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As a businessman when you visit a bank seeking credit facilities you are faced with a lot of banking jargon with which you are often not conversant. You tend to learn about them only when you start utilising such facilities. Further, if are young and starting a business afresh, you will be clueless about most of the banking terms.
How about knowing these facts before you visit your banker? That will definitely add value to your proposition. It is not as complex as you think; it is just knowing the basics right as in the case of any other proposition.
Always remember like in a doctor-patient relationship a banker-customer relationship should also be sincere when obtaining credit facilities, failing which both parties will face numerous problems in their relationship.
This article will give you an insight into various credit facilities available at banks in order to educate a layman on what type of facility suits their business the best. This article may also educate an experienced businessman/student seeking knowledge.
For a start let’s look at the two major types of credit facilities provided by a bank.
Funded lines/non-funded lines 
When a bank releases monies to the customer’s current account or the loan account in any type of facility it’s called a funded line. Example: Term loans, overdrafts, etc. In a funded facility the cost to the customer is interest. When a bank on behalf of the customer issues various types of undertakings and do not part with money they are called non-funded lines. Example: Letter of credit, bank guarantees, etc. In this type of facility the cost to the customer is commission.
The funded lines are more costly than non-funded lines to customers.
As the first step of this article let’s look at the funded lines provided by the banks which is the most commonly used by our businessmen especially the SME (Small and Medium Enterprises) sector.
Types of funded facilities
This facility is granted to a start-up business. A bank will analyse the feasibility of the project and structure a loan to part finance the start-up cost of the new business. A project loan will be usually given to manufacturing concerns as its gestation period will be longer than other types of businesses and will also need credit facilities at concessionary rates to fast track its breakeven point.
A project loan will usually finance fixed assets and a part of the working capital. In any case a bank will require the promoter also to finance a part of the project cost. Ideally these types of facilities need to be routed through a project finance unit of a bank or a development bank in order to gain their expertise in start-ups. A loan will be repaid over a period in line with the financial projections.
An overdraft is used to finance the working capital of a business. This will include purchase of goods, overheads, etc. Since the sales are also credited to this overdraft this will be a running account unlike a loan account where it has to be reduced on a monthly basis. An overdraft will have a limit and customers should ensure that the limit of the overdraft is in line with his working capital cycle. For this the bankers will do a proper analysis and it’s up to the customers give them actual stock turnover, debtor/creditor turnover periods. In well managed businesses overdraft balances are well fluctuated. Interest is charged on the daily balance outstanding and the rates are slightly above term loans.
A business may require additional working capital from time to time. It may be for seasonal purchases, purchase of a bulk stock at a discounted price, etc. In a situation like this a customer may request a temporary overdraft facility. A bank will consider such facilities to customers with a sound past track record only. Customers should ensure these facilities should be paid on the due date and requests for such facilities are not frequent. The rate of interest on such facilities is substantially higher than the permanent facilities.
A term loan is usually given to purchase a fixed asset to the business such as a machine, vehicle, etc. A part of a business’s working capital requirement is also funded as a term loan. This portion of working capital is identified as permanent working capital and is usually used to hold buffer stocks of a business. The repayment period of a term loan will be based on the businesses cash flows as well as the depreciation period of the asset. A term loan will have lesser interest than an overdraft.
One of the biggest mistakes made by customers is investing short-term funding in fixed assets which in turn will lead to huge cash flow constraints.
Import loans are given to importers for the purpose of releasing import documents to clear good. The repayment period of such loans will be dependent on the receipt of monies in cash form after the sale of such goods. Since a credit period is given to customers the repayment period must be in line with this credit period. Import loans are also granted to make advance payments and duty payments as well. The earlier an import loan is settled its profitable to the customer as the interest will depend on the number of days a facility is utilised.
Packing credit loans are given to exporters to process an order received from a buyer abroad. Such loans are usually backed by confirmed orders. The banks are very careful in lending under packing credit loans as the end use of funds will be hard to monitor as in an import loan.
Refinance loans are not funded by the bank which actually gives the facility but by another organisation such as the Central Bank. This facility is given to a sector that the policymakers decide that needs support from the Government which will in turn improve the economic conditions of the country. Sectors such as SME, agricultural and north reawakening are recent examples. Refinance loans are at very concessional rates and also has flexible repayment periods.
Leasing is a fast and easy way of purchasing a vehicle or machinery for your business. The ownership remains with the bank until all payments are met; therefore unlike in a loan the documentation is very simple. Further only a small down payment is requested from the client since the ownership remains with the bank. However, if the payments are not made promptly the vehicle can be seized at any time after giving notice of termination.
The above denotes the most commonly used funded lines used by our businessmen.
If the funded lines are costly its best that customers use the non-funded lines whenever they are available. Let’s look at the most common type of non-funded lines offered by banks.
Types of non-funded facilities
This is an undertaking by the bank to a supplier abroad that it undertakes to pay the supplier on submission of the proper import documents from which our client can clear the goods. In this situation what the bank does is eliminate the risk of the supplier of non-payment by the importer here. It must be mentioned that in international trade bank deals only with documents and not the goods and it’s up to the importer to request the necessary documents to fulfil that he receives the correct goods intact. For example, if customer X wants to import a textile stock from Y of China the Bank of X in Sri Lanka will issue a letter of credit favouring Y denoting the specified documents required for payment. Y of China ships the goods and sends the required documents to our bank. Our bank after perusing the docs and if they are in order will make payment to Y. Our customer X has to get the documents from our bank utilising his facilities (an import loan as mentioned above) or by payment of cash and then clear the goods.
A letter of guarantee is an undertaking from a bank that it will pay the principal a specified sum if the customer does not perform as per the contract he has entered with the principal. There are various types of letters of guarantees namely trade guarantees, construction related guarantees such as bid bonds, performance bonds, advance payment guarantees, and retention money guarantees. It must be stated that guarantees are issued to Government and reputed companies only to safeguard the interest of customers.
For example: If trader A wants to buy goods on credit for two months from Company B, trader A can go to his bank and obtain a trade guarantee from the bank. The bank will issue a guarantee to Company B that it will pay a specified sum of money to Company B if the trader A defaults.
Since the guarantee commission compared to overdraft interest is nominal it’s best that a trader uses this facility whenever possible. However, in the case of construction guarantees customers have no option but to use guarantee facilities which is in any case cheap.
Does the above sound like Greek to you? Do not think so, come on now get your proposition right and visit your banker with courage and obtain the best facility that suits you. You may even teach them some lessons from the above!
Good luck on your banking relationship!
[The writer, Msc Mgmt (USJ), FIBSL, FCPM, is Deputy General Manager – Branch Credit at Pan Asia Banking Corporation PLC.]
