9 Financial Instruments Used at Ail Chap 4

8/12/2019 9 Financial Instruments Used at Ail Chap 4

1/23

FINANCIAL INSTRUMENTS

WORKING CAPITAL MANAGEMENT Page 40

CHAPTER 4

FINANCIAL INSTRUMENTS USED AT

AARTI INDUSTRIES LIMITED


2/23



FINANCIAL INSTRUMENTS USED AT

AARTI INDUSTRIES LIMITED

4.1Fund Based Credit from Banks and FIs

4.2 Non-Fund Based Credit from Banks and FIs

4.1 FUND BASED CREDIT FROM BANKS AND FIs1.1 Overdrafts / Cash Credits

1.2 Packing Credit1.3 Packing Credit in Foreign Currency (PCFC)

1.4 Bills Purchased/Discounted

1.5 Foreign Currency Non-Resident (Bank) - FCNR (B)

1.6 Advances against Undrawn Balances

1.7 Commercial Paper

1.8 Working Capital Demand Loan

Once the Bank arrives at the Limit Assessed Bank Finance earlier known as MPBF,

which is lower of the Drawing Power and the Bank Financing Limit, the company can

utilize multiple numbers of instruments to get finance for supporting their working

capital needs. The Company cannot exceed its borrowing from the limit of ABF /

MPBF.

How fund based working capital loans are divided among different sub- heads:-

Company gets Fund based loans against Stock and Debtors. For e.g. if the company is

having stock of 100 crore, debtors of 300 crore and Creditors of 150 crore then

company will get Fund based loan of 150 crore.


3/23



For e.g.

Amt in crores

Stock 100

Debtors 300Total 400

Less: - 25% Margin Money (100)

300

Less: - Creditors (150)

Fund Based Loans 150

These 150 crore amount is also known as Drawing Power of the company. The

company receives these amounts from bank under two heads. They are

Fund Based Loan Packing Credit

First of all the amount of packing credit is deducted from the amount sanctioned by

the bank for Fund based loans. Company gets packing credit against export material.

Company receives Packing Credit for the purchase of the raw materials. Whenever

the bank receives the payment from the party then the amount of packing credit is

reversed by the bank.

After the amount of Packing Credit is deducted from the amount sanctioned, the

Remaining amount is divided among various components. These components are

Cash Credit Working Capital Demand Loan Foreign Discounting Bill Purchase Foreign Currency Non-Resident loan

The amount is divided among various components as per the decision of Bank.

Generally the bank gives Cash Credit equal to 20% of the remaining amount. The

company can ask the bank to transfer funds from Working Capital Direct Loan to

Cash Credit loan.

For e.g.

If the company is having 20 crore in Cash Credit a/c and it has to make payment of 30

crore then the company can ask bank to release 10 crore from Working Capital Direct

Loan to Cash Credit a/c. The company can ask bank to release funds from the

Working Capital Direct Loan as and when need arises. The bank charges interest on


4/23



the amount utilized by the company. It is not necessary for the company to raise

Foreign Currency Non-resident Loan. Company raises this type of loan when it is

required to make payment in currency other than Rupee.

1.1 Cash Credit/OverdraftsUnder cash credit/overdrafts form/ arrangement of bank finance, the bank specifies

a predetermined borrowings/credit limits. The borrower can draw/ borrow up to the

stipulated credit/overdraft limit. Within the specified limit/line of credit, any

number or drawings are possible to the extent of his requirement periodically.

Similarly, repayments can be made whenever desired during the period. The interest

is determined on the basis of the running balance/amount actually utilized by the

borrower and not on the sanctioned limit. A minimum charge may be payable

irrespective of the level of borrowing, for availing o this facility.

This form of advance is highly attractive from the borrowers point of view because

while the borrower has the freedom of drawing the amount in installments as and

when required, interest is payable only on the amount actually outstanding. Also, it

is flexible in that borrowed funds are repayable on demand, banks usually do not

recall cash advances. Aarti Industries Ltd. has to keep margin of 25% for cash

credit/overdraft. Rate of interest on OCC is not exceeding 9% for company

irrespective of BPLR (Banking Prime Lending Rate).

1.2 Packing credit

Packing credit is also known as Pre-shipment Credit. Financial assistance

provided by the commercial banks to exporters before the shipment of goods is

called pre-shipment finance. Pre-shipment finance is given for working capital for

purchase of raw material, processing, packaging, transportation, ware-housing etc.

of goods meant for export. Pre-shipment finance is presently given to Indian

exporters at a concessional rate of 10% for a period of 180 days. Pre-shipment credit

for a further period of 180 days to 270 days is given at 12%.

Packing Credit Finance Categories:Packing credit falls in following categories.

Rupee Pre-shipment credit or Packing Credit


5/23



Packing credit on deemed exports Rupee export packing credit to manufacturer-supplier for export

routed through export houses.

Rupee packing credit to sub-suppliers Rupee pre-shipment credit to specific sectors/segments.

Eligibility:The packing credit is given on the strength of letter of credit opened in favor of

exporters or in favor of some other person by foreign buyer or against a confirmed

and revocable export order received by company. The applicant should, however,hold an importer exporter code number from the licensing authority concerned.

Company can avail any loan or advance on the basis of:Letter of Credit opened in your favor or in favor of some other person, by an

overseas buyer;

(a) A confirmed and irrevocable order for the export of goods from India;

(b) Any other evidence of an order or export from India having been placed on the

exporter or some other person, unless lodgments of export order or Letter of

Credit with the bank has been waived.

Packing Credit is granted for a period depending upon the circumstances of the

individual case, such as the time required for procuring, manufacturing or processing

(where necessary) and shipping the relative goods. Packing credit is released in one

lump sum or in stages, as per the requirement for executing the orders/LC.

The pre-shipment / packing credit granted has to be liquidated out of the proceeds of

the bill dawn for the exported commodities, once the bill is purchased/ discounted

etc., Thereby converting pre-shipment credit into post-shipment credit. AIL has to

keep margin of 10% for packing credit. Rate of interest on Packing credit is not

exceeding 5%irrespective of BPLR.


6/23



It is granted to the clients for making advance payment to the suppliers for acquiring

goods to be exported. Thus, it is clean in nature and usually extended to the parties,

who are rated as first class, for a very short duration. However, bank should assess the

procurement period and once the goods are acquired and are in the custody of the

companys client.

There are three broad types of packing credit:A. CLEAN PACKING CREDIT

This represents an advance made to the exporter on the basis of a firmexport order or a letter of credit, without any control over raw materials or

goods.

Each proposal is decided on the basis of particular requirement of thetrade and the credit worthiness of the exporter.

B. PACKING CREDIT AGAINST HYPOTHECATION OF

GOODS

Under this arrangement, the goods meant for export are hypothecated tothe bank as security.

When the bank advance is to be utilized, the exporter is required tofurnish stock statements and continue to do so whenever there is stock

movement.

C. PACKING CREDIT AGAINST PLEDGE OF GOODS

Under this arrangement, the goods meant for export are pledged to thebank with an approved clearing agent who ships the same on the advice

of the exporter.

1.3 Packing Credit in Foreign Currency (PCFC)

The packing credit or pre-shipment credit that was spoken earlier was disbursement

of rupee funds, that is, advancing money in rupee to the exporter for the purpose of

procuring, processing or manufacturing the goods for exports. Under this scheme

the pre-shipment credit is disbursed in foreign convertible currency at interest rates

linked with LIBOR (London Inter Bank Offered Rate). This credit is again self-


7/23



liquidating in nature and is adjusted by the discounting or purchase or negotiation of

the export bills.

The banks change Earners Foreign Currency (EEFC), resident foreign currency

accounts, foreign currency non-resident account bank scheme accounts and foreign

currency available in escrow account. For all practical purposes this resembles the

packing credit advance disbursed in rupees, except that the interest charged is based

on LIBOR and the disbursement is made in foreign convertible currency. The

advantage of this scheme is lower rate of interest and covering of foreign exchange

risk where goods are imported for the purposes of export.

For instance, if export order is for US$ 20,000 and the import component is say

60percent, assuming that the exporter avails PCFC of US$ 12,000, the liability

would be adjusted against the submission of the export documents. Under the PCFC

of US$ 12,000 no exchange conversion is involved. The exporter saves the

difference between buying and selling exchange rates. If PCFC is availed by the

exporter against an export order, the bills drawn under the said export order will be

discontinued at LIBPR plus the loading factor of the bank.

Indian exporters can avail both pre and post shipment finance in foreign currency.

Interest rates under the scheme are linked to LIBOR and the rates charged by Indian

Banks over LIBOR for such credits would not exceed 1.5%. Export credit in foreign

currency is available in US Dollar, Euro, Pound Sterling and Japanese Yen. Export

credit is available without exchange risk and at internationally competitive rates.

Banks extend credit on "need basis" of exporters and collateral security is not

insisted. Banks also provide lines of credit for longer periods say three years, to

exporters with satisfactory track records without insisting on the submission of

export order/Letter of Credit.

Packing Credit Foreign Currency (PCFC)Interest charged at LIBOR + 1.5% (Max.)

A 90 days Dollar Packing Credit can be availed at 3m LIBOR + 1.5%.

6.10% + 1.50% = 7.60%.

PCFC drawls in cross currencies are allowed, subject to the exporter bearing the

risk in currency fluctuations. However, cross currency drawls are restricted to the

US Dollar. For instance, for an export order in a non-designated currency like the

Swiss Franc, PCFC will be given only in USD.


8/23



1.4 Bills Purchased/Discounted

Bank credit is being made available through discounting of usance bills by banks.

The RBI envisaged the progressive use of bills as an instrument of credit as against

the prevailing practice of using the widely-prevalent cash credit arrangement for

financing working capital. The amount made available under this arrangement is

covered by the cash credit and overdraft limit. Before discounting the bill, the bank

satisfies itself about the credit-worthiness of the drawer and the genuineness of the

bill. To popularize the scheme, the discount rates are fixed at lower rates than those

of cash credit, the difference being about 1-1.5 percent.

The modus oprendi of bill finance as a source of working capital financing is thatbill arises out of a trade sale-purchase transaction on credit. The seller of goods

draws the bill on the purchaser of goods, payable on demand or after ausance period

not exceeding 90 days. On acceptance of the bill the bank releases the funds to the

seller. The bill is presented by the bank to the purchaser/acceptor of the bill on due

date for payment. The bills can also be rediscounted with the other banks.

PCFC will be liquidated with the discounting of bills under export bill rediscounting

(EBR). All export bills, demand and usance, are eligible for EBR scheme. All

exporters are eligible to cover their bills drawn under letters of credit, non-credit

bills under sanctioned limits in the bill rediscounting scheme. The bank offers

export bill rediscounting for a maximum period of 180 days, inclusive of grace and

transit periods.

1.5 Foreign Currency Non-Resident (Bank) - FCNR (B)

FCNR (B) loans are a source of short term funding available to corporate. Out of theresources mobilized by the banks under the FCNR (B) scheme, banks have been

permitted to provide foreign currency denominated loans to their customers. Banks

decide the purpose, tenor and interest rates on such loans. While the introduction of

the scheme has placed cheap credit at the disposal of Indian corporate (as interest

rates are linked to LIBOR), the foreign exchange risk is borne by the party who has

availed the loan.


9/23



The interest rate for the tenor of the loan is fixed on the date of draw down and the

corporate can hedge his exchange rate risk by booking a forward cover. The

illustration given below will provide you with more clarity.

Corporate A has got a rupee credit at 16% p.a. Corporate A can switch this rupee loan to a dollar FCNR (B) loan/take a fresh.

FCNR (B) loan. The cost of a 6-month FCNR (B) LOAN is as follows

Date of Draw down 14/2/2007

6 Month $ Libor (%)-6.32

Banks Margin (Spread over LIBORassumed)-2.00

Cost of forward cover (annualized %)-3.10

Other transaction costs-0.58

Net rate (%)-12.00

The comparative cost advantage is evident as it results in a net saving of 4% over his

rupee cost of funding. The spread over LIBOR would depend on the credit worthiness

of the party involved. Thus, corporate can utilize this opportunity to reduce their

interest burden and thereby minimize costs.

Term deposit can be placed with authorized dealers in India in four specific foreigncurrencies (US Dollar, Pound Sterling, Euro or Japanese Yen). These accounts earn

fixed or floating rate of interest within the ceiling rate of LIBOR/SWAP rates for the

respective currency/ corresponding term minus 25 basis points (except on Yen). AIL

has to pay rate of interest on FCNR loans is LIBOR + 2%.

1.6 Advances against Undrawn Balances

Usually, in case of certain products exporters are required to draw bills on overseas

buyers upto 90 to 98% of FOB value of the contract, the residuary balances i.e.

unknown balances is payable by the overseas buyer after satisfying himself about

the quality/quantity of goods.

Hence, undrawn balances exist where the overseas buyer makes payment, after

making adjustment for difference in weight quality/quantity of goods. Payment of

undrawn balances is contingent in nature. Banks may consider granting advances

against undrawn balances at concessional rate of interest based on their commercial

judgments and the track record of the buyer. Advance against undrawn balances can


10/23



be made at a concessive rate of interest for a maximum period of 90 days. Such

advances are, however, eligible for concessional rate of interest for a maximum period

of 90 days only to the extent these are repaid by actual remittances are from abroad

and provided such remittances are received in 180 days.

1.7 COMMERCIAL PAPER

Commercial Paper (CP) is an unsecured money market instrument issued in the form

of a promissory note. It is a short-term loan issued by a corporation, typically for

financing accounts receivable and inventories It was introduced in India in 1990.It

was introduced with a view to enabling highly rated corporate borrowers/ to diversify

their sources of short-term borrowings and to provide an additional instrument toinvestors. Subsequently, primary dealers and satellite dealers were also permitted to

issue CP to enable them to meet their short-term funding requirements for their

operations. The people eligible to issue commercial paper are corporate, primary

dealers (PDs) and the All-India Financial Institutions (FIs).

But there is also a limitation to the corporate that are eligible. Only those corporate

who has:

the tangible net worth of the company, as per the latest audited balance sheet,not less than Rs. 4 crore;

been sanctioned working capital limit by bank/s or all-India financialinstitutions and

the borrower account classified as a Standard Asset by the financing bank/s/Institutions are eligible to issue commercial paper.

Commercial paper is available in a variety of denominations and usually ranges in

maturity from 2 to 270 days. A minimum of 15 days and a maximum of 1 year time

period have been prescribed for the commercial paper. The aggregate amount of CP

from an issuer shall be within the limit as approved by its Board of Directors or the

quantum indicated by the Credit Rating Agency for the specified rating, whichever is

lower.

As regards FIs, they can issue CP within the overall umbrella limit fixed by the RBI

i.e., issue of CP together with other instruments viz., term money borrowings, term

deposits, certificates of deposit and inter-corporate deposits should not exceed 100 per


11/23



cent of its net owned funds, as per the latest audited balance sheet. Usually the CP is

issued in the denominations of Rs.5 Lacs or multiples thereof.

Individuals, banking companies, other corporate bodies registered or incorporated in

India and unincorporated bodies, Non-Resident Indians (NRIs) and Foreign

Institutional Investors (FIIs) etc. can invest in CPs. However, amount invested by

single investor should not be less than Rs.5 Lacs (face value). However, investment

by FIIs would be within the limits set for their investments by Securities and

Exchange Board of India (SEBI).

There is an Issuance and Paying Agent (IPA) which is usually a scheduled bank. The

role of IPA is an important one when the redemption procedure is to be carried out.

Initially the investor in CP is required to pay only the discounted value of the CP by

means of across account payee cheque to the account of the issuer through IPA. On

maturity of CP,

(a) When the CP is held in physical form, the holder of the CP shall present the

instrument for payment to the issuer through the IPA.

(b) When the CP is held in demat form, the holder of the CP will have to get it

redeemed through the depository and receive payment from the IPA.

The roles and responsibilities as prescribed by the RBI can be briefly

stated as: Issuer:

Every issuer must appoint an IPA for issuance of CP. The issuer should disclose to the potential investors its financial position as

per the standard market practice.

After the exchange of deal confirmation between the investor and the issuer,Issuing company shall issue physical certificates to the investor or arrange for

crediting the CP to the investor's account with a depository.

Investors shall be given a copy of IPA certificate to the effect that the issuerhas a valid agreement with the IPA and documents are in order (Schedule II).

Issuing and Paying Agent:

IPA would ensure that issuer has the minimum credit rating as stipulated by the RBI

and amount mobilized through issuance of CP is within the quantum indicated by

CRA for the specified rating. IPA has to verify all the documents submitted by theissuer viz., copy of board resolution, signatures of authorized executants (when CP in


12/23



physical form) and issue a certificate that documents are in order. It should also

certify that it has a valid agreement with the issuer (Schedule III). Certified copies of

original documents verified by the IPA should be held in the custody of IPA.

1.8 Working Capital Demand Loan

A borrower may sometimes require ad hoc or temporary accommodation in excess of

sanctioned credit limit to meet unforeseen contingencies. Banks provide such

accommodation through a demand loan account or a separate non-operable cash credit

account. The borrower is required to pay a higher rate of interest above the normal

rate of interest on such additional credit. AIL has to pay rate of interest on WCDL not

exceeding 7% irrespective of bankers BPLR.


13/23



4.2 NON-FUND BASED CREDIT FROM BANKS AND FIS

Credit facilities, which do not involve actual deployment of funds by banks but help

the obligations to obtain certain facilities from third parties, are termed as non-fund

based facilities. These facilities include issuance of letter of credit, issuance of

guarantees, which can be performance guarantee/financial guarantee.

For its export financing purposes as well as for supplying and erection of transmission

it mainly uses non fund based working capital i.e.

2.1 Letter of Credit

2.2 Bank Guarantee

2.1 Letter of Credit

A letter of credit, often abbreviated as an LOC or LC, and also referred to as a

Documentary credit is a document issued by a financial institution or any bank which

essentially acts as an irrevocable guarantee of payment to a beneficiary. This means,

that once the beneficiary has presented to the issuing or negotiating bank documents

complying with the LC terms, the bank is obliged to pay irrespective of any

instructions of the applicant to the contrary. In other words, the obligation to pay isshifted from the applicant to the LC issuing bank.

The LC can also be the source of payment for a transaction, meaning that an exporter

will get paid by redeeming the letter of credit. Letters of credit are used nowadays

almost exclusively in international trade transactions of significant value, for deals

between a supplier in one country and a wholesale customer in another.

The parties to a letter of credit are usually a beneficiary who is to receive the money

(seller), the issuing bank of whom the applicant is a client, and the advising bank of

whom the beneficiary is a client. Since nowadays almost all letters of credit are

irrevocable, (i.e. cannot be amended or cancelled without prior agreement of the

beneficiary, the issuing bank and the confirming bank, if any), the applicant is not a

party to the letter of credit.


14/23


15/23



6. The exporter presents the whole set of documents required in the terms of theLetter of Credit to its bank. This bank will perform some document checking

to ensure their compliance with the terms of the documentary credit. In case

the bank had originally confirmed the credit or if a discount is granted to the

exporter, the payment will be done to the exporter.

7. The bank of the exporter is sending the documents to the issuing bank thatperforms the payment or acceptance after a thorough checking of the

documents.

8. The issuing bank transfers the documents to the importer and proceeds withthe debit of its account for the principal amount.

9. The importer receives the goods, especially thanks to the document of title(bill of lading).

B. Price of LC

The issuer pays the LC fee to the bank, and may in turn charge this on to the

beneficiary. From the bank's point of view, the LC they have issued can be called

upon at any time (subject to the relevant terms and conditions), and the bank then

looks to reclaim this from the issuer.

There is the chance that the issuer goes insolvent, for example, and thus the bank is

unable to claim back the money it has already paid out. This credit risk to the issuer

thus makes up a large portion of the cost of issuing LCs.

C.Forms of LC

The various types of letters of credit which are commonly used in the commercial

market are:

Revocable CreditThis can be amended or cancelled at any time by the importer without the

consent of the exporter. This option is not often used, as there is little

protection for the exporter. By default all credits are irrevocable, unless

otherwise stated.


16/23



Irrevocable CreditOnce issued this can only be changed or cancelled with the consent of all the

parties. The seller must merely comply with the terms and conditions of the

credit in order to receive payment.

Confirmed CreditIn some instances, exporters may request a credit to be confirmed by another

bank, (usually a bank in their own country). If a bank adds its confirmation to

a credit, it means that it is obliged to pay if the terms and conditions of the

credit are complied with. This obligation to pay exists even if the issuing bank

or country defaults.

Payment CreditThis is available for payment at the tellers of the paying bank, as nominated in

the credit. The seller can, therefore, present documents to the paying bank and

does not have to wait for the documents to be forwarded to the issuing bank

for checking and subsequent payment.

Negotiation CreditThis is always payable at the counters of the issuing bank. Buyers can use

negotiation credits to delay payment until the documents have been received

and checked by the issuing bank.

Deferred Payment CreditSimilar to payment credits, except that they are payable at a future date.

Acceptance CreditThe accepting bank guarantees payment to the holder of the bill of exchange

on maturity date - regardless of whether the credit is confirmed or not. This

option comes with an acceptance fee which can be substantial.

Back-to-Back CreditThe original letter of credit is used as security to open another credit in favor

of the exporter's own supplier. The bank confirming the original credit may

not necessarily be the issuing bank of the second credit.

Transferable CreditThis is normally used when the exporter is not supplying the goods and wishes

to transfer all or part of the responsibilities under the credit to the supplier(s).


17/23



Red Clause CreditThis enables the exporter to obtain advance payment before shipment. This is

provided against the exporter's certificate confirming its undertaking to ship

the goods and to present the documents in compliance with the terms andconditions of the documentary credit.

Green Clause CreditSimilar to a Red Clause Credit, but in addition to pre-shipment finance the

exporter also receives storage facilities at the port of shipment at the expense

of the buyer.

Packing CreditThis offers pre-shipment finance to the seller against warehouse receipts,

forwarding agent's receipts or similar documents that prove the goods are no

longer in the seller's possession.

Standby CreditSimilar to a normal letter of credit, this method differs in that it is a default

instrument, whereas a normal credit is a payment instrument. A standby credit

is only called upon in the event of failure to perform. Its function is, therefore,

that of a guarantee.

Revolving CreditThis allows for the credit to be automatically reinstated under certain

circumstances. It is normally used where shipments of the same goods are

made to the same importer.

D.Parties to Letter of Credit:-

There may be three to four parties to a Letter of Credit.

Applicant / Importer :Importer is the opener on whose behalf or account Letter of Credit issued by

the bank.

Applicant Bank :The bank that issues or opens the Letter of Credit on behalf of the customer /

importer is Applicant Bank.


18/23



Exporter:Exporter is the Beneficiary of the Letter of Credit who is entitled to

receive the payment of his bills according to the terms of Letter of Credit.

Intermediary bank / Confirming bank :Intermediary bank is the bank usually a branch or the corresponding of the

opening bank in the exporting country through which the credit without any

obligation on its parts, it is called the Advising or Notifying bank. If the

beneficiary bank adds its own undertaking to the credit while advising it to the

beneficiary, it becomes the confirmingbank.

Paying / Negotiating bank:The bank which negotiates the beneficiarys bills under thecredit and pays for

it is known as Paying Negotiating bank. In the international market, the

company is executing more & more projects. Projects worth USD 150 Million

are under execution apart from the bids submitted and jobs under view in the

international market. The turnkey international jobs are having three

components which are supply of towers, supply of bought-outs and local

construction work. The bought-outs are supplied internationally qualified

supplier only and these suppliers dont agree to supply without L/C, which has

resulted into higher requirements of L/Cs. In the current year company is

expected to buy bought out of approx. Rs.150 crores for which the L/Cs will be

opened on DA 90/180 days basis.

The availability of raw materials like chemicals Benzene, Sulphur, Chlorine,

Nitric Acid in time has become very difficult and since there is gap between

supply and demand so even certain domestic suppliers insists for letter of credit

or cash payment terms against delivery of goods. Of course, in oversea market,the suppliers are ready to extend credit upto 360 days under L/C or company

can arrange cheaper finance upto 360 days on its financial strength from

overseas branches of Indian banks.

Advantages of the L/C:

Provides a sort of an assurance to the exporter.

The exporter does not have to bother about the exchange control regulations of


19/23



the importers country, since the banks of the importers country, since the

banks of the importers country open them and these institutions are in the

know of the exchange control regulations of that country.

Eases the financial position of the exporter since he can get pre-shipment aswell as post-shipment credit.

If importer takes care of certain safeguards, the quantity and the quality of thegoods are assured.

Discrepancies:

Discrepancies are the mistakes committed either by negotiation or from common

errors. But due to this negotiation importer has to suffer a lot, and also at a same timeexporter has to pay fine for that so one should take precautions for that.

Some common Discrepancies are as under:

Credit expired. Classed Bill of Lading. Presented after permitted time from the date of issue of shipping documents. Credit amount exceeds. Short shipment. Description of goods on invoice differs from that of credit. Goods shipped on decks. Bill of Lading, Insurance documents, bill of exchange not endorsed correctly. Absence of signature, where required on the paper. Bill of exchange drawn on wrong party.

2.2 Bank Guarantee

A bank guarantee means the guarantee from a lending institution ensuring that the

liabilities of a debtor will be met. A letter of guarantee is a written promise issued by

the Bank to compensate (pay a sum of money) to the beneficiary (third party, local or

foreign) in the event that the obligor (customer) fails to honor its obligations in

accordance with the terms and conditions of the guarantee/agreement/contract. In

other words, if the debtor fails to settle a debt, the bank will cover it.


20/23



The purpose for which the bank guarantee is usually provided is for two

reasons:

Foreign Bank GuaranteeThis guarantee is issued at the request of a correspondent bank in favor of

local companies that organize international bids or foreign suppliers.

Local Bank GuaranteeThis is issued by the Bank at the request of contractors, wholesalers,

companies involved in transaction, etc. for the purpose of handling the

guarantee request they receive in their operation.

The Guarantee is a unilateral agreement between the Bank and the

beneficiary, which is conducted on behalf of a third, party usually the

beneficiarys business partner.

A.Legal Requirements:-

Guarantees are not governed by any particular legal regulations. Issuing

Guarantees for foreign beneficiaries is not subject to approval nor need these

Guarantees be reported. Guarantees can be issued by authorized dealers under

their delegated authorities notified vide FEMA 8/2000 date 3rd May 2000. Only

in case of revocation of Guarantees involving US $ 5000/- or more to be reported

to Reserve Bank of India along with the details of claim received or details of

claim not honored by the mandatory on revocation.

B.Elements of Guarantees:-

There are no standard International regulations for Guarantees, so Guarantees may

be worded freely, depending on individual requirements. However Guarantees

should at least contain the following clauses:

i) An introduction referring to the key elements of the underlying transactions.

ii) An abstract undertaking according to which Guaranteeing Bank promises to

pay the Guarantee amount upon receipt of the first written demand from the

beneficiary together with his statement of default.

iii) A clause specifying the expiry date by which any claim amount must have

been received by the Bank indicating specific calendar date or a statement that the

validity of the Guarantee is unlimited.


21/23



C.Direct or Indirect Guarantee:-

Direct Guarantee:A Direct Guarantee is one given directly to the beneficiary abroad by the Bank,

resulting in a direct legal relationship between the issuing Bank and the

beneficiary. The advantage of a direct Guarantee is not only that it is less

expensive but also that it is subject to the law of the country in which the

Guarantee is issued unless otherwise specified in the Guarantee. If the Guarantee

indicates a specific calendar date on which the Guarantee will expire, the Bank

and consequently the mandatory will be released from their liability even if the

letter of Guarantee is not returned.

Indirect Guarantee:When a beneficiary insists that the Guarantee be issued by a local bank then the

Guarantee will be issued through a correspondent of issuing Bank at the country

of the beneficiary. In such cases the Guarantee is known as Indirect Guarantee.

Such Guarantees will be issued by the correspondent against the counter

Guarantee of the mandatory. Issuing Indirect Guarantee is more time consuming

and always more expensive, because of the cost in addition to the Guarantee

commission charged by the foreign Bank. Commission is charged till final validityof the Guarantee and usually it will be collected in advance.


22/23



Flow of Bank Guarantee:-

The flow for acquiring bank guarantee is as follows:

1Contract

2 - Application to issue of a bank guarantee3a - Letter of guarantee sent to the beneficiary directly

3b - Letter of guarantee sent through the advising bank


23/23


WORKING CAPITAL MANAGEMENT P 62

Mode of security:

For working capital Loans, commercial banks seek security either in the form of

Hypothecation or in the form of pledge.

Hypothecation:

Under this arrangement, the owner of the goods borrows money against the security

of movable property, usually inventories. The owner does not part with the possession

of property. The rights of the lender (hypothecate) depend upon the arrangement

between the ender and the borrower. Should the borrower default n paying his dues,

the lender (hypothecate) can file a suit to realize his dues by selling the goodshypothecated.

In Aarti Industries Ltd. Working capital loans availed from scheduled banks, are

secured/to be secured by hypothecation of Raw materials, Stock-in-progress, Semi-

finished goods, Finished goods, Packing materials and Stores and Spares, Bills

receivables and Book debt and all other moveable, Both present and future. Also by

way of joint equitable mortage of the companys immovable properties situated at

Sarigam, Vapi and Jhagadia, in the state of Gujarat being second to the charge held by

ECB/Term lenders and further by way of hypothecation of all moveable Plant &

Machinery, Machinery Spares, Tools and Accessories and other movables, both

present and future (except Book Debt & Inventories) wherever situated.

Pledge:

In a pledge arrangement, the owner of the goods (pledge) deposits the goods with the

lender (pledge) a security for the borrowing. Transfer of possession of goods is a

precondition for pledge. The lender (pledge) is expected to take reasonable care of

goods pledged with him. The pledge contract gives the lender (pledge) the right to sell

goods and recover dues, should the borrower (pledge) default in paying debt.

Documents

9 Financial Instruments Used at Ail Chap 4