NON-FUND BASED LIMITS

LETTERS OF CREDIT & BANK GUARANTEES

R VENKATESH CHIEF MANAGER & FACULTY STATE BANK ACADEMY GURGAON

OVERVIEW
1. LETTERS OF CREDIT 2. BANK GUARANTEES

CHAPTER 1 LETTERS OF CREDIT

INTRODUCTION
Facilitates trade : Domestic and International Helps in reducing FBWC requirement for buyer

Helps seller to get immediate payment though credit is extended by him

Bank intermediate lends its creditworthiness for which it charges the applicant Transactions are guided by UCPDC

INTRODUCTION
A Letter of Credit (LC) is an arrangement whereby a bank (the issuing bank) acting at the request and on the instructions of a customer (the applicant) or on its own behalf,
i. Is to make a payment to or to the order of a third party (the beneficiary), or is to accept and pay bills of exchange (drafts drawn by the beneficiary); or

ii. Authorises another bank to effect such payment, or to accept and pay such bills of exchange (drafts); or

iii. Authorises another bank to negotiate against stipulated document(s), provided that the terms and conditions of the credit are complied with.

INTRODUCTION
In other words, a Documentary Credit is an undertaking issued by a bank (the issuing bank), on behalf of the buyer (the applicant), to the seller (the beneficiary) to pay for goods and services provided that the seller presents documents which comply with the terms and conditions of the Documentary Credit. Except as otherwise stated, Documentary Credits (LCs) are subject to the terms and conditions of UCPDC, ICC Publication No. 500 (1993).

PARTIES TO A LETTER OF CREDIT

Applicant (Buyer / Importer) Issuing Bank (LC Opening Bank)

Advising Bank
Confirming Bank Beneficiary (Seller / Exporter) Negotiating Bank (Paying Bank) Reimbursing Bank Second Beneficiary

DOCUMENTARY CREDIT PROCEDURE

1. The Buyer and Seller conclude a sales contract providing for payment by a Documentary Credit (DC). 2. The Buyer instructs his bank (the Issuing Bank) to issue a DC in favour of the Seller (Beneficiary). 3. The Issuing Bank issues the DC and asks another bank (the Advising Bank), usually in the country of the Seller to advise or confirm the DC. 4. The Advising Bank informs the Seller that the DC has been issued.

DOCUMENTARY CREDIT PROCEDURE

5. As soon as the Seller receives the DC and is satisfied that it meets the terms of the sales contract and that he can meet the DC terms and conditions, he is in a position to effect shipment. 6. Seller then sends the required documents to the bank where the DC is made available (the Nominated Bank). 7. The bank examines the documents against the DC. If they meet the requirements of the Dc, the bank will pay, accept or negotiate, according to the terms of the DC.

DOCUMENTARY CREDIT PROCEDURE

8. The bank which takes up the documents sends the documents to the Issuing Bank.

9. The Issuing Bank examines the documents and if the documents meet the DC requirements, reimburses in the pre-agreed manner the Confirming Bank or any other Nominated Bank that has paid, accepted, or negotiated under the DC. 10. When the documents have been examined by the Issuing Bank and are found to meet the DC requirements, they are released to the Buyer.

DOCUMENTARY CREDIT PROCEDURE

11. The Issuing Bank obtains reimbursement from the Buyer in the pre-agreed manner.

12. The Buyer forwards the transport document to the local office or agent of the carrier who will then effect delivery of the goods to him.

TYPES OF LETTERS OF CREDIT

1. With / without backing of documents:
Clean LC

Documentary LC

2. Security wise:
Revocable LC Irrevocable LC Confirmed LC

3. Payment wise:
Sight LC

Acceptance LC

TYPES OF LETTERS OF CREDIT

4. With advance payment:
Red Clause LC

Green Clause LC

5. Involving middlemen:
Transferable LC Back-to-back LC

6. Others:
Revolving LC Standby LC

OPENING OF LCs : PRECAUTIONS

1. 2. 3. 4. Applicant should normally be a customer and whose account has been satisfactorily operated. Ascertain means, creditworthiness and standing of the LC applicant. Appraisal memorandum to be prepared / limits to be sanctioned and in place. LC limit to be commensurate with turnover / CC Limit and should be for genuine trade / mfg. Activity. Usance period should ordinarily have relation to WC cycle.

5.

OPENING OF LCs : PRECAUTIONS

6. 7. Level of inventory to be commensurate with industry norms / past trends. LCs for purchase of machinery / CG should be backed by borrowers own funds or firm sanction of Term Loan. A suitable margin depending on the applicants means, creditworthiness, his other liabilities, etc. may be prescribed. If warranted, a lien may be maintained on the unutilised portion of CC Account for the value of bills to be received under the LC.

8.

9.

OPENING OF LCs : PRECAUTIONS

10. In respect of sister concerns or where applicant and beneficiary are otherwise linked, there should ordinarily be no need for LCs. Ensure against kite flying. Ascertain standing of the beneficiary. 11. Delivery against Acceptance (D/A) facilities should be granted only to applicants of undoubted standing and where security available is much more than the value of LC. 12. LCs permitting payment against documents which do not confer on the Bank a full and undisputed title to the relative goods to be treated as clean and should not ordinarily be issued.

OPENING OF LCs : PRECAUTIONS

13. Suitable insurance safeguarding the Banks interests, on warehouse to warehouse basis, should be invariably incorporated. If insurance is arranged by the applicant, cover notes to be obtained and cover notes & insurance policies to be deposited with the Bank.

14. The validity of Revolving LCs should not be for more than one year, and the value of the LC should be based on the value of material the borrower needs for his genuine mfg. / trading requirements during this period. A special limit for the revolving amount should invariably be stipulated.

OPENING OF LCs : PRECAUTIONS

15. The application-cum-guarantee form should be adequately stamped as an agreement. 16. LC not to contain any contradictory clauses or any other clause / condition impossible to fulfill and one which violates the laws of the country. 17. LCs issued should be entered in LC Established Register and LC Liability Register. 18. The application-cum-guarantee form after issue of the LC to be kept in strong room / fire proof safe and in the custody of the authorised officials. 19. LC to be serially numbered.

OPENING OF LCs : PRECAUTIONS

20. LCs, inclusive of amendments, to be signed by two authorised officials, when they are issued for amounts of Rs. 50,000/- and above. 21. Usance LCs or Capital Goods LCs to be opened only if provided for in the sanction. 22. The sanction / issue of LC should be as per the powers delegated in the Scheme of Delegation of Financial Powers and other instructions issued from time to time. 23. Before despatching the LC, ensure that the following particulars are contained in the LC:

OPENING OF LCs : PRECAUTIONS

a. Particulars of Import Licence, if any b. Full and correct address of the beneficiary

c. Precise / brief description of goods

d. Price of goods in words and figures e. Origin of goods f. Mode of transport Sea / Air / Land / Rail g. Last date of shipment of goods, negotiation of docs

h. Port of shipment / destination

i. j. Whether part-shipment / trans-shipment permitted Value of goods CIF / CF / FOB and its currency

OPENING OF LCs : PRECAUTIONS

k. Payment terms DP or DA Tenor of bill l. Expiry date of LC

m. Instructions regarding negotiation of documents and reimbursement

n. Documents to accompany the Lc and how many copies are required: Draft, Invoice, B/L or AWB or R/R or L/R, Packing List, Weigh List, Certificate of Origin, Insurance Policy / Certificate, Quality Certificate, Consumer Invoice / Certificate, Inspection Certificate

OPENING OF IMPORT LCs : ADDL. POINTS

1. Ensure that the goods to be imported under the LC are covered by valid Import Licence, where required, in the name of the customer or properly transferred in his favour. Verify amount, balance available, type of goods permitted, country of origin, validity period, limiting factor (quantity and / or value), any special conditions imposed, etc. The terms of payment stipulated in the Credit should fall within the permitted methods of payment as prescribed under FEMA. In case Forward Contract has to be arranged, an undertaking to be obtained from the applicant agreeing to accept the rate ruling on that date.

2.

3.

OPENING OF IMPORT LCs : ADDL. POINTS

4. When 100% margin is recovered from applicants, they should be advised that the margin represents a mere deposit against the proposed Credit and that all bills negotiated thereunder will have to be retired at the rate of exchange ruling at that time, unless the rate has been fixed under a FC.

5.

In case of LCs to be opened for import of Capital Goods, it is to be ensured that:

Beneficiaries of LCs are well reputed as revealed by the Opinion Reports on the beneficiaries LCs are established in favour of only those beneficiaries who were indicated in the Project Report

OPENING OF IMPORT LCs : ADDL. POINTS

6. Banks standard clauses to be incorporated in the LCs established and onerous responsibility detrimental to the Banks interests to be avoided. In case any special terms involving onerous responsibility for the Bank are proposed by the applicant or the beneficiary, the same would need clearance by the concerned controllers. 7. Trade Control / Exchange Control requirements.

8. Credit norms of RBI.

9. UCPDC provisions.

10. Banks internal Credit policies / procedures.

ASSESSMENT OF LC LIMIT : ILLUSTRATION

M/s XYZ COMPANY LIMITED LETTER OF CREDIT LIMIT OF Rs. 20 CRORES
(Rs. in crores)

Total purchase of Raw Materials (RM)

Purchase of RM under LC Average monthly purchase of RM Average usance period Lead time & transit period [A] [C]

172.64
69.41 5.78 1 month 23.12 20.00

[B] 3 months

Total of [B] & [C]

Requirement of LC Limit [A] x [D] LC Limit recommended

[D] 4 months

ASSESSMENT OF LC LIMIT
While assessing Letter of Credit Limit, the following points need to be noted:
Purchases of RM on LC basis should be net of Import Duty Transit time should be treated as Nil if usance period starts from shipment date

NEGOTIATION OF BILLS UNDER LCs

The following approach should be adopted while fixing limits for purchase of bills drawn under LCs of branches of SBI / Correspondent Banks abroad / First Class Banks in India, identified for the purpose by Corporate Centre:
a. Banks existing customers: Limit fixation should essentially be based on the assessment of volume of sales, which is expected to be backed by LCs and the terms thereof.

As far as possible, fixing of these limits should coincide with the sanction / renewal of ABF.

NEGOTIATION OF BILLS UNDER LCs

Whenever these limits are required to be fixed or enhanced subsequent to the sanction of ABF, the assumptions in regard to the level of Receivables made at the time of sanction of limits should be reviewed and if required, ABF re-assessed to ensure that there is no overfinancing.

It should also be ensured that Receivables backed by LCs are excluded in the Book Debts statement for the purpose of Drawing Power. b. For borrowers of other banks:Fixation of the limit would essentially be related to the volume of business under such LCs proposed to be given by the Bank and the terms thereof.

NEGOTIATION OF BILLS UNDER LCs

In all the cases of non-borrowers, including borrowers of other banks, past financial data should be called for and the following aspects should be satisfied:
i. Business is conducted satisfactorily ii. There are no liquidity problems in the business iii. Net Worth is adequate iv. Past experience in regard to payment of bills purchased is satisfactory

In such cases, there will be no need to obtain a NOC from the financing bank. A brief note covering the above aspects should be recorded.

NEGOTIATION OF BILLS UNDER LCs

c. Stray purchases: While no specific limit need be sanctioned for this purpose, the borrowers liability in such cases should be limited to one or two bills and the amount thereof should not exceed the capacity to meet the amount in the event of default.

NEGO/DISC. OF LC BILLS SPECIFIED BRs

Circles should permit use of the unrestricted powers for purchase of LC bills only at certain specified branches, which would be done with the approval of the Circle CGM. Thus, sanction of limits for purchase of demand and usance bills drawn under LCs (Export or Domestic) will be by exercise of the unrestricted power at only the designated branches, Category A branches and Category B branches which are authorised to purchase export bills.

NEGO/DISC. OF LC BILLS SPECIFIED BRs

Such unrestricted powers will be exercised only in respect of bills drawn in conformity with the terms of LCs opened by:
a. Branches of SBI b. Correspondent banks abroad as authorised and subject to the restrictions imposed by the Banks ID / FD from time to time, and c. First class banks in India identified as such from time to time by Corporate Centre

NEGO/DISC. OF LC BILLS SPECIFIED BRs

Bills conforming to LCs (export or domestic) opened by approved banks [b and c above] as well as those opened by SBI branches are specified security and hence, such bills purchased and discounted will be outside the purview of Total Indebtedness. Such bill limits will be assessed and sanctioned outside the ABF and no restriction is imposed on powers of BMs for purchase hereof.

NEGO/DISC. OF LC BILLS SPECIFIED BRs

Thus, while the rest of the limits in a proposal will be sanctioned by the appropriate authority in terms of the present Scheme of Delegation of Powers, the LC Bills Limit will be permitted to be sanctioned by the BMs of the specified branches in respect of advances handled thereat.

This will be an exception to the instruction that the highest authority to sanction a facility in a single proposal should sanction all the facilities recommended in the proposal.

NEGO/DISC. OF LC BILLS SPECIFIED BRs

Discrepant bills as also bills drawn under LCs opened by banks other than those mentioned above, will be purchased only as part of the limits sanctioned for non-credit bills. The above procedure will be applicable for sanctioning limits to borrowers of the Bank and also non-borrowers including borrowers of other banks.

NEGO/DISC. OF LC BILLS NON-SPEC. BRs

At non-specified branch, a limit for purchase of bills drawn under LCs of all banks should be sanctioned within the powers for advances against bills vested either with the Branch Officials or with a higher authority, as per Scheme of Delegation of Financial Powers.

Exercise of these powers will be within the Total Indebtedness ceiling applicable to the official concerned.
Financing of such bills will be within the ABF.

NEGO/DISC. OF LC BILLS NON-SPEC. BRs

When limit for purchase of bills under LCs for a customer of non-specified branch is to be sanctioned by the Controller of the Branch, he would exercise only his powers for sanction of advances against bills and not his unrestricted powers for sanction of bills under LCs.

In respect of stray purchase of bills under LCs, a non-specified branch will have to ensure that while no specific limit need to be sanctioned for this purpose, the borrowers liability in such cases should be limited to one or two bills and the amount thereof not to exceed the capacity to meet the amount in the event of default.

NEGO OF BILLS UNDER LCs : PRECAUTIONS

Notwithstanding the availability of LCs, the following should be ensured while negotiating bills:
Genuineness of the LC Genuineness of the underlying transaction by perusing the relative invoices, contracts or orders, etc. Scrutiny of RR / Truck Receipts / Bill of Lading tendered to verify their genuineness, quality and quantity of merchandise covered by them, the date of issue, etc., and to ensure that transport receipts are from approved carriers and are not stale

NEGO OF BILLS UNDER LCs : PRECAUTIONS

Past track record of payment of bills under LCs Caution to be exercised in respect of bills covering sales within a city or locality and between groups / associate concerns and those drawn by front companies of industrial groups Verify the standing and creditworthiness of the borrower as well as the drawee of the bills

OBTENTION OF DOCUMENTS
As a general rule, a charge on the Current Assets is not contemplated to be taken as security for this facility for the reason that bill purchases fully conforming to the terms of LCs opened by first class banks and other branches of SBI are treated on par with the advances against specified security. However, where the nature of the borrowers overall operations and his track record warrants strengthening of the security cover, these may be prescribed and appropriately covered.

CRA RATING FOR LC BD FACILITY

While CRA rating is not required for the limits under LCs sanctioned outside the Total Indebtedness at specified branches, such rating would be necessary for limits granted at nonspecified branches inasmuch as these will be a part of the ABF and within the Total Indebtedness ceiling.

SEPARATE LIMITS : EXPORT / INLAND

In the case of both borrowers and nonborrowers, separate limits for purchase of bills under LCs will be sanctioned for Export Bills and Inland Bills.

TREATMENT OF STOCKS COVERED BY USANCE IMPORT LCs

Earmarking of lien for the outstanding usance import LC bills against AVS ensures provision of margins on the stocks covered by usance LCs right from the time the stocks are bought on credit backed by the Banks commitment.

This provision ensures that the margin is available well before the CC Account is debited for the matured LC bill.

TREATMENT OF STOCKS COVERED BY USANCE IMPORT LCs

In cases where the bills drawn under LC are received but the relative goods are not yet received, the sanction for CC Limit may provide for facility of drawings against the documents of title to goods received under the Banks usance LCs. In such cases, lien for the full amount of outstanding bills may be earmarked against Advance Value of the total stocks including documents of title to goods received under Banks LCs. the the the the

RESTRICTION OF NEGOTIATION
Restriction of negotiation of bills drawn under our LCs only to the Banks branches is a desirable marketing strategy to the extent feasible. In cases where negotiation is not restricted, the Banks branch in the drawee centre should be alerted to attract the business of LC bill discounting.

RETIREMENT OF BILLS NEGO - FOLLOW-UP

a. Branches should scrutinise on receipt all documents negotiated under the Banks LC for any discrepancies and non-compliances of T & C. If necessary, they should consult the applicant whether to retain the bills or return them in the event of discrepancies.

b. Branches should take immediate steps to protect the Banks interest in the goods in case payment is not made by the applicant on presentation of the bills. These would include advising the Railway authorities or transport company of the Banks interest in the goods and ensuring the continuance of insurance against theft, fire, etc.

RETIREMENT OF BILLS NEGO - FOLLOW-UP

c. Bills drawn under LCs will be retired on receipt by debit to the applicants account. Only a reasonable period should be allowed to importers for retirement of bills drawn under LC. A period of 7 days is recommended for this purpose. This should be advised to the customers at the time of establishing LCs. d. Request for time for retirement of bills till the arrival of the goods can be entertained on being satisfied that the bills would be paid immediately on the arrival of the goods.

RETIREMENT OF BILLS NEGO - FOLLOW-UP

e. In the meantime, necessary confirmation of the drawees that the documents are in order and are acceptable to them should be obtained and recorded at the Branch. f. Where LCs have been opened against a valid Import Licence, and on arrival of goods the licence holder does not honour the bills drawn against the LC and does not produce the licence for the clearance of the goods, the Branch which has opened the LC will be able to clear the goods through Customs and remit the forex to the foreign suppliers / beneficiary by debit to the licensee in question.

RETIREMENT OF BILLS NEGO - FOLLOW-UP

g. For the purpose of clearance of goods, the Branch will provide Customs with certificates together with the Exchange Control copy of the licence to the effect that the import has been made and forex has been remitted by the Branch under the authority of a valid import licence and a confirmed irrevocable LC.

DEVOLVEMENT OF LC BILLS
The following approach should be adopted by branches to avoid problems arising from devolvement of LCs and the resultant excess drawings in the relative accounts:
a. While opening LCs, branches should satisfy themselves that the customer would be in a position to retire the bills when received. For this purpose, they may obtain cash flow projections and make an intelligent scrutiny to be sure about availability of funds on the due dates. b. The limits for Demand LCs and Usance LCs should be assessed separately with ample justifications. The usance period should not generally exceed the production cycle.

DEVOLVEMENT OF LC BILLS
c. In case of bulk imports, a longer usance period may be considered selectively. d. When liability under LC is met by creating an irregularity in the CC Account, the relative LC Limit should not be released for opening further LCs till the account is adjusted. In other words, the liability should not be marked off in LC Liability Register merely because of retirement of documents. The relative liability should be marked off only after the account is regularised.

e. In case of devolvement, if the irregularity in the account is not adjusted within 15 days, or if the LC devolved earlier is not adjusted, no further LCs should be opened without adequate margin.

DEVOLVEMENT OF LC BILLS
f. In persistently defaulting cases, cancellation of LC limits should be considered. g. Excess liquidity available during the usance period of LCs enables the borrowers to divert short-term funds which leads to devolvement. Lien has to be marked for the outstanding usance LC bills on the AVS as a general rule and Circles have been permitted to mark lien on the MVS selectively, to be permitted by CGM. h. Where Usance LCs are sanctioned, this should be borne out by the appraisal data relating to Sundry Creditors. i. Transactions in the account and the FFRs should be closely monitored to check diversions.

DEVOLVEMENT OF LC BILLS
j. Branches should not permit excess drawings in accounts which show persistent irregularity due to devolvement of LC bills.

k. The practice of allowing excess drawings against the credits made in the account, leaving the existing irregularity unadjusted, should also not be permitted.
l. In case of sick / weak units, requests for Usance LC facility should be examined with greater care.

All cases of LC devolvement will have to be reported to the Controllers within 7 days of devolvement as per LC-3. Irregularity Report should also be submitted to the appropriate authority in the usual manner.

DEVOLVEMENT OF LC BILLS
Branches should also furnish to their Controllers details of devolved LCs at quarterly intervals as per LC-4.

In branches where Concurrent Auditors have been posted, they may be entrusted with the task of monitoring the devolved LCs by furnishing a certificate to the Controllers at the end of every month stating that the details of all LCs devolved on the Bank during the month have been duly reported.

CRYSTALLISATION OF IMPORT BILLS

Sight bills under Import LC and in conformity with the terms thereof shall be crystallised if not retired by the customer on the 10th day from the date of receipt thereof by converting the Foreign Currency amount into Rupees at the Banks Bill Selling Rate prevailing on the date of conversion (crystallisation) or at the contracted rate, if a FC has been booked for the purpose. The crystallisation should be done by debit to a GL account Advance made to customers against Import Bills and the credit is to be put through and reported as sales to FD, Kolkata.

CRYSTALLISATION OF IMPORT BILLS

Usance bills under Import LC and in conformity with the terms thereof, may on acceptance, be held in Foreign Currency upto the date of maturity. In the vent of non-payment on the due date, the importers liability shall be crystallised by converting the Foreign Currency amount into Rupees at the Banks Bills Selling Rate prevailing on the due date or at the contracted rate in case a FC has been booked. The crystallisation should be done by debiting straight away the CC Account of the importer.

CRYSTALLISATION OF IMPORT BILLS

If the importer does not have CC Account, the relative debit should be raised to his Current Account.

The transactions should be reported as sales to FD, Kolkata, indicating that these relate to crystallisation of import bills.
Branches should refer to circulars issued by FD, Kolkata for detailed accounting procedure in regard to crystallisation of bills under Import LCs.

INTERCHANGEABILITY OF LIMITS : LC / BG
Generally, requests for inter-changeability between the two facilities shall be entertained only when the purposes for which the facilities have been sanctioned are similar. The extent to which such inter-changeability can be permitted, subject to detailed examination of circumstances requiring such inter-changeability, is as under:
Type From BG to LC From LC to BG SB-4 and above 100% 100% SB-5 and below 50% 25%

INTERCHANGEABILITY OF LIMITS : LC / BG
The inter-changeability from LC to BG and vice-versa need to be considered with caution as there would be change in quality of underlying exposure. Further, the following points are to be considered:
a. b. Time horizons of risk devolvement between the two facilities are different. Nature of risk is not the same, i.e. the risk associated with a performance guarantee is different from that of a financial guarantee or an LC. While examination of cash flows is vital at the time of opening an LC, it is not generally considered as relevant in most cases of issues of BGs. An usance LC limit has a bearing on the level of Sundry Creditors available and hence on the FB credit limit required.

c.

d.

CHAPTER 2 BANK GUARANTEES

INTRODUCTION
A contract of guarantee is defined as a contract to perform the liability of a third person in case of default. The parties to the contract of guarantee are:
a. Applicant : The principal debtor : The person at whose request the guarantee is executed.

b.
c.

Beneficiary : The person to whom the guarantee is given and who can enforce it in case of default.
Guarantor : The person who undertakes to discharge the obligations of the applicant in case of his default.

Thus, a contract of guarantee is a collateral contract, consequential to a main contract between the applicant and the beneficiary.

PURPOSE OF ISSUE OF BGs

BGs may generally be issued for the following purposes:
a. In lieu of Security Deposits / Earnest Money Deposits for participating in tenders. b. Mobilisation advance or advance money before commencement of the project by the contractor and for money to be received in various stages like plant layout, design / drawings in project finance. c. In respect of raw material supplies or for advances by the buyers. d. In respect of due performance of specific contracts by the borrowers and for obtaining full payment of the bills.

PURPOSE OF ISSUE OF BGs

e. Performance guarantee for warranty period on completion of contract which would enable the supplier to realise the proceeds without waiting for the warranty period to be over. f. To allow the units to draw funds from time to time from the concerned indentors against past execution of contracts, etc.

g. Bid bonds on behalf of exporters. h. Export performance guarantees on behalf of exporters favouring the Customs Department under EPCG Scheme.

GUIDELINES ON CONDUCT OF BG BUSINESS

Branches should, as a general rule, limit themselves to the provision of Financial Guarantees and exercise due caution with regard to Performance Guarantee business. The subtle difference between the two types of guarantees is that under a Financial Guarantee, a bank guarantees the customers (applicants) financial worth, creditworthiness and his capacity to take up financial risks. In a Performance Guarantee, the banks guarantee obligations relate to the performance related obligations of the applicant (customer).

GUIDELINES ON CONDUCT OF BG BUSINESS

While issuing Financial Guarantees, branches should satisfy themselves that customers would be in a position to reimburse the Bank in case the Bank is required to make the payment under the guarantee. In case of Performance Guarantee, branches should exercise due caution and have sufficient experience with the customer to satisfy themselves that the customer has the necessary experience, capacity, expertise and means to perform the obligations under the contract and no default is likely to occur.

GUIDELINES ON CONDUCT OF BG BUSINESS

Branches should not issue guarantees valid for more than 18 months without obtaining prior administrative clearance of the appropriate authority through their respective controlling authorities. No Bank Guarantee should normally have a maturity of more than 10 years. BG beyond maturity of 10 years may be considered against 100% cash margin with prior approval of the Controllers.

GUIDELINES ON CONDUCT OF BG BUSINESS

Branches should normally refrain from issuing guarantees on behalf of customers who enjoy other credit facilities not with them but with other banks. Unsecured guarantees, where furnished by exception, should individually be for a short period and for relatively small amounts. All DPGs should ordinarily be secured.

APPRAISAL OF BG LIMIT
Branches should appraise the proposals for guarantees with the same diligence as in the case of FB Limits. They may also obtain adequate cover by way of margin and security so as to prevent default on payments when guarantees are invoked.

Whenever an application for the issue of BG (or sanction of a regular BG Limit as part of WC Limits) is received, branches should examine and satisfy themselves thoroughly about the following aspects:

APPRAISAL OF BG LIMIT
a. b. The need for the BG and whether it is related to the applicants normal trade / business. Whether the requirement is one-time or on a regular basis.

c.
d.

The nature of BG, i.e., Financial or Performance.

Applicants financial strength / capacity (through an analysis of his financial statements, Cash & Funds Flow position and opinion reports) to meet the liability / obligation under the BG in case of invocation. Past record of the applicant in respect of BGs issued earlier, e.g., instances of invocation of BGs, the reasons thereof, the customers response to the invocation, etc. Present outstanding on account of BGs already issued. Margin

e.

f. g.

h.

Collateral security offered.

ASSESSMENT OF BG LIMIT

Assessment of BG Limit

MARGINS
Following are some of the factors to be kept in view by the branches while determining the margins required:
a. Cash margins provide a cushion against invocation. Margin money may be in the form of TDR or a lien marked on the DP in the constituents CC Account. (Specific approval of sanctioning authority is required in respect of the latter).
b. The margin to be stipulated would depend on the borrowers means, resources, creditworthiness, security available, past experience with regard to issue of BGs, nature of guarantee and the nature of underlying transactions. If existing borrower, margin on BG may generally be the same as on Stocks, Receivables, etc.

MARGINS
c. In case of Advance Payment Guarantees, lower margins may initially be stipulated. Once the advance is actually received, depending on the amount not likely to be immediately utilised, higher margins may be built up by impounding of cash advances. d. In respect of non-borrower applicants, Banks approach should normally be to obtain full margins. However, a credit risk can be taken on the applicants based on the financial indicators, credit worthiness, security available, etc.

e. 100% margin should ordinarily be retained in respect of guarantees issued in connection with disputed Customs / Central Excise duties, unless otherwise specified in the sanction.

SECURITY
Apart from the margin, BGs are usually secured by an extension of the charge on Current Assets obtained to cover WC facilities.

Adequate collateral security by way of Equitable Mortgage / Extension of charge on Current / Fixed Assets or third party guarantee should be taken depending on the merits of each case.

DOCUMENTS
Whenever a guarantee is issued and / or guarantee bond is countersigned by the Bank on behalf of a constituent, suitable Counter Guarantee should be obtained from the constituent. For each ad hoc BG issued, a separate Counter Guarantee is necessary. In the case of a regular BG Limit duly sanctioned, a stamped Omnibus Counter Guarantee for the BG Limit will suffice.

DOCUMENTS
In case of a Partnership Firm, Counter Guarantees should be signed / executed by all the partners of the Firm.

In case of Joint Stock Company, a Board Resolution should be got passed by the Company before executing the Counter Guarantee or Omnibus Counter Guarantee.
Both the Bank Guarantee (to be executed by the Bank) and the Counter Guarantee or Omnibus Counter Guarantee (to be executed by the applicant / borrower) are to be stamped as agreements as per Stamp Duty required at the place of execution.

FORMAT OF BANK GUARANTEES

BGs should normally be issued on the format standardised by IBA. When it is required to be issued on a format different from the IBA format, as may be demanded by some of the beneficiary Government Departments, it should be ensured that the BG is:
a.
b.

For a definite period.

For a definite objective enforceable on the happening of a definite event.

c.
d. e.

For a specific amount.

In respect of bona fide trade / commercial transactions. Contains the Banks standard limitation clause.

FORMAT OF BANK GUARANTEES

f. g. Not stipulating any onerous clause. Not containing any clause for automatic renewal of the BG on its expiry.

BGs should be issued with a pre-printed and numbered standard first page of the guarantee form, which contains the limitation clause.
The pre-printed form is to be used for all BGs. However, in case of a guarantee favouring a Govt. Dept. objects to the use of the pre-printed form, branches may issue the guarantee on nonjudicial stamp paper.

FORMAT OF BANK GUARANTEES

The text of the guarantee will appear on the pages succeeding the printed first page. It should be ensured that while filling up the first page of the BG, no separate claim period is provided. The validity period of the guarantee will be stated inclusive of the claim period. Further, each page of the text of the guarantee enclosed with the pre-printed form should also mention pre-printed serial number, BG number, date of issue and amount, etc.

FORMAT OF BANK GUARANTEES

In all the guarantees issued by the Bank, the limitation clause suggested by IBA should invariably be incorporated at the end of the ext as concluding paragraph of the BG.
Notwithstanding anything contained herein:
a. b. c. Our liability under this BG shall not exceed Rs. (Rupees only); This BG shall be valid upto..; and We are liable to pay the guaranteed amount or any part thereof under this BG only and if only if you serve upon us a written claim or demand on or before . (date of expiry of guarantee).

FORMAT OF BANK GUARANTEES

In case of BGs issued favouring Govt. Depts., the above clause should be incorporated in the Model Bank Guarantee (MBG) form, prescribed for BGs in favour of Govt. Depts. If period of claim is required to be stated separately, it has to be kept at the minimum. It should generally not exceed 3 months. The BG may be issued on a stamp paper on which the name of the customer appears as the purchaser thereof. BGs for Rs. 50,000/- and above to be signed by two officials jointly with their SS numbers.

EXTENSION / RENEWAL OF BGs

Branches may entertain requests from the applicants for extension / renewal of guarantee provided there is no change in the amount and other terms and conditions of the guarantee. Expired BGs may also be renewed with retrospective effect subject to the condition that the Bank remains indemnified as against the contingent liabilities, etc., which may arise under the said guarantee, i.e., the Counter Guarantee covers such liabilities retrospectively.

EXTENSION / RENEWAL OF BGs

Normally, requests for extension should emanate from the applicants. In case, however, the beneficiaries request the branches either to renew or pay the guarantee amount, the branches should acknowledge such letters to the beneficiaries and request the applicants to renew before the guarantees expire or deposit the guarantee amount for honouring the commitment. If no request for renewal is received by the branches in time, they should honour the guarantees invoked and recover the amount paid from the applicants in the usual manner.

ISSUE OF BGs WITH AUTOMATIC RENEWAL CLAUSE Requests may be received from the undernoted authorities / concerns in respect of units financed by the Bank for issue of guarantees with an automatic renewal clause:
Customs Authority for guarantees relating to import of capital goods / raw materials

Courts towards disputed liabilities

Overseas Project Owners in respect of project exports

Such requests may be entertained in line with extant instructions.

AMENDMENT OF BANK GUARANTEE

There is no provision for amendment of Bank Guarantees unlike in the case of Letters of Credit.

Instead, fresh guarantees need to be issued, cancelling the earlier ones.

TERMINATION / CANCELLATION OF BG
After the expiry of each BG (including the time limit stipulated for preferring claim, if any), a registered letter with A.D. should be sent to the beneficiary advising that the guarantee has expired and requesting the beneficiary to return the original guarantee.

It should be made clear in the letter that the beneficiary is no longer entitled to invoke the guarantee.
If the guarantee is not returned within a period of 1 month, a reminder should be sent.

TERMINATION / CANCELLATION OF BG
Thereafter, liability in branch books reduced by the amount of expired guarantee. Margin money and the collateral, if any, taken exclusively for the relative guarantee may then be refunded.

Branches should periodically verify the outstanding guarantees and take appropriate action for cancellation of outstanding guarantees beyond the respective dates of expiry / claim.

TERMINATION / CANCELLATION OF BG
Bank Guarantee can be cancelled:
a. Prior to expiry of the period only with the written consent of the two parties to the contract, i.e., the beneficiary and the applicant, or b. On the expiry of claim period.

In cases where the guarantee duly cancelled is received back before the expiry date, the liability will be marked off in branch books. However, the commission for the balance period is not refundable if the purpose for which the guarantee was issued has been fulfilled.

TERMINATION / CANCELLATION OF BG
Branches should diarise two months before expiry date and advise the applicant to take steps for either renewal or release of the guarantee. The applicant should also be put on notice that the Bank would be honouring the claim without further reference if the guarantee is invoked consequent upon non-renewal in time.

REVERSING THE ENTRIES RELATING TO EXPIRED BGs

On expiry of a BG, a registered letter advising the expiry of the guarantee and requesting for returning the original guarantee document should be sent to the beneficiary. After the lapse of a period of say 1 month, whether the original BG is returned or not, branches would carry out the following:
a. Reverse the entries relating to the BG in the Customer Liability Register and the Proforma Account in the GL. b. Mark off the BG in the Guarantee Register. c. Return the margin money and the collateral, if any, exclusively taken for the BG.

REVERSING THE ENTRIES RELATING TO EXPIRED BGs

Branches would review the position before 10th of March every year and confirm to their Controllers that no expired guarantee (beyond the waiting period of 1 month for receipt of the expired BG) is reflected as outstanding in their respective books.

Non-compliance would result in inflating the Contingent Liability of the Bank, thereby imposing an avoidable need to meet the additional Capital Adequacy requirement.

INVOCATION OF BANK GUARANTEE

The beneficiary of the BG can invoke in writing, the guarantee any time before the expiry of the guarantee period. Invocation can be done by Telex / Telegram / Hand Delivery also followed by Mail Confirmation. Branches should ensure that all valid claims received by them under BGs issued by them are settled promptly. In the case of any dispute, such honouring, on invocation, will be done under protest and the matters of dispute should be pursued separately.

INVOCATION OF BANK GUARANTEE

The Banks liability under BG is absolute and independent and exclusive of any other contract entered into by the applicant and beneficiary.

It is, therefore, obligatory on the part of the Bank to pay to the beneficiary without delay and demur the amount of BG on its invocation in accordance with the terms and conditions of the guarantee deeds.
It is not necessary for the beneficiary to satisfy the Bank about the default or the amount of actual loss suffered by him.

INVOCATION OF BANK GUARANTEE

In this connection, BMs have been vested with necessary powers to honour the claims under the guarantees issued by the Bank, provided the guarantee was executed under sanction from the competent authority and conditions stipulated for invocation of the guarantee have been fully complied with. Delay in honouring the claim immediately may unnecessarily put the Bank in problems pertaining to claim of interest, damages and at times injunction orders from Court.

INVOCATION OF BANK GUARANTEE

Only when the Bank has received an order of restraint / injunction from a competent / appropriate Court, the Bank can withhold payment under the BG. The liability of the Bank under the BG will continue till the Court case is decided.

The beneficiary of the guarantee should be advised appropriately of the reason for nonpayment of amount due under invoked guarantee.

DEFERRED PAYMENT GUARANTEE (DPG)

A DPG is a contract to pay to the supplier the price of the machinery supplied by him on deferred terms to the buyer, in agreed instalments with stipulated interest on the respective due dates in case of default in payment by the buyer.

Under the contract, the Bank executes a guarantee on behalf of the buyer to the sellers banker, who on the strength thereof, discounts the sellers bills drawn on the buyer.

DEFERRED PAYMENT GUARANTEE (DPG)

The seller receives payment for the P&M by his bills being discounted by his banker, and the buyer repays his obligations in instalments to the sellers banker by retiring those bills on the respective maturity dates. The period of DPGs should not ordinarily exceed 7 to 10 years. The standard covenants for DPGs are generally the same as those for Term Loans.

DEFERRED PAYMENT GUARANTEE (DPG)

Where both the buyer and seller have common banking arrangements, i.e., both are Banks constituents, DPGs as such will not be required to be executed. Instead, the Branch which handles the buyers account will issue a Letter of Commitment to the discounting Branch handling the sellers account, authorising the discount of bills without a separate DPG. The issue of such a Letter of Commitment on behalf of the buyer, however, should be treated on par with a DPG for all purposes.

DEFERRED PAYMENT GUARANTEE (DPG)

The liability of the Bank under DPG will be the amount for which the guarantee is issued inclusive of interest. The liability should be reduced by the amount of instalments, inclusive of interest component, as and when they are paid.

In the case of DPGs issued in forex, the conversion rate for control entries will be the BC Selling Rate for the currency concerned ruling on the date the guarantee is issued. Entries will be reversed as and when the amounts are paid, at the same rate at which the original entry was passed.

EXPORT PERFORMANCE GUARANTEES

Export Performance Guarantees are those which are executed favouring the Customs Department for amounts linked to the Customs Duty relief availed by the exporter customers on imports of capital goods under the Export Promotion Capital Goods Scheme.

The guarantees are for the due fulfilment of a specified level of export obligation undertaken by a customer to avail of the Customs Duty remission on the imports.

BGs IN FAVOUR OF OTHER BANKS / FIs

Branches should not issue guarantees favouring other banks / FIs / other lending agencies for the loans extended by the latter, as it is intended that the primary lender should appraise and assume the risk associated with sanction of credit and not pass on the risk by securing itself with a guarantee.

JUDGEMENTS BY COURTS
The following procedure should be adopted when judgements are delivered by Courts in respect of guarantees issued in favour of Govt. Depts. :
a. Where the Bank was a party to the proceedings initiated by Govt. for enforcement of the BG and the case was decided in favour of the Govt. by the Court, branches need not insist on production of certified copy of the judgement as the judgement / order was pronounced in open Court in the presence of the parties / their counsels and the judgement would be known to the Bank.

JUDGEMENTS BY COURTS
b. In case the Bank was not a party to the proceedings, a signed copy of the minutes of the order certified by the Registrar / Deputy / Assistant Registrar of the High Court or the ordinary copy of the judgement / order of the High Court, duly attested to be true copy by Govt. Counsel, would be sufficient for honouring the obligation under the guarantee, unless the Bank decides to file any appeal against the order of the High Court.

BGs FVG. GOVT. DEPTS : CORRESPONDENCE

In respect of guarantees issued by the branches favouring Government Departments, branches should not address any correspondence to the President of India, although such guarantees are favouring the President of India. The correspondence relating to such guarantees should instead be addressed to the concerned Govt. Ministry / Departments.

THANK YOU