MICRO STUDY

REPORT ON NON-
FUND BASED
FACILITIES IN
INDIAN BANKING
SECTOR AND
COMPARATIVE
STUDY ON THE
PERFORMANCE OF
PSBs AND
s PvSBs

SUBMITTED BY –

36107 – SHIVANI AGRAWAL

36112 - SUJITH DEEPAK KUMAR
K
1. Banking in India

Banking system plays an important role in growth of economy. The banking sector is the

lifeline of any modern economy. It is one of the important pillars of financial system,

which plays a vital role in the success or failure of an economy. It is a well-known fact

that banks are one of the oldest financial intermediaries in the financial system. They

play a crucial role in the mobilization of deposits from the disbursement of credit to

various sectors of the economy. The banking system reflects the economic health of the

country. The strength of the economy of any country basically hinges on the strength

and efficiency of its financial system, which in turn depends on a sound and solvent

banking system. A Banking Sector performs three primary function in economy, the

operation of the payment system, the mobilization of savings and the allocation of

saving to investment products.

Banking in India forms the base for the economic development of the country. Major

changes in the banking system and management have been seen over the years with

the advancement in technology, considering the needs of people.

2. NON-FUND BASED FACILITIES IN INDIAN BANKING

SECTOR:

The credit facilities given by the banks where actual bank funds are not involved are

termed as 'non-fund-based facilities. The bank does not give physical money but gives

an assurance to a third party.

2.1 ADVANTAGES OF NON-FUND BASED FACILITIES:

 No immediate outlay of funds;

 Future or contingent deployment of funds;

 Risks are similar to funded exposure and procedure is same;

 Earnings by way of Up-Front commission, fees and exchange income;

 Source for mobilization of deposits;

 Comparative easy monitoring;

 Costs less to Banker;

 Low probability of default.

These facilities are divided in three broad categories as under:  

 Letters of credit

 Guarantees

 Co-acceptance of-bills/deferred payment guarantees.

3. LETTER OF CREDIT

Letter of credit is, a method of settlement of payment of a trade transaction and is

widely used to finance purchase of machinery and raw material etc. It contains a written

undertaking given by the bank on behalf of the purchaser to the seller to make payment

of a stated amount on presentation of stipulated documents and fulfilment of all the

terms and conditions incorporated therein.

In other words, Letter of credit is a written undertaking by a bank (issuing bank) given to

the seller (beneficiary) at the request and in accordance with the instructions of buyer

(applicant) to effect payment of a stated amount within a prescribed time limit and

against stipulated documents provided all the terms and conditions of the credit are

complied with".

All letters of credit in India relating to the foreign trade i.e., export and import letters of

credit are subject to provisions of 'Uniform Customs & Practice for Documentary Credits'

(UCPDC). The latest revision of these provisions effective from 1st January, 1994 has

been issued by International Chamber of Commerce as its publication No. 500 of 1994.

These provisions neither have the status of law or automatic application but parties to a

letter of credit bind themselves to these provisions by specifically agreeing to do so.

These provisions have almost universal application and help to arrive at unambiguous

interpretation of various terms used in letters of credit and also set the obligations,

responsibilities and rights of various parties to a letter of credit.

Inland letters of credit may also be issued subject to the provisions of UCPDC and it is,

therefore, important that customers should be fully aware of these provisions and shall

also understand complete L/C mechanism as these transactions will find increasing use

in the coming days.

Letters of credit thus offers both parties to a trade transaction a degree of security. The

seller can look forward to the issuing bank for payment instead of relying on the ability

and willingness of the buyer to pay. He is further assured of payment being received on

due date enabling him to have proper financial planning. The only condition being

attached is submission of stipulated documents and compliance with the terms and

conditions of credit. The buyer on the other hand will be obliged to pay only after receipt

of documents of title to goods to his satisfaction.

Letter of credit is an independent document in itself as provided vide article 3 of UCPDC

which states that: "Credits, by their nature, are separate transactions from the sales or

other contract(s) on which they may be based and banks are in no way concerned with

or bound by such contract(s), even if any reference whatsoever to such contract(s) is

included in the credit."

Many disputes have arisen due to the reference of sale contract in the letter of credit.

The letter of credit is issued in accordance with the instructions of the applicant who

should provide complete and precise instructions to the bank to avoid any dispute later.

The undertaking of a bank to pay, accept and pay drafts or negotiate and/or to fulfil any
other obligations under the credit is not subject to claims or defences by the Applicant

resulting from his relationship with the issuing Bank or the Beneficiary.

Another very important provision which is very vital to letter of credit operations is

regarding disputes emanating from the quality/quantity of goods covered under a letter

of credit. Article 4 of UCPDC states: “In credit operations all parties concerned deal with

documents, and not with cods, services and/or other performances to which the

documents may relate.

An important point which emerges from the above article is that any dispute regarding

the quality/quantity of the goods may have to be settled outside the terms of letter of

credit. Letter of credit thus provides no protection on this account and the applicant

must specify submission of necessary weight certificate/quality analysis certificates etc.

as considered necessary to satisfy himself regarding the goods on the basis of these

documents alone.
3.1 PARTIES TO A LETTER OF CREDIT:

 Applicant/Opener:

It is generally the buyer of the goods who gets the letter of credit issued by

his banker in favour of the seller. The person on whose behalf and under

whose instructions the letter of credit is issued is known as applicant/ opener of

the credit.

 Opening bank/issuing bank.

The bank issuing the letter of credit.

 Beneficiary:

The seller of goods in whose favour the letter of credit is issued.

 Advising Bank.

Notification regarding issuing of letter of credit may be directly sent to the

beneficiary by the opening bank. It is, however, customary to advise the letter of

credit through sane other bank operating at the place/country of seller. The bank

which advises the letter of credit to the beneficiary is known as advising bank.

  Confirming Bank.

A letter of credit substitutes the credit worthiness of the buyer with that of

the issuing bank. It may sometimes happen especially in import trade that the
 issuing bank itself is not widely known in the exporter's country and exporter is

not prepared to rely on the L/C opened by that bank. In such cases the opening

bank may request other bank usually in the country of exporter to add its

confirmation which amounts to an additional undertaking being given by that

bank to the beneficiary. The bank adding its confirmation is known as confirming

bank. The confirming bank has the same liabilities towards the beneficiary as that

of opening bank.

 Negotiating Bank:

The bank who negotiates the documents drawn under letter of credit and

makes payment to beneficiary.

3.2 Mechanism of Letter of Credit:

The complete mechanism of a letter of credit may be divided in three parts as under:

 Issuing of Credit.

  Negotiation of Documents by beneficiary

 Settlement of Bills Drawn under Letter of Credit by the opener.

A. Issuing of Credit. 

Letter of credit is always issued by the buyer's bank (issuing bank) at the request and

on behalf and in accordance with the instructions of the applicant. The letter of credit

may either be advised directly or through some other bank. The advising bank is
responsible for transmission of credit and verifying the authenticity of signature of

issuing bank and is under no commitment to pay the seller.

The advising bank may also be required to add confirmation and in that case will

assume all the liabilities of issuing bank in relation to the beneficiary as stated already.

Refer to diagram given below for complete process of issuance of credit.

B. Negotiation of Documents by beneficiary

On receipt of letter of credit, the beneficiary shall arrange to supply the goods as per the

terms of L/C and draw necessary documents as required under L/C. The documents will

then be presented to the negotiating bank for payment/acceptance as the case may be.

The negotiating bank will make the payment to the beneficiary and obtain

reimbursement from the opening bank in terms of credit

C. Settlement of Bills Drawn under Letter of Credit by the opener. 

The last step involved in letter of credit mechanism is retirement of documents received

under L/C by the opener,

On receipt of documents drawn under L/C, the opening bank is required to closely

examine the documents to ensure compliance of the terms and conditions of credit and

present the same to the opener for his scrutiny. The opener should then make payment

to the opening bank and take delivery of documents so that delivery of goods can be

obtained by him
3.3 NEED OF LETTER OF CREDIT

International trade covers very large distance between two countries and exporter &

importers are not known to each other. Letter of credit can resolve the complications

arise in international trade of two countries separated by differences in:

i. Physical barriers - long distances;

ii. Political systems /legal systems;

iii. Currencies;

iv. Trade and exchange regulations;

v. Markets and marketing conditions;

vi. Trade practices;

 vii. Financial and commercial conditions.

MAJOR ADVANTAGES TO BUYER

Major advantages to buyer (importer) from letter of credit are as follows:

 No cash advance payment has to be made to the seller;

 Seller is paid only after shipment and delivery of documents within the LC validity

 Possibility to obtain more favorable payment terms; 

 Shipment schedule ensured.

MAJOR ADVANTAGES TO SELLER:

Major advantages to seller (exporter) from letter of credit are as follows: 

 Obligation of the buyer’s bank for payment

 Payment is assured if credit terms are fulfilled

 Date of receipt of payment can be determined

 Seller need not bother about the fluctuation of currency

 Seller need not bother about the import regulation of buyer country

 A financing possibility by discounting receivables under LC

3.4TYPES OF LETTERS OF CREDIT:

 Revocable letter of credit. 

This may be amended or cancelled without prior warning or notification to the

beneficiary. Such letter of credit will not offer any protection and should not be accepted

as beneficiary of credit.

 Irrevocable letter of credit. 

This cannot be amended or cancelled without the agreement of all parties

thereto. This type of letter of credit is mainly in use and offers complete protection to the

seller against subsequent development against his interest.

SOME OTHER TYPES OF LETTER OF CREDITS ARE:

 Deferred or Usance LC:

A letter of credit, that ensures payment after a certain period of time. The date of

payment is accepted by both buyer and seller. The bank may review the

documents early but the payment to the beneficiary is made after the agreed-to

time passes. It is also known as Usance LC

 Transferable LC:

It is an LC, where the beneficiary is entitled to transfer the LC, in whole or in part,

to the 2nd beneficiary/s (supplier of beneficiary). The 2nd beneficiary, however,

cannot transfer it further, but can transfer the unused portion, back to the original

beneficiary? It is transferable only once.

  A Back to Back credit:

A pair of LCs in which one is to the benefit of a seller who is not able to provide

the corresponding goods for unspecified reasons. In that event, a second credit

is opened for another seller to provide the desired goods. Back-to- back be

issued to facilitate intermediary trade. Intermediate companies such as trading

houses are sometimes required to open LCs for a supplier and receive Export

LCs from buyer.

 Red Clause LC:

It referred to a packing or anticipatory credit, has a clause permitting the

correspondent bank in the exporter's country to grant advance to beneficiary at

issuing bank's responsibility. These advances are adjusted from proceeds of the

bills negotiated.

 A Green Clause LC:

It permits the advances for storage of goods in a warehouse in addition to

reshipment advance. It is an extension of the red clause LC.

 Standby Credits:

It is similar to performance bond or guarantee, but issued in the form of LC. The

beneficiary can submit his claim by means of a draft accompanied by the

requisite documentary evidence of performance, as stipulated in the credit.

3.4 RISKS IN LETTER OF CREDIT TRANSACTIONS

Letter of credit transactions are not risks free. The risks inherent in these types of

transactions include:

Fraud Risks:

The payment will be obtained for non-existent or worthless merchandise against

presentation by the beneficiary of forged or falsified documents. Credit itself may be

funded.

Sovereign and Regulatory Risks:

Performance of the Documentary Credit may be prevented by government action

outside the control of the parties.

Legal Risks:

Possibility that performance of a documentary credit may be disturbed by legal action

relating directly to the parties and their rights and obligations under the documentary

credit.
Force majeure risk:

The event in which completion of the transaction is prevented by an external force, such

as war or natural disaster.

4. SWIFT CODE

SWIFT is the short form of "Society or Worldwide Interbank Financial

Telecommunication". In simple terms swift has two main roles in international financial

transactions, firstly SWIFT provide a secure communications platform by which financial

institutions can communicate each other reliably & fast and secondly SWIFT establishes

standard message formats which can be used on secure SWIFT platforms.

Today banks use SWIFT platform to communicate each other when sending a wire

transfer, issuing a letter of credit, advising a discrepancy message etc. each of these

message formats have a different code, which is called swift message types.

For example a bank must use MT700 Issue of a Documentary Credit when issuing a

letter of credit and MT 734 advice of a refusal when giving its refusal message. (MT

means Message Type)

According to the current letters of credit rules, UCP 600, a letter of credit will be deemed

to be operative letter of credit if it is transmitted via an authenticated electronic platform

such as SWIFT.
5. GUARANTEE

A contract of guarantee can be defined as a contract to perform the promise, or

discharge the liability of a third person in case of his default. 

5.1 PARTIES TO GUARANTEE:

 Principal debtor 

 The person who has to perform or discharge the liability and for whose default

the guarantee is given.

 Principal creditor            

The person to whom the guarantee is given for due fulfilment of contract by

principal debtor. Principal creditor is also sometimes referred to as

beneficiary.

 Guarantor or Surety                   

The person who gives the guarantee.

5.2 GUARANTEE TYPES:

Bank provides guarantee facilities to its customers who may require these facilities for

various purpose. The guarantees may broadly be divided in two categories as under -

Guarantee may be classified by nature as under:

 Inland Guarantee and Foreign Guarantee.

 Financial Guarantee and Performance Guarantee:

 Deferred guarantee

 INLAND GUARANTEE AND FOREIGN GUARANTEE

Inland Guarantee

Guarantee which issued with in India in favor of beneficiary located in India for

any contract or purpose originating within India.

Foreign Guarantee:

Guarantee which Issued in India in favor of beneficiary located in any other

country in Foreign Currency.

 FINANCIAL GUARANTEE

 Guarantees are issued by bank on behalf of customer’s requirement to deposit

a cash security or earnest money.

 Most Government department insist that before contract is awarded to

contractor, insist on an Earnest Money Deposit.

 Issued in respect of Excise / Custom duties and Octroi under dispute etc.
  Issued in respect liabilities towards tax, excise duties, custom duties etc. to

Govt.authorities in relation of specific transaction; Issued for covering

payments for supplies/services favoring Oil Companies, SAIL, Railways etc.

 PERFORMANCE GUARANTEE

 Performance Guarantees are issued by the bank on behalf of its customer

whereby the bank assure a third party, that the customer will perform the contract

as per condition stipulated in the contract.

 These are issued on behalf of customer, who enters into contracts to do certain

things on or before a given date. It involves a contractual obligation.

 DEFERRED PAYMENT

 It is issued in favor of suppliers to guarantee payment of installments for capital

goods purchased on deferred payment basis.

 It required when goods or machinery are purchase on long term credit and

payment is made through cheque or bills of different dates.

 Bank issue guarantee of payment of installments on due date, in event of default

by buyer.

 For example: Rs. 50 Lacs is cost of Machinery. Repayable in 5 yearly

installments. Default in payment by the buyer.

RBI GUIDELINES ON GUARANTEE:

1. The conditions relating to obliging being a customer of the bank enjoying credit

facilities as discussed in case of letters of credit are equally applicable for

guarantees also. In fact, guarantee facilities also cannot be sanctioned in

isolation.

2. Financial guarantees will be issued by the banks only if they are satisfied that the

customer will be in a position to reimburse the bank in case the guarantee is

invoked and the bank is required to make the payment in terms of guarantee.

3. Performance guarantee will be issued by the banks only on behalf of those

customers with whom the bank has sufficient experience and is satisfied that the

customer has the necessary experience and means to perform the obligations

under the contract and is not likely to commit any default.

 4. As a rule, banks will guarantee shorter maturities and leave longer maturities to

be guaranteed by other institutions. Accordingly, no bank guarantee will normally

have a maturity of more than 10 years.

5. Banks should not normally issue guarantees on behalf of those customers who

enjoy credit facilities with other banks.

PERFORMANCE OF A PSB AND A PS – A COMPARATIVE

STUDY-

Banks are classified as Public or Private depending on their ownership.

PUBLIC SECTOR BANKS -

A Public sector bank is one where the government owns a majority stake (i.e. more than

50%). In common parlance, they are also known as government banks. Due to its

ownership, the aims set for these banks revolve around social welfare and fulfillment of

the country’s economic needs.

PRIVATE SECTOR BANKS -

In these banks, most of the equity is owned by private bodies, corporations, institutions

or individuals rather than government. These banks are managed and controlled by

private promoters.
Of the total banking industry in India, Public sector banks constitute 72.9% share while

there stis covered by private players.

WHICH ONE IS PERFORMING BETTER?

1. CUSTOMER BASE-

Longer periods of existence in the Indian markets have allowed public banks to develop

a larger customer base in comparison to the private banks. This has motivated the

public banks to penetrate deeper into rural areas gaining a greater customer base.

Private Banks, on the other hand, enter only areas where they see a potential to earn a

profit. This is the reason private banks mainly function in urban areas and not rural.

2. MARKET SHARE

As of 2018 public sector banks account for 62% of the total banking assets and 58% of

the total income, the rest occupied by private banks. Although public banks have a

greater market share, their hold has been continuously slipping.

3. NON-PERFORMING ASSETS (NPA)

One would expect private banks to have a high number of NPA’s considering that in

order to gain an edge over public banks the private banks may be more approachable

when it comes to loans, leading to higher NPA’s. But this has not been the case as the

NPA’s of private sector banks have been lower in comparison to private banks.

To survive in this modern market every bank implements so many new innovative ideas,

strategies, and advanced technologies. The study emphases on the Non-fund Based

Income of selected public sector banks and private sector banks.

6. CONCLUSION -

It is evident that although the public sector still holds a greater market share they have

not been able to compete with the growth rate of private banks. In order to achieve this,

Private Banks have capitalized on the weaknesses of Public Banks. Coupling superior

customer service with the inclusion of technological changes has worked out in favour

of the private banks. It is good to see that these measures adopted by private banks are

forcing the public banks to implement them too.

But if the public banks keep playing catch up with the private banks they will soon be

seen falling behind even in terms of market share. This has called for multiple structural

reforms to ensure that does not happen because at the end of the day it is the public

banks that look after and perform in the interest of the economy.
“A COMPARATIVE STUDY OF NON-FUND BASED INCOME

OF SELECTED PUBLIC SECTOR BANKS & SELECTED

PRIVATE SECTOR BANKS IN INDIA“

CONCEPT OF NON-FUND BASED INCOME

Banks are among the main participants of the financial system in India. Banks also

perform certain activities which are ancillary to this business of accepting deposits or

lending. There are major two types of income for the banks like, Fund based income

and Non-fund Based income.

NON-FUND BASED INCOME

Non-fund based income is such income which are deriving from non-fund facilities

provided by the banks.

COMPONENTS OF NON-FUND BASED INCOME

Components of this income, like-

 Commission
  Exchanges

 Brokerage

 Rental Income

 Income on sale of Investment

 Income on sale of premises

 Dividend from others

 Other recourses

OBJECTIVE OF THE STUDY

To study of non-fund based income of the selected banks. Through this research study

society will able to know the real situation of Non-fund based income of the banks.

NON FUND BASED INCOME OF PUBLIC SECTOR BANKS-

STATE BANK OF India-

The above table shows the Non-fund Based Income of State Bank of India from the

year 2004 to 2008. Non-fund Based income was highest Rs 9398.43 Crore in Year

2008, and it was lowest Rs 7119.90 crore in the year 2005. After year 2005, non-fund

based income representing continuous increasing trend in year to year.

The Average Non fund based income is Rs 7793.29 Crore. Only 2008 income was

higher than average Non fund based income.

ICICI BANK-
The above table shows the Non-fund Based Income of ICICI Bank from the year 2004

to 2008. Non-fund Based income was highest Rs 8878.85 Crore in Year 2008, and it

was lowest Rs 3064.92 crore in the year 2004. Non-fund based income represents

continues increasing trends year to year. The Average Non-Fund based income is Rs

4931.91 Crore. Non fund based income of Year 2006,

2007 and 2008 was higher than average Non fund based income.
State Bank of India is the largest bank in India, with 7793.2900 crore average non-fund

based income. In case of public sector banks the Non-Fund Based Income in some of

them are increasing and some of them having a mix trend for year by year.

ICICI Bank is the largest Private Sector Banks in India, with 5471.9140 crore average

non-fund based income.

As compared to the developed world, the Indian banking sector, apart from the relying

on traditional sources of revenue like loan making are also focusing on the activities that

generate fee income, service charges, trading revenue, and other types of noninterest

income. While noninterest income plays an important role in banking revenues in the

developed world, its contribution to the total income of the Indian banking was 25% as

on 31st March 2008.

SUGGESTIONS-

1. The banks in India need to focus at ensuring greater financial stability to tackle

lots of challenges successfully to keep growing and strengthen of banking sector.

2. Bank must create strategic alliance with the rural regional banks to open up rural

branches and increased use of technology for improved products and services.

3. For the financial repression construct Indian banking industry have to focusing

and concerning the challenges intensity of the change in three polices likely,

interest rate controls, strategy pre-emption and directed credit.

4. Banking sector in India need to move towards a more market based system for to

create the sound and condition for well functioning of a market based banking

system.

5. Public sector banks required to set up modern IT infrastructure in place within a

short time of period. Both of banks need to expand branches in rural area.

6. Banking sector in India need to start moving into areas that yield Non-Fund

Based Income activities that earn more income rather than interest income.

CONCLUSION -
All these developments in Indian banking are says that, the Indian banks are moving

towards modern banking changing a face of traditional banking of Indian economy .It is

grate change of banking industry. They having a installing an information technology for

banking business and they trying to provide technology based banking products and

services to their customers

For a long term success of banking institution to require effective management of credit

risk and diversified into fee based activities. Non-traditional activities of banks are more

sophisticated and

versatile instrument for risk assessment.

It is tempting to conclude that interest based, intermediation activities have become less

central to financial health and business strategy of the typical commercial banks and

that fee based non-intermediation financial services have become more important

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