Non-fund based limits are credit facilities offered by banks and financial institutions to customers that do not involve the actual disbursal of funds. Instead, these facilities provide certain assurances or guarantees to support the customer’s business activities. Non-fund based limits are contingent liabilities for banks, meaning that the banks are obligated to pay only if certain conditions are not met by the borrower. Let’s explore the principles of lending, working capital assessment, and credit monitoring specific to non-fund based limits:
- Principles of Lending (Non-fund Based Limits):
a. Adequate Collateral: Even though non-fund based limits do not involve direct disbursal of funds, banks still consider the borrower’s creditworthiness and may require adequate collateral to secure the limits. This collateral provides recourse for the bank in case the borrower fails to meet their obligations.
b. Assessing Contingent Liability: Banks evaluate the borrower’s capacity to honor the contingencies that trigger the non-fund based limits. They assess the borrower’s financial position, cash flow, and reputation to ensure they can fulfill the obligations if necessary.
c. Prudent Risk Management: While non-fund based limits do not directly expose banks to credit risk, they still carry certain contingent risks. Banks employ prudent risk management practices to assess and monitor these contingent liabilities to protect their interests.
- Working Capital Assessment (Non-fund Based Limits):
a. Nature of Facilities: Non-fund based working capital limits include various facilities like letters of credit (LCs), bank guarantees, and performance bonds. Banks analyze the nature of these facilities and the purpose they serve in the borrower’s working capital cycle.
b. Trade Transactions: In the case of LCs, banks evaluate the underlying trade transactions to ensure that they are genuine and related to the borrower’s core business activities.
c. Performance Guarantees: For performance bonds and guarantees, banks assess the validity and enforceability of the guarantee terms to protect the borrower’s counterparty in case of non-performance.
- Credit Monitoring (Non-fund Based Limits):
a. Contingent Liability Tracking: Banks monitor the contingent liabilities arising from non-fund based limits to assess their potential impact on the borrower’s overall financial position. They keep track of any changes in the exposure level to manage the overall credit risk.
b. Collateral Valuation: In cases where collateral is required for non-fund based limits, banks regularly assess the value and condition of the collateral to ensure it remains adequate to cover the liabilities.
c. Compliance with Terms: Banks monitor whether the borrower adheres to the terms and conditions associated with non-fund based limits. They also check the borrower’s compliance with regulatory requirements related to these facilities.
d. Timely Renewals: Non-fund based limits are typically short-term facilities. Banks monitor the expiry dates of these facilities and work with the borrower to ensure timely renewals or adjustments as needed.
Non-fund based limits provide valuable financial support to businesses, facilitating trade, and other transactions. They are often utilized by companies to secure contracts, perform contractual obligations, and build trust with their trading partners. Banks’ careful evaluation, ongoing monitoring, and prudent risk management are essential to mitigate any potential risks associated with non-fund based credit facilities.