Module – 4

Lending Operation
MEANING OF BANK LENDING

Bank lending refers to the process of disposing of money or property with the expectation that the
same thing will be returned. Credit is the provision of resources (such as granting a loan) by one
party to another party where that second party does not reimburse the first party immediately,
thereby generating a debt and instead arranges either to repay or return those resources (or
material(s) of equal value. Where the first party would be the banker (lender or creditors) and the
second partly would be the customer (borrower or debtor).

PRINCIPLES OF BANK LENDING

Bank lending involves risk, banks need to follow certain basic principles at the time of lending loans
and advances. Some of the principles to be followed are:

1. Principle of Safety: Safety is the most important principle of good lending. When a banker lends,
he must feel certain that the advance is safe and the money will definitely come back. If the
borrower invests the money in an unproductive or speculative venture, or if the borrower himself
is dishonest, the advance would be in danger.

2. Principle of Liquidity: The borrower must be in a position to repay within a reasonable time
after a demand for repayment is made. This can be possible only if the money is employed by the
borrower for short-term requirements and not locked up in acquiring fixed assets, or in schemes
which take a long time to pay their way. The reason why bankers attach as much importance to
'liquidity' as to safety' of their funds in this.

3. Principle of Purpose: The purpose should be productive so that the money not only remain safe
but also provides a definite source of repayment. The purpose should also be short termed so that it
ensures liquidity. Banks should discourage advances for hoarding stocks or for speculative
activities.

4. Principle of Profitability: Profitability is a financial benefit that is realized when the amount of
revenue gained from a business activity exceeds the expenses, costs and taxes needed to sustain the
activity. Banks must make profits because they have to pay interest on the deposit received by
them. They have to deserve expenses on establishment, rent, stationery, etc.

5. Principle of Security: It has been the practice of banks not to lend far as possible except against
security. The banker carefully examines all the different aspects of an advance before granting it.

6. Principle of Spread: The principle of good lending is the diversification of advances. An element
of risk is always present in every advance, however secure it might appear to be. In fact, the entire
banking business is one of taking calculated risks and a successful banker is an expert in assessing
such risks.
7. Principle of National Interest, Suitability etc.: Even when an advance satisfies all good
principles, it may still not be suitable. The advance may run counter to national interest. The
Central Bank may have issued a directive prohibiting banks to allow a particular type of advance.

8. Principle of Ideal Advance: L. C. Mather describes an ideal advance as "one which is granted to
a reliable customer for an approved purpose in which the customer has adequate experience, safe
in the knowledge that the money will be used to advantage and repayment will be made within a
reasonable period from trading receipts or known maturities due on or about given dates."

5 C'S OF LENDING PRINCIPLES

(a) Character: The character of the borrower indicates two things: the ability to pay versus the
willingness to pay. The ability to pay refers to the borrower's financial credibility to pay. The lender
should check on the borrower's character.

(b) Capacity: Capacity refers to the sources of repayment, ie. the cash flow. The borrower must be
able to meet all his financial obligations on the due dates.

(c) Capital: Capital represents the degree of commitment and the ability to sustain this
commitment during bad times.

(d) Conditions: Condition refers to the macroeconomic environment. For example, if the loan is
needed for setting up a retail business in a particular area, then the lender must make a study of the
economic conditions (the degree of propensity to spend by residents in that locality).

(e) Collateral: Collateral is the lender's second line of defence. If the payback is derived from cash
flows, then the collateral will not be liquidated for repayment.

Kinds / Types of Lending

1. Fund-Based Lending

Fund-based lending involves the direct disbursement of funds by the lender (usually a bank) to the
borrower. The focus is on providing cash or financial resources that the borrower can use for
specific purposes.

Subcategories of Fund-Based Lending:

Long-Term Loans: These loans are provided for a long duration, often exceeding five years.

Examples:

Project Finance: Used for financing large-scale and capital-intensive projects like infrastructure,
power plants, or real estate developments.

Typically involves extensive due diligence and risk analysis.

Equipment Finance: Offered to businesses for purchasing machinery, tools, or equipment.

Short-Term Loans: These loans are usually for a period of less than one year, aimed at meeting
immediate or working capital needs.

Examples:

Bill Discounting: The bank advances funds against unpaid invoices or bills of exchange before
their maturity. Helps businesses maintain liquidity without waiting for customer payments.

Factoring of Receivables: A company sells its accounts receivables to a factor (third party) at a
discount to access immediate cash. The factor assumes responsibility for collecting payments from
customers.

2. Non-Fund-Based Lending This type of lending does not involve the actual disbursement of
funds. Instead, the bank provides financial instruments or guarantees to support the borrower’s
financial requirements. The risk lies in contingent liabilities, meaning the bank only disburses funds
if certain conditions are met.

3. Asset-Based Lending: Loans are secured by assets such as inventory, accounts receivable, or
collateral.

Examples:

Collateral-Based Lending: The borrower pledges tangible assets (e.g., real estate, inventory) to
secure the loan. The value of the loan depends on the appraised value of the collateral.

Letter of Credit (LC): A guarantee issued by a bank assuring that a seller will receive payment
from the buyer. Commonly used in international trade to mitigate payment risks.

Bank Guarantees: The bank promises to pay a specified amount to a third party if the borrower
fails to fulfill contractual obligations. Typically used for securing performance contracts or financial
agreements.

LOANS
One of the reasons for boom in Indian economy is that now a days louna ars easily available and the
rate of interests at which they are available are very reasonable. Banka are giving loan for and loan
against any and every thing Government is encouraging people to take loans for certain purposes.
For example, government is encouraging people to take housing loans by giving tax concessiona. In
view of the deluge of loans that are available in the market today, some useful information about
variety of loans that are available in India.

HOME LOANS

Home loan is the loan acquired from a financial institution to purchase a home. Home loans consist
of an adjustable or fixed interest rate and payment terms. Home loans may also be referred to as
mortgage loans. A home mortgage will have either a fixed or floating interest rate, which is paid
monthly along with a contribution to the principal loan amount. As the homeowner pays down the
principal over time, the interest is calculated on a smaller base so that future mortgage payments
apply more towards principal reduction as opposed to just paying the interest charges.

TYPES OF HOME LOANS

(i) Home Purchase Loans: This is the basic home loan for the purchase of a new home.

(ii) Home Improvement Loans: These loans are given for implementing repair works and
renovations in a home that has already been purchased.

(iii) Home Construction Loan: This loan is available for the construction of a new home.

(iv) Home Extension Loan: This is given for expanding or extending an existing home. For
instance, this may apply for a loan for the addition of an extra room and for similar cases.

(v) Home Conversion Loan: This is available for those who have financed the present home with a
home loan and wish to purchase and move to another home for which some extra funda are
required. Through home conversion loan, the existing loan is transferred to the new home
including the extra amount required, eliminating the need of pre-payment of the previous loan.

(vi) Land Purchase Loans: This loan is available for purchase of land for both construction and
investment purposes.

(vii) Bridge Loans: Bridge loans are designed for people who wish to sell the existing home and
purchase another one. The bridge loans help finance the new home.

(viii) Balance Transfer Loans: Balance transfer loans help to pay off an existing home loan and
avail the option of a loan with a lower rate of interest.

(ix) Refinance Loans: This loan helps to pay off the debt have incurred from private sources such
as relatives and friends, for the purchase of present home.

(x) Stamp Duty Loans: This loan is sanctioned to pay the stamp duty amount that needs to be paid
on the purchase of property.

FEATURES OF HOME LOAN

Buy a Home Now, Pay Later: A home loan lets you buy a house now and pay for it over many
years.

Tax Benefits: You can save money on taxes by claiming deductions on the interest and principal
you pay.

Lower Interest Rates: Home loans usually have lower interest rates compared to other loans.

Flexible Payment Plans: You can choose how long you want to pay back the loan, making it easier
to manage your finances.
Eligibility Criteria

i) The minimum age limit for the person applying for loan is 21 years.

(i) For Government employees and those working at public limited companies, the maximum age
limit for applying for home loan is 60 years, while for salaried individuals, it is 58 years.. For self
employed people, the maximum age limit is 65 years.

(iii) The applicant should be graduate.

(iv) The applicant should have a stable source of income, at the time of availing the loan and should
have a saving history as well.

Documents Required for Salaried Individuals

(i) Salary slip/Form 16 A

(ii) A photocopy of the first and last pages of Ration card or copy of PAN/Telephon Electricity bills

(iii) A photocopy of Investments (FD Certificates, Shares, any fixed asset ete. J or se other
documents supporting the financial background of the borrower

(iv) A photocopy of LIC policies with the latest premium payment receipts (if any),

(v) Two passport size photographs

(vi) A photocopy of bank statement for the last six months

Documents required for Self-Employed/Businessmen

(i) A brief introduction of Business/Profession.

(ii) Balance Sheet, Profit and Loss account and statement of income with Income Ta returns for the
last three years, certified by a CA.

(iii) A photocopy of Advance Tax payments (if applicable).

(iv) A photocopy of Registration Certificate of establishment under shops and Establishments

(v) A photocopy of Registration Certificate for deduction of Profession Tax (of applicable).

(vi) Bank statements of Current and Saving accounts for the last 6 months.

(vii) A photocopy of Certificate of Practice (if applicable).

(viii)A photocopy of any bank loan (if applicable).

(ix) A photocopy of the first and last pages of the Ration card or a copy of PAN
Telephone/Electricity Bills.
(x) A photocopy of LIC policy (if applicable).

(xi) A photocopy of investments FD Certificates, Shares, any other fixed asset.

(xii) Two passport size photographs.

There are various types of loans, each designed to meet different financial needs. When
applying for a loan, different documents are typically required to verify your identity,
income, and creditworthiness. Here’s a breakdown of the major types of loans and the
documents generally needed for each.

1. Personal Loans

Purpose: Unsecured loans used for personal needs, like debt consolidation, medical expenses, or
vacations.

Loan Type: Unsecured (no collateral required).

Documents Required:

Proof of Identity: Passport, driver’s license, or Aadhar card (in countries like India).

Proof of Address: Utility bills, bank statements, rental agreements.

Income Proof: Payslips, bank statements, tax returns, Form 16, or salary certificate.

Credit Score: Lenders will check your credit score to assess your creditworthiness.

Employment Details: Proof of employment or business documents if self-employed.

Bank Statements: Last 3–6 months of bank statements to verify income and spending habits.

2. Home Loans (Mortgages)

Purpose: Loans used to buy a house or property. They can be secured against the property being
purchased.

Loan Type: Secured (backed by the property).

Documents Required:

Proof of Identity: Passport, driver’s license, or any government-issued ID.

Proof of Address: Recent utility bills, rental agreements, or bank statements.

Income Proof: Latest payslips, Form 16, or tax returns (last 2–3 years).

Property Documents: Sale agreement, title deed, or property registration certificate.

Bank Statements: 6 months to 1 year of recent bank statements.

Employment Details: Letter from employer or self-employed income verification.

Tax Returns: Last 2–3 years of tax returns.

3. Car Loans

Purpose: Used to finance the purchase of a new or used vehicle.

Loan Type: Secured (the vehicle acts as collateral).

Documents Required:

Proof of Identity: Passport, driver’s license, or Aadhar card.

Proof of Address: Utility bills or bank statements.

Income Proof: Latest payslips, Form 16, or bank statements for the last 3–6 months.

Bank Statements: Last 3–6 months of bank statements.

Vehicle Documents: Proforma invoice, car registration documents, or insurance.

Credit Score: To assess eligibility and loan amount.

Employment or Business Proof: Employment letter or self-employed proof.

4. Education Loans

Purpose: Loans provided to students for educational expenses like tuition fees, books, and other
academic needs.

Loan Type: Secured or unsecured, depending on the loan amount and co-applicant.

Documents Required:

Proof of Identity: Passport, Aadhar card, or birth certificate.

Proof of Address: Utility bills or rental agreements.

Admission Proof: Offer letter from the educational institution.

Income Proof of Co-applicant: Parents or guardian’s income proof if the student is a minor.

Bank Statements: Bank statements of the co-applicant for the last 6 months.

Academic Records: Past academic records to demonstrate eligibility.

Fee Structure: Detailed fee structure from the educational institution.

Purpose: Loans for business needs, like working capital, expansion, equipment purchase, etc.

Loan Type: Secured or unsecured depending on the loan amount and business requirements.

Documents Required:

Proof of Identity: Government-issued ID (Passport, driver’s license).

Proof of Address: Business premises address proof (Utility bill, rent agreement).

Business Registration Documents: Company registration certificate, GST certificate, partnership

Income Proof: Last 3 years of income tax returns, balance sheet, and profit & loss statements.

Bank Statements: Business bank statements for the last 6–12 months.

Credit Score: Personal and business credit scores.

Business Plan: A clear plan detailing how the loan will be used to grow or maintain the business.

6. Marriage Loan

A marriage loan is a type of personal loan specifically designed to help individuals finance their
wedding expenses. It can be used to cover costs such as:

Venue booking: Renting a banquet hall or outdoor venue.

Catering: Food and beverage expenses.

Decorations: Floral arrangements, lighting, and other decorations.

Wedding attire: Bridal and groom's attire, as well as attire for the wedding party.

Photography and videography: Hiring professional photographers and videographers.

Jewelry: Purchasing wedding rings and other jewelry.

Travel and accommodation: Expenses for guests and the couple's honeymoon.

Key Features of Marriage Loans:

Quick Disbursal: Many lenders offer fast processing and quick disbursal of funds.

Minimal Documentation: The documentation process is usually straightforward and requires

Flexible Repayment Tenure: You can choose a repayment tenure that suits your budget and
financial situation.
Competitive Interest Rates: Lenders offer competitive interest rates on marriage loans.

No Collateral Required: Most marriage loans are unsecured, meaning you don't need to pledge
any asset as collateral.

Documents Required:

While specific requirements may vary between lenders, generally, you'll need the following
documents:

Proof of Identity: Aadhaar card, PAN card, passport, driver's license

Proof of Address: Aadhaar card, passport, utility bills

Income Proof: Salary slips, bank statements, IT returns

Cash Credit
What is a Cash Credit Facility?

A cash credit facility is a type of short-term loan extended by banks to businesses. It allows
businesses to withdraw funds up to a pre-approved limit as needed, similar to a revolving credit
facility.

How Does It Work?

Limit Sanction: The bank assesses the business's financial health and creditworthiness to
determine a credit limit.

Drawing Funds: The business can withdraw funds from the sanctioned limit as and when required.

Interest Calculation: Interest is charged only on the amount withdrawn, not on the entire
sanctioned limit.

Repayment: The business can repay the withdrawn amount along with interest at any time or as
per the agreed repayment schedule.

Key Features of a Cash Credit Facility:

Flexible Usage: Funds can be withdrawn multiple times within the sanctioned limit.

Interest on Utilized Amount: Interest is charged only on the amount withdrawn, making it cost-
effective.

Security Requirement: Typically, collateral is required to secure the loan, such as fixed assets or
inventory.

Repayment Flexibility: Businesses can repay the loan in installments or through a bullet payment.
Overdraft Facility: It functions like an overdraft facility, allowing businesses to maintain a
negative balance up to the sanctioned limit.

Benefits of a Cash Credit Facility:

Meeting Short-Term Needs: It helps businesses meet immediate working capital requirements,
such as purchasing inventory, paying suppliers, or meeting payroll expenses.

Improved Cash Flow: By providing immediate access to funds, it can improve the business's cash
flow and liquidity.

Flexibility: Businesses can withdraw and repay funds as needed, providing flexibility in managing
finances.

Tax Benefits: Interest paid on a cash credit facility may be tax-deductible.

Drawbacks of a Cash Credit Facility:

Interest Cost: While interest is charged only on the utilized amount, it can still be significant,
especially for businesses with high utilization.

Collateral Requirement: Most banks require collateral, which can limit access to the facility for
businesses with limited assets.

Risk of Overreliance: Overreliance on cash credit can lead to debt accumulation and financial
stress.

In conclusion, a cash credit facility can be a valuable tool for businesses to manage their short-term
financial needs. However, it's essential to use it judiciously and ensure timely repayments to avoid
financial burdens.

Overdraft
What is an Overdraft Facility?

An overdraft facility is a short-term lending arrangement provided by banks that allows individuals
and businesses to withdraw more money from their account than is available. It's like a safety net
that prevents transactions from bouncing due to insufficient funds.

How Does It Work?

Limit Sanction: The bank sets a specific overdraft limit based on the customer's creditworthiness
and account history.
Overdrawing: When the account balance falls below zero, the bank allows the customer to
withdraw funds up to the sanctioned limit.

Interest Charges: Interest is charged on the overdrawn amount, typically at a higher rate than
regular loan interest.

Repayment: The overdrawn amount, along with interest, needs to be repaid within a specified
period.

Key Features of an Overdraft Facility:

Emergency Fund: It acts as an emergency fund to cover unexpected expenses.

Flexible Usage: Funds can be withdrawn multiple times within the sanctioned limit.

Interest on Utilized Amount: Interest is charged only on the overdrawn amount, making it cost-
effective.

Repayment Flexibility: The overdrawn amount can be repaid in installments or as a lump sum.

Benefits of an Overdraft Facility:

Avoids Bounced Checks: Prevents financial embarrassment and penalties associated with
bounced checks.

Convenient Access to Funds: Provides immediate access to funds when needed.

Improved Cash Flow: Helps maintain a positive cash flow by covering temporary shortfalls.

Flexibility: Offers flexibility in managing finances.

Drawbacks of an Overdraft Facility:

High-Interest Rates: Interest rates on overdrafts are generally higher than regular loans.

Risk of Overreliance: Overreliance on overdrafts can lead to debt accumulation and financial
stress.

Limited Limit: The overdraft limit is usually lower compared to other loan facilities.

In conclusion, an overdraft facility can be a useful tool for managing short-term financial needs.
However, it's important to use it responsibly and avoid excessive borrowing to prevent financial
difficulties.

Bill Discounting
Advances made against demand bills are bills purchased. Today's fast-paced economy talks about
fast cash transactions. The urgency for fast cash especially wher the business is facing a shortfall.
That's why, in an endeavour to bring state-of-the art products and services to suit the banking
requirements, banks offer b discounting facility. Bill discounting is a short tenure financing
instrument for companies willing to discount their purchase/sales bills to procure short-term
funda Bill discounting facility gives an array of options to choose from the range of products
offered. Normally, letter of credit backed bill discounting and clean bill discounting are the
convenient mode of financing for domestic trade transactions.

MEANING OF BILLS DISCOUNTING

Bill discounting refers to the trading or selling a bill of exchange prior to the maturity date at a
value less than the par value of the bill. The amount of the discount will depend on the amount of
time left before the bill matures and on the perceived risk attached to the bill.

What is Bill Discounting?

Bill discounting is a financing technique where a business sells its unpaid invoices or bills of
exchange to a financial institution (like a bank) at a discount to receive immediate cash. This
process helps businesses improve their cash flow and working capital cycle.

How Does Bill Discounting Work?

Invoice Generation: A business sells goods or services to a customer and generates an invoice.

Bill Submission: The business submits the invoice to a financial institution for discounting.

Discounting: The financial institution assesses the creditworthiness of the buyer and discounts the
invoice, paying the business a certain percentage of the invoice amount.

Maturity: When the invoice matures, the buyer pays the financial institution the full invoice
amount.

Profit for the Financial Institution: The difference between the discounted amount paid to the
business and the full amount received from the buyer is the financial institution's profit.

TYPES OF BILL DISCOUNTING

Bills discounting is of two types:

i) Purchase Bill Discounting: A purchase bill discounting means that the investor discounts the
purchase bill of the company and pays the company, who in turn pay their supplier. The investor
gets his money back from the company at the end of the discounting period.
i) Sales Bill Discounting: A Sales bill discounting means the investor discounts the sales bill of the
company and pays directly to the company. The investor gets his return from the company at the
end of the discounting period.

Outward/Inward Bills

Outward Bill includes all bills, cheques, drafts etc. tendered for collection by the customer. The
concerned official will receive the same against proper receipt.

LETTERS OF CREDIT
Letter of credit is a document issued mostly by a financial institution, used primarily in trade
finance, which usually provides an irrevocable payment undertaking. It is a payment term generally
used for international sales transactions. It is basically a mechanism, which allows
importers/buyers to offer secure terms of payment to exporters/sellers in which a bank gets
involved. The letter of credit can be source of payment for a transaction, meaning that redeeming
the letter of credit will pay an exporter. Letters of credit are used primarily in international trade
transactions of significant value, for deals between a supplier in one country and a customer in
another. They are also used in the land development process to ensure that approved public
facilities will be built. The parties to a letter of credit are usually a beneficiary who is to receive the
money, the issuing bank of whom the applicant is a client, and the advising bank of whom the
beneficiary is a client. Almost all letters of credit are irrevocable, i.e., cannot be amended or
cancelled without prior agreement of the beneficiary, the issuing bank and the confirming bank, if
any. In executing a transaction, letters of credit incorporate functions common to giros and
Traveller's cheques. The documents a beneficiary has to present in order to receive payment
include a commercial invoice, bill of lading, and documents proving the shipment was insured
against loss or damage in transit. However, the list and form of documents is open to imagination
and negotiation and might contain requirements to present documents issued by a neutral third
party evidencing the quality of the goods shipped, or their place of origin. A Letter of Credit is a
payment term generally used for international sales transactions. It is basically a mechanism, which
allows importers/buyers to offer secure terms of payment to exporters/sellers in which a bank gets
involved. The technical term for Letter of credit is 'Documentary Credit'. At the very outset one
must understand is that Letters of credit deal in documents, not goods. The idea in an international
trade transaction is to shift the risk from the actual buyer to a bank. Thus a LC (Letters of Credit) is
a payment undertaking given by a bank to the seller and is issued on behalf of the applicant ie. the
buyer. The Buyer is the Applicant and the Seller is the Beneficiary. The Bank that issues the LC is
referred to as the Issuing Bank which is generally in the country of the Buyer. The Bank that
Advises the LC to the Seller is called the Advising Bank which is generally in the country of the
Seller.

Meaning of Letters of Credit

Letter of Credit refers to a letter from a bank guaranteeing that a buyer's payment to a seller will be
received on time and for the correct amount. In the event that the buyer is unable to make payment
on the purchase, the bank will be required to cover the full or remaining amount of the purchase. It
is a payment term generally used for international sales transactions.

The Money behind a Letter of Credit

A bank promises to pay on behalf of a customer. The bank will only issue a letter of credit if they
know the buyer will pay. Some buyers have to deposit (or already have) enough money to cover the
letter of credit, and some customers use a line of credit with the bank. Sellers must trust that the
bank issuing the letter of credit is legitimate.

Executing a Letter of Credit

A seller only gets paid after performing specific actions that the buyer and seller agree to. For
example, the seller may have to deliver merchandise to a shipyard in order to satisfy requirements
for the letter of credit. Once the merchandise is delivered, the seller receives documentation
proving that he made delivery. The letter of credit now must be paid even if something happens to
the merchandise. If a crane falls on the merchandise or the ship sinks, it's not the seller's problem.

To pay on a letter of credit, banks simply review documents proving that a seller performed his
required actions. They do not worry about the quality of goods or other items that may be
important to the buyer and seller.

Pitfalls of Letters of Credit

Letters of credit make it possible to do business worldwide. They are important and helpful tools,
but you should be careful when using letters of credit. As a seller, make sure you:

(i) Carefully review all requirements for the letter of credit before moving forward with a deal.

(ii) Understand all the documents required.

(iii) Can get all the documents required for the letter of credit.

(iv) Understand the time limits associated with the letter of credit, and whether they are
reasonable.

(v) Know how quickly your service providers (shippers, etc.) will produce documents for you.

(vi) Can get the documents to the bank on time.

(vii) Make all documents required by the letter of credit match the letter of credit application
exactly.

TYPES OF LETTER OF CREDITS

(i) Revocable Letter of Credit

(ii) Irrevocable Confirmed Letter of Credit

(iv) Revolving Credit

(v) Transferable Letter of Credit

(vi) Red Clause or Packing Credit

(vii) Stand by Credit

(i) Revocable Letter of Credit A revocable letter of credit may be cancelled or modified after its
date of issue, by the issuing bank. According to UCP600, credit shall be irrevocable.

(ii) Irrevocable Letter of Credit An irrevocable letter of credit can neither be amended nor
cancelled without the agreement of all parties to the credit. Under UCP500 all letters of credit are
deemed to be irrevocable unless otherwise stated. Here, the importer's bank gives a binding
undertaking to the supplier provided all the terms and conditions of the credit are fulfilled.

(iii) Confirmed Letter of Credit A confirmed letter of credit is one in which the advising bank, on
the instructions of the issuing bank, has added a confirmation that payment will be made as long as
compliant documents are presented. This commitment holds even if the issuing bank or the buyer
fails to make payment. The added security to the exporter of confirmation needs to be considered
in the context of the standing of the issuing bank and the current political and economic state of the
importer's country. A bank will make an additional charge for confirming a letter of credit. In many
cases, the confirming bank is located in beneficiary's country confirmation costs will vary according
to the country involved, but for many countries considered a high risk will be between 2%-8%.
There also may be countries issuing letters of credit, which banks do not wish to, confirm they may
already have enough exposure in that market or not wish to expose themselves to that particular
risk at all.

(iv) Revolving Letter of Credit The revolving credit is used for regular shipments of the same
commodity to the same importer. It can revolve in relation to time or value. If the credit is time
revolving once utilized it is re-instated for further regular shipments until the credit is fully drawn.
If the credit revolves in relation to value once utilized and paid the value can be reinstated for
further drawings. The credit must state that it is a wwolving letter of credit and it may revolve
either automatically or subject to certain provisions. Revolving letters of credit are useful to avoid
the need for repetitious arrangements for opening or amending letters of credit.

(v) Transferable Letter of Credit A transferable letter of credit is one in which the exporter has
the right to request the paying, or negotiating bank to make either panor for all of the credit falue
available to one or more third parties. This type of credit is useful for those scting as middlemen
especially where there is a need to finated pureful for third party suppliers.

(vi) Red Clause Letter of Credit Letter of credit allowing an initial advance to the beneficiary
before shipment of the goods. In the days of Telex, this clause in the Letter of Credit was printed in
red ink.
(vii) Standby Letters of Credit A standby letter of credit is used as support where an alternative,
less secure, method of payment has been agreed. They are also used in the United States of America
in place of bank guarantees.

(viii) Back-to-Back Letter of Credit A back-to-back letter of credit can be used as an alternative to
the transferable letter of credit. Rather than transferring the original letter of credit to the supplier,
once the letter of credit is received by the exporter from the opening bank, that letter of credit is
used as security to establish a second letter of credit drawn on the exporter in favour of his
importer. Many banks are reluctant to issue back to back letters of credit due to the level of risk to
which they are exposed, whereas a transferable credit will not expose them to higher risk than
under the original credit.

PROCEDURE FOR ISSUING A LETTER OF CREDIT

The procedure for issuing a letter of credit is outlined and explained here under:

L.C Application Form

Indent Performa invoice/Purchase Order

Insurance cover note/Marine insurance policy

Fixation of margin

Credit report of exporter

Forward exchange booking

Selection of foreign correspondent/Advising bank.

Transmission of letter of credit.

The applicant would fill out an application detailing the following information:

Name and address of beneficiary

Amount for which L/C is to be opened

Mode of availability of the credit

Name of the drawee of bill of exchange

Description of goods documenta required to be submitted by beneficiary for seeking payment/

Mentioning port of shipment and port of discharge of goods

Terms of payment of freight

Instructions regarding trans shipment or partial shipment

The date and place of expiry

The different types of documents required under letter of credit are outlined and explained
below:

Commercial Invoice

Bill of lading

Warrantee of title

Letter of indemnity

Commercial Invoice

The billing for the goods and services. It includes a description of merchandise, price, FOB origin
and name and address of buyer and seller. The buyer and seller information must correspond
exactly to the description in the letter of credit. Unless the letter of credit specifically states
otherwise, a generic description of the merchandise is usually acceptable in the other
accompanying documenta.

Bill of Lading

A document evidencing the receipt of goods for shipment and issued by a freight carrier engaged in
the business of forwarding or transporting goods. The documents evidence control of goods. They
also serve as a receipt for the merchandise shipped and as evidence of the carrier's obligation to
transport the goods to their proper destination.

Warranty of Title

A warranty given by a seller to a buyer of goods that states that the title being conveyed is good and
that the transfer is rightful. This is a method of certifying clear title to product transfer. It is
generally issued to the purchaser and issuing bank expressing an agreement to indemnify and hold
both parties harmless.

Letter of Indemnity

Specifically indemnifies the purchaser against a certain stated circumstance. Indemnification is

Common Defects in Documentation

About half of all drawings presented contain discrepancies. A discrepancy is an irregularity in the
documents that causes them to be in non-compliance to the letter of credit. Requirements set forth
in the letter of credit cannot be waived or altered by the issuing bank without the express consent
of the customer. The beneficiary should prepare and examine all documents carefully before
presentation to the paying bank to avoid any delay in receipt of payment. Commonly found
discrepancies between the Jetter of credit and supporting documents include:

(i)Letter of Credit has expired prior to presentation of draft.

(ii) Bill of Lading evidences delivery prior to or after the date range stated in the credit.

(iii) Stale dated documents.

(iv) Changes included in the invoice not authorized in the credit.

(v) Inconsistent description of goods.

(vi) Insurance document errors.

(vii) Invoice amount not equal to draft amount.

(viii) Ports of loading and destination not as specified in the credit.

(ix) Description of merchandise is not as stated in credit.

(x) A document required by the credit is not presented.

(xi) Documents are inconsistent as to general information such as volume, quality, etc.

(xii) Names of documents not exact as described in the credit. Beneficiary information must be
exact.

(xiii) Invoice or statement is not signed as stipulated in the letter of credit.