Credit ManagementMBA Banking & Finance

3rd Term

Chapter 3Commercial Financing FacilitiesPrinciples of commercial financing facilitiesThere are Five principles of Lending1. Safety2. Liquidity3. Dispersal4. Remuneration5. Suitability

Types of commercial financing facilitiesA: General financing facilities1: Temporary Bridge FinanceDefinition Financing extended to a person,

company, or other entity, using existing asstes as collateral in order to acquire new assets. Bridge financing is usually short term.

Definition Short-term financing which is expected to be paid back relatively quickly, such as by a subsequent longer-term loan. also called swing loan or bridge financing. A method of financing, used by companies before their IPO, to obtain necessary cash for the maintenance of operations.

These funds are usually supplied by the investment bank underwriting the new issue. As payment, the company acquiring the bridge financing will give a number of shares at a discount of the issue price to the underwriters that equally offsets the loan. This financing is, in essence, a forwarded payment for the future sales of the new issue

• Bridge financing is used as temporary funds to cover the cost of your new home if the sale of your current home isn't complete by the time your new home's purchase is complete.

Your loan options are:

A lump-sum personal loan with a fixed interest rate, with lump sum repayment at maturity.

• A personal demand loan with interest-only payments.

Benefits• No minimum or maximum loan amount – the

amount depends on the confirmed source of repayment.

  Full or partial prepayment at any time without penalty.

Competitive rates.

Running FinanceRunning Finance is a fluctuating or running account

wherein a customer arranged with his bank to permit him to overdraw his current account (known as over draft, O/D) up to a fix limit for a short period. When the over draft facility is given against collateral security, it is called secured over draft, and when it is against personal, it is named as clean draft.

• The granting of over Draft facility to a customer is advantageous to both parties, the customer and the bank

• Customer

1. Customer is able to to meet the working capital requirement of the business.

2. The customer gets the facility to over draw his account as and when the need arises up to the approved limit.

3.Whenever the customer has surplus fund, he may pay such fund to reduce overdraft balance or settle the balance.

4. It is running finance, there are no restrictions on drawing more than once provided the total amount overdrawn does not exceed the agreed limit.

5. The interest is charged only on amount overdrawn,6. A cheque book is issued in overdraft or running

account

Demand Finance Demand finance is also called Line of credit is an

agreement between a customer and the bank that the bank will entertain requests from the customer for a loan up to a predetermined amount. The line of credit is established when the bank gives a letter to customer stating the dollar amount of the line, the time it is in effect ( e.g. one year) and other conditions or provisions such as the relationship the customer must maintain

With the bank and the customer’s financial condition. If the borrower does not meet all the terms and condition of the letter, the bank is not obligated to make the loan

Usually the loans are for one year or less. The loan is payable on demand of the bank or with in ninety days.

Loan is used to finance increase in inventory and account receivable.

Term loan Term loan is usually a single loan for a stated

period of time, or a series of loans on specified dates. They are used for specific purpose, such as acquiring machinery, refinancing the debts, etc. they should not be used to finance day-to-day operations.

Term loans may have an original maturity of five years or more.

From banker point of view the maturity of loan should not exceed the economic life of the asset being financed, if used as a security.

The loan may be repaid on authorized basis or at one time.

The value of asset must be more then the amount of loan which represent equity of the borrower.

From banker point of view the maturity of loan should not exceed the economic life of the asset being financed, if used as a security.

• The loan may be repaid on authorized basis or at one time.

The value of asset must be more then the amount of loan which represent equity of the borrower.

• Inland Bill Financing• There are two types of bills • Inland bills also called local bills• Foreign bills• Definition of bills of exchange

An instrument in writing containing an unconditional order, signed by the maker, directing a certain person to pay on demand or at a fixed or determinable future time, a certain sum of money, only to or to the order of certain person or to the bearer of the instrument

The commercial banks sometimes purchase the clean and documentary bills of exchange on commission. These bills are demands bills and are purchased only from the approved customers of the banks. By purchasing the demand bills , the bank pays the amount of the bills after deduction of the commission to the customers.

The commission here is profit of the bank. The purchase of bill does not mean that bank is owner of the bills, but the demand bill is held by the bank and is cashed when money is required.

Local Bill Purchased

Discounting of bills

Purchasing and discounting of bills of exchange is another short term method of profitable investment of banks funds.

Bills of exchange can be discounted on rebate before its due date. The rebate or discounting is earning of the bank.

The bill of exchange usually mature in 90 days.

The main advantages of discounting bills by the banks are:

1. Safe employment of fund. The bank by discounting the clean or documentary bill advances the amount to the payee.

ON maturity of the bills , the amount is collected from the drawer. The discount is the safe earning of the bank, because the bill of exchange is the safe instrument. If at any time the bill is dishonored, the payee is responsible to make full payment of the bill to the bank.

2. Certainty of payment. On maturity of the bill, there is certainty of payment to the bank

Advantages of discounting bills

3. Advance is liquid.As the date of payment to the bank is sure, the short term advance is quite liquid. Rediscounting facilities are also available on discounted bill of exchange.

4. Free from price fluctuations. The payment made by the bank on discounted bill is free from fluctuations. The bank realizes the bill at par value.

5.Profitable earning. the discount rate is usually higher then interest charge on loans and advances. Bills offers good with no risk.

6. Facility of rediscounting. The banker has the rediscounting facilities, if it is short of fund any time.

7. Double benefit. The bank get double benefits by rediscounting bills. The bank may get new customer by opening an account.

Secondly the amount advanced by rediscounting the bill is credited in the account of the customer will remain with the bank.

International loans exhibits many of the same characteristics as domestic loans. Individuals multinational businesses, domestic import export companies, foreign business and foreign governments constitutes the basic borrowing groups. The only difference is some prerequisites and unique risks.

International lending

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