For the purpose of granting finance, banks are lending by way of fund based limits as well as non fund based limits. The following are treated as fund based limits:
a) Lock and key type – against of pledge of goods;
b) Open factory type pledge or open key advance – against hypothecation of goods; c) Advance against hypothecation of goods;
d) Advance against book debts;
e) Advance against bills.
The following are considered as non fund based limits granted by the banks to the public:
Letter of credit and bank guarantees:
Banks normally undertake a proper appraisal of the financial standing and requirement of the customer for non fund based facilities as in the case of fund based ones. This is because though the bank in the case of non funded facility, commits itself to pay only in the event of non-payment by or non performance of the customer, the possibility of the given non-funded credit facility resolving into real or funded credit facility on the customer's default or non performance cannot be ruled out.
Letter of credit:
A letter of credit is a written undertaking given by a bank on behalf of its customer who is a buyer, to the supplied, promising to pay a certain sum of money provided the supplier complies with the terms and conditions embodied in the letter of credit. A letter of credit is required where the supplier of goods and services deals with unknown parties or otherwise feels the need to safeguard his interest. In such circumstances he stipulates in his sales contract with the buyer that the goods will be supplied and payment made only under a bank's letter of credit. Under a bank's letter of credit a conditional commitment to make the payment is made by the bank which gives an assurance to the supplier that he will receive the necessary payment provided he does what the buyer requires him to do, within the time period specified in that regard.
Whereas in the case of fund based limits, the banks deal with goods, in the case of...
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