rate and PIB Rates matching the facility tenor

4. Bank’s spread over cost of deposits relating to customer and transaction risks5. Methods and frequency of mark-up recovery and their impact on income recognition

(Oops …. Exact data is not found) Please Consult any Lending book.

Pool Rate is the overhead costs for a Homogeneous Cost Pool divided by the appropriate Cost

Driver associated with the pool.

Homogeneous Cost Pool is a group of overhead costs associated with activities that can use the

same Cost Driver.

Cost Driver is a factor that has a direct cause-effect relationship to a cost, such as direct labor

hours, machine hours, beds occupied, computer time used, flight hours, miles driven, or

contracts.

Loan rates:

The contractual loan rate is set at some mark-up over the base rate, so that interest income

varies directly with movements in the level of borrowing costs.

The magnitude of the mark-up reflects differences in perceived default and liquidity risk

associated with the borrower.

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Floating-rate loans are popular at banks because they increase the rate sensitivity of loans in

line with the increased rate sensitivity of bank liabilities.

Floating-rate loans:

increase the rate sensitivity of bank assets

increase the GAP

reduce potential net interest losses from rising interest rates

Because most banks operate with negative funding GAPs through one-year

maturities, floating-rate loans normally reduce a bank’s interest rate risk.

Given equivalent rates, most borrowers prefer fixed-rate loans in which the bank

assumes all interest rate risk.

Banks frequently offer two types of inducements to encourage floating-rate

pricing:

1. Floating rates are initially set below fixed rates for borrowers with a

choice

2. A bank may establish an interest rate cap on floating-rate loans to limit the

possible increase in periodic payments

KIBOR:

The karachi Interbank Offered Rate, or KIBOR, is the average interest rate at which term

deposits are offered between prime banks in the Pakistani wholesale money market or interbank

market.

It is Karachi Inter Bank Offer Rate (KIBOR), given by specialized institution on daily, weekly,

monthly and on 1, 2 and 3 yearly basis to all the commercial banks of Pakistan so that they

charge interest to their customers on that basis. This rate is inflation adjusted rate and then banks

by adding 2 or 3% in KIBOR rate charge their customers for their profit.

Daily current Kibor rate: …………

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SBP Discount rate: The central bank is scheduled to announce monetary policy for the period of

next two months on Friday (today) and it is expected that discount rate will stay unchanged at 12

per cent.

The offered rates for the Pakistan Investment Bonds (PIBs) have shot up to 13.11 percent as

compared with 12.7 percent last month.

-------------------------------------------------

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Chapter # 2Lending Risk Assessment and Management

Overview Fundamental concept of Risk Management Risk and the economic environment Corporate governance and organizational structure External reporting

b. Sources of lending risk Obligor Risk Obligor Business and industry risk – cycles, price trends of raw materials, price trends of competition products Transaction failure risk Other risks – political, economic, market, liquidity, foreign exchange, interest rate risk

c. Risk Assessment Financial analysis Market check Market research Compliance with regulation requirement Customer Integrity and capability

d. Risk Management Credit Policy Delinquency portfolio – trends and control measures Collection and Recovery – strategies and methods

Study following document …. Guidelines by SBP

Risk ManagementGuidelines for Commercial Banks & DFIs. (Page 1 to 42)

e. Types of collateral• Stated and implied lien over customer’s assets

• Hypothecation

• Assignment of receivables

• Pledge of paper securities

• Pledge of goods

• Mortgage of immovable assets

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Types of collateral

There is a wide range of possible collaterals used to collateralize credit exposure with various degrees of risks.

Implied lien

Implied lien is a lien which may be implied and declared by a court of equity out of general

considerations of right and justice as applied to the relations of the parties and the circumstances

of their dealings. It will be based upon the fundamental maxims of equity and it may be created

in the absence of an express contract.

The lien in favor of a vendor who has conveyed the legal title to real estate to a purchaser, as

security for the unpaid purchase money is an implied lien. The implied lien of a vendor is only

permitted as a security for an unpaid purchase price. Such an implied lien will not be enforced

when it would operate as a means of deception or in prejudice of good faith to those affected by

it.

Hypothecation

Hypothecation is the practice where a borrower pledges collateral to secure a debt. The

borrower retains ownership of the collateral, but it is "hypothetically" controlled by the creditor

in that he has the right to seize possession if the borrower defaults. A common example occurs

when a consumer enters into a mortgage agreement, in which the consumer's house becomes

collateral until the mortgage loan is paid off.

The detailed practice and rules regulating hypothecation vary depending on context and on the

jurisdiction where it takes place. In the US, the legal right for the creditor to take ownership of

the collateral if the debtor defaults is classified as a lien.

Rehypothecation is a practice that occurs principally in the financial markets, where a bank or

other broker-dealer reuses the collateral pledged by its clients as collateral for its own borrowing.

Hypothecation in consumer and business finance

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Hypothecation is a common feature of consumer contracts involving mortgages – the borrower

legally owns the house, but until the mortgage is paid off the creditor has the right to take

possession in the hypothetical case that the borrower fails to keep up with repayments.[1] If a

consumer takes out an additional loan secured against the value of his mortgage (approximately

the current value of the house minus outstanding repayments) the consumer is then

hypothecating the mortgage itself – the creditor can still seize the house but in this case the

creditor then becomes responsible for the outstanding mortgage debt. Sometimes consumer

goods and business equipment can be bought on credit agreements involving hypothecation – the

goods are legally owned by the borrower, but once again the creditor can seize them if required.

'Assignment of Accounts Receivable'

A lending agreement, often long term, between a borrowing company and a lending institution

whereby the borrower assigns specific customer accounts that owe money (accounts receivable)

to the lending institution. In exchange for assignment of accounts receivable, the borrower

receives a cash advance for a percentage of the accounts receivable. The borrower pays interest

and a service charge on the advance.

In other words,

If the borrower retains ownership of the accounts, then the borrower continues to collect the

accounts receivable and passes the payments on to the lender. Since the borrower retains

ownership, he also retains the risk that some accounts receivable will not be repaid. In this case,

the lending institution may demand payment directly from the borrower. This arrangement is

called assignment of accounts receivable with recourse. Assignment of accounts receivable

should not be confused with pledging or factoring of accounts receivable.

Disposition of A/R: Assignment and factoring

To shorten the cash-to-cash operating cycle (see diagram), a company may transfer the

receivables to another company or third party for cash:

Cash => purchase => sell goods => collect cash

Goods on account

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Firms may assign their receivables in a borrowing arrangement whereby the A/R serve as

collateral. Assignment can be of two types:

1. General assignment:

All of the receivables serve as collateral for the note (the borrowed funds). The company

records the following journal entry:

Cash....................x

Notes payable.............x

No journal entry is made to the A/R to record the assignment.

However, the arrangement should be disclosed parenthetically or in a note.

New A/R can be substituted for the ones collected during the loan period.

If the company fails to pay back the loan, the lender can seize the assigned A/R.

2. Specific assignment:

Specific A/R are assigned as collateral. (Under general assignment, only a general dollar amount

of A/R is assigned.)

The borrower and lender agree on the conditions:

(1) Who is to receive the collections

(2) The finance charges (in addition to any interest on the borrowed funds)

(3) The specific accounts that will serve as collateral

(4) Notification or non-notification of the account debtors

The following journal entries recognize the liability and reclassify the assigned A/R:

Cash..............................x

N/P......................................x

A/R (assigned)............x

A/R......................................x

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Pledge of paper securities

Definition of pledge of securities

Securities may be pledged such that the person for whose benefit the pledge is established has

the right to demand satisfaction of a claim out of the pledged securities.

Application of provisions concerning possessory pledge

The provisions concerning possessory pledge apply to a pledge of securities unless otherwise

provided by law.

Establishment of pledge on securities

(1) A pledge of bearer securities is created upon delivery of the securities to the pledgee.

(2) A pledge of other securities is created upon delivery of the securities on the basis of a written

pledge contract or endorsement.

Pledge of documents of title

(1) By pledging securities which grant rights in particular goods (document of title), the goods

are also pledged.

(2) If in addition to a document of title there is a special pledge instrument (warrant) and if the

document of title has a notation concerning the pledge which indicates the amount of debt and

due date of the claim, the pledge of the warrant is sufficient for establishment of a pledge on the

goods.

Representation of pledged shares

Pledged shares do not grant the pledgee the right to participate in a general meeting as a

shareholder. This right is retained by the shareholder.

Performance of claim upon pledge of registered securities and bearer securities

If bearer securities, bills of exchange or other securities which may be transferred by

endorsement are pledged, the pledgee has the right to submit a claim arising from the specified

securities regardless of the due date of the claim. The debtor shall perform the obligation of the

securities to the pledgee.

Pledge of paper securities as collateral:

By collateral security is meant stocks, bonds, and other evidences of property deposited by the

borrower to secure a loan made to him by the bank. Such securities are deposited as a pledge or

guarantee that the loan will be repaid at maturity; if not paid the securities may be sold to

reimburse the lender. Collateral loans though made generally to brokers on such security as

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stocks are made also to merchants and commercial houses, and all kinds of collateral are offered.

They may be made on "time," running for thirty days to several months, or on "call," that is,

subject to payment on demand. The various forms of collateral offered to secure bank loans may

be roughly grouped into three divisions: stocks and bonds, merchandise, and real estate. Some of

the more important types of collateral loans may now be briefly considered.

Pledge of goods

Pledging is defined as “Offering assets /stocks /goods to a lender as collateral for a loan”. Though the asset will be pledged to the lender, it it still owned by the borrower unless he/she defaults on the loan.

Pledge of Goods may be considered for use where a debt is owed or may in the future be owed

by a person, and additional security is required. By signing this Cession and Pledge of Goods,

the debtor agrees to transfer to the creditor the right to the goods being ceded or pledged should

the debtor default. The goods may include, for example, shares, Kruger Rands, or an investment

account

How mortgage, pledge and hypothecation are different to each other?MORTGAGE:

Mortgage as “the transfer of interest in specific immovable property for the purpose of securing

the payment of money, advanced or to be advanced by way of loan, an existing or future debt, or

the performance of an engagement which may give rise to a pecuniary liability”.

The transferor is called the ‘mortgagor,’ the transferee is a ‘mortgagee’. The principal money

and interest thereon, the payment of which is secured are called the ‘mortgage money’.

PLEDGE:

Pledge as “bailment of goods as security for payment of a debt or performance of a promise”.

The person who offers the security is called ‘pawner’ or ‘pledger’ and the bailee is called the

‘pawnee’ or ‘pledgee’.

In case of pledge:

There should be bailment of goods; and

the objective of the bailment should be to hold the goods as security for the payment of a

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Lending Notes

debt or the performance of a promise. The bailment should be on behalf of a debtor or an

intending debtor.

The pawner or pledger remains the owner of the property except to the extent of interest

which rests with the pledge because of the loan borrowed from the bank.

There is actual or constructive delivery of goods.

Pledge is not created in respect of future goods. The goods must be specific and be

capable of identification.

The goods must be in possession of pledgee. Otherwise there is no pledge.

Pledge agreement may be oral or implied.

HYPOTHECATION:

Hypothecation is a charge against property for an amount of debt where neither ownership nor

possession is passed to the creditor. Hypothecation is a charge against movable property. The

goods will, unlike a pledge, be retained by the borrower and be in the borrower’s possession. The

borrower gives only a letter stating that the goods are hypothecated to the banker as security for

the loan granted. There will be no transfer of the property to the borrower.

Features:

It is an equitable charge created against immovable property.

Neither the possession nor the ownership of the property is transferred to the banker.

The contents of the letter of hypothecation determine the rights of the banker.

The banker has the right to take possession of the property (if there is default) and sell the

hypothecated goods to realize his dues.

If selling rights are not incorporated in the letter, the banker has to approach a court of

law to recover the dues against the hypothecated property.

Hypothecated goods can be sold any time to the genuine purchaser for value without the

knowledge of the banker or the hypothecated property can be pledged to another person

provided the pledgee has no knowledge of the previous hypothecation.

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Mortgage of immovable assets

A mortgage loan is a loan secured by real property through the use of a mortgage note which

evidences the existence of the loan and the encumbrance of that realty through the granting of a

mortgage which secures the loan. However, the word mortgage alone, in everyday usage, is most

often used to mean mortgage loan.

The word mortgage is a Law French term meaning "death contract," meaning that the pledge

ends (dies) when either the obligation is fulfilled or the property is taken through foreclosure.

A home buyer or builder can obtain financing (a loan) either to purchase or secure against the

property from a financial institution, such as a bank, either directly or indirectly through

intermediaries.

Features of mortgage loans such as the size of the loan, maturity of the loan, interest rate, method

of paying off the loan, and other characteristics can vary considerably.

How Mortgages Work

In simple terms, a mortgage is a loan in which your house functions as the collateral. The bank

or mortgage lender loans you a large chunk of money (typically 80 percent of the price of the

home), which you must pay back -- with interest -- over a set period of time. If you fail to pay

back the loan, the lender can take your home through a legal process known as foreclosure.

(See detail of Legal process taken by bank in case of default in IBP journal)

------------------------------------------

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Chapter # 3

Documentation and Collateral

a. Different types of financing agreements Project financing Account receivable financing Lease financing

Project financing

Project finance is the long term financing of infrastructure and industrial projects based upon the projected cash flows of the project rather than the balance sheets of the project sponsors. Usually, a project financing structure involves a number of equity investors, known as sponsors, as well as a syndicate of banks or other lending institutions that provide loans to the operation.

The loans are most commonly non-recourse loans, which are secured by the project assets and paid entirely from project cash flow, rather than from the general assets or creditworthiness of the project sponsors, a decision in part supported by financial modeling.

The financing is typically secured by all of the project assets, including the revenue-producing contracts. Project lenders are given a lien on all of these assets, and are able to assume control of a project if the project company has difficulties complying with the loan terms.

Project financing is an innovative and timely financing technique that has been used on many

high-profile corporate projects, including Euro Disneyland and the Eurotunnel. Employing a

carefully engineered financing mix, it has long been used to fund large-scale natural resource

projects, from pipelines and refineries to electric-generating facilities and hydro-electric projects.

Increasingly, project financing is emerging as the preferred alternative to conventional methods

of financing infrastructure and other large-scale projects worldwide.

Project Financing discipline includes understanding the rationale for project financing,

how to prepare the financial plan, assess the risks, design the financing mix, and raise the funds.

In addition, one must understand the cogent analyses of why some project financing plans have

succeeded while others have failed. A knowledge-base is required regarding the design of

contractual arrangements to support project financing; issues for the host government legislative

Anam Rauf (GCUF) 52

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provisions, public/private infrastructure partnerships, public/private financing structures; credit

requirements of lenders, and how to determine the project's borrowing capacity; how to prepare

cash flow projections and use them to measure expected rates of return; tax and accounting

considerations; and analytical techniques to validate the project's feasibility

Project finance is finance for a particular project, such as a mine, toll road, railway, pipeline,

power station, ship, hospital or prison, which is repaid from the cash-flow of that project. Project

finance is different from traditional forms of finance because the financier principally looks to

the assets and revenue of the project in order to secure and service the loan. In contrast to an

ordinary borrowing situation, in a project financing the financier usually has little or no recourse

to the non-project assets of the borrower or the sponsors of the project. In this situation, the

credit risk associated with the borrower is not as important as in an ordinary loan transaction;

what is most important is the identification, analysis, allocation and management of every risk

associated with the project.

Parties to a Project Financing

There are several parties in a project financing depending on the type and the scale of a project. The most usual parties to a project financing are;

1. Project company2. Sponsor3. Borrower4. Financial Adviser5. Technical Adviser6. Lawyer7. Debt financiers8. Equity Investors9. Regulatory agencies10. Multilateral Agencies11. Host government / grantor

Contractual Framework

The typical project finance documentation can be reconducted to four main types

Shareholder/sponsor documents Project documents Finance documents Other project documents

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Loan Agreement

An agreement between the project company (borrower) and the lenders. Loan agreement governs

relationship between the lenders and the borrowers. It determines the basis on which the loan can

be drawn and repaid, and contains the usual provisions found in a corporate loan agreement. It

also contains the additional clauses to cover specific requirements of the project and project

documents. Basic terms of a loan agreement include the following provisions.

General conditions precedent

Conditions precedent to each drawdown

Availability period, during which the borrower is obliged to pay a commitment fee

Drawdown mechanics

An interest clause, charged at a margin over base rate

A repayment clause

Financial covenants - calculation of key project metrics / ratios and covenants

Dividend restrictions

Representations and warranties

The illegality clause

See detail related its regulations & practices in law in following document:SBP Guidelines for Infrastructure Project Financing (IPF) ( Page 1 to 26)

-------------------

Account receivable financing

A type of asset-financing arrangement in which a company uses its receivables - which

is money owed by customers - as collateral in a financing agreement. The company receives an

amount that is equal to a reduced value of the receivables pledged. The age of the receivables

have a large effect on the amount a company will receive. The older the receivables, the less the

company can expect. Also referred to as "factoring".

Uses of Receivable financing:

Receivable financing allows you to improve cash flow and business output.

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Receivable financing is a tremendous source of immediate capital for your business.

It is a great solution for solving cash flow problems with a business, and also has tons of

distinct advantages over more traditional options like a standard business loan or a small

business line of credit.

With receivable financing you sell your accounts receivables to a third party company

that will pay you for the invoices.

This gives your business instant cash instead of having to wait to receive payment which

is why many businesses run into cash flow issues.

Advantages to receivable financing

The 3 Main Advantages of account receivables financing:

Immediate Cash/No Waiting. You can receive quick payment following shipment,

delivery and invoicing (less than 24 hours in some cases) to generate cash much sooner

than if you collect the money on your own.

Analysis of customers' creditworthiness. Prior to purchasing your invoice, a factor

conducts a credit analysis on the client you are invoicing to determine the risk. You are

entitled to the resulting analysis and can assist you in your future business dealings with

that customer/client.

You are not borrowing money. Again, the cash advanced is based on your client's credit

status, not yours.

With receivable financing you can also take advantage of discounts on inventory or purchases for

your business through being able to buy in larger volumes or being able to take advantages of

early payment discounts from the suppliers. There is also no limit on the amount of capital you

can get with this financing option because the capital available increases as sales increase.

Lease FinancingLeasing is a super financing alternative if you are seeking funding to obtain business equipment.

Finance companies, banks, and many firms that sell high-priced equipment will lease to you.

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Lending Notes

When you lease an item, the lessor retains ownership of it. You use the equipment by virtue of

the monthly payments you will be required to make. You can often purchase the equipment at

the end of the lease term for its market value or less.

Advantage to leasing

A great advantage to leasing is that it may be allowed to be "off the balance sheet." This means

that leases can be disclosed as balance sheet footnotes. They do not appear as debt even though

they represent an ongoing company liability. This may sound like financial doublespeak, but it's

not. Let's say a supplier is considering whether or not to extend credit to you, or a bank is

weighing a loan proposal you have submitted. The lease commitment will play a relatively minor

role in evaluating your debt burden.

b. Types of collateral documentation Hypothecation agreement Lien agreement Pledge agreement Standby letter of credit

Hypothecation Agreement

An agreement between a borrower and a lender where by the borrower pledges asset as collateral

on a loan without the lender taking possession of the collateral. It especially applies to

mortgages; the borrower hypothecates when he/she pledges the house as collateral for payment

of the mortgage, or he/she may hypothecate the mortgage in order to borrow against the value of

the house.

In both situations, the borrower retains possession of the house, but the lender has the right to

take possession if the borrower does not service the debt. Hypothecation agreements also occur

in trading; a broker will allow an investor to borrow money in order to purchase securities with

those securities as collateral. The investor owns the securities, but the broker may take them if

the debt is not serviced or if the value of the securities falls below a certain level.

Lien Agreement:

A legal claim against an asset which is used to secure a loan and which must be paid when the

property is sold. Liens can be structured in many different ways. In some cases, the creditor will

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have legal claim against an asset, but not actually hold it in possession, while in other cases the

creditor will actually hold on to the asset until the debt is paid off. The former is a more common

arrangement when the asset is productive, since the creditor would prefer that the asset be used

to produce a stream of income to pay off debt rather than just held in possession and not used. A

claim can hold against an asset until all the obligations to the creditor are cleared (a general lien),

or just until the obligations against that particular assets are cleared (a particular lien).

Pledge Agreement:

A contract of pledge specifies what is owed, the property that shall be used as a pledge, and

conditions for satisfying the debt or obligation. In a simple example, John asks to borrow $500

from Mary. Mary decides first that John will have to pledge his stereo as security that he will

repay the debt by a specific time. In law John is called the pledgor, and Mary the pledgee. The

stereo is referred to as pledged property. As in any common pledge contract, possession of the

pledged property is transferred to the pledgee. At the same time, however, ownership (or title) of

the pledged property remains with the pledgor. John gives the stereo to Mary, but he still legally

owns it. If John repays the debt under the contractual agreement, Mary must return the stereo.

But if he fails to pay, she can sell it to satisfy his debt.

Pledged property must be in the possession of a pledgee. This can be accomplished in one of two

ways. The property can be in the pledgee's actual possession , meaning physical possession (for

example, Mary keeps John's stereo at her house). Otherwise, it can be in the constructive

possession of the pledgee, meaning that the pledgee has some control over the property, which

typically occurs when actual possession isimpossible.

For example, a pledgee has constructive possession of the contents of a pledgor's safety deposit

box at a bank when the pledgor gives the pledgee the only keys to the box.

In pledges both parties have certain rights and liabilities.

Pledger Rights:

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The contract of pledge represents only one set of these: the terms under which the debt or

obligation will be fulfilled and the pledged property returned. On the one hand, the pledgor's

rights extend to the safekeeping and protection of his property while it is in possession of the

pledgee. The property cannot be used without permission unless use is necessary for its

preservation, such as exercising a live animal. Unauthorized use of the property is called

conversion and may make the pledgee liable for damages; thus, Mary should not use John's

stereo while in possession of it.

Pledgee Rights:

For the pledgee, on the other hand, there is more than the duty to care for the pledgor's property.

The pledgee has the right to the possession and control of any income accruing during the period

of the pledge, unless an agreement to the contrary exists. This income reduces the amount of the

debt, and the pledgor must account for it to the pledgee. Additionally, the pledgee is entitled to

be reimbursed for expenses incurred in retaining, caring for, and protecting the property. Finally,

the pledgee need not remain a party to the contract of pledge indefinitely. She can sell or assign

her interest under the contract of the pledge to a third party. However, the pledgee must notify

the pledgor that the contract of pledge has been sold or reassigned; otherwise, she is guilty of

conversion.

Standby Letter of Credit - SLOC'

A guarantee of payment issued by a bank on behalf of a client that is used as "payment of last

resort" should the client fail to fulfill a contractual commitment with a third party.

Standby letters of credit are created as a sign of good faith in business transactions, and are proof

of a buyer's credit quality and repayment abilities. The bank issuing the SLOC will perform brief

underwriting duties to ensure the credit quality of the party seeking the letter of credit, then send

notification to the bank of the party requesting the letter of credit (typically a seller or creditor).  

Also known as a "non-performing letter of credit".

Standby letters of credit are issued by banks to stand behind monetary obligations, to insure the

refund of advance payment, to support performance and bid obligations, and to insure the

completion of a sales contract. The credit has an expiration date.

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Use of standby letter of credit

The standby letter of credit is often used to guarantee performance or to strengthen the credit

worthiness of a customer. In the above example, the letter of credit is issued by the bank and held

by the supplier. The customer is provided open account terms. If payments are made in

accordance with the suppliers' terms, the letter of credit would not be drawn on. The seller

pursues the customer for payment directly. If the customer is unable to pay, the seller presents a

draft and copies of invoices to the bank for payment.

Standby Letter of credit is Domestic Transaction

The domestic standby letter of credit is governed by the Uniform Commercial Code. Under these

provisions, the bank is given until the close of the third banking day after receipt of the

documents to honor the draft.

Procedures required to execute a Standby Letter of Credit are less rigorous. The standby credit is

a domestic transaction. It does not require a correspondent bank (advising or confirming). The

documentation requirements are also less tedious as compared to commercial letter of credit.

c. Safe-keeping of borrower/customer documentation In-house arrangements and its modus operandi Ex-house arrangements and its modus operandi Arrangements for storage of documents and the system for recording Procedures to be followed for depositing and retrieving documents

In-House Arrangements

In-house arrangements are explained in various manuals obtainable via the secretary. New staff

is required to acquaint themselves with the contents of an elaborate file describing operational

processes and procedures. Volunteers are required to read information applicable to them and so

are interns.

The purpose of written, in-house arrangements and policies is to ensure as smooth an operation

as possible and to provide clarity and stability to all parties about agreed on practices. There is a

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process in place of regularly reviewing policies and in-house arrangements are reviewed on a

regular basis.

Recording File Movements

Files are issued to action officers in at least three circumstances.

A document arrives in the records office, is recorded and filed, and the file is passed to the officer.

A file is to be ‘brought up’ to the officer (see Section 8). The officer requests the file in person or by telephone.

Records office staff must be able to determine the location of every file for which they are

responsible. Each time a file moves, this fact must be recorded in the records office. File

movements are monitored in a number of ways: on file transit sheets that are filed in a file transit

book, on transit ladders that appear on file covers, on file movement slips and through regular file

censuses.

Retrieving Files from the Records Centre

Files that have been closed and transferred to the records centre may only be retrieved by

authorised staff. The records centre will not accept requests for files from anyone except the

head of the records office in the agency concerned, or an agency that is a successor to it. All

requests for files should therefore be directed through the head of the records office.

When a user requests a file which is held in the records centre, consult the records centre

Transfer file to determine the exact title, reference number, box number and location number.

Then complete three copies of the Records Centre Request Form. The three copies of the form

should be sent or taken to the records centre and the file collected. One copy of this form will be

sent with the file requested to the records office. The two other copies will be retained by the

records centre.

[See exact data & detail in any Lending book… sorry data is not found ]

d.Bank’s risk under various types of collateralIdeally, collateral taken by a central bank as part of its OMO should not carry credit

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or liquidity risk, though it will inevitably carry some market risk.

• The majority of central banks, for a variety of reasons, extend the list of eligible

collateral beyond domestic-currency denominated government (or central bank)

Securities and face trade-offs between minimizing additional risk (credit, liquidity,

exchange rate, operational) and providing access to a sufficiently wide group of

counterparties to allow the effective implementation of monetary policy and liquidity

management.

• The incentives for adverse selection will change depending on market conditions.

Central banks need to remain alert to such changes and the impact on the markets

Use of collateral.

Risk associated with various types of collateral:

Increases Operational Risk

Legal Risk

Concentration Risk

Settlement Risk

Valuation risk

Increasing Market Risk

Increased overhead

Reduced trading activity

Risk faced by banks:

Credit risk – risk that party to contract fails to fully discharge terms of contract

Interest rate risk – risk deriving from variation of market prices owing to

interest rate change

Market risk – more general term for risk of market price shifts

Liquidity risk – risk asset owner unable to recover full value of asset when sold

(or for borrower, credit not rolled over)

Market liquidity risk – risk that a traded asset market may vary in liquidity of the

Claims traded

Other risks

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operational risk

risk of fraud

reputation risk

Systemic risk – that the financial system may undergo contagious failure following other forms

of shock/risk.

e. Monitoring of charge/margin Appointment and role of Muccudums Obligations of the custodial services under the arrangement Monitoring Guarantees- issuer’s status, guarantee validity, conditions for claims Monitoring of Insurance Policies- issuer’s status, policy validity, conditions for claims Monitoring of Immovable Assets Monitoring of stock reports and valuation Proper system and credible sources for monitoring prices of financed assets and collateral

Source: www. Google.com and websites searched from Google.

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