- 1 -

“ A STUDY ON FOREIGN EXCHANGE OPERATIONS ”

IN

UNION BANK OF INDIA, CHENNAI

PROJECT REPORT

Submitted in partial fulfillment of the

Requirements for the award of

Post Graduation Program in Business Management

2008

NAME : JOTHISWAROOPINI

REGISTRATION NO : 3024

Under the Supervision of

Mr. Sarvan Krishnamurthy, M.S. (Industrial Mgt), B.E. (Mech)

KOHINOOR BUSINESS SCHOOL, KHANDALA

- 2 -

Kohinoor Business School Old Pune-Mumbai Highway,

Khandala - 410 301.

This is to certify that Ms.Jothiswaroopini, a student of Post Graduation Program in

Business Management, 2007 – 09 batch has undertaken the project titled “ A study on

Foreign Exchange Operations in Union Bank of India, Chennai ” for a duration of two

months.

She has successfully completed the above said project to the best of our satisfaction.

Prof. Sarvan Krishnamurthy Dr.B.P.Verma

Project Guide Director

- 3 -

INDEX

Chapters Title Page Numbers

1 Declaration 4

2 Acknowledgement 5

3 Executive Summary 7

4 Industry Profile 9

5 Company Profile 14

6 Research Methodology 20

7 Treasury 22

8 Foreign Exchange 35

9 Exchange Rate Mechanism 64

10 Work Desk 72

11 Conclusion 81

12Appendix

Abbreviations 83

13 Bibliography 87

- 4 -

DECLARATION

I, JOTHISWAROOPINI a Bona-fide student of Kohinoor Business School, Khandala,

hereby declare that the project titled “ A study on Foreign Exchange Operations in Union

Bank of India, Chennai ” in partial fulfillment of the requirements of the Post Graduation

Program in Business Management is my original work.

Date :

Place :

Signature

- 5 -

ACKNOWLEDGEMENT

I am deeply indebted to Dr.B.P.Verma, The Director, Kohinoor Business

School, Khandala for having allowed me to carry out the project successfully.

I specially thank Mr. Sarvan Krishnamurthy, Assistant Professor,

Strategic Management for his constant guidance, professional help and support during

the course of the project.

I express my grateful thanks to Mr. Venkataramaiah, Chief Manager,

Human Resource Management for according me an opportunity to be associated with

Union Bank of India, Chennai. My deepest gratitude to Mr. Parthasarathy, Senior

Manager; Mrs. Suseela, Assistant Manager, Foreign Exchange; Mr. Santhosh,

Assistant Manager, Foreign Exchange for their immense help and cooperation to

permit me to complete this intensive project.

- 6 -

CHAPTER - IIII

EXECUTIVE SUMMARY

- 7 -

EXECUTIVE SUMMARY

The Reserve Bank of India administers exchange controls in accordance with the

Government’s policy designed to maintain general control over the foreign exchange

situation, particularly outgoing financial flows. The Foreign Exchange Regulation Act

(FERA), 1973 confers powers to the Reserve Bank of India concerning foreign exchange

control. General or specific permission is required from the Reserve Bank of India for all

foreign exchange transactions. Foreign companies operating in India are governed by the

Foreign Exchange Regulation Act (FERA), 1973, which sets guidelines for bank

accounts, loans, foreign exchange trading and the remittance of dividends and profits.

The Asian Clearing Union (ACU) was established in 1974 under the auspices of the

Economic and Social Commission for Asia and the Pacific as a mechanism for settlement

of payments among participating countries’ central banks. The Reserve Bank of India is

one of the original participants. The other participants are Bangladesh, the Islamic

Republic of Iran, Nepal, Pakistan, Sri Lanka, and Myanmar. All authorized banks in India

can handle transactions cleared through the Asian Clearing Union. It is compulsory that

all eligible payments among participants be settled through the Asian Clearing Union.

In March 1993, the government ended certain FERA restrictions on domestic

borrowing, trading and acquisition of immovable property by companies with more than

40 % foreign equity. Residents may use up to 25 % of foreign exchange earnings to

maintain a foreign currency bank account in India. Foreign employees, liaison offices,

project offices and branches of foreign companies may open and use a resident bank

account in Indian currency provided that they have approval from the Reserve Bank for

operations in India.

In August 1994, the rupee was made fully convertible on the current account.

Rupee convertibility on the trade account is restricted by the negative list of imports and

exports and limited to those involved in trade. All export and import transactions are

conducted at the market rate of exchange.

- 8 -

CHAPTER – IV

INDUSTRY PROFILE

- 9 -

INDUSTRY PROFILE

The Indian Banking industry, which is governed by the Banking Regulation Act of India,

1949 can be broadly classified into two major categories, non-scheduled banks and

scheduled banks. Scheduled banks comprise commercial banks and the co-operative

banks. In terms of ownership, commercial banks can be further grouped into nationalized

banks, the State Bank of India and its group banks, regional rural banks and private sector

banks (the old / new domestic and foreign). These banks have over 67,000 branches

spread across the country.

The first phase of financial reforms resulted in the nationalization of 14 major banks in

1969 and resulted in a shift from Class banking to Mass banking. This in turn resulted in

a significant growth in the geographical coverage of banks. Every bank had to earmark a

minimum percentage of their loan portfolio to sectors identified as “priority sectors”. The

manufacturing sector also grew during the 1970s in protected environments and the

banking sector was a critical source. The next wave of reforms saw the nationalization of

6 more commercial banks in 1980. Since then the number of scheduled commercial banks

increased four-fold and the number of bank branches increased eight-fold.

After the second phase of financial sector reforms and liberalization of the sector in the

early nineties, the Public Sector Banks (PSBs) found it extremely difficult to compete

with the new private sector banks and the foreign banks. The new private sector banks

first made their appearance after the guidelines permitting them were issued in January

1993. Eight new private sector banks are presently in operation. These banks due to their

late start have access to state-of-the-art technology, which in turn helps them to save on

manpower costs and provides better services.

During the year 2000, the State Bank of India (SBI) and its 7 associates accounted for a

25 percent share in deposits and 28.1 percent share in credit. The 20 nationalized banks

accounted for 53.2 percent of the deposits and 47.5 percent of credit during the same

period. The share of foreign banks (numbering 42), regional rural banks and other

scheduled commercial banks accounted for 5.7 percent, 3.9 percent and 12.2 percent

- 10 -

respectively in deposits and 8.41 percent, 3.14 percent and 12.85 percent respectively in

credit during the year 2000.

The industry is currently in a transition phase. On the one hand, the Public Sector Banks,

which are the mainstay of the Indian Banking system, are in the process of shedding their

flab in terms of excessive manpower, excessive Non Performing Assets (NPAs) and

excessive governmental equity, while on the other hand the private sector banks are

consolidating themselves through mergers and acquisitions.

Public Sector Banks, which currently account for more than 78 percent of total banking

industry assets are saddled with non-performing assets (a mind-boggling Rs 830 billion in

2000), falling revenues from traditional sources, lack of modern technology and a

massive workforce while the new private sector banks are forging ahead and rewriting

the traditional banking business model by way of their sheer innovation and service. The

Public Sector Banks are of course currently working out challenging strategies even as 20

percent of their massive employee strength has dwindled in the wake of the successful

Voluntary Retirement Schemes (VRS) schemes.

The private players however cannot match the Public Sector Banks’ great reach, great

size and access to low cost deposits. Therefore one of the means for them to combat the

Public Sector Banks has been through the merger and acquisition (M& A) route. Over the

last two years, the industry has witnessed several such instances. The UTI bank- Global

Trust Bank merger however opened a Pandora’s box and brought about the realization

that all was not well in the functioning of many of the private sector banks.

Private sector Banks have pioneered internet banking, phone banking, anywhere banking,

mobile banking, debit cards, Automatic Teller Machines (ATMs) and combined various

other services and integrated them into the mainstream banking arena, while the Public

Sector Banks are still grappling with disgruntled employees in the aftermath of successful

VRS schemes. Also, following India’s commitment to the WTO agreement in respect of

the services sector, foreign banks, including both new and the existing ones, have been

- 11 -

permitted to open up to 12 branches a year with effect from 1998-99 as against the earlier

stipulation of 8 branches.

Talks of government diluting their equity from 51 percent to 33 percent in November

2000 have also opened up a new opportunity for the takeover of even the Public Sector

Banks. The FDI rules being more rationalized in Q1FY02 may also pave the way for

Foreign banks taking the M& A route to acquire willing Indian partners.

Meanwhile the economic and corporate sector slowdown has led to an increasing number

of banks focusing on the retail segment. Many of them are also entering the new vistas of

Insurance. Banks with their phenomenal reach and a regular interface with the retail

investor are the best placed to enter into the insurance sector. Banks in India have been

allowed to provide fee-based insurance services without risk participation invest in an

insurance company for providing infrastructure and services support and set up of a

separate joint-venture insurance company with risk participation.

After the first phase and second phase of financial reforms, in the 1980s commercial

banks began to function in a highly regulated environment, with administered interest

rate structure, quantitative restrictions on credit flows, high reserve requirements and

reservation of a significant proportion of lendable resources for the priority and the

government sectors. The restrictive regulatory norms led to the credit rationing for the

private sector and the interest rate controls led to the unproductive use of credit and low

levels of investment and growth. The resultant ‘financial repression’ led to decline in

productivity and efficiency and erosion of profitability of the banking sector in general.

This was when the need to develop a sound commercial banking system was felt. This

was worked out mainly with the help of the recommendations of the Committee on the

Financial System (Chairman: Shri M. Narasimham), 1991. The resultant financial sector

reforms called for interest rate flexibility for banks, reduction in reserve requirements,

and a number of structural measures. Interest rates have thus been steadily deregulated in

the past few years with banks being free to fix their Prime Lending Rates (PLRs) and

- 12 -

deposit rates for most banking products. Credit market reforms included introduction of

new instruments of credit, changes in the credit delivery system and integration of

functional roles of diverse players, such as, banks, financial institutions and non-banking

financial companies (NBFCs). Domestic Private Sector Banks were allowed to be set up,

PSBs were allowed to access the markets to shore up their Cars.

The growth in the Indian Banking Industry has been more qualitative than quantitative

and it is expected to remain the same in the coming years. Based on the projections made

in the "India Vision 2020" prepared by the Planning Commission and the Draft 10th Plan,

the report forecasts that the pace of expansion in the balance-sheets of banks is likely to

decelerate. The total assets of all scheduled commercial banks by end-March 2010 are

estimated at Rs 40, 90,000 crores. That will comprise about 65 per cent of GDP at current

market prices as compared to 67 per cent in 2002-03. Bank assets are expected to grow at

an annual composite rate of 13.4 per cent during the rest of the decade as against the

growth rate of 16.7 per cent that existed between 1994-95 and 2002-03. It is expected that

there will be large additions to the capital base and reserves on the liability side.

- 13 -

CHAPTER - V

COMPANY PROFILE

- 14 -

COMPANY PROFILE

Brief history of the bank and its constitution :-

Prior to the Nationalisation of major banks in 1969, Union Bank was functioning

as a limited liability company with a Board of Directors elected by its share holders.

Union Bank was incorporated on 11th of November 1919, having its Registered Office in

Bombay. It was included in the 2nd Schedule to the Reserve Bank of India Act on 5th of

July 1935 and was granted a license under section 22 of the Banking Regulation Act,

1949 on 10th of December 1952. By 1969, Union Bank was well established in different

parts of the country. It was nationalized along with thirteen other major banks with effect

from 19th July 1969, under the Banking companies ( Acquisition and Transfer of

Undertakings ) Act, 1970. It is now a Corporation established by an Act of Parliament

with a common seal.

The bank came out with its maiden Initial Public Offering of 1800 lacs equity

shares of Rs. 10/- each at a premium of Rs. 6/- per share, in August 2002. The response to

this Initial Public Offer aggregating to Rs.288 crores (Rs. 180 crores + share premium Rs.

108 crores) was overwhelming and was over subscribed by 5.2 times. As a sequel to this

Initial Public Offer, Government of India holding is reduced to 60.85 % of the total

equity capital (Post IPO – August 2002) of the bank. The bank’s affairs are managed by

the chairman and Managing Director, as per the direction and control of the Board of

Directors constituted by the Government of India. Besides appointing the chairman and

Managing Director, the Government has also appointed an Executive Director for the

bank. Other directors on the Board include one director – each representing the Reserve

Bank of India, Government of India, the Bank’s officer staff, the Bank’s non-officer staff

and Nominated Directors.

After the IPO, the constitution of the Board of Directors will also include four

representatives of share holders. The bank continues to be a Scheduled Bank under the

Reserve Bank of India Act. It is required to maintain statutory minimum balances with

the Reserve Bank of India calculated on the basis of the bank’s Demand and Time

- 15 -

Liabilities and is eligible for financial accommodation and other benefits as a Scheduled

Bank from the Reserve Bank of India.

It also continues to be an Authorized Dealer in Foreign Exchange and is

authorized to deal in all currencies. It continues to be subject to the supervision and

control of the Reserve Bank of India under the provision of the Banking Regulations Act

in regard to various matters such as inspection, opening and shifting of branches,

maintenance of statutory liquidity, and compliance with Directives of the Reserve Bank

of India in the matters of Income Recognition and Asset classification, Disclosure Norms

and preparation and audit of Balance sheet and Profit and Loss account etc. The bank also

continues to be an Insured Bank under the Deposit Insurance Corporation Act.

The bank is, however, free to set its own norms and rules and regulations in the

matter of granting of loans and advances, making investments, trading in securities,

formation of Deposit Schemes and pricing of its deposits and advances and other

services. The bank carries out this exercise through Assets and Liability Management by

collecting relevant data from branches and depending on the market conditions.

Union Bank of India is firmly committed to consolidating and maintaining its

identity as a leading, innovative commercial Bank, with a proactive approach to the

changing needs of the society. This has resulted in a wide gamut of products and services,

made available to its valuable clientele in catering to the smallest of their needs. Today,

with its efficient, value-added services, sustained growth, consistent profitability and

development of new technologies, Union Bank has ensured complete customer delight,

living up to its image of, “GOOD PEOPLE TO BANK WITH”. Anticipative banking-

the ability to gauge the customer's needs well ahead of real-time - forms the vital

ingredient in value-based services to effectively reduce the gap between expectations and

deliverables.

The key to the success of any organization lies with its people. No wonder, Union Bank's

unique family of about 26,000 qualified / skilled employees is and ever will be dedicated

- 16 -

and delighted to serve the discerning customer with professionalism and

wholeheartedness.

Organizational Set up :-

The revamping of the organizational set up of the bank started in 1997 – 98 is

now complete and the resultant 3 tier management structure as shown below is in place :

1. Central Management : Central ( corporate ) office including Field General

Manager’s Offices ( extended aim of Central Office )

2. Regional Management : Regional Offices in the field.

3. Branch Management : Branch Offices in the field.

The above three tiers of management constitute the bank’s management structure.

However, at present, three Zonal Offices are also functioning in the field at the following

centres and are reporting directly to the Central Office.

1. Ahmedabad – covering branches in the state of Gujarat

2. Pune - covering branches in the state of Maharashtra ( except branches under

Metropolitan Mumbai Zone ) and Goa.

3. Bhopal - covering branches in the state of Madhya Pradesh and Chattisgarh.

Central Office, Mumbai :

Central Office or Central Management is responsible for planning, policy

formulation, budgeting, finalization of accounts and liaisoning with the Government,

Reserve Bank of India, other financial institutions and other authorities.

It formulates Corporate Plans – long term as well as short term – in consultation

with Field General Managers and extends guidance / assistance to field functionaries in

implementing these plans.

The Managing Director, who is the Chief Executive of the bank, is directly

responsible to the Board of Directors for implementation of its policy decisions and

smooth running of the bank. He exercises overall control over the bank’s affairs with the

assistance of the Executive Director and other Executives. The corporate level functions

are appropriately grouped on functional basis for effective working and each of these

- 17 -

groups is headed by a Top Executive. These groups are placed under the charge of

General Managers at coordinating level. The concerned General Managers report to the

Executive Director and evolve operational policies and programmes under the guidance

of the Executive Director / Managing Director. The Executive Director will report to the

Managing Director. The top Executive – in – charge of Vigilance will report on vigilance

matters directly to the Managing Director. The coordinating and functional level

Executives perform such duties and exercise such powers as may from time to time be

delegated to them by the Board of Directors or the Managing Director.

Field General Manager’s Office ( FGMO ) :

The Field General Manager’s Office is conceptualized to bring the Head Office

closer to the grass roots via its presence in the field. The role focus of Field General

Manager’s Office is designed to serve this basic objective without creating a tier.

The Field General Manager’s Office is responsible for

Meeting competition

Leadership support, challenges and development of the people in the field.

Translating the corporate policies into practice, as well as providing feed-back

and suggestions on the update of the policies.

Promote the culture of computerization and its effective utilization.

Field General Manager’s Office will conduct evaluation studies in various areas

of its operations with a view to bringing about qualitative shift in working of regions /

branches. They would render guidance, assistance and help to improve regional / branch

operations.

Regional Offices :

Branches have been grouped into Regions. Each identified Region will be under

the charge of a Regional Head – an executive in Senior / Top Management Grade. The

Regional Office or Regional Management level shall be directly responsible for

implementation of the policies of the bank controlling branch operations including

business development, branch expansion, sanctioning and follow-up of advances, etc. In

other words, Regional Office is the first controlling management tier for branches. It shall

- 18 -

provide appropriate leadership to the branches to accomplish the Regional objectives. In

Lead Districts, Lead District Mangers shall be provided to undertake Lead

responsibilities. Those Regional Offices located in Lead Districts shall be additionally

responsible for Lead activities such as preparation of Annual Credit Plans and Annual

Action Plans for the District, monitoring of progress etc,.

Foreign Exchange business has emerged as an area of vital importance in the

development strategy of banks the world over. The rapidly expanding global market with

innovative financial products, presents challenging opportunities in international banking.

Union Bank of India commenced foreign exchange operations with a provisional license

in 1955. In the initial years, it utilized the services of The Chartered Bank Ltd., whose

systems were largely adopted when the full fledged authorized dealers license was

granted by Reserve Bank of India in 1956. The Foreign Division as it was then called,

was set up by experienced officials from foreign banks, including Mr.U.S.Prabhu and

Mr.J.B.Desai from the First National City Bank of New York Ltd., Robert J.Angus from

the National Westminster Bank Ltd., and others.

The quantum of Foreign Exchange business rose impressively during the sixties and

seventies, with the bank being awarded on more than one occasion, certificates of merit

from the Government of India, for its contribution to export development. The bank’s

expertise in the field of Foreign Exchange operations was acknowledged in the banking

industry with major banks deputing their officials to Union bank for training and

consultation.

- 19 -

CHAPTER – VI

RESEARCH METHODOLOGY

- 20 -

RESEARCH METHODOLOGY

The project study has been done with the help of Observation method. The value of

observation is that we can collect the original data at the time they occur. We need not

depend on reports by others. Another strength is that we can secure information that most

participants would ignore either because it is so common and expected or because it is

not seen as relevant. The third advantage of observation is that it alone can capture the

whole event as it occurs in its natural environment. Whereas the environment of an

experiment may seem contrived to participants, and the number and types of questions

limit the range of responses gathered from respondents, observation is less restrictive

than most primary collection methods. Finally, participants seem to accept an

observational intrusion better than they respond to questioning. Observation is less

demanding of them and normally has a less biasing effect on their behavior than does

questioning.

Direct observation occurs when the observer is physically present and personally

monitors what takes place. This approach is very flexible because it allows the observer

to react to and report subtle aspects of events and behaviors as they occur. A weakness of

this approach is that observers’ perception circuits may become overloaded as events

move quickly, and observers must later try to reconstruct what they were not able to

record.

- 21 -

CHAPTER - VII

TREASURY

- 22 -

TREASURY

Credit Policy

Resources mobilization and deployment thereof in the most profitable manner within the

frame work stipulated by the Regulator i.e. the Reserve Bank of India are the main

functions of any bank. The major portion of the deployment of resources is through credit

dispensation and hence the returns thereon and safety thereof are of paramount

importance. Hence the policy of lending is formulated mainly from this angle. The policy

envisages, in the light of the dynamic and multifarious changes in the financial sector in

the recent past, as also the various directives issued by the Regulator during the

intervening period, a sustained growth plan of the advances portfolio. It is designed with

a focus on optimum usage of resources without compromising on the asset quality, the

strategies for deployment of credit, system of assessments, financial parameters, pricing,

prudential norms, risk management, etc,. It also indicates the chosen areas for credit

deployment, low priority areas, borrower standards, group approach, consortium

arrangements, geographical spread and sectoral deployment of credit.

The primary objectives of the credit policy are as under :-

Ensuring the loan assets remain safe & secure,

Ensuring the loan assets remain performing,

Ensuring the profitable deployment of resources enduring Asset – Liability

matching and recycling of funds,

Ensuring due compliance of regulatory norms, particularly Capital Adequacy

norm issues, Income Recognition, Asset Classification etc.,

Ensuring balanced deployment of credit to various sector and geographical

regions, and

Introduction of Risk Management concepts for credit portfolio in a scientific

manner.

- 23 -

Chosen areas for Credit Policy :-

Priority Sector lending

Agricultural Sector

Small Scale Industry

Cottage Industries,

Khadi Village Industries,

Artisans and Tiny Industries, etc,.

Weaker Section

Credit to Women for upliftment and economic development

Export Finance

Software Developers and Service providers

Credit to Midsized Corporates

This includes both short term and long term requirements such as

Commercial papers, external commercial borrowing, foreign currency

loans, public deposits, private placement of debentures and bonds, etc,.

The top corporate borrowers having good credit rating reduce their

dependence on bank finance and large limits sanctioned to them remain

unutilised to a great extent.

Infrastructure Financing

Activities involved in Infrastructure Financing are Roads, Ports, Power,

Telecom, Urban infrastructure facilities, Development of Industrial areas.

- 24 -

CREDIT POLICY

Managing Director and Executive Director are empowered to sanction credit facilities to

parties within their delegated authority without any ceiling as to fund based and non-fund

based limits. The maximum Fund based and Non-Fund based limits that can be

sanctioned to any single borrower is restricted to 9 times the Tangible Net Worth of the

borrower.

Working Capital Term Loan ( WCTL ) is given to improve the current ratio and

reduction in margin will not fall within the ambit.

Working Capital :-

The most important aspect while preparing a credit proposal is working out the credit

requirement of the customer in the appropriate manner so that the funds placed at his

disposal are put to optimum use. The bank will have to make its own assessment of credit

requirements of the borrowers based on a total study of borrower’s business operations,

ie., taking into account the production / processing cycle of industry as well as the

financial and other relevant parameters of the borrowers.

Fund Based Credit Limit Non-Fund Based Credit Limit

1. Working Capitala. Secured

facilityb. Unsecured

facility2. Term Finance

a. Secured facility

1. Inland / Import Letter of Credit

a. DA basis b. DP basis

2. Deferred Payment Guarantees

3. Letters of Guarantee

- 25 -

Methods to assess Bank Finance / Bank Credit :

1. Turnover Method

The working capital requirement under this method is to be computed on the

basis of 20 % of the projected annual turnover. In order to ensure that there is a

minimum margin by way of promoter’s contribution to support the working capital

needs, the borrowers are required to bring in at least 5 % of the projected annual

turnover as their contribution towards margin. The projected turnover has to be

interpreted as gross sales inclusive of excise duty. As regards 5 % of the promoter’s

stake, the same should be brought in by way of Net Working Capital and it is

expected that wherever the level of holding of Current Assets / Production /

Processing cycle is longer, then the borrower should bring in proportionately higher

stake in relation to his requirement of Bank Finance.

2. Flexible Bank Finance

Under the system, Fund based working capital requirement will be assessed as

the difference between Working Capital Gap and Projected Net Working Capital.

Though the benchmark for Current Ratio will continue to be 1.33 : 1, we may accept

some deviation in the same provided the Current Ratio is not less than 1.17 : 1 . In

cases where the Current Ratios have deteriorated on account of diversions taking

place because of short term funds flow to Fixed Assets, we may correct the position

by giving a Term Loan to be repaid within 12 to 36 months provided the Debt Service

Coverage Ratio, Debt Equity Ratio, and security coverage are at acceptable levels.

In the assessment method based on the Maximum Permissible Bank Finance

(MPBF) concept, the amount of working capital Finance is arrived at as a residual

source after netting off from the Working Capital Gap, the available Net Working

Capital or the required minimum Net Working Capital whichever is higher. The

projected bank borrowing which reflects the finance sought by the borrower, will be

validated as hitherto with reference to the operating cycle of the borrower, projected

level of operations, nature of projected build up of Current Asset / Current Liability,

profitability, liquidity, etc,. Where these parameters are acceptable, the projected

- 26 -

bank borrowing will stand validated for sanction. This amount will be termed as

‘ Flexible Bank Finance ’.

3. The Cash Budget System

Presently Cash Budget method is in use for assessing working capital finance

for seasonal industries and for construction activity. In these cases, the required

finance is quantified from the projected cash flows and not from the projected values

of assets and liabilities. In this method of assessment, besides the cash budget, other

aspects like the borrower’s projected profitability, liquidity, gearing, funds flow etc,.

are also analysed.

Term Finance :-

A loan is termed as Term Loan when it has been sanctioned with an original

repayment period of not less than 36 months. The maximum period for repayment of

term loans other than Housing loans shall be normally 84 months (including moratorium

period). This may however, be increased to 180 months in respect of infrastructural

projects and other projects having long gestation periods. For Housing loans, the

repayments may be extended up to 240 months. Term lending institutions have generally

been assigned the responsibility of granting term loans to industries – both large scale and

small scale – for industrial purposes.

In considering the project feasibility, the following points may be taken into

account.

1. Economic Feasibility.

Whether the project belongs to the priority sector and / or is likely to help

development of backward region(s). Whether it is social benefit oriented,

employment oriented or earner of foreign exchange; gestation period required in

relation to size of investments and benefits.

- 27 -

2. Technical Feasibility

Technical know-how is required and its availability, the rate of technological

obsolescence of the proposed method and processes; evaluation of the proposed

location of the project in terms of availability of raw materials, power, fuel, labour.

3. Managerial Feasibility

Whether the promoters are entrepreneurs only or managers as well, the extent of

managerial experience possessed by them, whether they have any plans to ensure

sustained supply of managers through a programme of management education and

training.

4. Organisational Feasibility

Whether a separate organization will be required for the project or it can be

accommodated within the existing internal control system like inventory control,

preventive maintenance and adequacy of organization structure, whether there is

proper training programme for apprentice, skilled labour and technical personnel and

organization arrangement to take care of this aspect.

5. Commercial Feasibility

Whether there is adequate arrangement for procurement of materials and services

and reasonableness of the terms of purchase; whether arrangements have been made

to obtain license from the State and Central Governments for foreign exchange,

capital issues, import of equipment and stress.

6. Financial Feasibility

Whether the firm undertaking the project is financially sound; assessment of fund

requirements till the project goes on stream such as capital expenditure, interest on

loans, working capital, initial expenses, return on capital employed, etc,.

Letter of Credit for purchase / import of raw material should normally be sanctioned to

customers, who have cash credit facility so that the payment can be made by debiting

cash credit etc,. If it is for capital equipments, the same should backed by a sanction of a

term loan otherwise backed by 100 % or 110 % cash margin. It can be either on DA basis

i.e. Deliverable against Acceptance or on DP basis i.e. Deliverable against Payment basis.

- 28 -

Deferred Payment Guarantee Loan ( DPGL ) are issued normally for purchasing capital

equipments and hence such requests should be put to the same degree of appraisal

required for sanctioning Term Loan as the redemption of Deferred Payment Guarantee

will be associated with the return on employing the capital equipment covered by the

DPGL on the cash flow / profitability, Debt Equity Ratio, Debt Service Coverage Ratio,

etc., of the firm / company seeking the facility. Further adequate cash margin should be

insisted for such facilities.

Letters of Guarantee are issued for various purposes which take the form of performance

or financial guarantees. A guarantee which lays stress on the performance of certain act

like supply of a product, completion of any work, for achievement of certain level of

exports etc., will constitute a performance guarantee. A guarantee for discharge of only

the pecuniary liability of a third party on default will constitute a financial guarantee.

Since the Risk Weight for the capital adequacy purpose of financial guarantees is more,

the charges for the same are kept at a higher level than for performance guarantee for

which the Risk Weight is less.

Difference between Letter of Credit and Letter of Guarantee :-

The liability of Letter of Credit gets extinguished upon effecting the payment on

receipt of documents. The contingent liability ( consequently Capital Adequacy for the

Bank ) gets extinguished only on receipt of original Letter of Guarantee duly discharged

or at least letter of discharge, for which we have to get the guarantee bond returned by the

beneficiary and efforts should be made to get back the Guarantee bond or getting a letter

of discharge in the prescribed manner so that the bank need not maintain capital on the

expired guarantee(s).

Excess / Ad-hoc Powers :-

Excess may be interpreted as a facility of a temporary nature sanctioned for meeting the

temporary mismatches on cash flows of the borrowers for a period normally not

- 29 -

exceeding 7 days, subject to availability of Drawing Power. Excess powers have been

given to all the delegates.

Ad-hoc may be interpreted as any facility, which is sanctioned for a period normally not

exceeding 3 months the need for which has arisen due to unexpected situation like receipt

of additional orders, increase in sales beyond projected level, short term mismatches in

cash flows, bunched receipt of raw materials, etc,. Ad-hoc powers have been given only

to the Regional Heads and above in the controlling offices and Branch Managers.

Credit Risk Management (CRM) :-

It has been introduced for effective control, monitoring and assessment of various

risks and distribution thereof amongst various sectors and segments. Credit Risk

Management system covers various aspects viz., Delegation of Powers, Prudential Limits

and Norms, Risk Rating System, Risk Pricing, Portfolio Management, Review

Mechanism Documentation and Legal Compliance.

Pre-requisites to be observed :-

The borrowers should be the customers of the Bank and the Branch should have

reasonable experience of their dealings. It may, however, be possible that

prospective borrowers, in some cases may not be the customers of the Bank.

Branch Managers before sanctioning or recommending credit lines to such

prospective borrowers, should satisfy themselves as regards purpose of finance

and integrity or credit worthiness, etc,. of the borrowers.

An appropriate application in writing as well as the prescribed Credit Information

Form will be obtained from the borrower.

Every accommodation will be justified by the borrower’s past performance or

record of his dealings with the Bank and supported by a good Credit Report on

him. A Credit Report on the party will be compiled before granting any

accommodation. In case of a new connection which is a part of group, having

banking arrangement with other banks, satisfactory Credit Report, from the group

- 30 -

bankers, should be obtained on overall activities and creditworthiness of the

borrowers.

Reasonable requirement for any new connection :-

Borrower Company should have

Current ratio of 1.17 and above

Debt Equity Ratio of less than 2 : 1

Total outside Liabilities to Net Worth Ratio of less than 4 : 1, and

Debt Service Coverage Ratio of 1.5 : 1

Different types of borrowers :-

1. Individuals

If the borrower is an individual, it should be ensured that he is not a minor,

that he / she is not of unsound mind, or that he / she is not an undischarged insolvent.

2. Joint Hindu Family

If the borrower is a Joint Hindu Family, prescribed Karta Form must be

obtained to bind the co-parceners and to secure their consent to all acts of Karta in

conducting the Bank account.

3. Sole Proprietorship Firms

If an individual carries on business under a trade name, a declaration of sole

proprietorship in the prescribed form must be obtained.

4. Partnership Firms

If the borrower is a partnership firm, it is preferable that it is a registered

partnership. Partnership letter in the prescribed form showing the names of all

partners should also be taken.

5. Limited Liability Companies

If the borrower is a limited company whether public or private, the date of its

registration must be noted from the Certificate of Registration which should be seen

and a copy may be kept on record. Under Section 293(1)(D) of Companies Act,

- 31 -

Borrowings other than those of short term nature should not exceed its Paid up capital

and free reserves, unless authorized by the company in the General Board Meeting.

6. Co-operative Societies

In case of a co-operative society, its date of registration should be noted. Its

bye-laws should be examined to ascertain the borrowing powers and the permitted

business.

7. Trusts

A trust may be created under a will or a deed of settlement duly registered. It

is an equitable obligation imposing on the Trustees, the duty of dealing with trust

fund over which they have control, for the objectives of the trust only.

Compilation of credit report on borrower :

The creditworthiness of the borrower should be considered in relation to his

1. Character

He should be reliable and his integrity and business morality should be

undoubted.

2. Capacity

He should be capable of using the borrowed funds profitably and to repay

the same in due coarse for which he should have necessary experience and

expertise.

3. Capital

He should have some definite stake in the business by investing his own

funds up to a reasonable percentage of the funds borrowed or proposed to be

borrowed. The repaying capacity of the borrower must be ascertained by

identifying the source of funds from which the borrower will be able to repay the

agreed installments or the entire amount of advance on due date as the case may

be.

In addition to obtaining the Credit Information Form duly filled in and signed by

the borrower, the Branch Manager should also obtain the following information

from the borrower.

- 32 -

1. Latest Balance sheet, Trading and Profit and Loss Account together with the

break-up of Sundry Creditors, Debtors, Loans, Deposits and Advances.

2. Copy of last Income-Tax Assessment Order and latest Income-Tax Returns

supported by challans of Advance Income-Tax paid.

3. Copies of ‘ Proprietors / Partners / Directors ’last Wealth Tax Assessment

Orders and latest returns filed supported by challans of tax payment, if any.

4. Partners Capital Account and Personal Balance sheet

5. Details of payment of statutory dues.

Foreign Currency Loans are permitted

To exporters for working capital needs

To importers for meeting their import obligations

To importers of capital goods

To enable customers to prepay medium term Foreign Currency Loans, raised

earlier for meeting their capital expenditure from overseas financial institutions.

To high value corporate clients of good track record to meet their working capital

requirements in Rupees in substitution of their existing Working Capital Demand

Loan (WCDL).

As extension of Foreign Currency Loan, exposes customers to exchange risk, the

customers are required to cover their exchange risk through Forward cover of

appropriate maturity. The credit decision in respect of the above categories of Foreign

Currency Loan is in the purview of the Central Advances Department which is based on

the prudential norms, credit discipline and credit monitoring guidelines in force. The

interest rate for such loans is the appropriate LIBOR plus the Bank’s spread. Any request

from customers of good track record for availing of Foreign Currency Loan in

substitution of Working Capital Demand Loan is to be referred to Central Office for their

approval. Central Office will permit extension of Foreign Currency Loans, based on

customers’ credit rating, track record and further business potential, after ascertaining the

availability Foreign Currency Resources, for the same from the International Banking

Division.

- 33 -

On receipt of the appropriate sanction for extension of Foreign Currency Loan,

the branch will inform International Service Branch (ISB), Mumbai, about customers

request for loan draw down giving two clear days notice and also confirming that

compliance of sanction terms and security documents have been obtained. International

Service Branch, after ascertaining the availability of funds and based on guidelines given

by International Banking Division, will convey their concurrence for draw down. The

branch has to report the transaction to International Service Branch if the loan is to be

converted to Rupee and obtain appropriate exchange rate (Buying T.T Rate) and also the

Interest rate applicable to the Transaction.

Repayment :- On maturity date, the customer has to repay the loan plus unpaid interest in

foreign currency. This is done by either purchasing foreign currency from the Bank at

selling T.T Rate or by tendering export documents for purchase in which case documents

can be purchased under FDBP (FCY) Scheme or by adjustment of proceeds of Export

documents sent on collection basis.

- 34 -

CHAPTER – VIII

FOREIGN EXCHANGE

- 35 -

Foreign Exchange

Foreign Exchange as defined in Foreign Exchange Management Act (FEMA) 1999

means “ foreign currency and includes

All deposits, credits, balances payable in any foreign currency ;

Drafts, travellers’ cheques, letters of credit and bills of exchange expressed or

drawn in Indian currency and payable in foreign exchange; and

Drafts, travellers’ cheques, letters of credit or bills of exchange drawn by banks,

institutions or persons outside India but payable in Indian currency ” .

Foreign Exchange does not involve trade and services alone, but also includes external

borrowing and investment.

FOREIGN EXCHANGE

International Trade

External Receipts and Payments

1. Import Trade2. Export Trade

1. Current Account2. Capital Account

- 36 -

Exchange Control Administration

The exchange control administration gets its statutory footing by virtue of the

Foreign Exchange Management Act (FEMA) 1999. Based on the Act, Government of

India and Reserve Bank of India ( acting as custodians of foreign exchange on behalf of

Government of India ) are empowered to issue notifications regulating foreign exchange

dealings to ensure its proper utilization. The instructions / guidelines of Reserve Bank of

India are administered through the Authorized Persons in foreign exchange.

Authorized persons are banks and institutions authorized by Reserve Bank of

India to deal in foreign exchange. Additionally, Reserve Bank of India has granted

“ money changers ” licenses to certain firms, hotels and other organizations permitting

them to deal in foreign currency notes, coins and travelers cheques.

Full Fledged Money Changers are authorized to undertake both purchase and sale

transactions with public.

Restricted Money Changers are authorized only to purchase foreign currency

notes, coins and travelers cheques, subject to the condition that all such

collections are surrendered by them in turn to authorized dealers in foreign

exchange / Full fledged money changers.

International trade is the movement of goods and services from one country to another.

The seller supplies the goods or services to the buyer and the buyer in turn pays for the

goods or services received from the seller. The payment for the international sale /

purchase amongst countries, each with their sovereign currently necessitates the supplier

and buyer agreeing to settle the transaction in anyone currency. International trade is

therefore is one of the primary reasons for the inflow and outflow of foreign exchange.

The law on the subject of Import and export from India is governed by the Foreign Trade

Development and Regulation Act 1992.

- 37 -

INTERNATIONAL TRADE

Import Trade

Import is defined as bringing into India any item by sea, land, air or through

electronic media. Control over import of goods into India is exercised by the Director

General of Foreign Trade (DGFT) under the Ministry of Commerce, Government of

India. The policy enunciated by this Authority is made available to the public through the

Export-Import (EXIM) Policy announced from time to time. Earlier the EXIM Policy

used to be announced annually. However, with effect from 1.4.1992, the Government of

India comes out with EXIM Policy valid for 5 years period to afford continuity and

stability.

For the purposes of import, the goods have been classified as ‘Freely importable

items’, and Negative items. The negative list is further categorized as (a) prohibited item,

(b) restricted items, and (c) canalized items. Goods falling under Freely importable

category can be imported by all, while items under restricted category can be imported

with a license. Items falling under prohibited category cannot be imported at all.

Canalized items can be imported only by Agencies approved by Government authorizing

Import Trade Export Trade

Non –Fund Based Credit Facility

Fund Based Credit Facility

Pre -Shipment

Post -Shipment

- 38 -

import of such canalized items. The import of goods is controlled by Government of

India through Import Trade Control Regulations.

The Non – Fund Based Credit Facility is in the form of Letters of Credit. It contains an

undertaking by the bank to pay against presentation of prescribed documents conforming

to the terms and conditions stipulated in the Letter of Credit. Since the Bank relies on

goods being imported under Letter of Credit as a security for payment of relative bill, the

marketability of such goods, taking into account the licensing conditions, should also be

considered. The import licenses are issued in two copies :-

‘ Customer Copy ’ is for the purpose of clearing the imported goods through

customs, and

‘ Exchange Control Copy ’ is to facilitate remittance of foreign exchange on

respect of relative import bill.

The remittance in respect of an import bill must not exceed the CIF value ( Cost,

Insurance, Freight ) covered by Exchange Control Copy of Import License. If the import

bill is drawn on FOB ( Free on Board ) or C & F ( Cost and Freight ), the amount of

Insurance and Freight or Insurance, as the case may, be marked off in the value of license

and only the balance would be available for purpose of remittance.

The Fund based Import Finance generally takes the form of a back up limit to the Letter

of Credit limit sanctioned to a customer. Such limits are considered where import of

goods is made in Economic Order Quantities for use in production over a period of time.

However, in the normal course, whenever an import Letter of Credit is considered, it

should be ensured that the importer will have sufficient cash flow available to retire the

bills presented under the Letter of Credit, promptly. If that is not ensured, the Bank would

be forced to fund the transaction after crystallizing the foreign exchange liability.

Importer – Exporter Code Number

The importer must possess an ‘Importer-Exporter Code Number’ allotted

by Director General of Foreign Trade. Customs authorities will not allow any person to

- 39 -

import or export goods into or from India unless he holds a valid IEC number. The

following categories of organizations are exempted :

Ministries / Departments of Central and State Government

Import / Export for personal use not connected with trade / manufacturing /

agriculture

CIF value of single consignment not exceeding Rs.25,000 /-

Indo-Myanmar border trades for CIF value of single consignment under Barter

Trade agreement not exceeding US $ 1000.

Categories of Importers :

Importers are broadly classified as under :

1. Actual user importer

2. Stock and sale importer

3. Private importer

For the purpose of licensing, importers are divided into the following broad categories :

IMPORTERS

‘Actual User’ means an importer who utilizes the imported goods for himself, may be

industrial or non-industrial.

Actual User Exporters holding registration cum membership (RCMC)

1. Industrial ( AU[I] )2. Non-industrial ( AU[NI] )

1. Manufacturer Exporter2. Merchant Exporter

- 40 -

Actual user ( Industrial ) means a person who utilizes the imported goods for

manufacturing in his own Industrial unit or manufacturing for his own use in other

Industrial unit including a jobbing unit.

Actual user ( Non-industrial ) means a person who utilizes the imported goods for his

own use in :

Any commercial establishment carrying on any business, trade or profession; or

Any laboratory, Scientific or Research and Development Institution or other

Educational Institution; or

Any service industry ( includes an individual, firm, society, company,

corporation, or any other legal person ).

‘Registration cum Membership Certificate’ (RCMC) means a certificate issued by any

Export Promotion Council, Commodity Board or other registering authority designated

by Government for the purposes of export promotion. For Export Houses, Trading

Houses, RCMC will be issued by Federation of Indian Export Organisations (FIEO).

‘Manufacturer Exporter’ means a person who manufactures goods and exports or intends

to export such goods.

‘Merchant Exporter’ means a person engaged in trading activity and exporting or intends

to export such goods.

Time limit for settlement of Import Payments :-

In terms of the extant rules, remittances against imports should be completed not

later than 6 months from the date of shipment except in cases where amounts are with

held towards guarantee / performance etc. Authorized dealers may make remittances of

amounts so withheld, provided the earlier remittance had been made through them. No

payment of interest permissible on such withheld amounts. Accordingly, deferred

payment arrangements involving payments beyond a period of 6 months from the date of

- 41 -

shipment up to 3 years are treated as external commercial borrowings which require prior

approval of the authorized dealer branches.

Interest on Import Bills

Authorized dealers may allow payment of interest on usance bills or overdue

interest for a period of less than 3 years from the date of shipment. All in cost per annum

payable for the credit not to exceed LIBOR + 50 basis points for credit up to 1 year and

LIBOR + 125 basis points for credit for periods beyond 1 year but less than 3 years for

the currency of credit.

Import of Foreign Exchange

A person may –

Send into India without limit foreign exchange in any form other than currency

notes, bank notes, and travelers cheques ;

Bring into India from any place outside India without limit foreign exchange (

other than unissued notes ).

Letters of Credit

A letter of credit is an arrangement whereby a bank acting at the request of a

customer, undertakes to pay a third party by a given date, on documents being presented

in compliance with the conditions laid down. Letters of credit is also known as

‘Documentary credits.’

Parties to a letter of credit.

A letter of credit transaction normally involves the following parties :

1. Applicant / opener – The buyer of the goods ( Importer ) who has to make

payment to an overseas supplier.

2. Issuing Bank – The bank which issues the credit and undertakes to make the

payment on behalf of the applicant as per terms of the letter of credit.

- 42 -

3. Beneficiary – The seller of the goods (exporter) who obtains payment on

presentation of documents complying with the terms and conditions of the letter

of credit.

4. Advising Bank – Banks which advises the letter of credit certifying its

authenticity to the beneficiary and is generally a bank operation in the country of

the beneficiary.

5. Confirming Bank – A bank which adds its guarantee to the letter of credit opened

by another bank and thereby undertakes responsibility for payment / acceptance /

negotiation / incurring deferred payment under the credit in addition to that of the

Issuing bank. It is normally a bank operating in the country of the beneficiary and

hence its guarantee adds to the acceptability of the letter of credit to the

beneficiary.

6. Nominated Bank – Bank specifically authorized by the issuing bank to make

payment etc. under the letter of credit.

7. Reimbursing Bank – Bank authorized to honour the reimbursement claim made

by the paying, accepting or negotiating bank. It is normally the bank with which

issuing bank has account from which the payment is to be made.

8. Transferring Bank – In a transferable letter of credit the first beneficiary may

request the bank authorized to pay, incur a deferred payment undertaking, accept

or negotiate, to transfer the letter of credit in favour of second beneficiary. Such a

bank is called transferring bank. In the case of a freely negotiable credit, the bank

specifically authorized in the letter of credit as a transferring bank, can transfer

the letter of credit.

Types of letters of credit :-

1. Revocable letter of credit.

A revocable letter of credit is one which can be cancelled or amended by the

issuing bank at any time and without prior notice to or consent of the beneficiary.

2. Irrevocable letter of credit

- 43 -

An irrevocable letter of credit is one which cannot be cancelled or amended

without the consent of all parties concerned.

3. Revolving letter of credit

A revolving letter of credit is one where, under the terms and conditions

thereof, the amount is renewed or reinstated without specific amendments to the

credit being needed.

4. Transferable letter of credit

A transferable credit is one that can be transferred by the original (first)

beneficiary to one or more second beneficiaries. When the sellers of goods are not

the actual suppliers or manufacturers, but are dealers / middlemen, such credits

may be opened, giving the sellers the right to instruct the advising bank to make

the credit available in whole or in part to one or more other beneficiary (ies).

5. Back to back letter of credit

When a middlemen enters into a contract to supply goods to be obtained from

other suppliers but is unwilling to disclose the identity of the buyer and the buyer

also is unwilling to open a transferable letter of credit. Actual manufacturer

supplier insists on payment against documents but the beneficiary of first credit is

short of funds, such back to back credits are opened. The beneficiary of the

original letter of credit will become the applicant for the second set of letter of

credit (back to back letter of credit).

6. Red clause letter of credit

Such letters of credit contain a clause which enables the beneficiary to avail of

an advance before effecting shipment to the extent stated in the letter of credit.

The clause used to be printed in red, hence the letter of credit is called Red Clause

letter of credit.

7. Green clause letter of credit

This is an extension of Red clause letter of letter, in that it provides for

advance not only for purchase of raw materials, processing and / or packing but

also for warehousing & insurance charges at the port pending availability of

shipping space.

8. Payment letter of credit

- 44 -

Payment credit is a sight credit which is available for payment at sight basis

against presentation of requisite documents to the designated paying bank.

9. Deferred payment letter of credit

Deferred payment credit is an usance credit where, payment will be made by

designated bank, on respective due dates, determined in accordance with the

stipulations of th credit, without the drawing of Bill of Exchange.

10. Acceptance letter of credit

Acceptance credit is similar to deferred payment credit except for the fact that

in this credit drawing of a usance Bill of Exchange is a must.

11. Negotiation letter of credit

Negotiation credit can be a sight credit or a usance credit. A Bill of Exchange

is usually drawn in negotiation credit. In a negotiation credit, the negotiation can

be restricted to a specific bank or it may allow free negotiation, in which case it is

called as ‘Freely Negotiable Credit’ whereby any bank who is willing to negotiate

can do so.

12. Confirmed letter of credit

Confirmed letter of credit is a letter of credit to which another bank (bank

other than the issuing bank) has added its confirmation. This is to say, in a

confirmed letter of credit, the beneficiary will have a firm undertaking of not only

the issuing the credit, but also of confirming bank.

13. Standby credit

Standby credit is a documentary credit or similar arrangement however named

or described which represents an obligation to the beneficiary on the part of the

issuing bank to make payment on account of any indebtedness undertaken by the

applicant, money borrowed or for any default by the applicant in the performance

of an obligation.

Overdue Import Bills

If the import bills are not retired by the applicant, branches have to crystallize the

Foreign Currency amount into Rupee liability on the 10th day after the date of receipt of

documents in the case of demand bills and on the due date in the case of usance bills. If

- 45 -

the 10th day or due date happens to be a holiday / Saturday, crystallization shall be done

on the next working day.

Cancellation of letter of credit due to frustration of contract :-

Normally letters of credit issued by the banks are irrevocable letters of credit

which contain a firm understanding on our part and cannot be cancelled or amended

without the consent of the parties to letter of credit, particularly the beneficiary. If the

applicant approached the bank for cancellation of the letter of credit, bank has to first

give notice to the beneficiary through the advising bank about revocation of letter of

credit and obtain consent for cancellation. The original letter of credit has to be obtained

back for cancellation. Alternatively authenticated message from advising bank to the

effect that beneficiary’s consent has been obtained and original letter of credit held by

them duly cancelled is to be received by issuing branch. After obtaining consent of

beneficiary, reimbursement authority given to the reimbursing bank has to be revoked.

Export Trade

Exports from India should strictly conform to EXIM policy and exchange control

regulations. Every exporter has to apply for and obtain an Importer Exporter code

number. Application for Importer Exporter Code number shall be made to the Regional

Licensing Authority of the Director General of Foreign Trade ( DGFT ). Goods exported

must be those which can be exported freely or those under allocable quotas or those

covered by specific export licenses, in keeping with the Export – Import Policy in force.

Exports may be made under Export Promotion Capital Goods ( EPCG ) Scheme which

facilitates prior import of capital goods, subject to export obligation to be fulfilled over a

period of time.

Goods exported must be those, which can be exported freely or those under

allocable quotas or those covered by specific export licenses. Export invoices have to be

denominated and realized in freely convertible currencies. Deemed exports refer to

supply of goods within India to specified categories by main / sub contractors of goods

- 46 -

manufactured in India. Deemed exports are eligible for certain benefits as also pre / post

shipment export credit, etc.

Delay in submission of shipping documents by Exporters :

In cases where exporters present documents pertaining to exports after the

prescribed period of twenty-one days from date of export, authorized dealers may handle

them without prior approval of Reserve Bank of India, provided they are satisfied with

the reasons for the delay.

Exporters Caution List :

Reserve Bank may place exporters on Caution List for various reasons including,

huge amount of exports outstanding unrealized by the exporter/s. In such instances,

Reserve Bank of India will advise exporters that any further export by them will be

subject to prior approval of Exchange Control. Authorized Dealers may accept for

collection / negotiation of export documents from exporters who have been placed in

Caution List, only if the Exporter produces evidence of having received an advance

payment, or a letter of credit covering full value of the proposed Export.

Insurance

Exporters should, in their own interest, arrange for insurance cover ( throughout

the voyage ) with seller’s interest clause permitting payment to them even in case of

exports made on Free On Board ( FOB ) or Cost & Freight ( C&F ) terms and not

covered by irrevocable Letters of Credit. Certain countries impose restrictions requiring

importers in their countries to obtain marine insurance cover from local insurers,

settlement under which in favour of exporters in India may not be permissible in the

event of cargo getting lost before reaching the port of destination, due to exchange

control regulations governing remittances against imports into those countries. Exporters

may in such cases avail of contingency marine insurance policies from New India

Assurance company etc., General Insurance company and its subsidiaries in order to

protect their interests till the goods are paid for claims on such policies will be payable

only to the exporter in India and such policies will not be assignable to overseas buyer or

any other party. In such cases, the insurance premium paid to New India Assurance

- 47 -

Company and other General Insurance companies will not be recoverable from overseas

buyers.

‘Pre-shipment’ means any loan or advance granted or any other credit provided by a bank

to an exporter for financing the purchases, processing, manufacturing or packing of goods

prior to shipment, on the basis of letter of credit opened in his favour or in favour of some

other person, by an overseas buyer or a confirmed and irrevocable order for the export of

goods from India or any other evidence of an order for export from India having been

placed on the exporter or some other person, unless lodgment of export orders or letter of

credit with the bank has specifically been waived by Reserve Bank of India. Financial

assistance extended up to the time of shipping the goods is called Pre-shipment advance,

which is controlled in the books under the head ‘ Packing credit ’.

Packing Credit is an advance granted to an exporter or a sub-supplier for financing the

procurement of raw materials, processing, manufacturing, packing, transporting,

warehousing and shipping of goods meant for export. Packing Credit is generally granted

to an exporter who has an export order or Letter of Credit in his own name and will

actually export the goods. However, Packing Credit can also be granted to supporting

manufacturers or suppliers of goods who do not have export orders or Letters of Credit in

their own names but are exporting through merchant exporters or export houses. The

advance is granted against pledge or hypothecation of stocks to be processed / produced

to execute the export order.

Packing Credit contract or Letter of Credit wise loan (Rupee) account :-

1. The packing credit loan is normally given contract – wise, where a separate

account is maintained for each contract.

2. When disbursement is made in stages depending upon the need of the exporter, a

schedule of disbursement may be called for before granting the advance.

3. The relative export order or Letter of Credit in original against which the advance

is granted should invariably be endorsed on the reverse giving reference number,

under which the advance is granted, amount of advance etc., and should be

- 48 -

stamped and initialed by the officer. Entries should be made in the account of the

customer in the Packing Credit Ledger.

4. The details of the advance viz., contract order or Letter of Credit, date of advance,

amount of advance, expected date of shipment etc., should also be recorded in the

Contract – wise Register.

5. Due date of shipment is to be noted in the Due Date Diary for follow up purposes.

6. As far as possible amounts should be directly disbursed to suppliers of raw

materials, services etc., after taking necessary instructions from the borrower. If

trade practices call for cash payments to suppliers of raw materials etc., Packing

Credit advance can be credited to the operative account of the customer like CD /

CC accounts and disbursals there from are to be supervised to ensure proper end

use.

Supervision of the Advance :-

Periodical inspection of stocks and books of the borrower must be undertaken to ensure

that the monies borrowed are in fact used for the purpose for which they were lent.

Inspection report must be prepared and sent to Regional Office as may be required. The

Packing Credit account should be backed by sufficient valid export orders / Letters of

Credit in addition to sufficient stocks to cover the advance and specified margin.

Inspecting officials should verify purchase invoices and mention to that effect be made in

the inspection report.

Repayment of packing credit :-

Packing Credit must be repaid from either one or a combination of any of the following

sources of export proceeds.

i. Proceeds of export bills negotiated, bills discounted, proceeds of bills sent on

collection basis for the contract or letter of credit for which packing credit has

been granted.

ii. Advance foreign inward remittances received from overseas buyer for the contract

by TT, cheque, DD, PO, etc.

- 49 -

iii. Undrawn balance remittance relating to any other earlier shipments.

iv. Rupee payment received from the merchant exporter confirming shipment of

goods with details of export order or letter of credit duly certified by the banker of

the merchant exporters.

v. Receipt of Foreign currency from foreigners during their visit to India evidencing

sale of goods or receipt of foreign currency by the exporter during his foreign visit

towards sale of goods / advance payment for export.

vi. Duty draw back received from Government agencies may also be permitted to be

credited to packing credit.

vii. Exporters may be permitted to repay packing credit advances from balances held

in their EEFC account to the extent exports have actually taken place.

viii. Exporters may be permitted to repay packing credit advances from balances held

in their EEFC account to the extent exports have actually taken place.

The exporters have an option

To avail export finance at pre-shipment stage in rupees and then post shipment

credit either in rupees or in foreign currency.

To avail pre-shipment credit in foreign currency and discount the export bills in

foreign currency at post shipment stage.

With a view to making credit available to exporters at internationally competitive rates,

authorized dealers have been permitted to extend Pre-shipment Credit in Foreign

Currency (PCFC) to exporters for domestic and imported inputs of exported goods at

LIBOR / EURO LIBOR / EURIBOR related interest rate.

Currency of Credit :-

Reserve Bank of India has permitted granting of pre-shipment credit in any of the

convertible currencies. However, for the present Pre-shipment Credit in Foreign Currency

is being granted in US Dollars, Sterling Pounds (GBP), and EURO subject to availability

of funds.

- 50 -

Pre-shipment Credit in Foreign Currency (PCFC) can be extended in one convertible

currency in respect of an export order invoiced in another convertible currency at the risk

and cost of cross currency transaction to the exporter.

Sharing of Pre-shipment Credit in Foreign Currency between Merchant Exporter and

Manufacturer :-

1. The rupee export packing credit is allowed to be shared between an Export Order

Holder (EOH) and the manufacturer of the goods to be exported. Branches may

extend Pre-shipment Credit in Foreign Currency also to the manufacturer on the

basis of the disclaimer from the export order holder through his bank. PCFC

granted to the manufacturer can be repaid by transfer of foreign currency from the

export order holder by availing of Pre-shipment Credit in Foreign Currency or by

discounting of bills. It should be ensured that no double financing is involved in

the transaction and the total period of Pre-shipment Credit is limited to the actual

cycle of production of the exported goods.

2. The facility may be extended where the banker or the leader of consortium of

banks is the same for both the export order holder and the manufacturer or, the

banks concerned agree to such an agreement where the bankers are different for

export order holder and manufacturer. The sharing of export benefits will be left

to the mutual agreement between the export order holder and the manufacturer.

Discounting Foreign Bills in Foreign Currency :-

1. The facility of Pre-shipment Credit in Foreign Currency will be self-liquidating in

nature. Generally, the Pre-shipment Credit in Foreign Currency should be

liquidated out of proceeds of export documents or submission for discounting /

rediscounting under the EBR scheme.

- 51 -

2. Any surplus amount available, (net of EEFC, if any) after full adjustment of

PCFC including interest, should be credited to the customer’s account at T.T

buying rate / forward rate.

3. Shortfall if any, in the delivery of foreign currency on discount of bills should be

recovered at T.T selling rate.

4. PCFC cannot be treated as a loan to be repaid in order to avail of post-shipment

credit separately.

5. The PCFC should not be liquidated with foreign exchange acquired from other

sources, except balances held in EEFC account of the exporter, to the extent of

exports already made.

[ Note :- If export takes place and the exporter does not wish to avail post

shipment credit for adjustment of pre-shipment advance and requests for

liquidation of the same by debiting his current account or EEFC account, his

request can be acceded to for adjustment of PC to the extent of shipment made

and handle export documents on collection basis. No penal rate of interest to be

levied for such liquidation. Sale of foreign currency for adjustment of PCFC in

such cases is allowed. ]

6. Pre-shipment Credit in Foreign Currency can also be liquidated out of rupee

resources of the exporter to the extent of exports have already taken place.

Export Letters of Credit :-

Branches are required to check the Letter of Credit for their authenticity and ensure

that the terms of the credit are not in violation of any exchange control regulations.

Further the terms of the credit should not contradict with one another and should contain

precise and unambiguous instructions. The following points are also to be verified :-

1. At times the Letter of Credit is made available for negotiation at the counters of

the Letter of Credit opening bank at a foreign centre. It means that the Letter of

Credit issuing bank would be liable to pay only if documents are drawn in

conformity with the terms of Letter of credit and reach its counters before the time

limit stipulated which the negotiating bank cannot guarantee.

- 52 -

2. Some Letters of credit are initially provisional i.e., they become operative after the

occurrence of an event, such as, issue of import license to the applicant or after

receipt of aid or credit from development agencies like Asian Development Bank,

World Bank etc. Such Letters of Credit are purely provisional in nature and

become operative only after the receipt of the specific amendment from the

opening bank to that effect.

Advising Letters of Credit :-

In International trade, Letters of Credit are normally advised through banks operating in

the beneficiary’s country. If the beneficiary receives the Letter of credit directly, he will

not be able to establish its authenticity.

Letter of credit opening bank will utilize the services of their correspondent bank, which

will establish apparent authenticity and hand over the letter of credit to the beneficiary.

Cancellation of letter of credit :-

1. When issuing bank seeks to cancel letter of credit before due date, obtain

beneficiary’s concurrence for cancellation and obtain back the original letter of

credit.

2. Call for and file away the original letters of credit under advice to opening bank

or return the same to opening bank duly cancelled under stamp and signature.

Post-shipment finance is an advance normally granted to an exporter of goods and

services after shipment from India, till the date of repatriation of the export proceeds. The

advance may be against shipping documents or on the security of duty drawback or

export related receivables from Government of India.

Post-shipment finance is generally short-term working capital finance. However,

depending upon the credit terms e.g. deffered export, it can also grant for longer periods.

As a general rule in case of physical exports, post – shipment finance is extended to the

actual exporter who has exported the goods or to an exporter in whose name the export

- 53 -

documents are transferred. Post shipment finance is also granted for deemed exports in

which the goods do not leave the country and the proceeds for demand exports are

received by the supplier in India itself.

Types of Post-shipment Finance :-

‘ Post-shipment’ finance is granted under the following heads.

1. Negotiation by payment / acceptance of export bill drawn under a Letter of Credit.

The negotiating bank will be entitled for re-imbursement of the bill

amount paid by it under the Letter of Credit, only if the bill negotiated strictly

conforms to the terms and Conditions of Letter of Credit.

2. Purchase / Discount of export bills drawn under confirmed contract / orders.

In respect of bills drawn under these arrangements, the bank has to look

primarily to the drawer – customer for repayment of advance in the event of non –

payment of bills, since re-import of relative exported goods ( if these goods are

lying uncleared at destination ) is quite expensive and the ultimate sale proceeds

in all probability would be disproportionately small in relation of the bill amount.

3. Advance against export bills sent for collection

At times, the exporter might have fully utilized his bills limit and in

certain cases the bills drawn under letter of credit may have some discrepancies.

In such cases the bills will be sent on collection basis. In some cases, the exporter

himself may request for sending the bills on collection basis anticipating the

strengthening of the foreign currency. Bank may allow advance against these

collection bills to an exporter.

Concessive rate of interest can be charged for this advance up to the transit

period in the case of DP bill and transit period + usance period + grace period (if

any) in the case of Usance bills. Beyond this period, the interest rate will be

subject to the various rates prescribed by Reserve Bank of India depending upon

the usance of the bill.

- 54 -

4. Advance against export / goods sent on consignment basis.

Occasionally, goods exported are not on the basis of confirmed sale

contract / order, but only to be held at the destination by the other party (

consignee ) at the risk and responsibility of the exporter until they are sold. The

consignee at the destination can be an Agent of the exporter or exporter’s other

Branch / Office.

5. Advance against undrawn balance receivable.

Certain type of goods exported involve test / analysis at the point of

shipment and also at destination and allowance is required to be made, if the

quality / weight of goods ( eg. Oil seeds extraction ) is found to be lower than the

stipulations. To cover possibility of such allowances, the exporter is required to

draw bills only to the extent of certain percentage of the invoice value, leaving the

balance to be settled on the basis of test / analysis at the destination of goods.

Such undrawn balance is usually a small percentages, say 5 % to 10 % of invoice

value as may be permitted by Exchange Control at the relevant time.

Period and Notional Due Date :-

As per FEDAI guidelines, if export bills drawn in foreign currency are ‘at sight’ or ‘on

demand’ basis concessive rate of interest is applicable for the Normal Transit Period

(NTP) i.e., presently 25 days. In case of usance bills, concessional rate of interest as

directed by the Reserve Bank of India on export bills is applicable for the normal transit

period plus usance period e.g. A foreign currency bill payable at 60 days after sight will

be eligible for concessional interest rate for 60 days usance plus the normal transit period

of 25 days i.e., a total number of 85 days.

- 55 -

Fixed Due Date :-

In case of export usance bills (foreign currency and rupee bills) where due dates are

reckoned from date of shipment or date of bill of exchange etc., no normal transit period

shall be applicable, since the actual due date is known.

Export Credit and Guarantee Corporation of India Limited (ECGC) :

The Whole Turnover Guarantee Schemes were introduced for providing cover to

the both packing credit advances and post shipment advances granted by all our branches

throughout India, in respect of losses which may be incurred while granting such

advances. The Guarantee cover provided by the Corporation covers the losses incurred by

bank while granting such advance to exporters on following counts :

Insolvency of the exporter

Protracted default by the exporter to pay the amounts due to the bank.

The Whole Turnover Guarantees (WTPCG and WTPSG) does not cover packing credit

advances granted to following clients :

Public Sector Undertakings wholly owned by Government of India

Packing credit advances for exports on deferred payment terms, and export of

construction and services.

(Advances for the above category of borrowers will be covered by ECGC on specific

application being made under Individual Packing Credit Guarantee scheme).

The transport documents that are normally tendered by the exporters are :

1. Bill of Lading (BL)

The Bill of Lading, issued by shipping company, is a document of title to

goods. Bill of Lading is normally issued in more than one original and delivery of

goods can be taken on any single original negotiable copy. The date of shipment

shown in the bill of lading should not be later than the date stipulated in the letter

of credit as last date for shipment. The date on which the goods are placed ‘on

Board’ is treated as the actual date of shipment. Bill of Lading should clearly

- 56 -

indicate ‘Freight Paid’ or ‘Freight Payable at destination’ as the case may be. If

the value of goods as per letter of credit is Cost, Insurance, and Freight (CIF) or

Cost and Freight (C&F), bill of lading must show ‘Freight Paid’, and if on Free on

Board basis, it must show ‘Freight Payable at destination’.

2. Airway Bill (AWB)

Airway Bill is an acknowledgement issued by an Airline company or their

authorized agents (and not forwarding agents) stating that they have received the

goods detailed therein (number of packages, quantity and nature of goods) for

dispatch by Air to the named consignee at the address stated therein. Unlike a bill

of lading, Airway bill is not a document of title to goods because it is merely an

acknowledgement of goods. When it is not a title to goods, naturally it is not a

negotiable document.

Air Consignment Note :-

It is otherwise called as Air Receipt. This is issued generally by forwarding

agents. This document shows the departure and the destination stations as well as

the name of the shipper and the addressee. It must also indicate forwarding station

and date stamp. This document also gives the description of goods etc., and their

apparent good order and condition.

3. Post Parcel Receipt (PPR)

As the name indicates, it is a receipt issued by postal authorities. It can be a Sea

Mail receipt or Airmail receipt depending upon the mode by which they are sent.

Postal receipt is also an acknowledgement of receipt of goods for delivery to a

named consignee hence, it is not a document of title to goods nor is it a negotiable

instruments. Though the postal receipt is not a must for taking delivery of goods

in certain countries, receipt must be shown to the customs and postal authorities

for clearance and delivery postal regulations in certain countries allow senders to

issue and authenticate their own certificates of posting. Considering all these, it is

not considered a safe document from the banker’s point of view.

- 57 -

Negotiation of Export bills drawn under irrevocable letter of credit :-

When an overseas bank opens a letter of credit at the instance of its customer in

favour of an exporter for import of goods, it irrevocably commits itself to honour the

drawing of the exporter, subject to the condition that all the terms stipulated in the letter

of credit are complied with. Exporters from India are governed by the trade control and

the FEMA guidelines. Therefore the bank, which negotiates a bill drawn under a letter of

credit, has to ensure strict compliance not only with the terms and conditions of the letter

of credit but also that there is no violation of the above-mentioned regulations. This also

applies to cases where export bills have been purchased without the backing of a letter of

credit or are taken for collection only.

Escrow accounts :-

Escrow accounts is a mechanism for settlement of payment for imports into India and for

exports from India under ‘counter trade’ arrangements entered into between Indian

parties and their overseas counterparts. ‘Counter trade’ means any arrangement under

which exports / imports from / into India are balanced either by direct import / export

from the importing / exporting country or through a third country under a trade

arrangement or otherwise. Export / import under counter-trade may be carried out

through Escrow account, buy-back arrangements, barter trade or any similar arrangement.

The balancing of exports and imports could wholly or partly be in cash, goods and / or

services. Escrow accounts are funded by proceeds of imports made by Indian parties and

the funds in these accounts are utilized for payment to them for their exports under

counter-trade arrangements. Under the Escrow accounts mechanism, the overseas

importer / exporter are common whereas the Indian importer and exporter may be

different.

Packing credit and post shipment finance can be made available to exporters under

counter trade arrangements. The rates of interest will be as per Reserve Bank of India

interest rate structure. Whenever an exporter receives advance payment either direct or

through Escrow account, the pre-shipment credit should be curtailed to the extent of

- 58 -

amount of advance received. Normally pre-shipment advance under Escrow account

Reimbursement Mechanism should be given only against letter of credit opened by the

bank maintaining escrow account. If importer does not open letter of credit, but only

places a confirmed order providing for reimbursement to the debit of Escrow account,

branches should forward copies of the confirmed orders to the bank maintaining Escrow

account and obtain confirmation from them that reimbursement will be made on due

presentation of export documents. The Escrow account maintaining bank should also

specify the details of documents required by them for honoring the reimbursement claim

pre-shipment finance should be granted only thereafter.

Crystallization :-

The proceeds of all export bill negotiated / purchased / discounted should be

repatriated on or before due date. The branch will transfer the exchange risk to the

exporter by crystallizing the foreign currency liability into rupee liability on the 30th day

after the normal transit period / notional due date or actual due date whichever is earlier.

In case the 30th day falls on a holiday / Saturday, the crystallization will be done on the

next working day. For crystallization into Rupee liability, the branch will report notional

sale to the Dealing room and crystallize the bill at T.T selling rate. If the crystallized

Rupee liability is more than the amount originally advanced, branches will not pass on

the surplus to the customer. If the crystallized Rupee liability is less than the amount

originally advanced branches will recover the shortfall from the customer. For bills

crystallized which are more than Rs.25.00 lacs, a monthly statement is to be sent to

International Banking Division.

Realisation on or after notional due date / actual due date but before crystallization :-

Debit or Credit the shortfall / excess amount received ( excess may be

representing interest or other charges etc. collected ) to the customer’s account.

Charge overdue interest from notional due date to the value date.

If in case of usance bills, if actual due date falls before notional due date,

originally charged interest from actual due date to notional due date is to be

refunded.

- 59 -

Write off of unrealized Export Bills :

An exporter who has not been able to realize the outstanding export dues despite

best efforts, may approach the authorized dealer, who had handled the relevant shipping

documents, with appropriate supporting documentary evidence with a request for write

off of the unrealized portion. Authorized dealers may accede to such requests subject to

the under noted conditions :

a) The relevant amount has remained outstanding for one year or more;

b) The aggregate amount of write off allowed by the authorized dealer during a

calendar year does not exceed 10 % of the total export proceeds realized by the

concerned exporter through the concerned authorized dealer during the previous

calendar year;

c) Satisfactory documentary evidence is furnished in support of the exporter having

made all efforts to realize the dues;

d) The case falls under any of the under noted categories:

i. The overseas buyer has been declared insolvent and a certificate from the

official liquidator indicating that there is no possibility of recovery of

export proceeds produced.

ii. The overseas buyer is not traceable over a reasonably long period of time.

iii. The goods exported have been auctioned or destroyed by the

Port/Customs/Health authorities in the importing country.

iv. The unrealized amount represents the balance due in a case settled through

the intervention of the Indian Embassy, Foreign Chamber of Commerce or

similar Organization.

v. The unrealized amount represents the undrawn balance of an export bill

(not exceeding 10 % of the invoice value) remained outstanding and

turned out to be unrealizable despite all efforts made by the exporter.

vi. The cost of resorting to legal action would be disproportionate to the

unrealized amount of the export bill or where the exporter even after

winning the court case against the overseas buyer could not execute the

court decree due to reasons beyond his control.

- 60 -

vii. Bills were drawn for the difference between the letter of credit value and

actual export value or between the provisional and the actual freight

charges but the amount have remained unrealized consequent on

dishonour of the bills by the overseas buyer and there are no prospects of

realization.

e) The case is not the subject matter of any pending civil or criminal suit.

f) The exporter has not come to the adverse notice of the Enforcement Directorate or

the Central Bureau of Investigation or any such other law enforcement agency.

The exporter has surrendered proportionate export incentives, if any, availed of in respect

of the relative shipments. Documentary evidence regarding surrender of incentive

required.

Export documentary bills for collection :-

Foreign bills collection business is accepted by the bank only on the condition

that the bank is not liable for loss, damages or delay, howsoever caused, except

directly due to the negligence or default of its officers / employees. Bank is also

not responsible for acts of omission or commission of its agents / correspondents

and for the consequential losses / delays.

The establishment of these conditions is a necessary protection against the serious

risks to which the bank would otherwise be exposed for no fault of its own in the

``conduct of such business. It is essential to be able to prove that the customer is

aware of these conditions and that, by implication, he accepts them.

When the bank accepts export bills on collection basis, the customer is given

credit only after the bills are realized. Though exporter is primarily responsible

for repatriation of export proceeds, bank also has to take all reasonable

precautions / steps for realization of bills.

Exchange Earners Foreign Currency Account :

Exporters and beneficiaries of Inward Remittances in convertible foreign

currencies are permitted to open and maintain foreign currency denominated accounts

entitled EEFC Account. Funds can be credited to EEFC account only on realization of

- 61 -

export proceeds / receipt of inward remittances. EEFC funds can be utilized for all

permitted current account transactions as permitted under FEMA. EEFC account can be

maintained in the form of non-interest bearing current account only.

The country’s external receipts and payments can be classified broadly under

Current account, and

Capital account.

EXTERNAL RECIEPTS AND PAYMENTS

Current Account can be further divided into merchandise trade and invisibles. The

merchandise trade comprises of export and import of goods / services, difference between

which is commonly referred to as balance of trade. Invisibles refer to current international

payments for other than merchandise trade and includes travel, transportation, interest,

dividend, etc,.

The difference in the external receipt and payment on these two counts jointly gives the

current account surplus or deficit.

Current Account

Capital Account

1. Merchandise trade2. Invisibles

1. External borrowings2. External investments3. External Divestments

- 62 -

Capital Account includes transfers connected with external borrowings, external

investments or disinvestments. External borrowings of the Government of India,

commercial borrowing from abroad, foreign investments, non-resident deposit, etc., form

part of the capital account.

‘ Capital Account Transaction ’ means a transaction which alters the assets or liabilities

including contingent liabilities outside India of persons resident in India or assets or

liabilities in India of persons resident outside India.

- 63 -

CHAPTER – IX

EXCHANGE RATE MECHANISM

- 64 -

EXCHANGE RATE MECHANISM

The rate at which one currency is converted into another is called the exchange rate.

There are two methods of quoting the exchange rate.

1. Direct Method

2. Indirect Method

A given number of units of local currency for a unit of foreign currency is the ‘Direct

Method’ for quoting exchange rate e.g. USD 1 = Rs.48.30. In the Direct method, home

currency is variable. However, certain foreign currencies are quoted for 100 units, since

their one unit value is less than one Rupee e.g. Japanese Yen, Indonesian Rupiah, Kenyan

Shilling, etc,. In the ‘Indirect Method’ of quotation, the variable is the foreign currency

expressed in a fixed unit of home currency. For e.g. Rs. 100 = USD 2.4272.

Purchase Transactions

In a purchase transaction, the bank receives foreign exchange.

Example :

1. Export – Bank gets or buys the foreign exchange from the exporter and pays

equivalent Indian Rupees.

2. Tender of foreign currency notes / traveler cheques / DD / cheques by a customer.

Sale Transactions

In a sale transaction, the bank parts with foreign exchange.

Example :

1. Import – Bank delivers foreign exchange against Indian Rupees paid by the

importer.

2. Issuance of Telegraphic Transfer (TT) / DD payable abroad.

Types of Rates :

All purchase / sale transactions are not alike and hence attract different rates. The

different types of rates are as below :

- 65 -

Purchase Sale

TT Buying TT Selling

OD Buying (Bill Buying Rate) BC Selling (Bill Selling Rate)

TC Buying TC Selling

Currency Note Buying Currency Note Selling

The foreign exchange quotation will also be determined by the date of delivery i.e. the

date on which the transaction is completed. The delivery under a foreign exchange

contract can be made in one of the following ways :

Ready for cash : Delivery on the same day i.e., on the deal date

TOM : Delivery made on the next working day after deal date

SPOT : Delivery on the second working day after deal date

Forward : Delivery subsequent to SPOT date.

‘Forward Rates’ are quoted either at a higher ( premium ) or lower ( discount ) rate than

the spot rate. This is because in a free exchange market, the rates would be based on

demand and supply, with the currency in excess supply tending to be cheaper and a

scarce one costlier. Further, the exchange rate is also connected to the cost of funds

(interest) in respective countries. In a totally free market, the premium / discount on

forwards would be difference in the interest rate in the two countries. Currencies with

higher interest rates tend to be priced at a discount while currencies with lower interest

rates at a premium. Always premium will be added to and discount deducted from the

spot rate to arrive at the forward rate in the case of direct quotation.

Computation of Rates :

The bank is a trader in foreign exchange and hence the purchase / sale are not

effected at the same rate. The purchases are made at a lower price and the sale at a higher

price, with the differentiated being the exchange profit. In the foreign exchange market,

quotations are always ‘two-way’ i.e., for both buying and selling. The ‘two way’ quote

for U.S.Dollar would appear as USD 1 = Rs. 41.20 / 21 where the buying rate is

Rs. 41.20 and selling rate is Rs. 41.21. The buying rate is known as the ‘Bid’ rate and the

selling rate as the ‘Offer’ rate.

- 66 -

Base Rate

Base rate is the rate derived from ongoing market rate, based on which buying /

selling rates are quoted for merchant transactions. The inter bank rates are normally for

spot deliveries. Hence, for quoting rates for merchant transaction on cash basis (i.e. Value

Today), the base rate will be adjusted to the extent of cash / spot differences.

Spread

Spread is the difference between TT selling rate and TT buying rate of a given

currency. In line with the business maxim of ‘Buy Low Sell High’ while arriving at the

merchant rate the exchange margin is reduced from the base rate in case of purchases and

added on for sale transactions in the case of direct quotation.

Cross Rate

The U.S.Dollar being the most commonly denominated currency in international

trade is the intervention currency where a quotation in Rupee has to be given for a

currency other than the U.S Dollar. The cross rate is worked out as follows :

1 USD = Rs. 41.20 1 USD = CHF 1.4850

Therefore, 1 CHF = Rs. 27.74

Forward Contracts

There is an inherent ‘Exchange Risk’ in an international trade transaction

denominated in a foreign currency, as an advance movement in the exchange rate may

reduce the realization of home currency for an exporter or increase the cost for an

importer. To reduce this exchange risk for a transaction to be concluded at future date,

‘Forward Contracts’ are booked. It is a mechanism through which the rate is fixed in

advance for purchase or sale of foreign currency needed at that future date. FEDAI has

defined Forward Contract as a contract deliverable at a future date, duration of the

contract being computed from spot value date at the time of transaction.

Forward contract is an agreement to exchange one currency for another currency

on a specified date in future, at a pre-determined exchange rate, set at the time the

- 67 -

contract is made. The contract locks in an exchange rate and regardless of what the

exchange rate may be on the future date, the transaction will be put through at the

contracted rate.

Types of Forward contracts :

Forward contracts can broadly be classified as ‘Fixed Date Forward contracts’

and ‘Option Forward contracts’. In fixed date forward contracts, the buying / selling of

foreign exchange takes place at a specified future date i.e. a fixed maturity date. The

foreign exchange cannot be received / delivered prior to / after the predetermined date.

The option Forward contract is entered into in order that the customer gets the flexibility

to receive / deliver the foreign exchange on any day during a specified period.

Derivatives

Derivatives are instruments whose value is based on or derived from prices of

currencies, commodities, interest rates, share indices etc,. Financial derivatives were

designed in view of the need to hedge risks caused by volatility in exchange rates and

interest rates. The forward contract can also be considered as a derivative instrument as

the value is derived from spot exchange and interest rates.

Foreign Currency Option

A foreign currency option contract is an agreement between two parties which

provides the purchases with the right, but not obligation to buy or sell a fixed amount of

currency at an agreed exchange rate known as the strike or exercise price. A right to buy

a specified currency is known as a call option and a right to sell a specified currency is

called a put option. A currency option protects against downside risks and at the same

time, provides an opportunity to participate in profit, if the exchange rate moves

favourably.

Example :

A customer has to make the payment of EUR 500,000 in three months but has

only USD funds with him. He would like to restrict the payment to not more than USD

1.20 per EUR. Hence he buys a call option on the EUR at the exercise or strike price of

- 68 -

USD 1.19 paying a cost (premium) of USD 0.25 (spot rate is 1 EUR USD 1.19). on due

date, if the EUR is USD 1.25 he exercises the option, if it is USD 1.15, he allows the

option to expire and buys EUR in the open market.

When the strike price in relation to the currency market rate is favourable to the

buyer, it is referred to as ‘in the money’, when the strike is not favourable it would be

‘out of the money’ and when the strike price is equal to current price, it is known as ‘at

the money’. An option which can be exercised at any time until the expiry date is called

an American Option. An option which can be exercised only on expiry date, is called an

European Option.

RBI has permitted banks to offer cross currency options to customers with an

exposure to exchange risks in specific transactions. The option should be written on a

fully covered basis by buying an identical option for the same amount, same or

favourable strike price and maturity. The option contracts are booked subject to

customer’s declaration that they have not already booked / will not book foreign currency

forward cover / currency option for the same transaction.

Foreign Currency – Rupee Swaps

RBI has permitted banks to arrange foreign currency rupee swarps between

corporates, who have exposures arising out of these long-term foreign currency

commitments. Entities, who do not have any forex exposure but are willing to assume

forex liability in lien of the long term rupee liability may also become counter parties in

the arrangement. Banks may enter into foreign currency rupee swaps between entities to

assist the exchange of such obligations between them and absorb the residual currency /

interest mismatches within their open position / gap discipline.

Swaps

A swap has been defined as an exchange of payments in one currency for a stream

of payments in another currency over a period of time.

- 69 -

The banks in India have also been permitted to offer the following products to Indian

Corporates for hedging their foreign currency loan liabilities:

1. Currency Swaps

2. Interest Rate Swaps

3. Forward Coupon Swaps

4. Interest rate cap / collars (purchase)

5. Forward Rate Agreements

Currency Swaps

Under a currency swap, two counterparties agree to exchange the different

currencies at the outset and repay them in the future. There may not be any exchange of

currencies but only the servicing payments are swapped. A currency swap completely

converts a long term liability or asset in the currency to a long term liability, or asset in

another currency.

For example :

A company with U.S.Dollar income has borrowed in Japanese Yen for 5 years.

The company enters into a swap arrangement through its bank, whereby the bank

provides the Yen necessary to cover the loan liability in exchange for US Dollars which

the company delivers.

Interest Rate Swap

An interest rate swap is a contract between the customer and the bank to exchange

two different interest rate cash flows, one usually determined on a floating rate basis and

the other on a fixed rate basis. The interest rate swap enables customers to convert one

kind of income / payment stream for another kind of income / payment stream.

For example :

If customer has a floating rate debt and perceives interest rates moving up the

floating rate can be swapped for a fixed rate to eliminate the exposure to an increase in

rates.

- 70 -

Forward Coupon Swaps

A coupon swap is a form of interest rate swap where there is an exchange of fixed

rate for floating rate.

Interest Rate caps / collars

A cap is an agreement between two parties which limits interest rate exposure to a

maximum rate for a defined period of time.

A floor is an arrangement which maintains interest rate income to a minimum rate

for a defined period of time.

A collar is an arrangement whereby one party buys one cap and sells one floor

simultaneously so that the cap rate is higher than the floor rate.

In a collar, a borrower can buy a cap (to protect against a risk in rates) and

simultaneously sell a floor with a lower strike rate. The floor would result in loss of

benefits of lower interest rates if the fall is below the floor strike rate. The cost of the

collar for the customer is generally the premium charged for the cap and the premium

received for the floor.

Forward Rate Agreements (FRAs)

A Forward rate agreement is a forward contract on interest rate. It allows the

buyer to fix an interest rate for a specific future period, enabling him to accurately

estimate the future cash flows. The forward rate agreement is used to hedge against future

interest rate movements.

For example :

The agreed six month LIBOR rate of interest on a Forward rate agreement is

1.25%. If LIBOR is 1.35 %, the bank will pay the difference 0.10 % to be borne by the

customer. However, if the LIBOR rate is 1 % the customer will pay the 0.25 %,

difference to the bank. The interest cost in both the cases remains at 1.25 % for the

customer.

- 71 -

CHAPTER - X

WORK DESK

- 72 -

WORK DESK

Transaction - I

Import Bill for collection ( Usance bill )

ABC Company Ltd (Importer) submits its Letter of Credit which has expiry date

of 8th July 2008 and to be paid in US Dollar, for e.g. US $ 10,000.

Once the UBI – Forex receives documents from the exporter, it will send the

confirmation to the exporter’s bank, in this case it is Standard Chartered Bank

through SWIFT for receiving the said documents.

In turn, the customer (ABC Company Ltd) will send an acceptance letter to UBI –

Forex for agreeing to pay the bill amount to his exporter on the due date.

UBI – Forex will retain copies of the following documents and will return all the

documents in original to the customer – importer.

Covering letter from ABC Company Ltd’s bank,

Bill of Lading,

Invoice, and

ABC Company Ltd’s acceptance letter.

While UBI – Forex returns all the documents in original to the customer –

importer, he should give his signature on the UBI-Forex ’s copy stating “Received

Original” .

On the due date (8th July 2008), UBI-Forex will make the payment of US $

10,000 in INR, converting it at the prevailing exchange rate on that day.

While making the payment, UBI-Forex will charge letter of credit charges and

SWIFT charges to the customer – importer.

UBI-Forex will make the payment to the exporter to whom ABC Company Ltd

has to pay though there will be no funds available in the customer – importer’s

current account, and it will charge OD charges in ABC Company Ltd’s account

from the due date till the date he deposits the funds in his current account.

- 73 -

Transaction - II

Import Bill for Collection ( Sight Bill )

STU Company Ltd ( Importer ) has entered into a contract with PQR International

Ltd, United Kingdom to import certain goods from them. The contract is on ‘at

sight’ basis.

Once UBI-Forex receives the documents amounting US $ 142,199.25 from the

exporter – PQR International Ltd, it will intimate the receipt of the same to the

customer-importer.

STU Company Ltd ( Importer ) will arrive at UBI-Forex with a letter requesting

for “Release of collection documents” .

UBI-Forex will receive the entire bill amount from STU Company Ltd, and it will

retain the service charges ( say US $ 30 ).

It will remit US $ 142,169.25 to PQR International Ltd, United Kingdom through

SWIFT by converting the same into INR at the prevailing exchange rate.

UBI-Forex will give away all the documents in original to STU Company Ltd.

- 74 -

Transaction – III

Inland Bill Discounted

LMN Ltd ( buyer of the goods) entered into a letter of credit with UBI Allahabad

branch to pay Rs.25,00,000 to XYZ Ltd, Chennai ( seller of the goods ) through

UBI-IFB, Chennai branch on the due date.(in this case it is 13th September 2008 ).

With the full consent from LMN Ltd, XYZ Ltd presents the bill at UBI-IFB

before the due date ( for e.g. on April 22, 2008 ).

UBI-IFB will communicate this movement to UBI, Allahabad branch.

With their approval in writing to pay XYZ Ltd before the due date, UBI-IFB will

issue pay order to XYZ Ltd.

The commission for pay order, and the interest from the date of crediting the

funds to XYZ Ltd ( in this case, it is April 22, 2008 ) till the due date ( here it is

13th September, 2008 ) will be calculated and intimated to the UBI, Allahabad

branch.

On the due date, these additional charges and the amount credited to XYZ Ltd

will be transferred from UBI Allahabad branch to UBI – IFB.

UBI, Allahabad branch will claim these amounts from LMN Ltd.

If LMN Ltd does not make the payment to UBI, Allahabad branch on the due

date, they will charge OD charges in LMN Ltd’s account from the due date till the

date LMN Ltd makes the payment.

- 75 -

Transaction – IV

Free of Payment ( F.O.P) Bill

Company A receives an export order from its Germany customer

The Germany customer makes the full payment of EUR 20,390 to Company A on

March 28, 2008 well before dispatching the goods from the Indian Port.

The bank will get this amount as Inward Remittance and the same will be reported

to the Reserve Bank of India.

Company A dispatches the goods on April 02, 2008 to Germany, it will submit

the following documents to the bank

o Commercial Invoice

o Packing List

o Bill of Lading

o Shipping Bill for Exports – Exchange Control Copy

The bank has to link that Inward Remittance with the Free of Payment Bill to

show that the funds were received against these goods, and this will again have to

be reported to the Reserve Bank of India.

- 76 -

Transaction – V

Export Bill Discounted

Company B submits the following documents to the bank

o Request letter for Export Bill Discounting

o Bill of Exchange

o Commercial Invoice

o Packing List

o Certificate of analysis from Quality Assurance Department

o Certificate of Origin, in this case it is from Madras Chamber of Commerce

& Industry

o Order sheet

o Bill of Lading

o Insurance Certificate / Policy Original

o Shipping Bill for Export – Exchange Control Copy

The bill is to be paid in GBP 350,000. The bank will convert GBP into INR at the

then prevailing rate.

On the due date, the bank will receive funds from the foreign importer.

- 77 -

Transaction - VI

Realization of Crystallized Bill

On due date ( 17th February, 2008 ), an export bill has not been paid by the

foreign importer to whom the Indian Exporter ( UBI’s customer ) had supplied the

goods.

UBI-Forex will wait for 30 more days after the due date (i.e. till 18th March,

2008) for crystallization, expecting that the foreign importer will make the

payment. Meanwhile, UBI-Forex will calculate OD charges for these 30 days.

On the 30th day ( in this case, it is 18th March, 2008), UBI-IFB will crystallize the

bill by debiting the customer – Indian exporter’s Rupee account for the entire bill

amount and the OD charges.

When the foreign importer makes the payment after crystallizing the bill, it is

called Realization of Crystallized Bill.

If the payment from UBI-Forex is made in foreign currency, the collection should

also be in foreign currency.

In case of crystallization, the recovery is made out of exporter’s Rupee account,

and not in foreign currency.

Hence, export bill will remain outstanding even after crystallization, though it

might have been closed in the books of accounts at the bank.

When UBI-IFB receives funds in Inward Remittance from foreign importer, it

will relate Realization of crystallized bill with export bill outstanding to close the

outstanding export bill.

- 78 -

Transaction – VII

Bank Charges

In case of exports, JKL Ltd – foreign importer will make the payment on the due

date to EFG Ltd – exporter in Chennai for the bill amounting USD 256,184.00

(This amount will be the Inward Remittance).

At the time of realization, UBI-IFB will credit the entire bill amount

US $ 256,184.00, as they will not know the bank charges that was charged to JKL

Ltd by his bank.

Three or four days later, the amount for bank charges will be intimated to UBI,

Central Office. The same will be re-directed to UBI-IFB, Chennai to debit those

bank charges, for e.g. US $ 60. These charges will be considered as ‘ Outward

Remittance ’.

Transaction – VIII

Outward Remittance

Mr. Ram wishes to send US $ 10,000 to his daughter, who is studying in Unites

States of America.

He will submit his cheque to UBI-Forex valuing in INR.

UBI-Forex will buy US $ 10,000 from the market at the prevailing exchange rate.

The same will be sent to USA bank through SWIFT.

- 79 -

R-Return

UBI-Forex has to report all the transactions with respect to Foreign Exchange to

the Reserve Bank of India every fortnight.

FET-ERS is the software developed by Balance of Payments, Statistical Division,

Department of Statistical Analysis and Computer Services, Reserve Bank of

India, Mumbai.

This software is being used to make the report to Reserve Bank of India.

The following are the transactions that are usually to be reported fortnightly.

Imports Exports

Collection Bills Realization Bills

Payment against documents (PAD) Inward Remittances

Bank charges / commission Purchase Bills

Outward Remittances

- 80 -

`

CHAPTER – XI

- 81 -

CONCLUSION

Global economic integration has created a market for all kinds of products and services

cutting across national borders. The Indian economy is also clearly on the path of

integration with the global economy facilitated by a number of measures such as

declining tariff barriers, liberalized foreign direct investment regime, capital market

reforms and legal protection for Intellectual Property Rights. India has one of the lowest

labour costs among developing countries, and it also offers a cost-effective

manufacturing base. The Ministry of Commerce & Industry, Government of India has

estimated that off-shoring operations to India can result in a cost benefit of up to 40 – 60

percent for companies from developed countries. The low cost scenario in India has been

utilized by multi-national companies to make India a sourcing and export hub. This is

aptly illustrated by companies in the auto components and industrial goods industries.

The addressable market for global off-shoring exceeds US $ 300 billion. We believe that

India can sustain its global leadership position, grow its offshore IT and Business Process

Off-shoring (BPO) industries at an annual rate greater than 25 per cent, and generate

export revenues of about US $ 60 billion by 2010.

`

- 82 -

CHAPTER - XII

APPENDIX

- 83 -

ABBREVIATIONS

1 B/L Bill of Lading

2 CS Export Bill Collection at Sight

3 CU Export Bill Collection at Usance

4 DA Basis Deliverable against Acceptance

5 DGFT Director General of Foreign Trade

6 DP Basis Deliverable against Payment

7 DP Note Demand Promissory Note

8 DPG Deferred Payment Guarantees

9 Duty Draw backRefund of excise and custom duty to the exporter by the

Government.

10 ECB External Commercial Borrowings

11 ECGC Export Credit and Guarantee Corporation

12 EEFC Exchange Earner's Foreign Currency

13 EHTP Electronic Hardware Technology Parks

14 EOH Export Order Holder

15 EPCG Export Promotion Capital Goods

16 EPZ Export Processing Zone

17 ESTP Electronic Software Technology Parks

18 ETX Extension of Time Limit

19 FBP Foreign Bills Purchased

20 FCNR(B) Foreign Currency Non-Resident (Banks)

21 FEDAI Foreign Exchange Dealers Association of India

22 FEMA, 1999 Foreign Exchange Management Act

23 FERA Foreign Exchange Regulation Act

24 FET-ERS Foreign Exchange Transaction Electronic Reporting System

25 FTT Foreign Telegraphic Transfer

26 FTZ Free Trade Zone

- 84 -

27 FUBD Foreign Usance Bill Discounted

28 IBD International Banking Division

29 ICC International Chamber of Commerce

30 ICES / E Indian Customs EDI System - Exports

31 IEC Importer - Exporter Code Number

32 ISB International Service Branch

33 LC Letter of Credit

34 LG Letter of Guarantee

35 LIBOR London Inter-Bank Offer Rate

36 NS Export Bill Negotiation at Sight

37 NTP Normal Transit Period

38 NU Export Bill Negotiation at Usance

39 P0101 Value of export bills negotiation / discount / purchase

40 P0107 Realization of npd export bills

41 P0802 Receipt of consultant / implementation not SOFTEX

42 P1019 Receipts for other services not included

43 PAD Payment Against Document ( Letter of credit )

44 PC Packing Credit

45 PCFC Packing Credit in Foreign Currency

46 PS Export Bill Purchase at Sight

47 PU Export Bill Purchase at Usance

48 RFC A/C Resident Foreign Currency a/c

49 RTGS Real Time Gross Settlement

50 S0102 Payment towards import settlement

51 S0701 Financial intermediation, Bank charges, Commission, etc.

52 S0802 Payment for software consultancy / implementation

53 S1019 Remit towards other services

54 SWIFT Society for Worldwide Inter-bank Financial Transaction

- 85 -

55 T.T.Rate Telegraphic Transfer Rate

56 UCPDC Uniform Customs & Practices for Documentary Credits

57 WTPCG Whole Turnover Packing Credit Guarantee

58 WTPSG Whole Turnover Post-Shipment Guarantee

- 86 -

CHAPTER - XIII

BIBLIOGRAPHY

- 87 -

BIBLIOGRAPHY

1. Book of Instructions, Union Bank of India,

Manual on Advances.

2. Book of Instructions, Union Bank of India,

Operations, Volume – 1.

3. Book of Instructions on Exports

Volume – 1,

Union Bank of India, International Banking Division

Central Office, Mumbai.

4. Book of Instructions Imports, Remittances, Guarantees

Volume – 2,

Union Bank of India, International Banking Division

Central Office, Mumbai.

5. Book of Instructions on NRI Deposits and Investments

Volume – 3,

Union Bank of India, International Banking Division

Central Office, Mumbai.

6. Business Research Methods

Donald R. Cooper, Pamela S. Schindler

Eighth Edition, Tata McGraw Hill

7. www.indiamart.com

8. www.researchandmarkets.com

9. www.rbi.org.in

10. www.india-forex.com

11. www.images.google.com