Monday, April 11, 2016

Types of Finance Provided by Banks

Types of Finance provided by banks
1. Take-Out Financing: Banks usually lend for short-term. It is because their source of funds for financing comes from deposits which are usually for a maximum period of 3 to 5 years. However, presently banks are encouraged to provide finance for long-term projects like infrastructure industry.
Hence when a bank, say, lend for 10 years against a 4 years deposit, there is a problem of continuing the loan after 4 years. It is possible that the bank will continue to get deposits every year. Yet, the fact today is a 10-year loan has been made based on a 4- year deposit which is a risky affair. In such a situation, few banks will come together and under an agreement each one of them will take up the loan portfolio in turn, for a fixed period of time till the loan matures.
For example, if Bank A has provided a 10 year loan, with an arrangement with Bank B and Bank C whereby, after the end of the 4th year, Bank B will finance the loan for next 3 years and Bank C will finance the loan during the last 3 years.
2. Revolving Credit Facility: Under a Revolving Credit Facility a bank fixes up a credit limit to a borrower for certain period, say Rs.10 crore for 3 years period. The borrower will get a maximum credit facility of Rs.10 crore at any point of time once the loan is repaid. The borrower's facility automatically gets renewed up to Rs.10 crore during the 3 year period any number of times. In other words, the credit facility revolves around with a maximum of Rs.10 crore outstand­ing at any point of time over a 3 year period. In principle, under a Revolving Facility there is no formal repayment period. The borrower is allowed to draw, repay and again draw throughout the loan period.

3. Ever greening of Loan: Sometimes a bank provides a second finance facility to a borrower to help him to pay back the original loan. It is because when a borrower defaults on payment of interest/principal to the bank as per prudential norms, the loan account will become an NPA and the bank has to make provisions. To avoid such an unpleasant situation and to show a rosy picture of bank's loan portfolio, sometimes banks do resort to ever greening. RBI does not permit this type of replacement credit.
4. Syndicated Loan: It is a loan facility provided to a single borrower by a group of banks. As the loan is extended by a group of lenders, the size of syndicated loan is normally large and a single lender/ banker may not have been in a position to extend such a facility. Since, the bankers involved in providing such loan facility are many; usually co-ordination work is done by a 'lead manager' who acts as an intermediary between the lenders and the borrower. Also under this arrangement one bank in the syndicate acts as an agent for collecting interest and other payments from borrower and distributes to other banks.
5. Bridge Loan: Bridge loan is a short-term temporary loan extended by financial institutions to help the borrower to meet the immediate expenditure pending disposal of requests for long- term funds or regular loans. Here, the bridge loan is not against any main loan arrangement but against anticipated cash flow. Again, if an indi­vidual is negotiating the sale of his asset, say a house, a bridge loan may be extended by a bank to meet the seller's immediate cash requirements. The loan will be paid off when the borrower realizes his sale proceeds.
6. Consortium Finance: Under consortium finance a large credit facility may be jointly arranged by a combina­tion of several banks. Usually, one of the banks in the group will act as the leader for the credit. The consortium leader will extend a larger share of the credit as compared to other banks in the consortium. The word consortium here refers to 'a combination of many banks who have agreed to extend the credit facility'. The share of credit agreed to be extended will be decided by the banks in the beginning. The borrower need not deal separately with all the banks in the group. A bank is however not permitted to extend credit beyond 25 per cent of its net owned funds or 25 per cent of borrower's net owned funds (whichever is lower) to a single borrower.
7. Preferred Financing: In the highly competitive world of banking today, banks are reaching out to custom­ers, particularly high net worth or wealthy customers. One area of lucrative finance for bankers is consumer finance, more particularly car finance. A preferred financier is a lender or a bank, which provides large consumer loans like car loan under an arrangement with the car manufacturer. Because of the tie-up, the manufacturer agrees to provide some conces­sion in the car price and some additional facilities in the car. Thus, the manufacturer makes available for two reasons. One, purchase price is assured and second it gives some push for the demand of that car. Preferred Financier also benefits. He gets wealthy customers. Default in the consumer finance sector is minimum because most of the customers have regular income.
8. Guarantee Services/Non-fund Based Business: Non-fund based business is not a credit facility or a financial assistance. However, the banks make sizeable income out of non-fund based business, mainly from guarantee ser­vices. Banks offer 'Guarantee Services' to valued customers. Guarantee service refers to a legal undertaking by the bank to pay a certain sum of money to a third-party or a creditor in the event of the bank's client/customer fails to fulfill his part of obligation. The obliga­tion may be to pay some money or to perform certain duties like a contract job. The guar­antee from bank enhances the certainty of performance or payment.

Usually, banks issue guarantees on behalf of their customers in favour of Government Departments like Cus­toms authority saying if the customer does not perform under a contract or does not pay the required sum, the bank will pay the money or damages. This function of issuing a guarantee is done for certain amount of fees. Hence, it is called fee-based services of banks. Under a guarantee a bank does not provide any credit facility to the customer. Hence, this type of services by banks is called non-fund based business. Other examples are issue of Travelers' Cheques, Demand Drafts, remittance facilities, arrange­ment of foreign currency loans, etc.