Lending Operations

LENDING OPERATIONS 1

LENDING OPERATIONS

AND

RISK MANAGEMENT

SYED FAZAL AZIZ


LIFE IS UNCERTAINTYLife is uncertainty. None of us can be totally sure about anything save death and taxes, the French philosopher noted :“Knowledge is like a balloon in an atmosphere of ignorance – as the balloon grows, contact with the unknown increase twice as fast. The more we know, the more realize we don’t know”It is in this atmosphere that risk management exists.Risk management provides a logical and systematic method for dealing with uncertainty.


What is lending? The principal reason banks are chartered by state and

federal authorities is to make loan to their customers. Banks are expected to support their local communities with an adequate supply of credit for all legitimate business and consumer financial needs and to price that credit reasonably in line with competitively determined interest rates.

Moreover, bank loans often seem to convey positive information to the marketplace about a borrower's credit quality, enabling a borrower to obtain more and perhaps somewhat cheaper funds from other sources.


For most banks, loans account for half or more of their total assets and about half to two-thirds of their revenues.

Risk in banking tends to be concentrated in the loan portfolio. When a bank gets into serious financial trouble, its problems usually spring from loans that have become uncollectible due to mismanagement, illegal manipulation of loans, misguided lending policies, or an unexpected economic downturn.


TYPES OF LOANSMADE BY BANK’SWhat types of loans do bank made? Banks make wide variety of loans to a wide variety

of customers for many different purposes.

From setting up a business, industry or purchasing raw material, to meet day to day need or purchasing auto mobiles and buying new furniture, taking dream vacations or pursuing college education to constructing home. This diversity of bank lending have been arranged by grouping bank loans according to their purpose.


Why lending is important?Role of Bank’s for the growth of economy This industry, composed of thousands of firms

worldwide literally affects the welfare of every other industry and the economy as a whole. As many countries in Asia have recently discovered, when banks stop lending and accepting the risks that go with it, the rest of the economy grinds nearly to a hall, land and security prices fall, unemployment lines lengthen, and businesses begin to fail. Healthy banks and healthy economies just seem to go together.


Banks are among the most important financial institutions in the economy. They are the principal source of credit (loanable funds) for millions of individuals and families and for many units of government (school districts, cities, counties, etc.). Moreover, for small local businesses ranging from grocery stores to automobile dealers, banks are often the major source of credit to stock the shelves with merchandise or to fill a dealer's showroom with new cars. When businesses and consumers must make payments for purchases of goods and services, more often than not they use bank-provided cheques, credit or debit cards,


or electronic accounts connected to a computer network. And when they need financial information and financial planning, it is the banker to whom they turn most frequently for advice and counsel.

Banks are among the most important sources of short-term working capital for businesses and have become increasingly active in recent years in making long-term business loans for new plant and equipment.

Moreover, bank reserves are the principal channel for government economic policy to stabilize the economy.


Life line for the economy

Five C’s Character Capacity Capital Condition Cash flow


FUND BASED FACILITIESDomestic BusinessImportExport

Domestic BusinessFund Based FacilitiesFacilities where funds are provided to customers upon sanction to the respective credit lines.


Policies All financing facilities shall be governed in

conformity of SBP PRs and Bank's Policies. In Compliance with the regulatory

requirement laid down in BC circular No. 13/1984, financing to be necessarily structured around the Shariah compliant frame work of "Sale and buyback of goods“

Drawings in Cash Finance account shall be allowed against stocks, whose purchase is financed by the bank.


No finance facility shall he allowed against perishable goods without additional conditions as mentioned in Security chapter.

Pledge facility shall not outstand against stocks older than 180 days or before their shelf life whichever is earlier.


Purpose A business may borrow for various short term

or long term financial needs in any of the following common modes of financing:WORKING CAPITAL FINANCEThis caters to the regular needs of business. Normally, a certain limit is granted and the loan amount fluctuates within the limits. It is normally granted in the form of Running Finance / Cash finance for a period of one year.


SEASONAL WORKING CAPITAL The seasonal working capital on the other hand is for

a specific season and must ordinarily be paid off in full towards the end of the season. This is normally applicable for agriculture and agro based industries such as cotton ginning, wheat, rice paddy etc.

FIXED INVESTMENT These are long term financing facilities with tenors

exceeding 01 year and are usually allowed to finance acquisition of fixed assets i.e. plant & machinery payable in installments or lump sum at pre-determined future time period.


COMBINATION OF FUND BASED AND NON FUND BASED FACILITIES At times depending upon the requirement of the

borrowers, limits are structured in such a way that it consists of combination of fund-based and Non-fund based facilities. For instance, in case of imported plant and machinery, if bank finances retirement or documents then a non-fund based working capital facility (L/C) would be converted to a term loan that is adjustment of a contingent liability will give rise to a long term funded facility and shall be called LC cum DF facility. The other combinations are LC cum FlM or LC cum CF e.t.c.


MODE OF FINANCESHORT TERM

Following modes of financing are included in the Short Term category as their liquidation is likely to take place within a year:‑

Working Capital Finance:

a) Running Financeb) Cash Financec) Pre-shipment Export Finance Packing Financed) Post shipment Export Finance

Export Bills Purchased Export Bills Discounted


Import Finance:a) Letter of Creditb) Payment against Documentc) Finance against Imported merchandised) Finance against Trust Receipt Bill Financing:a) Inland Bills Purchased / Discounted

LONG TERMFixed Investment:a) Term Finance

Demand Finance


COMBINATION Fund-based and Non-fund based facilities a) Import L/C cum Demand Financeb) Import L/C cum Cash Financec) Import L/C cum Financed) Others


WORKING CAPITAL FINANCE FACILITIESCASH FINANCE Cash finance facility account is a drawing account against a credit

limit granted by the Bank. Its a revolving facility which may be freely drawn upon, as the

borrower requires during its currency by way of multi transactions within the approved limit and available drawing power subject to compliance of approved terms and conditions.

Moreover borrower can reduce the balance temporarily whenever he is in a position to do so.

The security may change from time to time according to the borrower's business requirement but within the items admissible under the sanctioned terms provided it always fully covers the balance outstanding in the account plus the stipulated margin.

The account is generally used when the finance limit granted is secured against the pledge / hyp of goods / produce (raw material produced locally or imported for value addition or finished commodities).


OPERATIONAL PROCEDURE The operational procedure of the account differs

from bank to bank. Some banks debit the Cash finance account with the entire amount of credit limit and the corresponding entry is passed by crediting the Current account from where he withdraws the amount as and when needed.

In NBP bank this practice is not followed instead the borrower shall be allowed to withdraw the amount from cash finance account up to the drawing power according to the value of security and the terms of limit.


ADVANTAGES Principal advantages of a Cash finance

account to the borrower are that unlike the recipient of a demand Finance. he may draw on the account within the prescribed limit as he requires and can save Mark up on the advance by reducing the outstanding temporarily whenever lie is in a position to do so.


RUNNING FINANCE Like Cash finance, the Running finance account is

also a drawing account which may be freely operated by way of multi transactions provided the security available covers the outstanding balance and the margin. The borrower does not require withdrawing against his security under pledge to the Bank as frequently as required in Cash Finance Account.

The facility is generally granted against the pledge of various deposits certificates, Govt. securities.

It can also be provided against any other tangible securities such as stocks of-stores & spares work in process and assignment of receivables.


The nomenclature of account would be as under:

Running Finance (Pledge) other than the stocks/produce

Running Finance ( Hyp) Running Finance (Mortgage) In considering applications for Running Finance

against mortgage of immoveable properties as a primary security, it must be borne in mind that immovable property are regarded as undesirable security by the Bank as immovable property is, as a general rule, difficult to realize.


Conditions in Case RF against hypothecation of Stocks in Trade / Produce:

The facility shall only be allowed to high net-worth customers.

Healthy turnover in the account corresponds to sale proceeds.


DIFFERENCE The borrower does not require withdrawing

against his security under pledge to the Bank as frequently as required in Cash Finance Account.


EXPORT FINANCE FACILITIESAVAILABLE MODESThe following common modes of export financefacilities are:-

1. Packing Finance2. Bill Financing3. Export Refinance

Policies / Guidelines on each mode is coveredbelow.


PACKING FINANCE Packing Credit facility is made available to clients engaged in export business.

Basic Features:‑

Facility is allowed by the bank from its own resources.

They are given to intending exporters of various commodities including those commodities not eligible for financing under Export Re-Finance Scheme.


This credit facility is to enable him to produce or buy goods for eventual shipment in accordance with the letter of credit or the foreign buyer's contract.

The facility is required from the time the customer purchases the goods or raw material with the Bank's money until the export documents are received and negotiated by the Bank.

The facility involves a self-liquidation mechanism as it will be adjusted through realization of export proceeds.


OUT-WARD BILLS FINANCING TYPES OF BILLS Outward Bills against which finance is provided can broadly be categorized in two types:‑

i. Inland Billsii. Foreign Bills

MODES OF BILL FINANCINGFinancing against inland/foreign bills can be provided toExporters/drawers of bills by allowing post shipment financing facility under any of the following modes:‑

i. Negotiationii. Purchaseiii. Discounting

Whatever terminology is used all the modes involve financing against exports receivables. Bank pays the exporter and receivesthe export proceeds to adjust the facility.


NEGOTIATION Concept The act of buying an export bill is called

Negotiation. This is a post shipment facility, extended by the Bank to exporters to finance export receivables through purchase of export bills from exporters.

The bank as a negotiating bank pays exporter the value of export bill and assumes risks of non-realization of export proceeds due to documentation errors exchange rate risks.


FINANCING AGAINST EXPORT BILLS Concept Besides Negotiation it is another mode of post-

shipment finance facility extended to exporters in order to finance export receivables until realization.

A post shipment finance limit called "Finance Against Foreign Bill" (conventionally called "Export Bills Purchased Limit EBP") is sanctioned in favor of exporter.It is allowed in instances:‑

Where the criteria of Negotiation are not met or Borrower prefers to avail this type of facility over

negotiation to avail the gain through favorable exchange rate fluctuation as explained subsequently


DISCOUNTING Concept This is also a post shipment facility to finance

export receivables. It is always extended for the purchase of Usance

export bills. It is similar to the FBP facility with the difference

that the export bill being purchased must be duly accepted by issuing bank (in case of an LC) or the importer (in case of documents on collection basis) for payment at a fixed or determinable maturity date.


NEGOTIATION SPECIFIC POLICIES Under this mode, the bank as a negotiating

bank buys the bill and pays exporter the value of export bill and accepts risk of non-realization of bill proceeds due to documentation error.


IMPORT FINANCE FACILITIES (FUND BASED) When the importer require post-import financing

whereby the Bank will pay exporters (through negotiating abroad) to be subsequently re-paid by the importer after a specific period. Such a financing facility can take following forms:‑

MODES

1. Payments Against Documents (PAD)2. Financing against Trust Receipt (FATR)3. Financing against Imported Merchandise (FIM)

a. Pre-approved Arrangementsb. Forced FIM


PAYMENTS AGAINST DOCUMENTS (PAD)/Bill of Exchange (BE) The documents as per mark-up agreement would be

purchased by the Bank and sold to the importer at the marked-up price. When an import Bill is received and lodged, two types of transactions shall be deemed to have taken place i.e. purchase and sale of documents.

Purchase The documents pertaining to the import Bill will be

purchased by the importer's bank at Bill amount plus negotiating bank's charges less margin, if any. This shall be the Purchase Price of the import Bill by the bank.


SaleAfter the import Bill is so purchased at the above price, it shall be sold by the Bank to the importer after applying the mark-up and Bank commission where applicable. This marked-up amount shall be the selling price of the import bill by the Bank. The sale price of the bill shall be payable by the borrower upon receipt of shipment.

Forced FIM In case of borrower's failure to retire import

documents despite arrival of shipment, immediate step shall be taken for conversion of PAD facility into forced FIM.


FINANCING AGAINST TRUST RECEIPTS The customers, on whose behalf the Bank issues a letter of

credit (local/foreign) may desire to obtain the documents of title to goods received under the L/C to enable them to obtain delivery of goods and arrange to retire the bill out of the sale proceeds of goods. If bank considers the request favorably.

The documents of title are delivered against the customers signature on the prescribed Trust Receipt form and execution of related security documents.

This is a liberal financing facility because it allows the borrower to freely deal in the goods i.e. sell them without the bank interfering in sale activities.

However, as the title suggest, the goods are released by the bank in "trust" which pre-supposes that the trust reposed by the bank in the customer will not be betrayed.


It implies that in terms of the Trust Receipt executed by the customer at the time of taking the import documents, the customer will promptly deposit with the Bank sale proceeds of these goods.


FINANCING AGAINST IMPORTED MDSE (FIM) CONCEPT: Under the facility of Finance Against Imported

Merchandise (FIM), imported goods come into the control of the Bank as soon as they are off loaded from the carrier (aircraft/ship).

Clearing/forwarding shall be carried out by the Bank's approved clearing/forwarding agent and the agent is required to transport the goods to a warehouse under supervision of the Bank's approved Muccadum.

The stored goods remain under Bank's custody of lock and key and watch & ward.

The client takes delivery of the goods against payment later on either in lumpsum or in piecemeal.


ACCOUNTS SUITABLE FOR FIXED INVESTMENTDemand Finance Term loans facilities are allowed for fixed investment

financing. It mostly has maturity of more than one year however it can be for a period less than one year.

PurposeThe facility is generally allowed for purchase of plant & machinery & spare parts or for other needs of capital expenditure however, DF may also be created as a result of restructuring/rescheduling of working capital facility (ies).


Account Mechanism A Demand Finance account is an advance of

fixed amount for a tenor of more than one year, where no debits to the account may be made subsequent to the initial advance except for the mark-up, insurance premium and other sundry charges applied by the Bank.


NON-FUND BASED FACILITIES CONCEPT

Non-fund based facility is a contingent liability i.e. a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events. Under such type of financing, banks takes no funded exposure on the borrower.

GUARANTEESIntroduction / ConceptNeed

Generally guarantees are issued by Banks for guaranteeing specific payments at future dates by its customers or for guaranteeing completion of a particular performance by the customer.


Nature of The Bank Guarantee Facility Bank guarantee is an undertaking given by the bank to a third

party, called beneficiary on behalf of a person, a customer; to be answerable for a debt of any person or its customer, upon default of the debtor (customer).

TYPES OF GUARANTEES THE BANK ISSUEIn the normal course of business the Bank issue the following types of Guarantees and Bonds, categorized according to the nature of purpose its issued for:

1. Performance Guarantees2. Bid Bonds/Tender Deposit Guarantee3. Shipping Guarantees4. Guarantees for Advance Payments/Mobilization Guarantees5. Security Deposit Guarantees6. Guarantees for payment of dues / Court Guarantees


7. Loan repayment guarantee8. Permanent guarantee9. Guarantee expressed in FCY10. Standby Letter of Credit (SBLC )

As a general rule directed by State Bank of Pakistan guarantee issued must be for a specific amount, specific period, that is, the guarantee text issued must have a specific expiry date, and all claims must be lodged within the expiry date.


However, for certain specific instances, SBP has lately vide its amendment No. BPRD Circular # 07 dated 4th April 2000 and 24 dated 9th September 2002 (also the part of PR # 7 of (Corporate/Commercial) allowed issuance of continuing / open-ended (that is for indefinite period of time) guarantees as under:

“Banks are allowed to issue open-ended Guarantees without clearance from State Bank of Pakistan provided Banks/DFIs have secured their interest by adequate collateral or other arrangements acceptable to the Bank/DFI for issuance of such guarantees in favor of Government Departments, Corporations/Autonomous bodies owned/controlled by the Government and guarantee required by the court”.


LETTER OF CREDIT CONCEPT OFF (LCs)

Letters of Credit (LCs) are among those banking facilities, which bank commonly offers. It is a liability of the importer to the LC issuing bank and that of LC issuing bank to the LC negotiating bank.

It is termed contingent because at the time of establishing the LC, neither the importer nor the LC issuing bank are liable for payment under the LC.



TRUST RECEIPTTO:BANK: BRANCH:

DEAR SIRS,

1. IN CONSIDERATION OF YOUR HANDING OVER TO ME/US AT MY/OUR REQUEST THE GOODS/DOCUMENTS OF TITLE TO GOODS AS PER PARTICULARS AT THE FOOT OF THIS INSTRUMENT HELD BY YOU AS SECURITY FOR MY/OUR INDEBTEDNESS TO YOU I/WE HEREBY AGREE AND UNDERTAKE TO HOLD ANY AND ALL THE GOODS/DOCUMENTS IN TRUST FOR YOU AND AS SECURITY FOR ALL THE OBLIGATIONS FOR WHICH THEY FORMED SECURITY BEFORE THEIR DELIVERY TO ME/US HEREUNDER AND ALSO FOR ANY VALUE ADVANTAGE OR CONVENIENCE GRANTED OR AGREED TO BE GRANTED BY YOU TO ME/US AS APART OF THIS TRANSACTION.


2. I/WE FURTHER AGREE TO KEEP ANY AND ALL SUCH GOODS/DOCUMENTS IN WHATEVER FORM THE SAME MAY BE AT ALL TIMES SEPARATE AND CAPABLE OF IDENTIFICATION AS PROPERTY HELD IN TRUST AT ALL TIMES ACCESSIBLE TO YOU FOR INSPECTION OR OTHERWISE AND TO SURRENDER THE SAME AND ACCOUNT THEREFORE TO YOU FORTHWITH UPON DEMAND.

3. I/WE ADMIT THAT MY/OUR REQUEST FOR THE DELIVERY OF GOODS/DOCUMENTS TO ME/US IS FOR LIMITED AND SPECIFIED PURPOSE OF ENABLING ME/US MUCCADUM/CLEARING & FORWARDING AGENT IN DUE COURSE OF THE BUSINESS IN RESPECT OF WHICH FINANCE IN DUE COURSE OF THE BUSINESS IN RESPECT OF WHICH FINANCE HAS BEEN PROVIDED TO ME/US BY YOU TO BE CARRIED ON BY ME US AT MY/OUR PREMISES OR PREMISES WITHIN OUR EXCLUSIVE CONTROL AT AND I/WE UNDERTAKE NOT TO DEVIATE FROM THE SAID SPECIFIC PURPOSE NOR TO REMOVE OR PERMIT OR CAUSE THE REMOVAL OF THE SAID GOODS OR DOCUMENTS OF TITLE RELATING THERE TO FROM THE SAID PREMISES, WITHOUT YOUR PRIOR WRITTEN CONSENT.


4. I/WE FURTHER AGREE TO KEEP INSURED IN YOUR NAME AND AT MY/OUR OWN COST AND EXPENSES ALL GOODS DELIVERED TO ME/US OR GOODS REPRESENTED BY ANY OF THE DOCUMENTS HEREINBEFORE REFEREED TO AGAINST LOSS BY FIRE, THEFT, RIOT, CIVIL COMMOTION AND ANY OTHER RISK REQUIRED BY YOU AT ANY TIME AND TO DELIVER ANY AND ALL POLICIES AND PREMIA RECEIPTS OF SUCH INSURANCE TO YOU IMMEDIATELY.

5. IT IS HEREBY AGREED AND ACKNOWLEDGED THAT YOU MAY TERMINATE THIS TRUST OR TRANSACTION WITH OR WITHOUT NOTICE TO ME/US AND MAY ENTER INTO ANY PLACE WHERE ANY GOODS /DOCUMENTS REFERRED TO ABOVE ARE KEPT OR MAY BE FOUND AND RESUME DIRECT CONTROL THEREOF.

6. I/WE AGREE THAT IF ANY OF THE GOODS REFERRED TO ABOVE ARE UNDER YOUR APPROVAL OR ACCORDING TO THE TERMS HEREOF SOLD BY ME/US THE PROCEEDS THEREOF SHALL BE YOUR PROPERTY AND SHALL IN ALL RESPECTS BE TREATED BY ME/US AS BELONGING TO YOU AND EARMARKED AS YOUR PROPERTY AND IN TRUST WITH ME/US FOR YOU.


7. WHERE SALE IS CONTEMPLATED WITHIN THE SAID SPECIFIC PURPOSE I/WE FURTHER UNDERTAKE THAT NO SALE BY ME/US OF THE ABOVEMENTIONED GOODS SHALL BE MADE EXCEPTING FOR CASH TO BE PAID OVER TO YOU FORTHWITH.

8. I/WE FURTHER AGREE THAT NO FAILURE OF COMMISSION OR INDULGENCE ON YOUR PART TO TAKE ACTION ON MY/OUR FAILURE TO COMPLY WITH ANY OF THE PROVISIONS OF THIS INSTRUMENT SHALL BE DEEMED TO BE A WAIVER BY YOU OF ANY OF YOUR RIGHTS OR REMEDIES.

9. IT IS AGREED THAT ON PAYMENT BY ME/US IN FULL OF MY/OUR INDEBTEDNESS TO YOU THIS INSTRUMENT SHALL BE CANCELLED BY YOU AND DELIVERED UTO ME/US AND THEREUPON THE ABOVEMENTIONED GOODS SHALL CEASE TO BE GOVERNED BY THIS INSTRUMENT.


10. I/WE FURTHER REPRESENT AND CONFIRM THAT THE ABOVE MENTIONED GOODS/DOCUMENTS HAVE NOT BEEN PLEDGED HYPOTHECATED, CHARGED OR ENCUMBERED IN ANY MANNER WHATSOEVER AND I/WE AM/ARE THE ABSOLUTE OWNER(S) THEREOF, SUBJECT ONLY TO YOUR RIGHTS AS PLEDGEE.

11. I/WE FURTHER AGREE AND UNDERTAKE NOT TO PART WITH POSSESSION OF PLEDGE, HYPOTHECATE, CHARGE OR ENCUMBER THE ABOVE MENTIONED GOODS/ DOCUMENTS TO ANY OTHER BANK, COMPANY OR PERSON FOR OBTAINING ANY FINANCE OR FOR ANY OTHER PURPOSE AND IF I/WE ATTENTION TO DO SO YOU SHALL BE ENTITLED FORTHWITH TO TAKE POSSESSION THEREOF AND DISPOSE OF THE SAME IN ANY MANNER AND TAKE POSSESSION THEREOF AND DISPOSE OF THE SAME IN ANY MANNER AND TAKE SUCH ACTION AGAINST ME/US AS YOU DEEM FIT.


12. I/WE AGREE AND ACCEPT FULL RESPONSIBILITY FOR ANY ACT, OMISSION, FAULT, NEGLIGENCE, FRAUD DISHONESTY OR INEFFICIENCY OF ANY OF THE AGENTS AND EMPLOYEES PARTICIPATING, ENGAGED OR EMPLOYED IN THIS CONNECTION AND I/WE UNDERTAKE NOT TO HOLD YOU RESPONSIBLE FOR ANY LOSSES, HARMS OR DETRIMENTS OCCURRING IN CONSEQUENCE THEREOF OR HOWSOEVER ARISING.

13. I/WE AGREE THAT IN CONNECTION WITH ANYTHING RELATING TO THIS INSTRUMENT IF YOU RECOMMEND OR HAVE RECOMMENDED ANY AGENTS OR EMPLOYEES OR ENGAGE OR HAVE ENGAGED THEM OR IF THEY HAPPEN TO BE PERSONS WHO WORK FOR YOU OR ARE BOUND BY THE TERMS OR ANY CONTRACT WITH YOU THEN THIS FACT SHALL NOT EFFECT MY/OUR RELATIONSHIP WITH THEM AS PRINCIPALS AND AGENTS AND YOU SHALL NOT BE RESPONSIBLE OR LIABLE FOR ANY OF THEIR ACTS, OMISSIONS, NEGLIGENCE, DEFAULT, FRAUD, DISHONESTY OR INEFFICIENCY.


DATES & DESCRIPTION OF DOCUMENTS OF TITLE TO THE GOODS AND IDENTIFICATION

QUANTITY AND ESTIMATED VALUE NUMBERS AND MARKS EMANATING FROM WHAT

TRANSAACTION