There are number of banking terms used in business transactions. If you want to learn the corporate banking lingo – here you go!
What is Bank Guarantee?
A bank guarantee is an agreement (usually called tripartite agreement) made between the banker, the beneficiary, and the customer. It is also known as a financial instrument, which is like a contract made between parties to seek compliance with the contract. It is of the sort of a derivative of the core contract made between two or more parties. A guarantee which is given by a bank on behalf of its corporate customer to make the payment on the customer’s behalf if it fails to do so is called bank guarantee. It effectively makes the bank a co-signer for the purchases made by the customer.
The banking system, all over the world, has evolved significantly from the minor service of acceptance of deposits to a wide variety of financing services which it provides today. It has become an essential part of the commercial transactions and bank guarantees, as well as individual guarantees, has now become any bank’s common features. Bank Guarantee is an important instrument which reduces the risks which are usually involved in a business contract. To enforce the ordinary guarantee, dependence on the primary contract usually led to disputes and litigation, which caused a substantive effect on the guarantee, and in that way, it used to block the funds involved in litigation. Therefore, there was a need for a new instrument which could serve the original purpose of a guarantee, i.e., providing security. The bank guarantee is the kind of new instrument discussed above in which, if there is a breach of contract, the beneficiary can immediately encash the guarantee without going through the hassles of litigation.
What is a letter of Credit?
Usually, a promise to pay is called a letter of Credit. The letters of credit, sometimes referred as a documentary credit, are issued by banks to make sure that the buyers or sellers will be getting paid as long as the buyers or sellers do what they have agreed upon. Most commonly, the letters of credit are used in international trade, but they are not very uncommon in domestic trades also. In Letter of Credit, the bank is a party which is not interested in either buyer or seller but at the same time guarantees that the payment will be done if the party satisfies the conditions presented before it.
For example, the letter of credit can be used in international trade to protect the interests of both importers and the exporters. Generally doing business with a buyer who stays overseas can be risky as the seller does not usually know who they are. Even if the buyer is honest or is a person of good intentions on his side, but the political chaos or the business troubles can cause a delay in the payment. In such a situation, the letter of credit puts forward such conditions which will be beneficial for both the buyer and the seller.
In other words, a simple letter which is given by the bank assuring that the payment will be received from the buyer and given to seller on time and that too with the correct amount. In case, the buyer is unable to make the full payment of the purchase; the bank will be bound to cover the amount of the purchase.
In short, both Bank Guarantee, as well as Letter of credit, try to reduce the financial risk but the former reduces the loss if the transaction does not go as it was planned whereas the latter ensured that the transaction proceeds as planned.
What is Bank Loan Rating?
The bank provides several facilities in terms of finance like term loans, term loans in foreign currency, cash credit, bank guarantee, letter of credit, packing credit, etc. To justify the credentials of a client concerning its timely payment of interest and the principal amount of the facilities mentioned earlier, the bank carries out a proper credit rating of its client which is called Bank Loan Rating.
The apex bank of any country generally issues guidelines about the capital adequacy requirements of the bank, according to which the banks are required to maintain such capital which is commensurate with the credit risk of their assets. Credit rating for bank loans is a technique used by banks to calculate the amount of capital they require to fund that particular loan. The banks try to save their capital for the companies which have high credit worthiness and save some additional capital for the companies which are low rated.
The scheme of Bank loan rating benefits the company by reducing the cost of a loan for the entities or companies which have a high credit rating. It also has many advantages for the banks like it enables them to process the loans easily and at a faster pace, helps them to compute the capital adequacy ratio, and it also helps them to inculcate financial discipline in borrowers. An organization which regularly pays of the loan on the due date can command a good credit rating than the organization which makes the default of the due date. Most Credit rating gives the rating as a symbol of Alphabets followed by mathematical sign (+,-) like, for example AA+, A- BBB+, etc.
What is Bill Discounting?
Most of the international business transactions are done with the use of the letter of credit. Letter of credit is like a letter issued by the bank of the buyer to the seller guaranteeing that after a certain period the payment will be made. Now, the period could be either at sight or after 30days/120 days from the date of bill of lading. Now, as soon as the seller receives the letter of credit, he organizes the documents to present them to the bank. The utmost important factor in the whole process is the bill of exchange which is used by the seller to negotiate the letter of credit and in turn, gets money from the bank after discounting the bill of exchange. Hence, the term Bill Discounting has evolved. From now on, it is the responsibility of the bank of the seller to send the Bill of Exchange and other documents to the buyer’s bank for acceptance at his end.
In other words, it can be said that the Bill Discounting is a process which includes efficiently selling a bill to a registered entity called bank for a little less amount than the parity value and also before the date of maturity which is usually associated with all the bills. The bank, in return, pays the amount agreed upon to the new holder of the bill. This system of financing permits the person who has issued the bill to receive the amount agreed upon before the actual due date.
What is Packing Credit?
Usually, the word pre-shipment finance is used to define packing credit. Now the word pre-shipment means financing the cost of buying or making a product, and then packing and transporting them just before the actual shipment occurs. The packing credit is given to exporters at a very low rate of interest to boost exports. The packing credit is provided by only the approved banks and that too when an instruction is given by the apex Bank based on the policy of boosting exports and strengthening the economic situation of its country
The function of a packing credit is to help the exporters to acquire the raw materials and to arrange the goods which are ready to be exported. If an exporter desires to get a packing credit, it has to submit its export order with the bank. Packing credit is provided by the bank against the security of stock in trade and also finished goods in some of the cases. The amount given as a packing credit is not in any way connected with any other loans or advances given by the bank. It is, altogether, a separate form of finance. The lender opens a special account called the packing credit loan account, and when the borrower receives the payment against the shipment, the loan amount will be adjusted accordingly, and the special account will be closed. Since this loan carries a lower rate of interest as compared to other working capital loans like Cash credit, bills discounting, etc., any non-payment of packing credit loan on the due date is seen negatively for the organization and it may hamper the credit rating of the organization.