Non-Fund Based Credit
What is Non-Fund Based Credit?
Non-fund based credit is a type of financial support provided by banks where no direct outflow of funds takes place. Instead, the bank acts as a guarantor for the customer and promises to pay a third party on the customer’s behalf in case of non-performance or default.
This form of credit is critical for businesses involved in contracts, tenders, or imports and exports. Since funds are not immediately disbursed, the risk and exposure for banks remain contingent until the facility is invoked.
Types of Non-Fund Based Credit Facilities
- Letter of Credit (LC): Ensures payment to a seller/exporter by a buyer’s bank, reducing the risk in trade transactions.
- Bank Guarantee (BG): Assures payment to a third party if the borrower fails to fulfill contractual obligations.
- Performance Guarantee: Covers non-performance of a contract or failure to meet quality/quantity terms.
- Bid Bond Guarantee: Secures the government or buyer against bidders who back out after winning a tender.
- Advance Payment Guarantee: Guarantees the buyer that advance funds given will be returned if no delivery occurs.
- Deferred Payment Guarantee: Ensures payment in installments over a period as per sales agreements.
- Standby Letter of Credit (SBLC): Used as a secondary guarantee in global contracts and trade settlements.
Advantages of Non-Fund Based Credit
- Enhances trust and creditworthiness between trade partners.
- Improves liquidity as funds are not immediately blocked.
- Helpful for startups and MSMEs in securing tenders and contracts.
- Reduces working capital pressure on the company.
Risks to Bank
- If the borrower defaults or fails to perform, the bank must pay the third party.
- Fraud risk in fake transactions or forged documents.
- Contingent liability may convert to actual loss.
- Operational risk due to procedural lapses or misrepresentation.
Process Flow
- The borrower applies for a non-fund based facility (e.g., LC/BG).
- The bank assesses creditworthiness and may demand collateral or margin.
- The bank issues the instrument on behalf of the client to the beneficiary.
- If no default or claim occurs, the transaction closes without fund outflow.
- If invoked, the bank pays and recovers the same from the borrower.
Security and Collateral Requirements
Depending on the credit risk profile of the customer, banks may require:
- Fixed deposits or lien-marked savings.
- Property mortgages or other tangible security.
- Personal or corporate guarantees.
- Margin money—typically 10% to 30% of the guarantee amount.
RBI Oversight and Prudential Norms
- RBI requires banks to classify invoked guarantees as funded exposure.
- Contingent liabilities must be disclosed in financial statements.
- Provisioning norms apply if the borrower fails to repay after invocation.
- Non-fund based limits must be included in the credit exposure ceiling.
Did You Know? Non-fund based facilities are crucial in EPC contracts, infrastructure bidding, and international trading where banks provide credibility instead of liquidity.
Real Example: An Indian company wins a government highway project worth ₹100 crore. To assure the government of its intent, it submits a bid bond guarantee worth ₹2 crore issued by its bank. If it backs out later, the bank will pay the government and recover the amount from the company.
Conclusion: Non-fund based credit plays a critical role in India's trade, infrastructure, and public procurement ecosystem. It provides financial assurance, reduces upfront capital needs, and strengthens the formal credit system when regulated prudently.