Fee Based Services

Deregulation and new technology have eroded banks comparative

Introduction

advantages as well as margins. To augment their income, banks have entered into businesses, which undertake fee-based or non-fund based activities
Letters of credit, Guarantees
Financial, Performance, Deferred payment and Shipping & Railway Guarantees

Subsidiary services
Payment and clearing operations, project consultancy, turnaround/mergers and

acquisitions, one-time settlement appraisal/consultancy, loan syndication, advisory services, acting as broker, registrar and share transfer agency, depository participants for dematerialization of shares, etc.
Off Balance Sheet activities
Loan commitments, under-writing, derivative transactions.

Non-Fund Based Services or Fee Based Services

Letters of Credit: A bank or finance company issues a letter of credit on behalf of an importer or buyer, authorizing the exporter or seller to obtain payment within a specified time frame once the terms and conditions outlined in the letter of credit are met.
Letters of credit acts like an insurance contract for both the buyer and seller. Practically eliminates the credit risk for both parties. Reduces payment delays. Letters of credit accomplish their purpose by substituting the credit of the bank for that of

the customer, for the purpose of facilitating trade.

How it works?

After a contract is concluded between buyer and seller, buyer's bank supplies a letter of credit to seller.

Seller consigns the goods to a carrier in exchange for a bill of lading and then provides the bill of lading to bank in exchange for payment. Seller's bank exchanges bill of lading for payment from buyer's bank. Buyer's bank exchanges bill of lading for payment from buyer.

Buyer provides bill of lading to carrier and takes delivery of goods.

Benefits
BENEFITS TO SELLERS Assures the security of payment from an international bank once the terms of the letter of credit are met. Seller can determine when payment will be satisfied and ship the goods accordingly. Bank bears the responsibility of oversight. Seller does not have to open an account and grant payment terms to buyer. Credit risk is nearly eliminated. The risk of exchange control created with payment delays is greatly reduced. Provides seller easier access to financing once the letter of credit has been issued. Once the bank confirms the letter of credit, political and economic risk and questions regarding the buyers ability to pay are eliminated. The confirming bank is obliged to pay, even if the buyer goes bankrupt, provided the terms of the letter of credit are met. BENEFITS TO BUYERS Facilitates financing for example, creating bankers acceptances. Buyer can confirm that the merchandise is shipped on or before the required date. It is safer to deal with bank than to prepay. Buyer may get better terms and prices. No cash is tied up in the process. Buyer does not have to pay cash up front to a foreign seller before receiving the documents of title to the goods purchased. This is particularly helpful when the buyer is unfamiliar with local suppliers and laws. Protects the buyer since the bank only pays when the supplier complies with the specific terms and conditions and produces the documents required by the buyer. The buyer can build safeguards into the letter of credit, including inspection of the goods and quality control, and set production and delivery times.

Types of Letters of Credit

Revocable LC
Allows for amendments, modifications and cancellation of the terms outlined in the letter

of credit at any time and without the consent of the exporter or beneficiary. Generally, not accepted.
Irrevocable LC
Requires the consent of the issuing bank, the beneficiary and applicant before any

amendment, modification or cancellation to the original terms can be made. Irrevocable letters of credit can be
Confirmed

The seller/beneficiary may also look to the creditworthiness of the additional confirming bank for payment assurance. Unconfirmed When a letter of credit is not confirmed by any bank other than the issuing bank. Back to back Opened with another letter of credit as the security, i.e. if a foreign buyer will issue a letter of credit to an exporter, certain banks and trade finance companies will issue independent letters of credit to the exporters suppliers so that the required goods can be purchased.

Deferred Payment LC
Deferred payment LCs allows the issuing bank to make the payment to the beneficiary in

installments. The timing and the amounts of these installments are predetermined. The buyer accepts the documents and agrees to pay the issuing bank on a fixed maturity date; thus, the buyer gets a grace period for payment.

 Anticipatory LC
It is a letter of credit under which payment is made to the beneficiary even at the pre-

shipment stage. There are two kinds of anticipatory letters of credit. Under the red clause credit, advance is given for purchase of raw material, processing and/or packing of goods. Under the green clause credit, advance is also given for warehousing and insurance charges at port.
Standby LC
A standby letter of credit is a form of a bank guarantee. Banks issue them to stand behind monetary obligations, to ensure the refund of advance

payment, to support performance and bid obligations, and to ensure the completion of a sales contract. The credit has an expiration date. They are often called non-performing letters of credit because they are only used as a backup should the buyer fail to pay as agreed.
Thus, a standby letter of credit allows the customer to establish a rapport with the seller by showing that it can fulfill its payment commitments.

Guarantees
A bank guarantee is defined under Section 126 of the Indian Contracts Act 1872 as follows: A contract to perform the promise or discharge the liability of a third person in case of his default. The person who gives the guarantee is called the surety; the person in respect of whose default the guarantee is given is called the principal debtor and the person to whom the guarantee is given is called the creditor. A guarantee may be either oral or written. The guarantees are classified as financial guarantees and performance guarantees:
Financial Guarantees The bank guarantees its customers credit-worthiness and his or her capacity to take up financial risks. Financial guarantees are typically issued for the following purposes: In lieu of Earnest Money/Tender deposit/Retention money. Issued to Government departments for releasing disputed claim money like excise duty/customs duty etc. Performance Guarantees The bank guarantees obligations that relate to the technical, managerial, administrative experience and capacity of the customer. The liabilities under the performance guarantees are reduced to monetary terms. Performance guarantees typically cover the following areas: For performance of machinery/goods supplied deposit/Retention money For satisfactory performance of Turnkey projects for a specific period for releasing disputed claim money like excise duty/customs duty, etc.

Deferred Payment Guarantee: The Deferred Payment Guarantee (DPG) is a bank facility where the bank extends a guarantee to the equipment manufacturer on behalf of its client that the finance extended by the manufacturer (by himself or through its preferred financier) would be repaid as per the terms agreed upon. The advantage to the buyer here is that he or she benefits to the extent of savings in interest charges accruing on account of opting for equipment financing, minus the guarantee charges paid to the bank. In the normal course where the guarantee does not transfer onto the banker, the banker stands to earn fee-based income.

Shipping and Railway Guarantee:

A bank is requested to issue a shipping and railway guarantee when the shipping documents are not received but the ship carrying the goods has arrived and the shipping company agrees to deliver the goods against the production of a bank guarantee. As this guarantee does not specify the amount of guarantee it is issued only on behalf of very respectable customers.
The features of Shipping and railway guarantee are that they:
Enable immediate possession of the goods before payment.
Avoid unnecessary delays to the day-to-day running of your business. Eliminate expensive demurrage/storage charges. Defer payment until your suppliers documents have been presented.

Subsidiary Services
Remittance of Funds Mail transfers, telegraphic transfers, bank drafts, and travelers cheque. Safe Custody of Valuables Payment and Clearing Operations

The most important non-fund based service of the banking system throughout the world is its payment and clearing operation. At a considerably low cost, funds are transmitted between various people. In a paper-based payment instruction, the key elements that lead to the payment are the words and figures, and the signature identifying the party giving the payment instruction.
Scope for fraudulent alterations is high. Takes considerable time, which may extend from a single day to a few weeks. In contrast to this

mode of payment is

The electronic approach, takes the payment instruction in the form of computer

codes. An electronic key is designated to authenticate a message.

Requires adequate safety measures in order to prevent the electronic message being erased or

transferred to other magnetic material without being easily discovered.

The different types of electronic payments and settlement systems used in India are as follows:
Telegraphic Transfers Banks install in-house systems(Telex/Telephone) to enable inter-branch transfer of funds within the bank.

Magnetic Ink Character Recognition (MICR)

Electronic Credit Transfers Facilitates a person to make payments through a bank to different payees of the same bank or those of other banks electronically without involving any paper instructions. The payment orders in electronic credit transfers are classified into two types: High-volume low-value transfers High value transfers. Electronic Debit Transfers In a debit transfer, the payee will instruct the bank to transfer a certain amount from his or her account to the payees account. This facility extends to the payment of telephone bills, electricity bills, insurance premium, loan payments, etc.

Electronic Fund Transfers. It is a payment transaction carried out between two parties without the use of cash or paper to effect the transaction. The payment is effected by communication of electronically transmitted message to the bank by the customer of the bank or a bank to another bank. The bank to which the message is sent assumes an obligation to the beneficiarys account with the amount directed to be paid. It is a substitute method for DDs, Mail Transfer and Telegraphic Transfers

Off Balance Sheet Activities

Banks also generate fee income through business, which generates income without creating a balance sheet entry. Such activities are called off balance sheet activities where a bank is not required to invest bank funds. Such business often creates a contingent liability a liability that comes into existence only when triggered by a specific event. Such activities must be recorded as asset/liabilities at fair market value. Some of the OBS activities are as follows:
Loan Commitments A promise to make credit available (usually to firms) when it is required. The promise is an agreement and the bank charges a fee for setting up the agreement. When required and created, the amount of the loan in use will appear on the balance sheet, but the fee-earning commitment, which may be much larger, does not appear. Underwriting Banks are often engaged in issue of new securities. Even where they are not directly involved, they may be part of an underwriting syndicate (group) of banks who promise to take up any new issues not bought by investors. Banks earn a fee for the commitment, but the balance sheet is only affected if the syndicate has to take up some of the unsold shares. Derivative Transactions Most commercial banks enter derivatives transactions as hedgers or dealers.