Types of Credit Facilities
Mainly credit facilities divided into 2 types
Fund based lending
The facilities like Overdrafts,Cash Credit A/c, Bills Finance, Demand Loans, Term Loans etc, wherein immediate flow of funds available to borrowers, are called funds based facility.
Non fund based lending
The non fund based facilities like issuance of letter of guarantee, letter of credit wherein banks get fees income and there is no immediate outflow of funds from bank.
Cash Credit System
Cash credit account is a running account just like a current account where debit balance in the account up to a sanctioned limit or drawing power fixed based on stock holding whichever is less. Sanction of Limit generally for 1 year. The limits are renewed or enhanced/reduced based on assessment of customer’s actual requirement on the basis of working of the unit. Customer has to submit periodic Stock statements depending on Operating Cycle, Turnover, and Cash Budget or Projected Balance Sheet. Cash Credit facility is offered normally against pledge or hypothecation of prime security such as – book debts, stocks of raw materials, semi finished goods and finished goods.
Advantages of Cash Credit System
Flexibility: Borrower is withdraw amount whatever is needed, not required to withdraw full limit
Operative Convenience: In cash credit account allowed number of credit and debit entry. There are not required to open new account at every withdrawal.
Disadvantages of cash Credit system
Fixation of Credit Limit: The cash credit limits are prescribed once in a year
Bank’s inability to verify end use of funds: Banks could compare the sales figure to the credits in the account to see if the limit is used efficiently
Lack of proper cash management
Overdrafts
Overdraft means allowing the customer to draw cheques over and above credit balance in his account. Overdraft is normally allowed to Current Account Customers and in exceptional case SB A/c holders are also allowed to overdraw their account. The high rate of interest is charged but only on daily debit balance. An overdraft is repayable on demand. There are two types of overdraft prevalent in Banks i.e.
Temporary overdraft or clean overdraft
Secured overdraft.
Temporary overdrafts are allowed purely on personal credit of the party and it is for party to meet some urgent commitments on rare occasions. Allowing a customer to draw against his cheques sent in clearing also falls under this category.
Secured overdraft is allowed up to a certain limit against some tangible security like bank deposits, LIC policies, National Saving Certificates, shares and other similar assets. Secured overdraft is most popular with traders as lesser operating cost, simple application and document formalities are involved in this facility.
Demand Loans
Demand loans are secured loans repayable on demand. Demand loan is granted against marking lien on bank’s own fixed deposits, Assignment of Life Insurance Policies with adequate surrender value, National Saving Certificates and so on. Demand loans can be gradually liquidated over a period generally in monthly, quarterly, half yearly installments or lump-sum payment at one shot or it can be closed from maturity proceeds of the security offered.
Bills Finance
Bills finance is short term in tenor and self liquidating finance in nature. Demand Bill is purchased and Usance bill is discounted by the banks. The bills drawn under Letter of Credit (LC may be on sight draft or usance draft) are negotiated by the banks. The advantage of bills finance is that the seller of goods (borrower) gets immediate money from the bank for the goods sold by him irrespective of whether it is a purchase, discount or negotiation by the bank according to type of bills.