Bank Overdraft –
a facility where the account holder is permitted to draw more funds that
the amount in his current account
Cash Credit –
an arrangement where the working capital requirements of a business are
assessed based on financial projections of the company, and various norms regarding
debtors, inventory and creditors. Accordingly, a total limit is sanctioned. At regular
intervals, the actual drawing power of the business is assessed based on its holding of
debtors and inventory. Accordingly, funds are made available, subject to adherence to
specified limits of Current Ratio, Liquid Ratio etc.
Funding could come from a consortium of bankers, where one bank performs the role of lead banker. Alternatively, the company may make multiple banking arrangements
Bill Purchase / Discount –
When Party A supplies goods to Party B, the payment terms
may provide for a Bill of Exchange (traditionally called hundi).
A bill of exchange is an unconditional written order from one person
(the supplier of the goods) to another (the buyer of the goods), signed by the person giving it (supplier),requiring the person to whom it is addressed (buyer) to pay on demand or at some fixed future date, a certain sum of money, to either the person identified as payee in the bill of exchange, or to any person presenting the bill of exchange.
o When payable on demand, it is a Demand Bill
o When payable at some fixed future date, it is a Usance Bill.
The supplier of the goods can receive his money even before the buyer makes the
payment, through a Bill Purchase / Discount facility with his banker. It would
operate as follows:
o The supplier will submit the Bill of Exchange, along with Transportation Receipt
to his bank.
o The supplier’s bank will purchase the bill (if it is a demand bill) or discount the bill
(if it is a usance bill) and pay the supplier.
o The supplier’s bank will send the Bill of Exchange along with Transportation
Receipt to the buyer’s bank, who is expected to present it to the buyer:
For payment, if it is a demand bill
For acceptance, if it is a usance bill.
o The buyer will receive the Transportation Receipt only on payment or acceptance,
as the case may be.
Term Loan / Project Finance –
Banks largely perform the role of working capital financing.
With the onset of universal banking, some banks are also active in funding projects. Thiswould entail assessing the viability of the project, arriving at a viable capital structure,and working out suitable debt financing facilities. At times, the main banker for the business syndicates part of the financing requirement with other banks
For Individuals
Credit Card –
The customer swipes the credit card to make his purchase. His seller will then submit the details to the card issuing bank to collect the payment. The bank will deduct its margin and pay the seller. The bank will recover the full amount from thecustomer (buyer). The margin deducted from the seller’s payment thus becomes a profit
for the card issuer. So long as the customer pays the entire amount on the due date, he does not bear anyfinancing cost. He may choose to pay only the minimum amount specified by the bank. Inthat case, the balance is like a credit availed of by him. The bank will charge him interest on the credit.
Such a mechanism of availing of credit from the credit card is called revolving credit.
It is one of the costliest sources of finance – upwards of 3% p.m. Besides, even for a few days of delay in payment, the bank charges penalties. Similarly, penalties are charged if the credit card outstanding crosses the limit specified by the bank.
Owners of many unorganized businesses (who find it difficult to avail of normal bank
credit) end up using the credit card to fund their business in this manner undesirable,
but at times, inevitable.
Personal Loan –
This is a form of unsecured finance given by a bank to its customer based
on past relationship. The finance is given for 1 to 3 years. Cheaper than credit card, but costly. It is not uncommon to come across interest rates of 1.5% p.m. plus 2-3% upfront for making the facility available plus 3-5% foreclosure charges for amounts pre-paid on the loan.
At times, banks convert the revolving credit in a credit card account to personal loan.
Such a conversion helps the customer reduce his interest cost and repay the money
faster. This is however a double edged sword. Once the credit card limit is released,
customers tend to spend more on the card and get on to a new revolving credit cycle.
Vehicle Finance –
This is finance which is made available for the specific purpose of buying
a car or a two-wheeler or other automobile. The finance is secured through hypothecation (discussed in next Chapter) of the vehicle financed. The interest rate for used cards can go close to the personal loan rates. However, often automobile manufacturers work out special arrangements with the financiers to promote the sale of the automobile. This makes it possible for vehicle-buyers to get attractive financing terms for buying new vehicles.
Home Finance –
This is finance which is made available against the security of real estate. The purpose may be to buy a new house or to repair an existing house or some other purpose. The finance is secured through a mortgage of the property.
The finance is cheaper than vehicle finance. As with vehicle finance, real estate developers do work out special arrangements with financiers, based on which purchasers of new property can get attractive financing terms
