Different Forms of Credit

Sk. Nazibul Islam.

Faculty Member
Bangladesh Institute of Bank Management
Like every other business activity, banks are
profit oriented.

A bank invests its funds in many ways to earn

income.

The bulk of its income is derived from loans

and advances .
 Forms of credit

Banks make advances in different

forms. All types of credit facilities can
be broadly classified into two groups:
a) Funded credit
b) Non- funded credit
 Funded Credit

• Any type of credit facility which involves

direct outflow of bank's fund on account of
granting credit to borrower refers to funded
credit facility.
• Funded credit facilities may be classified into
two forms say, loan and advance. The two
words loan and advance are generally used
interchangeably but there are some
differences between the two.
 Loan
• When a credit is made in a lump sum and
repayable either in fixed monthly /
quarterly/half-yearly/annual installment or
in lump sum and no subsequent debit is
ordinarily allowed except interest,
incidental charges, etc. is called a loan.
• A loan, once repaid in full or in part, can
not be withdrawn again by the borrower.
• It is given for a fixed period at an agreed rate of
interest.
• The whole amount of loan is debited to the
customer's name on a loan account to be opened
in the ledger and is paid to the borrower either in
cash or by way of credit to his account.
• Interest is charged on the entire amount of debit
balance, usually with quarterly rests, unless there
is an agreement to the contrary.
 Advance

• In case of advance a limit is sanctioned by the bank

usually for 12 months which the borrower can
withdraw as per drawing power from his cash credit
Account as he need.
• The account can be adjusted by the sale proceeds as
the borrower desires and the borrower again can
avail of it for buying the stock.
• Interest is charged on daily product basis of debit
balance, usually with quarterly rests, unless there is
an agreement to the contrary.
 Funded Credit

Agricultural loan- Farming and Off- Framing

a. Crop- Food grains, Cash crops, Winter crops,
Summer crops
b. Fishery- White fish, Shrimp culture, fingerlings
production, Fish processing
c. Live Stock- Bullock, cow, Goat,Beef fattening
and other draft animals.
d. Poultry /Dairy
e. Agro-equipment and farm machineries – LLP,
HPTW, STW and DTW
f. Horticulture , Fruit & Tree plantation etc.
g. Tea- Production loan, Development loan,
Trading loan
h. Rubber production
I. Continuous loan for processing,
preservation, and marketing of
agricultural products.
j. agribusiness
k. Poverty alleviation and micro credit
 Contd…
• Consumer loans
• Transport loan
• SME loan
• Agro-Processing loan
• Agro-based industries loan
• Syndicated loan
• Lease financing
• Hire purchase
• Import Financing ( PAD, LIM, etc.)
• Export Financing (Packing credit, etc.)
Funded credit facilities may be classified
into four major types:
i) Loans
ii) Cash credit
iii) Overdraft
iv) Bill purchase and Discount
The term loans are granted for a
specific period and repayment is
made in installments. The term loan
can also be repayable on demand if
default occurs in repayment or some
eventualities, as listed in the
agreement, take place.
Term Loan are made to meet fixed
capital expenditure, which is usually for
the period of couple of years.
The schedule of repayment and duration
of loan are fixed on the basis of the
assessed ability of the undertaking to
generate surpluses for making
repayments.
• Term loans, are sanctioned for acquisition of
capital goods for development of manufacturing
/ service industry as well as agro-based industries
/ SMEs etc.
• Term loans are sanctioned for setting up a new
project as well for BMRE of the existing one.
• This type of account is not suitable for trading
purposes.
Security: The security is usually mortgage of
immovable property, lien of fixed deposit
receipts and Usual charge documents etc.
 Cash credit

• Cash credit is a type of working capital

facility and is generally sanctioned by
banks to industrial, business and trading
units.
• Such facilities are allowed against the
security of stock/merchandise like raw
materials, goods -in –progress, finished
goods, consumable stores/spares etc.
• Cash credit is a running account where a regular
limit is sanctioned by the banker against goods
and it is meant for meeting day to day expenses
of the business.
• The cash credit account is like a current account
with a limit up to which he can withdraw from
the bank.
• The moveable assets are mostly in the shape of
produce and commodities and these advances
are covered by either pledge or hypothecation.
 Assessment of cash credit be
evaluated on the basis of:
• Capacity
• Efficiency
• Past operating experience.
• Production cycle
• Elements of costing for acquiring raw materials,
packing materials, factory on-cost, cost of
powers, wages
• Administrative cost
• Repair and maintenance of plant and machinery
• Cost of marketing of finished products.
 Operating cycle:
• The cash credit requirement of a concern is basically
influenced by the nature of its business.
• The size of the business also has an important impact
on its cash credit needs.
• While assessing cash credit need of a firm, the cycle of
production as to number of days should be worked
out.
• The operating cycle differs product to product.
• While assessing operating cycle, the number of days
taken for acquiring raw materials, processing period ,
normal marketing period, sum total of these involved
would constitute the operating cycle of an unit.
 Margin:

• Margin is the amount invested in the unit by the

borrower himself and is asked for providing protection
to bankers against a possible decline in value.
• The margin indicates the owner’s stake which very
often governs his motivation, i.e., the zeal and interest
with which he will work for the success of the unit.
• The banker should study this amount invested in
relation to the borrower’s total resources and also in
relation to the total investment required in the unit.
 Drawing power:

• The drawing power of a limit is determined and

fixed by the sanctioning authority up to which the
borrower can draw.
• The drawing power should be calculated on the
basis of pledged goods/stock, its valuation to be
determined as per prescribed rate.
• Value will be determined on the basis of cost
price and market price whichever is lower or any
other prices as specified in the sanction letter.
• All release of limit must be channelized through
drawing power register.
 Overdraft (OD)
• Basically this is an arrangement between a
banker and his customer by which the later is
allowed to withdraw over and above this
credit balance in his/their current account.
This is a temporary accommodation of fund to
the client. Overdraft facility to the borrower
may be allowed in the form of clean OD or
SOD.
 Import Finance

Payment Against Documents (PAD): The bank

which opens the letter of credit is bound to
honor its commitment to pay for import bills
when these are presented for payment, if
drawn strictly in terms of letter of credit.
The foreign correspondent bank, which
negotiates the documents, debits the account
of the opening bank and, in fact, the amount
thus stands loan on behalf of the importer.
The opening bank will lodge the shipping
documents to their book and will respond to
the debit advice originated by the foreign
correspondent to the debit of "Payment
Against Documents (PAD)" account or "Bills of
Exchange (B/E)" account and present the bill
to the importer for payment.
 Loan Against Imported Merchandise (LIM): Usually,
importer fails to retire the documents in spite of
repeated reminders from the banker or the bank has
to clear the goods imported under the letter of credit
at the request of the importer(borrower).
• In both the cases, whether the importer fails to retire
the documents or requests for clearance of goods,
the outstanding under PAD or B/E is transferred to
"Loan Against Imported Merchandise (LIM)" account
and the overdue interest from the date of
accompanying Bills of Exchange or negotiating date
to the date of transfer to LIM account is charged.
• At the time of opening of letter of credit the
banks obtain from the importer an agreement
on stamped paper which provides for
financing and, if necessary, clearance and
storage of goods by debiting importer's
account at their risk and responsibilities.
• After clearance, consignments are taken
delivery by the importer on full payment of
bank's liability.
Export Finance - Pre Shipment Credit
Packing Credit: Packing credit is a short term
credit granted by a bank to an exporter for
assisting him to buy, process, pack and ship
the goods. The credit is gradually extended for
payment of freight, handling charges,
insurance and export duties. A packing credit
advance does not normally extend beyond
180 days and has to be liquidated by
negotiation/ purchase of the bills of exchange.
 Export Trust Receipt: Under this
arrangement, credit is allowed against trust
receipt and the exportable goods remain in
the custody of the exporter but he is required
to execute a stamped export trust receipt in
favor of the bank, wherein a declaration is
made that goods purchased with financial
assistance of bank are held by him in trust for
the bank.
 Bills Discounted and Purchased
• The banks also grant credit to their customers by
discounting or purchasing their bills of exchange. Such
bills of exchange arise out of commercial transactions
both in inland trade and foreign trade. Bills are
classified into (i) Clean Bills and (ii) Documentary Bills.
• When the drawer of a bill encloses with the bill the
documents of title to goods, such as, Bill of Lading,
Railway Receipt, Steamer Receipt, to be delivered to
the drawee of the bill on payment or against
acceptance of bill, as the case may be, the bill is called
a documentary bill.
•
• In the absence of such documents it is termed
as a clean bill. By nature of payment, bills can
also be classified into two categories (i)
Demand Bills and (ii) Usance Bills.
• Where a bill is payable 'at sight1 or 'on
demand' or 'on presentation' it is called a
demand bill. If a bill matures for payment
after a certain period of time, say 15, 30 or 60
days after the date, it is called a usance bill.
• In case of purchase and discounting of bills,
the banker credits the customer's account
with the amount of the bill after deducting his
charges or discount.
• Bankers purchase the demand bills but
discount the usance bills. In purchasing the
income is interest but in discounting the
income is discount.
 Non-funded Credit
• Though these types of credit facilities are
primarily non-funded in nature but at any
time it may turn into funded facilities. These
non-funded facilities are termed as contingent
liabilities. The major facilities are:
• Letter of Credit (L/C): Letter of credit is a
credit contract whereby the issuing bank
(buyer's bank) is committed (on behalf of the
buyer) to place an agreed amount of
money at the seller's disposal under some
agreed conditions. A documentary credit
may be different types viz. revocable,
irrevocable, transferable, back-to-back, red
clause, etc.
• Back-to-Back Letter of Credit: Bank also
finance export trade normally by opening an
Inland Letter of Credit on behalf of
exporter/export house, or agency, who has
received an export letter of credit from
overseas buyers. It happens that sometimes
exporters may receive export letter of credit
from foreign buyers for export of goods to
them but the exporter may not be the actual
manufacturers or producers of the goods.
• They have to procure the goods from the
manufacturer in his own country or foreign
country to enable him (exporter) to complete the
deal under the L/C.
• Actual manufacturers/producers may not supply
the goods unless the payment of the goods is
guaranteed by the bank in the form of opening
inland/foreign letter of credit. Since the inland
letter of credit is opened on the strength of, and
backed by, the export letter of credit it is
technically called Back-to-Back Letter of Credit.
• Bid Bond
One kind of bank guarantee or undertaking
issued by a bank on behalf of its clients
(mostly contractor) to enable him to submit
his bid in a tender. For issuing bid bond bank
usually obtains cash margin and counter
guarantee from the customer.
• Performance Bond: A performance guarantee is
given after the tender or bid of a particular client
of the bank has been accepted. It is a guarantee
where the bank gives an undertaking to the third
party that its clients shall complete the job as per
terms of the tender or to pay damage up to the
guarantee money. Banks while issuing such
guarantee, takes certain cash margin and counter
guarantee from its clients to secure its position.
• Guarantee: Banks also issue letter of guarantee
on behalf of customers.
Classification : On the Basis of Security

1.Clean
2. Secured
 Classification : On the Basis of Term

• Short Term
• Mid Term
• Long Term
 Sectoral Classification

• Private , Public, Commercial and

Industrial , Agriculture , House
Building , SME Financing .
• Thank you very much