BUYER’S CREDIT

Buyer's credit is the credit availed by an importer (buyer) from overseas lenders, i.e. banks

and financial institutions for payment of his imports on due date. The overseas banks usually

lend the importer (buyer) based on the letter of comfort (a bank guarantee) issued by the

importers bank. Importer's bank or Buyers Credit Consultant or importer arranges buyer's credit

from international branches of a domestic bank or international banks in foreign countries. For

this service, importer's bank or buyer's credit consultant charges a fee called an arrangement

fee.

Buyer's credit helps local importers gain access to cheaper foreign funds close to LIBOR rates as

against local sources of funding which are costly compared to LIBOR rates.

The duration of buyer's credit may vary from country to country, as per the local regulations. For

example in India, buyer's credit can be availed for one year in case the import is for trade-able

goods and for three years if the import is for capital goods. Every six months, the interest on

buyer's credit may get reset.

Benefits to importer

1. The exporter gets paid on due date; whereas importer gets extended date for making an import

payment as per the cash flows

2. The importer can deal with exporter on sight basis, negotiate a better discount and use the

buyers credit route to avail financing.

3. The funding currency can be in any FCY (USD, GBP, EURO, JPY etc.) depending on the choice of

the customer.

4. The importer can use this financing for any form of trade viz. open account, collections, or LCs.

5. The currency of imports can be different from the funding currency, which enables importers to

take a favourable view of a particular currency.

Steps involved

1. The customer will import the goods either under DC, collections or open account

2. The customer requests the Buyer's Credit Arranger before the due date of the bill to avail buyers

credit financing

3. Arrange to request overseas bank branches to provide a buyer's credit offer letter in the name of

the importer. Best rate of interest is quoted to the importer

4. Overseas bank to fund Importer's bank Nostro account for the required amount.

5. Importer's bank to make import bill payment by utilizing the amount credited (if the borrowing

currency is different from the currency of Imports then a cross currency contract is utilized to

effect the import payment)

6. Importer's bank will recover the required amount from the importer and remit the same to

overseas bank on due date.

Cost involved

1. Interest cost: This is charged by overseas bank as a financing cost

2. Letter of Comfort / Undertaking: Your existing bank would charge this cost for issuing letter of

comfort / Undertaking

3. Forward Booking Cost / Hedging cost

4. Arrangement fee: Charged by person who is arranging buyer's credit for buyer.

5. Risk premium: Depending on the risk perceived on the transaction.

6. Other charges: A2 payment on maturity, For 15CA and 15CB on maturity, Intermediary bank

charges.

7. WHT (Withholding tax): The customer may have to pay WHT on the interest amount remitted

overseas to the local tax authorities depending on local tax regulations. In case of India, the WHT

is not applicable where Indian banks arrange for buyer's credit through their offshore offices.

Indian regulatory framework

Banks can provide buyer’s credit up to USD 20 million per import transactions for a maximum

maturity period of one year from date of shipment. In case of import of capital goods, banks can

approve buyer’s credits up to USD 20 million per transaction with a maturity period of up to

three years. No rollover beyond that period is permitted.

RBI has issued directions under Sec 10(4) and Sec 11(1) of the Foreign Exchange Management

Act, 1999, stating that authorised dealers may approve proposals received (in Form ECB) for

short-term credit for financing—by way of either suppliers' credit or buyers' credit—of import of

goods into India, based on uniform criteria. Credit is to be extended for a period of less than

three years; amount of credit should not exceed $20 million, per import transaction; the `all-in-

cost' per annum, payable for the credit is not to exceed LIBOR + 50 basis points for credit up to

one year, and LIBOR + 125 basis points for credits for periods beyond one year but less than

three years, for the currency of credit.

All applications for short-term credit exceeding $20 million for any import transaction are to be

forwarded to the Chief General Manager, Exchange Control Department, Reserve Bank of India,

Central Office, External commercial Borrowing (ECB) Division, Mumbai. Each credit has to be

given `a unique identification number' by authorised dealers and the number so allotted should

be quoted in all references. The International Banking Division of the authorised dealer is

required to furnish the details of approvals granted by all its branches, during the month, in

Form ECB-ST to the RBI, so as to reach not later than 5th of the following month. (Circular AP

(DIR Series) No 24 dated September 27, 2002.

As per RBI Master circular on External Commercial Borrowing and Trade Finance 1st July 2011,

the all-in cost ceiling for interest is now six month L + 200 bps(bps is Basis Points . A unit that is

equal to 1/100th of 1%) for buyer's credit arrange for tenure up to three years. All cost ceiling

includes arranger fee, upfront fee, management fee, handling and processing charges, out-of-

pocket and legal expenses, if any.

The above ceiling go revised on 15/11/2012 to 6 Month Libor + 350 bps and got further

extended on 30/03/2012 till 30/09/2012.

Letter of credit

After a contract is concluded between buyer and seller, buyer's bank supplies a letter of credit to

seller

Seller consigns the goods to a carrier in exchange for a bill of lading.

Seller provides bill of lading to bank in exchange for payment. Seller's bank exchanges bill of

lading for payment from buyer's bank. Buyer's bank exchanges bill of lading for payment from

the buyer.

Buyer provides bill of lading to carrier and takes delivery of goods.

A letter of credit is a document that a financial institution or similar party issues to a seller of

goods or services which provides that the issuer will pay the seller for goods or services the

seller delivers to a third-party buyer. The issuer then seeks reimbursement from the buyer or

from the buyer's bank. The document serves essentially as a guarantee to the seller that it will

be paid by the issuer of the letter of credit regardless of whether the buyer ultimately fails to

pay. In this way, the risk that the buyer will fail to pay is transferred from the seller to the letter

of credit's issuer.

Letters of credit are used primarily in international trade for large transactions between a

supplier in one country and a customer in another. In such cases, the International Chamber of

Commerce Uniform Customs and Practice for Documentary Credits applies (UCP 600 being the

latest version).[2] They are also used in the land development process to ensure that approved

public facilities (streets, sidewalks, storm water ponds, etc.) will be built. The parties to a letter

of credit are the supplier, usually called the beneficiary, 'the issuing bank,' of whom the buyer

is a client, and sometimes an advising bank, of whom the beneficiary is a client. Almost all

letters of credit are irrevocable, i.e., cannot be amended or canceled without the consent

of the beneficiary, issuing bank, and confirming bank, if any. In executing a transaction,

letters of credit incorporate functions common to giros and Traveler's cheques.

Introduction

Letter of Credit  L/c also known as Documentary Credit is a widely used term to make payment secure in domestic and international trade. The document is issued by a financial organization at the buyer request. Buyer also provide the necessary instructions in preparing the document.

The International Chamber of Commerce (ICC) in the Uniform Custom and Practice for Documentary Credit (UCPDC) defines L/C as: 

"An arrangement, however named or described, whereby a bank (the Issuing bank) acting at the request and on the instructions of a customer (the Applicant) or on its own behalf :

1. Is to make a payment to or to the order  third party ( the beneficiary ) or is to accept bills of exchange (drafts) drawn by the beneficiary.

2. Authorised another bank to effect such payments or to accept and pay such bills of exchange (draft).

3. Authorised another bank to negotiate against stipulated documents provided that the terms are complied with.

A key principle underlying letter of credit (L/C) is that banks deal only in documents and not in goods. The decision to pay under a letter of credit will be based entirely on whether the documents presented to the bank appear on their face to be in accordance with the terms and conditions of the letter of credit.

Definition of 'Letter Of Credit'

A letter from a bank guaranteeing that a buyer's payment to a seller will be received on time and for the correct amount. In the event that the buyer is unable to make payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase.

Investopedia explains 'Letter Of Credit'

Letters of credit are often used in international transactions to ensure that payment will be received. Due to the nature of international dealings including factors such as distance, differing laws in each country and difficulty in knowing each party personally, the use of letters of credit has become a very important aspect of international trade. The bank also acts on behalf of the buyer (holder of letter of credit) by ensuring that the supplier will not be paid until the bank receives a confirmation that the goods have been shipped.

Definition of 'Irrevocable Letter Of Credit - ILOC'

A letter of credit that can't be canceled. This guarantees that a buyer's payment to a seller will be received on time and for the correct amount

Definition of 'Sight Letter Of Credit'

A letter of credit that is payable once it is presented along with the necessary documents. An organization offering a sight letter of credit commits itself to paying the agreed amount of funds provided the provisions of the letter of credit are met.

Investopedia explains 'Sight Letter Of Credit'For example, a business owner may present a bill of exchange to a lender along with a sight letter of credit, and walk away with the necessary funds right then. A sight letter of credit is thus more "on demand" than some other types of letters of credit.  

Origin of the term

The English name “letter of credit” derives from the French word “accréditation,” a power to do

something, which in turn derives from the Latin “accreditivus,” meaning trust. This applies to

any defense relating to the underlying contract of sale. This is as long as the seller performs

their duties to an extent that meets the requirements contained in the letter of credit.

Parties to Letters of   Credit

Applicant (Opener): Applicant which is also referred to as account party is normally a buyer or customer of the goods, who has to make payment to beneficiary. LC is initiated and issued at his request and on the basis of his instructions.

Issuing Bank (Opening Bank) : The issuing bank is the one which create a letter of credit and takes the responsibility to make the payments on receipt of the documents from the beneficiary or through their banker. The payments has to be made to the beneficiary within seven working days from the date of receipt of documents at their end, provided the documents are in accordance with the terms and conditions of the letter of credit. If the documents are discrepant one, the rejection thereof to be communicated within seven working days from the date of of receipt of documents at their end. 

Beneficiary : Beneficiary is normally stands for a seller of the goods, who has to receive payment from the applicant. A credit is issued in his favour to enable him or his agent to obtain payment on surrender of stipulated document and comply with the term and conditions of the L/c.If L/c is a transferable one and he transfers the credit to another party, then he is referred to as the first or original beneficiary.

Advising Bank : An Advising Bank provides advice to the beneficiary and takes the responsibility for sending the documents to the issuing bank and is normally located in the country of the beneficiary.

Confirming Bank : Confirming bank adds its guarantee to the credit opened by another bank, thereby undertaking the responsibility of payment/negotiation acceptance under the credit, in additional to that of the issuing bank. Confirming bank play an important role where the exporter is not satisfied with the undertaking of only the issuing bank. 

Negotiating Bank:  The Negotiating Bank is the bank who negotiates the documents submitted to them by the beneficiary under the credit either advised through them or restricted to them for negotiation. On negotiation of the documents they will claim the reimbursement under the credit and makes the payment to the beneficiary provided the documents submitted are in accordance with the terms and conditions of the letters of credit. 

Reimbursing Bank : Reimbursing Bank is the bank authorized to honor the reimbursement claim in settlement of negotiation/acceptance/payment lodged with it by the negotiating bank. It is normally the bank with which issuing bank has an account from which payment has to be made. 

Second Beneficiary : Second Beneficiary is the person who represent the first or original Beneficiary of credit in his absence. In this case, the credits belonging to the original beneficiary is transferable. The rights of the transferee are subject to terms of transfer.

Types of Letter of Credit

1. Revocable Letter of Credit L/c

A revocable letter of credit may be revoked or modified for any reason, at any time by the issuing bank without notification.  It is rarely used in international trade and not considered satisfactory for the exporters but has an advantage over that of the importers and the issuing bank.

There is no provision for confirming revocable credits as per terms of UCPDC, Hence they cannot be confirmed. It should be indicated in LC that the credit is revocable. if there is no such indication the credit will be deemed as irrevocable.

2. Irrevocable Letter of CreditL/c

In this case it is not possible to revoked or amended a credit without the agreement of the issuing bank, the confirming bank, and the beneficiary.  Form an exporters point of view it is believed to be more beneficial. An irrevocable letter of credit from the issuing bank insures the beneficiary that if the required documents are presented and the terms and conditions are complied with, payment will be made. 

3. Confirmed Letter of Credit  L/c

Confirmed Letter of Credit is a special type of L/c in which another bank apart from the issuing bank has added its guarantee. Although,  the cost of confirming by two banks makes it costlier, this type of  L/c is more beneficial for the beneficiary as it doubles the guarantee.

4. Sight Credit and Usance Credit  L/c

Sight credit states that the payments would be made by the issuing bank at sight, on demand or on presentation. In case of usance credit, draft are drawn on the issuing bank or the correspondent bank at specified usance period. The credit will indicate whether the usance draft are to be drawn on the issuing bank or in the case of confirmed credit on the confirming bank.

5. Back to Back Letter of Credit  L/c

Back to Back Letter of Credit is also termed as Countervailing Credit. A credit is known as backtoback credit when a L/c is opened with security of another L/c.

A backtoback credit which can also be referred as credit and countercredit is actually a method of financing both sides of a transaction in which a middleman buys goods from one customer and sells them to another.

The parties to a BacktoBack Letter of Credit are:     1.  The buyer and his bank as the issuer of the original Letter of Credit.     2.  The seller/manufacturer and his bank,     3.  The manufacturer's subcontractor and his bank.

The practical use of this Credit is seen when L/c is opened by the ultimate buyer in favour of a particular beneficiary, who may not be the actual supplier/ manufacturer offering the main credit with near identical terms in favour as security and will be able to obtain reimbursement by presenting the documents received under back to back credit under the main L/c.

The need for such credits arise mainly when :

1. The ultimate buyer not ready for a transferable credit2. The Beneficiary do not want to disclose the source of supply to the openers.3. The manufacturer demands on payment against documents for goods but the beneficiary of

credit is short of the funds

6. Transferable Letter of Credit  L/c

A transferable documentary credit is a type of credit under which the first beneficiary which is usually a middleman may request the nominated bank to transfer credit in whole or in part to the second beneficiary. 

The L/c does state clearly mentions the margins of the first beneficiary and unless it is specified the L/c cannot be treated as transferable. It can only be used when the company is selling the product of a third party and the proper care has to be taken about the exit policy for the money transactions that take place. 

This type of L/c is used in the companies that act as a middle man during the transaction but don’t have large limit. In the transferable L/c there is a right to substitute the invoice and the whole value can be transferred to a second beneficiary.

The first beneficiary or middleman has rights to change the following terms and conditions of the letter of credit:

1. Reduce the amount of the credit.2. Reduce unit price if it is stated3. Make shorter the expiry date of the letter of credit.4. Make shorter the last date for presentation of documents.5. Make shorter the period for shipment of goods.6. Increase the amount of the cover or percentage for which insurance cover must be effected.7. Substitute the name of the applicant (the middleman) for that of the first beneficiary (the

buyer). 

Standby Letter of Credit   L/c

Initially used by the banks in the United States, the standby letter of credit is very much similar in nature to a bank guarantee. The main objective of issuing such a credit is to secure bank loans. Standby credits are usually issued by the applicant’s bank in the applicant’s country and advised to the beneficiary by a bank in the beneficiary’s country.

 Unlike a traditional letter of credit where the beneficiary obtains payment against documents evidencing performance, the standby letter of credit allow a beneficiary to obtains payment from a bank even when the applicant for the credit has failed to perform as per bond.  

A standby letter of credit is subject to "Uniform Customs and Practice for Documentary Credit" (UCP), International Chamber of Commerce Publication No 500, 1993 Revision, or "International Standby Practices" (ISP), International Chamber of Commerce Publication No 590, 1998.

Import Operations Under   L/c

The Import Letter of Credit guarantees an exporter payment for goods or services, provided the terms of the letter of credit have been met.

A bank issue an import letter of credit on the behalf of an importer or buyer under the following Circumstances

When a importer is importing goods within its own country. When a trader is buying good from his own country and sell it to the another country for the

purpose of merchandizing trade. When an Indian exporter who is executing a contract outside his own country requires importing

goods from a third country to the country where he is executing the contract.

The first category of the most common in the day to day banking

Documents that can be presented for payment

To receive payment, an exporter or shipper must present the documents required by the letter

of credit. Typically, the payee presents a document proving the goods were sent instead of

showing the actual goods. The Original Bill of Lading (OBL) is normally the document accepted

by banks as proof that goods have been shipped. However, the list and form of documents is

open to imagination and negotiation and might contain requirements to present documents

issued by a neutral third party evidencing the quality of the goods shipped, or their place of

origin or place. Typical types of documents in such contracts might include:

What's the difference between a bank guarantee and a letter of credit?

A bank guarantee and a letter of credit are similar in many ways but they're two different things.

Letters of credit ensure that a transaction proceeds as planned, while bank guarantees reduce

the loss if the transaction doesn't go as planned.

A letter of credit is an obligation taken on by a bank to make a payment once certain criteria are

met. Once these terms are completed and confirmed, the bank will transfer the funds. This

ensures the payment will be made as long as the services are performed.

A bank guarantee, like a line of credit, guarantees a sum of money to a beneficiary. Unlike a line

of credit, the sum is only paid if the opposing party does not fulfill the stipulated obligations

under the contract. This can be used to essentially insure a buyer or seller from loss or damage

due to nonperformance by the other party in a contract.

For example a letter of credit could be used in the delivery of goods or the completion of a

service. The seller may request that the buyer obtain a letter of credit before the transaction

occurs. The buyer would purchase this letter of credit from a bank and forward it to the seller's

bank. This letter would substitute the bank's credit for that of its client, ensuring correct and

timely payment.

A bank guarantee might be used when a buyer obtains goods from a seller then runs into cash

flow difficulties and can't pay the seller. The bank guarantee would pay an agreed-upon sum to

the seller. Similarly, if the supplier was unable to provide the goods, the bank would then pay the

purchaser the agreed-upon sum. Essentially, the bank guarantee acts as a safety measure for

the opposing party in the transaction. 

These financial instruments are often used in trade financing when suppliers, or vendors, are

purchasing and selling goods to and from overseas customers with whom they don't have

established business relationships. The instruments are designed to reduce the risk taken by

each party.

PACKING CREDIT IN FOREING CURRENCY (PCFC)

Pre Shipment Finance is issued by a financial institution when the seller want the payment of the goods before shipment. The main objectives behind preshipment finance or pre export finance is to enable exporter to:

Procure raw materials. Carry out manufacturing process. Provide a secure warehouse for goods and raw materials. Process and pack the goods. Ship the goods to the buyers. Meet other financial cost of the business.

Types of Pre Shipment Finance

Packing Credit Advance against Cheques/Draft etc. representing Advance Payments.

Preshipment finance is extended in the following forms :

Packing Credit in Indian Rupee Packing Credit in Foreign Currency (PCFC)

Requirment for Getting Packing Credit

This facility is provided to an exporter who satisfies the following criteria

A ten digit importerexporter code number allotted by DGFT. Exporter should not be in the caution list of RBI. If the goods to be exported are not under OGL (Open General Licence), the exporter should have

the required license /quota permit to export the goods.

Packing credit facility can be provided to an exporter on production of the following evidences to the bank:

1. Formal application for release the packing credit with undertaking to the effect that the exporter would be ship the goods within stipulated due date and submit the relevant shipping documents to the banks within prescribed time limit.

2. Firm order or irrevocable L/C or original cable / fax / telex message exchange between the exporter and the buyer.

3. Licence issued by DGFT if the goods to be exported fall under the restricted or canalized category. If the item falls under quota system, proper quota allotment proof needs to be submitted.

The confirmed order received from the overseas buyer should reveal the information about the full name and address of the overseas buyer, description quantity and value of goods (FOB or CIF), destination port and the last date of payment.

Eligibility

Pre shipment credit is only issued to that exporter who has the export order in his own name. However, as an exception, financial institution can also grant credit to a third party manufacturer or supplier of goods who does not have export orders in their own name.

In this case some of the responsibilities of meeting the export requirements have been out sourced to them by the main exporter. In other cases where the export order is divided between two more than two exporters, pre shipment credit can be shared between them

Quantum of Finance

The Quantum of Finance is granted to an exporter against the LC or an expected order.  The only guideline principle is the concept of NeedBased Finance. Banks determine the percentage of margin, depending on factors such as:

The nature of Order. The nature of the commodity. The capability of exporter to bring in the requisite contribution.

Different Stages of Pre Shipment Finance 

Appraisal and Sanction of Limits

1. Before making any an allowance for Credit facilities banks need to check the different aspects like product profile, political and economic details about country. Apart from these things, the bank also looks in to the status report of the prospective buyer, with whom the exporter proposes to do the business. To check all these information, banks can seek the help of institution like ECGC or International consulting agencies like Dun and Brad street etc.

The Bank extended the packing credit facilities after ensuring the following" The exporter is a regular customer, a bona fide exporter and has a goods standing in the

market. Whether the exporter has the necessary license and quota permit (as mentioned earlier)

or not. Whether the country with which the exporter wants to deal is under the list of Restricted

Cover Countries (RCC) or not.

Disbursement of Packing Credit Advance

2. Once the proper sanctioning of the documents is done, bank ensures whether exporter has executed the list of documents mentioned earlier or not. Disbursement is normally allowed when all the documents are properly executed. 

Sometimes an exporter is not able to produce the export order at time of availing packing credit. So, in these cases, the bank provide a special packing credit facility and is known as Running Account Packing.

Before disbursing the bank specifically check for the following particulars in the submitted documents"

Name of buyer Commodity to be exported Quantity Value (either CIF or FOB) Last date of shipment / negotiation. Any other terms to be complied with

The quantum of finance is fixed depending on the FOB value of contract /LC or the domestic values of goods, whichever is found to be lower. Normally insurance and freight charged are considered at a later stage, when the goods are ready to be shipped.

In this case disbursals are made only in stages and if possible not in cash. The payments are made directly to the supplier by drafts/bankers/cheques.

The bank decides the duration of packing credit depending upon the time required by the exporter for processing of goods.

The maximum duration of packing credit period is 180 days, however bank may provide a further 90 days extension on its own discretion, without referring to RBI.

Follow up of Packing Credit Advance

3. Exporter needs to submit stock statement giving all the necessary information about the stocks. It is then used by the banks as a guarantee for securing the packing credit in advance. Bank also decides the rate of submission of this stocks.

Apart from this, authorized dealers (banks) also physically inspect the stock at regular intervals.

Liquidation of Packing Credit Advance

4. Packing Credit Advance needs be liquidated out of as the export proceeds of the relevant shipment, thereby converting preshipment credit into postshipment credit.

This liquidation can also be done by the payment receivable from the Government of India and includes the duty drawback, payment from the Market Development Fund (MDF) of the Central Government or from any other relevant source.

In case if the export does not take place then the entire advance can also be recovered at a certain interest rate. RBI has allowed some flexibility in to this regulation under which substitution of commodity or buyer can be allowed by a bank without any reference to RBI. Hence in effect the packing credit advance may be repaid by proceeds from export of the same or another commodity to the same or another buyer. However, bank need to ensure that the substitution is commercially necessary and unavoidable.

Overdue Packing

5. Bank considers a packing credit as an overdue, if the borrower fails to liquidate the packing credit on the due date. And, if the condition persists then the bank takes the necessary step to recover its dues as per normal recovery procedure.

Special Cases 

Packing Credit to Sub Supplier

1. Packing Credit can only be shared on the basis of disclaimer between the Export Order Holder (EOH) and the manufacturer of the goods. This disclaimer is normally issued by the EOH in order to indicate that he is not availing any credit facility against the portion of the order transferred in the name of the manufacturer.

This disclaimer is also signed by the bankers of EOH after which they have an option to open an inland L/C specifying the goods to be supplied to the EOH as a part of the export transaction. On basis of such an L/C, the subsupplier bank may grant a packing credit to the subsupplier to manufacture the components required for exports.On supply of goods, the L/C opening bank will pay to the sub supplier's bank against the inland documents received on the basis of the inland L/C opened by them.

The final responsibility of EOH is to export the goods as per guidelines. Any delay in export order can bring EOH to penal provisions that can be issued anytime.

The main objective of this method is to cover only the first stage of production cycles, and is not to be extended to cover supplies of raw material etc. Running account facility is not granted to subsuppliers.

In case the EOH is a trading house, the facility is available commencing from the manufacturer to whom the order has been passed by the trading house.

Banks however, ensure that there is no double financing and the total period of packing credit does not exceed the actual cycle of production of the commodity. 

Running Account facility

2. It is a special facility under which a bank has right to grant preshipment advance for export to the exporter of any origin. Sometimes banks also extent these facilities depending upon the good track record of the exporter. In return the exporter needs to produce the letter of credit / firms export order within a given period of time.

Preshipment Credit in Foreign Currency (PCFC)

3. Authorised dealers are permitted to extend Preshipment Credit in Foreign Currency (PCFC) with an objective of making the credit available to the exporters at internationally competitive price. This is considered as an added advantage under which credit is provided in foreign currency in order to facilitate the purchase of raw material after fulfilling the basic export orders.

The rate of interest on PCFC is linked to London Interbank Offered Rate (LIBOR). According to guidelines, the final cost of exporter must not exceed 0.75% over 6 month LIBOR, excluding the tax.

The exporter has freedom to avail PCFC in convertible currencies like USD, Pound, Sterling, Euro, Yen etc. However, the risk associated with the cross currency truncation is that of the exporter.

The sources of funds for the banks for extending PCFC facility include the Foreign Currency balances available with the Bank in Exchange, Earner Foreign Currency Account (EEFC), Resident Foreign Currency Accounts RFC(D) and Foreign Currency(NonResident) Accounts.

Banks are also permitted to utilize the foreign currency balances available under Escrow account and Exporters Foreign Currency accounts. It ensures that the requirement of funds by the account holders for permissible transactions is met. But the limit prescribed for maintaining maximum balance in the account is not exceeded. In addition, Banks may arrange for borrowings from abroad. Banks may negotiate terms of credit with overseas bank for the purpose of grant of PCFC to exporters, without the prior approval of RBI, provided the rate of interest on borrowing does not exceed 0.75% over 6 month LIBOR.

Packing Credit Facilities to Deemed Exports

4. Deemed exports made to multilateral funds aided projects and programmes, under orders secured through global tenders for which payments will be made in free foreign exchange, are eligible for concessional rate of interest facility both at pre and post supply stages.

Packing Credit facilities for Consulting Services

5. In case of consultancy services, exports do not involve physical movement of goods out of Indian Customs Territory. In such cases, Preshipment finance can be provided by the bank to allow the exporter to mobilize resources like technical personnel and training them.

Advance against Cheque/Drafts received as advance payment

6. Where exporters receive direct payments from abroad by means of cheques/drafts etc. the bank may grant export credit at concessional rate to the exporters of goods track record, till the time of realization of the proceeds of the cheques or draft etc. The Banks however, must satisfy themselves that the proceeds are against an export order.

EXPORT POST SHIPMENT FINANCE (PSFL )

Introduction

Post Shipment Finance is a kind of loan provided by a financial institution to an exporter or seller against a shipment that has already been made. This type of export finance is granted from the date of extending the credit after shipment of the goods to the realization date of the exporter proceeds. Exporters don’t wait for the importer to deposit the funds.

Basic Features

The features of postshipment finance are:

Purpose of FinancePostshipment finance is meant to finance export sales receivable after the date of shipment of goods to the date of realization of exports proceeds. In cases of deemed exports, it is extended to finance receivable against supplies made to designated agencies.

Basis of FinancePostshipment finances is provided against evidence of shipment of goods or supplies made to the importer or seller or any other designated agency.

Types of Finance

Postshipment finance can be secured or unsecured. Since the finance is extended against evidence of export shipment and bank obtains the documents of title of goods, the finance is normally self liquidating. In that case it involves advance against undrawn balance, and is usually unsecured in nature.Further, the finance is mostly a funded advance. In few cases, such as financing of project exports, the issue of guarantee (retention money guarantees) is involved and the financing is not funded in nature.

Quantum of FinanceAs a quantum of finance, postshipment finance can be extended up to 100% of the invoice value of goods. In special cases, where the domestic value of the goods increases the value of the exporter order, finance for a price difference can also be extended and the price difference is covered by the government. This type of finance is not extended in case of preshipment stage.Banks can also finance undrawn balance. In such cases banks are free to stipulate margin requirements as per their usual lending norm.

Period of FinancePostshipment finance can be off short terms or long term, depending on the payment terms offered by the exporter to the overseas importer. In case of cash exports, the maximum period allowed for realization of exports proceeds is six months from the date of shipment. Concessive rate of interest is available for a highest period of 180 days, opening from the date of surrender of documents. Usually, the documents need to be submitted within 21days from the date of shipment.

Financing For Various Types of Export Buyer's Credit

Postshipment finance can be provided for three types of export :

Physical exports: Finance is provided to the actual exporter or to the exporter in whose name the trade documents are transferred.

Deemed export: Finance is provided to the supplier of the goods which are supplied to the designated agencies.

Capital goods and project exports: Finance is sometimes extended in the name of overseas buyer. The disbursal of money is directly made to the domestic exporter.

Supplier's Credit

Buyer's Credit is a special type of loan that a bank offers to the buyers for large scale purchasing under a contract. Once the bank approved loans to the buyer, the seller shoulders all or part of the interests incurred. 

Types of Post Shipment Finance

The post shipment finance can be classified as :

1. Export Bills purchased/discounted.2. Export Bills negotiated3. Advance against export bills sent on collection basis.4. Advance against export on consignment basis5. Advance against undrawn balance on exports6. Advance against claims of Duty Drawback.

1. Export Bills Purchased/ Discounted.(DP & DA Bills)

Export bills (Non L/C Bills) is used in terms of sale contract/ order may be discounted or purchased by the banks. It is used in indisputable international trade transactions and the proper limit has to be sanctioned to the exporter for purchase of export bill facility.

2. Export Bills Negotiated (Bill under L/C)

The risk of payment is less under the LC, as the issuing bank makes sure the payment. The risk is further reduced, if a bank guarantees the payments by confirming the LC. Because of the inborn security available in this method, banks often become ready to extend the finance against bills under LC.

 However, this arises two major risk factors for the banks:

1. The risk of nonperformance by the exporter, when he is unable to meet his terms and conditions. In this case, the issuing banks do not honor the letter of credit.

2. The bank also faces the documentary risk where the issuing bank refuses to honour its commitment. So, it is important for the for the negotiating bank, and the lending bank to properly check all the necessary documents before submission.

3. Advance Against Export Bills Sent on Collection Basis

Bills can only be sent on collection basis, if the bills drawn under LC have some discrepancies. Sometimes exporter requests the bill to be sent on the collection basis, anticipating the strengthening of foreign currency. Banks may allow advance against these collection bills to an exporter with a concessional rates of interest depending upon the transit period in case of DP Bills and transit period plus usance period in case of usance bill.The transit period is from the date of acceptance of the export documents at the banks branch for collection and not from the date of advance.

4. Advance Against Export on Consignments Basis

Bank may choose to finance when the goods are exported on consignment basis at the risk of the exporter for sale and eventual payment of sale proceeds to him by the consignee.However, in this case bank instructs the overseas bank to deliver the document only against trust receipt /undertaking to deliver the sale proceeds by specified date, which should be within the prescribed date even if according to the practice in certain trades a bill for part of the estimated value is drawn in advance against the exports.

In case of export through approved Indian owned warehouses abroad the times limit for realization is 15 months.

5. Advance against Undrawn Balance

It is a very common practice in export to leave small part undrawn for payment after adjustment due to difference in rates, weight, quality etc. Banks do finance against the undrawn balance, if undrawn balance is in conformity with the normal level of balance left undrawn in the particular line of export, subject to a maximum of 10 percent of the export value. An undertaking is also obtained from the exporter that he will, within 6 months from due date of payment or the date of shipment of the goods, whichever is earlier surrender balance proceeds of the shipment. 

6. Advance Against Claims of Duty Drawback

Duty Drawback is a type of discount given to the exporter in his own country. This discount is given only, if the inhouse cost of production is higher in relation to international price. This type of financial support helps the exporter to fight successfully in the international markets.

In such a situation, banks grants advances to exporters at lower rate of interest for a maximum period of 90 days. These are granted only if other types of export finance are also extended to the exporter by the same bank.

After the shipment, the exporters lodge their claims, supported by the relevant documents to the relevant government authorities. These claims are processed and eligible amount is disbursed after making sure that the bank is authorized to receive the claim amount directly from the concerned government authorities.

Crystallization of Overdue Export Bills

Exporter foreign exchange is converted into Rupee liability, if the export bill purchase / negotiated /discounted is not realize on due date. This conversion occurs on the 30th day after expiry of the NTP in case of unpaid DP bills and on 30th day after national due date in case of DA bills, at prevailing TT selling rate ruling on the day of crystallization, or the original bill buying rate, whichever is higher.

BANK GUARANTEE

Introduction

A bank guarantee is a written contract given by a bank on the behalf of a customer. By issuing this guarantee, a bank takes responsibility for payment of a sum of money in case, if it is not paid by the customer on whose behalf the guarantee has been issued. In return, a bank gets some commission for issuing the guarantee. 

Any one can apply for a bank guarantee, if his or her company has obligations towards a third party for which funds need to be blocked in order to guarantee that his or her company fulfils its obligations (for example carrying out certain works, payment of a debt, etc.).

In case of any changes or cancellation during the transaction process, a bank guarantee remains valid until the customer dully releases the bank from its liability.

In the situations, where a customer fails to pay the money, the bank must pay the amount within three working days. This payment can also be refused by the bank, if the claim is found to be unlawful.

Benefits of Bank Guarantees

For Governments1. Increases the rate of private financing for key sectors such as infrastructure.2. Provides access to capital markets as well as commercial banks.3. Reduces cost of private financing to affordable levels.4. Facilitates privatizations and public private partnerships.5. Reduces government risk exposure by passing commercial risk to the private sector.

For Private Sector1. Reduces risk of private transactions in emerging countries.2. Mitigates risks that the private sector does not control.3. Opens new markets.4. Improves project sustainability.

Legal Requirements

Bank guarantee is issued by the authorised dealers under their obligated authorities notified vide FEMA 8/ 2000 dt 3rd May 2000. Only in case of revocation of guarantee involving US $ 5000 or more need to be reported to Reserve Bank of India (RBI).

Types of Bank Guarantees 1. Direct or Indirect Bank Guarantee: A bank guarantee can be either direct or indirect.

Direct Bank Guarantee It is issued by the applicant's bank (issuing bank) directly to the guarantee's beneficiary without concerning a correspondent bank. This type of guarantee is less expensive and is also subject to the law of the country in which the guarantee is issued unless otherwise it is mentioned in the guarantee documents.

Indirect Bank Guarantee With an indirect guarantee, a second bank is involved, which is basically a representative of the issuing bank in the country to which beneficiary belongs. This involvement of a second bank is done on the demand of the beneficiary. This type of bank guarantee is more time consuming and expensive too.

2. Confirmed Guarantee It is cross between direct and indirect types of bank guarantee. This type of bank guarantee is issued directly by a bank after which it is send to a foreign bank for confirmations. The foreign banks confirm the original documents and thereby assume the responsibility.

3. Tender BondThis is also called bid bonds and is normally issued in support of a tender in international trade. It provides the beneficiary with a financial remedy, if the applicant fails to fulfill any of the tender conditions.

4. Performance BondsThis is one of the most common types of bank guarantee which is used to secure the completion of the contractual responsibilities of delivery of goods and act as security of penalty payment by the Supplier in case of nondelivery of goods. 

5. Advance Payment GuaranteesThis mode of guarantee is used where the applicant calls for the provision of a sum of money at an early stage of the contract and can recover the amount paid in advance, or a part thereof, if the applicant fails to fulfill the agreement.

6. Payment Guarantees This type of bank guarantee is used to secure the responsibilities to pay goods and services. If the beneficiary has fulfilled his contractual obligations after delivering the goods or services but the debtor fails to make the payment, then after written declaration the beneficiary can easily obtain his money form the guaranteeing bank.

7. Loan Repayment GuaranteesThis type of guarantee is given by a bank to the creditor to pay the amount of loan body and interests in case of nonfulfillment by the borrower. 

8. B/L Letter of IndemnityThis is also called a letter of indemnity and is a type of guarantee from the bank making sure that any kind of loss of goods will not be suffered by the carrier. 

9. Rental GuaranteeThis type of bank guarantee is given under a rental contract. Rental guarantee is either limited to rental payments only or includes all payments due under the rental contract including cost of repair on termination of the rental contract.

10. Credit Card GuaranteeCredit card guarantee is issued by the credit card companies to its customer as a guarantee that the merchant will be paid on transactions regardless of whether the consumer pays their credit.

How to Apply for Bank Guarantee

Procedure for Bank Guarantees are very simple and are not governed by any particular legal regulations. However, to obtained the bank guarantee one need to have a current account in the bank.  Guarantees can be issued by a bank through its authorised dealers as per notifications mentioned in the FEMA 8/2000 date 3rd May 2000. Only in case of revocation of guarantee involving US $ 5000/ or more to be reported to Reserve Bank of India along with the details of the claim received.

Bank Guarantees vs. Letters of Credit

A bank guarantee is frequently confused with letter of credit (LC), which is similar in many ways but not the same thing. The basic difference between the two is that of the parties involved. In a bank guarantee, three parties are involved; the bank, the person to whom the guarantee is given and the person on whose behalf the bank is giving guarantee. In case of a letter of credit, there are normally four parties involved; issuing bank, advising bank, the applicant (importer) and the beneficiary (exporter).

Also, as a bank guarantee only becomes active when the customer fails to pay the necessary amount where as in case of letters of credit, the issuing bank does not wait for the buyer to default, and for the seller to invoke the undertaking.

Statements of Accounting Standards (AS 11)

Accounting for the Effects of Changes in Foreign Exchange Rates

(In this Accounting Standard, the Standard portions have been set in bold italic type. These should be read in the context of the background material which has been set in normal type, and in the context of the 'Preface to the Statements of Accounting Standards'.)

The following is the text of Accounting Standard (AS) 11, 'Accounting for the Effects of Changes in Foreign Exchange Rates', issued by the Council of the Institute of Chartered Accountants of India.

This Standard will come into effect in respect of accounting periods commencing on or after 1.4.1995 and will be mandatory in nature.

Objective

An enterprise may have transactions in foreign currencies or it may have foreign branches. Foreign currency transactions should be expressed in the enterprise's reporting currency and the financial statements of foreign branches should be translated into the enterprise's reporting currency in order to include them in the financial statements of the enterprise.

The principal issues in accounting for foreign currency transactions and foreign branches are to decide which exchange rate to use and how to recognise in the financial statements the financial effect of changes in exchange rates.

Scope

1. This Statement should be applied by an enterprise :

(a) in accounting for transactions in foreign currencies; and

(b) in translating the financial statements of foreign branches for inclusion in the financial statements of the enterprise.

Definitions

2. The following terms are used in this Statement with the meanings specified :

Reporting currency is the currency used in presenting the financial statements.

Foreign currency is a currency other than the reporting currency of an enterprise.

Exchange rate is the ratio for exchange of two currencies as applicable to the realisation of a specific asset or the payment of a specific liability or the recording of a specific transaction or a group of inter-related transactions.

Average rate is the mean of the exchange rates in force during a period.

Forward rate is the exchange rate established by the terms of an agreement for exchange of two currencies at a specified future date.

Closing rate is the exchange rate at the balance sheet date.

Monetary items are money held and assets and liabilities to be received or paid in fixed or determinable amounts of money, e.g., cash, receivables, payables.

Non-monetary items are assets and liabilities other than monetary items e.g. fixed assets, inventories, investments in equity shares.

Settlement date is the date at which a receivable is due to be collected or a payable is due to be paid.

Recoverable amount is the amount which the enterprise expects to recover from the future use of an asset, including its residual value on disposal.

Foreign Currency Transactions

Exchange Rate

3. A multiplicity of foreign exchange rates is possible in a given situation. In such a case, the term 'exchange rate' refers to the rate which is applicable to the particular transaction.

4. The term 'exchange rate' is defined in this Statement with reference to a specific asset, liability or transaction or a group of inter-related transactions. For the purpose of this Statement, two or more transactions are considered inter-related if, by virtue of being set off against one another or otherwise, they affect the net amount of reporting currency that will be available on, or required for, the settlement of those transactions. Although the exchange rates applicable to realisations and disbursements in a foreign currency may be different, an enterprise may, where legally permissible, partly use the receivables to settle the payables directly, in which case the payables and receivables are reported at the exchange rate as applicable to the net amount of receivable or payable. Further, where realisations are deposited into, and disbursements made out of, a foreign currency bank account, all the transactions during a period (e.g. a month) are reported at a rate that approximates the actual rate during that period. However, where transactions cannot be considered inter-related as stated above, by set-off or otherwise, the receivables and payables are reported at the rates applicable to the respective amounts even where these are receivable from, or payable to, the same foreign party.

Recording Transactions on Initial Recognition

5. A transaction in a foreign currency should be recorded in the reporting currency by applying to the foreign currency amount the exchange rate between the reporting currency and the foreign currency at the date of the transaction, except as stated in para 4 above in respect of inter-related transactions.

6. A transaction in a foreign currency is recorded in the financial records of an enterprise as at the date on which the transaction occurs, normally using the exchange rate at that date. This exchange rate is often referred to as the spot rate. For practical reasons, a rate that approximates the actual rate is often used, for example, an average rate for all transactions during the week or month in which the transactions occur. However, if exchange rates fluctuate significantly, the use of the average rate for a period is unreliable.

Reporting Effects of Changes in Exchange Rates Subsequent to Initial Recognition

7. At each balance sheet date :

(a) monetary items denominated in a foreign currency (e.g. foreign currency notes, balances in bank accounts denominated in a foreign currency, and receivables, payables and loans denominated in a foreign currency) should be reported using the closing rate. However, in certain circumstances, the closing rate may not reflect with reasonable accuracy the amount in reporting currency that is likely to be realised from, or required to disburse, a foreign currency monetary item at the balance sheet date, e.g., where there are restrictions on remittances or where the closing rate is unrealistic and it is not possible to effect an exchange of currencies at that rate at the balance sheet date. In such circumstances, the relevant monetary item should be reported in the reporting currency at the amount which is likely to be realised from, or required to disburse, such item at the balance sheet date;

(b) non-monetary items other than fixed assets, which are carried in terms of historical cost denominated in a foreign currency, should be reported using the exchange rate at the date of the transaction;

(c) non-monetary items other than fixed assets, which are carried in terms of fair value or other similar valuation, e.g. net realisable value, denominated in a foreign currency, should be reported using the exchange rates that existed when the values were determined (e.g. if the fair

value is determined as on the balance sheet date, the exchange rate on the balance sheet date may be used); and

(d) the carrying amount of fixed assets should be adjusted as stated in paragraphs 10 and 11 below.

Recognition of Exchange Differences

8. Paragraphs 9 to 11 set out the accounting treatment required by this Statement in respect of exchange differences on foreign currency transactions.

9. Exchange differences arising on foreign currency transactions should be recognised as income or as expense in the period in which they arise, except as stated in paragraphs 10 and 11 below.

10. Exchange differences arising on repayment of liabilities incurred for the purpose of acquiring fixed assets, which are carried in terms of historical cost, should be adjusted in the carrying amount of the respective fixed assets. The carrying amount of such fixed assets should, to the extent not already so adjusted or otherwise accounted for, also be adjusted to account for any increase or decrease in the liability of the enterprise, as expressed in the reporting currency by applying the closing rate, for making payment towards the whole or a part of the cost of the assets or for repayment of the whole or a part of the monies borrowed by the enterprise from any person, directly or indirectly, in foreign currency specifically for the purpose of acquiring those assets.

11. The carrying amount of fixed assets which are carried in terms of revalued amounts should also be adjusted in the manner described in paragraph 10 above. However, such adjustment should not result in the net book value of a class of revalued fixed assets exceeding the recoverable amount of assets of that class, the remaining amount of the increase in liability, if any, being debited to the revaluation reserve, or to the profit and loss statement in the event of inadequacy or absence of the revaluation reserve.

12. An exchange difference results when there is a change in the exchange rate between the transaction date and the date of settlement of any monetary items arising from a foreign currency transaction. When the transaction is settled within the same accounting period as that in which it occurred, the entire exchange difference arises in that period. However, when the transaction is not settled in the same accounting period as that in which it occurred, the exchange difference arises over more than one accounting period.

Forward Exchange Contracts

13. An enterprise may enter into a forward exchange contract, or another financial instrument that is in substance a forward exchange contract, to establish the amount of the reporting currency required or available at the settlement date of a transaction. The difference between the forward rate and the exchange rate at date of the transaction should be recognised as income or expense over the life of the contract, except in respect of liabilities incurred for acquiring fixed assets, in which case, such difference should be adjusted in the carrying amount of the respective fixed assets.

14. The difference between the forward rate and the exchange rate at the inception of a forward exchange contract is recognised as income or expense over the life of the contract. The only exception is in respect of forward exchange contracts related to liabilities in foreign currency incurred for acquisition of fixed assets.

15. Any profit or loss arising on cancellation or renewal of a forward exchange contract should be recognised as income or as expense for the period, except in case of a forward exchange contract relating to liabilities incurred for acquiring fixed assets, in which case, such profit or loss should be adjusted in the carrying amount of the respective fixed assets.

Depreciation

16. Where the carrying amount of a depreciable asset has undergone a change in accordance with paragraph 10 or paragraph 11 or paragraph 13 or paragraph 15 of this Statement, the depreciation on the revised unamortised depreciable amount should be provided in accordance with Accounting Standard (AS) 6, Depreciation Accounting.

Translation of the Financial Statements of Foreign Branches

17. The need for foreign currency translation arises in respect of the financial statements of foreign branches of the parent enterprise.

18. The financial statements of a foreign branch should be translated using the procedures in paragraphs 19 to 25 of this Statement.

19. Revenue items, except opening and closing inventories and depreciation, should be translated into reporting currency of the reporting enterprise at average rate. In appropriate circumstances, weighted average rate may be applied, e.g., where the income or expenses are not earned or incurred evenly during the accounting period (such as in the case of seasonal businesses) or where there are exceptionally wide fluctuations in exchange rates during the accounting period. Opening and closing inventories should be translated at the rates prevalent at the commencement and close respectively of the accounting period. Depreciation should be translated at the rates used for the translation of the values of the assets on which depreciation is calculated.

20. Monetary items should be translated using the closing rate. However, in circumstances where the closing rate does not reflect with reasonable accuracy the amount in reporting currency that is likely to be realised from, or required to disburse, the foreign currency item at the balance sheet date, a rate that reflects approximately the likely realisation or disbursement as aforesaid should be used.

21. Non-monetary items other than inventories and fixed assets should be translated using the exchange rate at the date of the transaction.

22. Fixed assets should be translated using the exchange rate at the date of the transaction. Where there has been an increase or decrease in the liability of the enterprise, as expressed in Indian rupees by applying the closing rate, for making payment towards the whole or a part of the cost of a fixed asset or for repayment of the whole or a part of monies borrowed by the enterprise from any person, directly or indirectly, in foreign currency specifically for the purpose of acquiring a fixed asset, the amount by which the liability is so increased or reduced during the year, should be added to, or reduced from, the historical cost of the fixed asset concerned.

23. Balance in 'head office account', whether debit or credit, should be reported at the amount of the balance in the 'branch account' in the books of the head office after adjusting for unresponded transactions.

24. The net exchange difference resulting from the translation of items in the financial statements of a foreign branch should be recognised as income or as expense for the period, except to the extent adjusted in the carrying amount of the related fixed assets in accordance with paragraph 22 above.

25. Contingent liabilities should be translated into the reporting currency of the enterprise at the closing rate. The translation of contingent liabilities does not result in any exchange difference as defined in this Statement.

Disclosures

26. An enterprise should disclose -

(i) the amount of exchange differences included in the net profit or loss for the period;

(ii) the amount of exchange differences adjusted in the carrying amount of fixed assets during the accounting period; and

(iii) the amount of exchange differences in respect of forward exchange contracts to be recognised in the profit or loss for one or more subsequent accounting periods, as required by paragraph 13.27. Disclosure is also encouraged of an enterprise's foreign currency risk management policy.

LIBOR

The Libor is the average interest rate that leading banks in London charge when lending to other banks. It is an acronym for London Interbank Offered Rate (LIBOR ) Banks borrow money for one day, one month, two months, six months, one year, etc., and they pay interest to their lenders based on certain rates. The Libor figure is an average of these rates. Many financial institutions, mortgage lenders and credit card agencies track the rate, which is produced daily at 11 a.m. to fix their own interest rates which are typically higher than the Libor rate. As such, it is a benchmark for finance all around the world.

Introduction

In 1984, it became apparent that an increasing number of banks were trading actively in a

variety of relatively new market instruments, notably interest rate swaps, foreign currency

options and forward rate agreements. While recognizing that such instruments brought more

business and greater depth to the London Interbank market, bankers worried that future growth

could be inhibited unless a measure of uniformity was introduced. In October 1984, the British

Bankers' Association (BBA)—working with other parties, such as the Bank of England—

established various working parties, which eventually culminated in the production of the BBA

standard for interest rate swaps, or "BBAIRS" terms. Part of this standard included the fixing of

BBA interest-settlement rates, the predecessor of BBA Libor. From 2 September 1985, the

BBAIRS terms became standard market practice.

BBA Libor fixings did not commence officially before 1 January 1986. Before that date, however,

some rates were fixed for a trial period commencing in December 1984.

How Is LIBOR Used?

In addition to setting rates for interbank loans, LIBOR is also used to guide banks in setting rates for adjustable-rate loans, including interest-only mortgages and credit card debt. Lenders typically add a point or two to create a profit. The BBA estimates that $10 trillion in loans are affected by the LIBOR rate.

LIBOR is also the rate used to base the price for credit default swaps. These are a form of

insurance against the default of loans. They helped caused the financial crisis of 2008 by lulling

banks and hedge funds into thinking there was no risk to the mortgage-backed securities these

swaps insured. However, when the subprime mortgages that were behind

these derivatives began to default, insurance companies like AIG didn't have enough cash on

hand to pay off all the swaps. The Federal Reserve had to bail out AIG to keep all those who held

swaps from going bankrupt. Even today, LIBOR is the basis for $350 trillion of credit default

swaps.

LIBOR was created in the 1980s as banks called for a reliable source to set interest rates for

derivatives. The first LIBOR rate was announced in 1986 for three currencies: the U.S. dollar, the

British sterling and the Japanese Yen.

Repo (Repurchase) Rate

Repo rate is the rate at which banks borrow funds from the RBI to meet the gap between the

demand they are facing for money (loans) and how much they have on hand to lend.

If the RBI wants to make it more expensive for the banks to borrow money, it increases the repo

rate; similarly, if it wants to make it cheaper for banks to borrow money, it reduces the repo rate.

Reverse Repo Rate

This is the exact opposite of repo rate.

The rate at which RBI borrows money from the banks (or banks lend money to the RBI) is termed

the reverse repo rate. The RBI uses this tool when it feels there is too much money floating in

the banking system

If the reverse repo rate is increased, it means the RBI will borrow money from the bank and offer

them a lucrative rate of interest. As a result, banks would prefer to keep their money with the

RBI (which is absolutely risk free) instead of lending it out (this option comes with a certain

amount of risk)

Consequently, banks would have lesser funds to lend to their customers. This helps stem the

flow of excess money into the economy

Reverse repo rate signifies the rate at which the central bank absorbs liquidity from the banks,

while repo signifies the rate at which liquidity is injected.

Bank Rate

This is the rate at which RBI lends money to other banks (or financial institutions .

The bank rate signals the central bank’s long-term outlook on interest rates. If the bank rate

moves up, long-term interest rates also tend to move up, and vice-versa.

Banks make a profit by borrowing at a lower rate and lending the same funds at a higher rate of

interest. If the RBI hikes the bank rate (this is currently 6 per cent), the interest that a bank pays

for borrowing money (banks borrow money either from each other or from the RBI) increases. It,

in turn, hikes its own lending rates to ensure it continues to make a profit.

Call Rate

Call rate is the interest rate paid by the banks for lending and borrowing for daily fund

requirement. Si nce banks need funds on a daily basis, they lend to and borrow from other banks

according to their daily or short-term requirements on a regular basis.

CRR

Also called the cash reserve ratio, refers to a portion of deposits (as cash) which banks have to

keep/maintain with the RBI. This serves two purposes. It ensures that a portion of bank deposits

is totally risk-free and secondly it enables that RBI control liquidity in the system, and thereby,

inflation by tying their hands in lending money

SLR

Besides the CRR, banks are required to invest a portion of their deposits in government

securities as a part of their statutory liquidity ratio (SLR) requirements. What SLR does is again

restrict the bank’s leverage in pumping more money into the economy.

Q 1. WWhat is an EEFC Account and what are its benefits?Ans. Exchange Earners' Foreign Currency Account (EEFC) is an account maintained in foreign currency with an Authorised Dealer i.e. a bank dealing in foreign exchange. It is a facility provided to the foreign exchange earners, including exporters, to credit 100 per cent of their foreign exchange earnings to the account, so that the account holders do not have to convert foreign exchange into Rupees and vice versa, thereby minimizing the transaction costs.

Q 2. Who can open an EEFC account?Ans. All categories of foreign exchange earners, such as individuals, companies, etc. who are resident in India, may open EEFC accounts.

Q 3. What are the different types of EEFC accounts? Can interest be paid on these accounts?Ans. An EEFC account can be held only in the form of a current account. No interest is payable on EEFC accounts.

Q 4. How much of one’s foreign exchange earnings can be credited into an EEFC account?Ans. One can credit up to 100 per cent of his/ her foreign exchange earnings into the EEFC account, subject to permissible credits and debits.

Q 5. Whether EEFC Account can be opened by Special Economic Zone (SEZ) Units?Ans. No, SEZ Units cannot open EEFC Accounts.However, a unit located in a Special Economic Zone can open a Foreign Currency Account with an authorised dealer in India subject to certain conditions. SEZ Developers can open EEFC Accounts.

Q 6. Is there any Cheque facility available?Ans.  Yes; Cheque facility is available for operation of the EEFC account.

Q 7. What are the permissible credits into this account?Ans.i) Inward remittance through normal banking channels, other than remittances received on account of foreign currency loan or investment received from abroad or received for meeting specific obligations by the account holder; 

ii) Payments received in foreign exchange by a 100 per cent Export Oriented Unit or a unit in (a) Export Processing Zone or (b) Software Technology Park or (c) Electronic Hardware Technology Park for supply of goods to similar such units  or to a unit in Domestic Tariff Area;

iii) Payments received in foreign exchange by a unit in the Domestic Tariff Area for supply of goods to a unit in the Special Economic Zone (SEZ);

iv) Payment received by an exporter from an account maintained with an authorised dealer for the purpose of counter trade. (Counter trade is an arrangement involving adjustment of value of goods imported into India against value of goods exported from India in terms of the Reserve Bank guidelines); 

v) Advance remittance received by an exporter towards export of goods or services; 

vi) Payment received for export of goods and services from India, out of funds representing

repayment of State Credit in U.S. Dollar held in the account of Bank for Foreign Economic Affairs, Moscow, with an authorised dealer in India; 

vii) Professional earnings including directors fees, consultancy fees, lecture fees, honorarium and similar other earnings received by a professional by rendering services in his individual capacity;

viii) Re-credit of unutilised foreign currency earlier withdrawn from the account; 

ix) Amount representing repayment by the account holder's importer customer, of loan/advances granted, to the exporter holding such account; and

x) The disinvestment proceeds received by the resident account holder on conversion of shares held by him to ADRs/GDRs under the Sponsored ADR/GDR Scheme approved by the Foreign Investment Promotion Board of the Government of India.

Q 8. Can foreign exchange earnings received through an international credit card be credited to the EEFC account?Ans. Yes, foreign exchange earnings received through an international credit card for which reimbursement has been made in foreign exchange may be regarded as a remittance through normal banking channel and the same can be credited to the EEFC account.

Q 9. What are the permissible debits into this account?Ans. i) Payment outside India towards a permissible current account transaction [in accordance to the provisions of the Foreign Exchange Management (Current Account Transactions) Rules, 2000] and permissible capital account transaction [in accordance to the Foreign Exchange Management (Permissible Capital Account Transactions) Regulations, 2000].ii) Payment in foreign exchange towards cost of goods purchased from a 100 percent Export Oriented Unit or a Unit in (a) Export Processing Zone or (b) Software Technology Park or (c) Electronic Hardware Technology Parkiii) payment of customs duty in accordance with the provisions of the Foreign Trade Policy of the Central Government for the time being in force.iv) Trade related loans/advances, extended by an exporter holding such account to his importer customer outside India, subject to compliance with the Foreign Exchange Management (Borrowing and Lending in Foreign Exchange) Regulations, 2000.v) Payment in foreign exchange to a person resident in India for supply of goods/services including payments for airfare and hotel expenditure.

Q 10. Is there any restriction on withdrawal in rupees of funds held in an EEFC account?Ans. No, there is no restriction on withdrawal in Rupees of funds held in an EEFC account. However, the amount withdrawn in Rupees shall not be eligible for conversion into foreign currency and for re-credit to the account.

Q. 11. Whether the EEFC balances can be covered against exchange risk?Ans. Yes, the EEFC account balances can be hedged. The balances in the account sold forward by the account holders has to remain earmarked for delivery.   However, the contracts can be rolled over.

Definition of 'Forward Contract'A cash market transaction in which delivery of the commodity is deferred until after the contract has been made. Although the delivery is made in the future, the price is determined on the initial trade date.

Investopedia explains 'Forward Contract'

Most forward contracts don't have standards and aren't traded on exchanges. A farmer would use a forward contract to "lock-in" a price for his grain for the upcoming fall harvest.

Definition of 'Currency Forward'A forward contract in the forex market that locks in the price at which an entity can buy or sell a currency on a future date. Also known as "outright forward currency transaction", "forward outright" or "FX forward".

Investopedia explains 'Currency Forward'In currency forward contracts, the contract holders are obligated to buy or sell the currency at a specified price, at a specified quantity and on a specified future date. These contracts cannot be transferred. 

Why we are paying service tax and on what basis service tax charged?

This question must be asked to the Finance Minister that why we are paying service tax, because he has imposed the same on the public and what basis means in all categories, which services are provided to the Govt. Dept. and the public sector each and every person have to pay service tax, automatically it will go to the Govt. Treasury and will be utilized for the benefits of peoples only

Service tax is payable when advance is received.o Service requires two parties. One cannot give service to himself.o Service tax is payable by service providero In case of Goods Transport Agency (GTA), Import of Service, Sponsorship service and Agent

of mutual fund and insurance, service tax is payable by service receiver.o Service tax is payable on gross amount charged for taxable service provided or to be

provided o Tax is payable on reimbursement of expenses which are part of service, but not on payments

made by service provider as ‘pure agent’ of service receivero Service tax is not payable on amounts collected by service provider from service receiver

which are not part of service but are paid by service provider to third parties for administrative convenience and then recovered from service receiver, even if all requirements of definition of ‘pure agent’ are not satisfied.

o If value is not ascertainable, valuation can be on basis of similar service or on basis of value which shall not be less than cost.

o The exemption is not available if service is provided under brand name of other person.o Services provided to SEZ unit or developer are exempt if wholly consumed within SEZ. In

case of services consumed by SEZ outside SEZ, refund claim has to be filed.o Services provided by RBI are exempt but service provided to RBI are not exempt.

o Service tax is not payable on basis of amounts charged in the bills/invoice, but only on amounts actually received during the relevant period, except in case of associated enterprises. If partial amount is received, tax will be payable on pro rata basis.

o The exception is that in case of service provided to associated enterprises, service tax is payable as soon as book entry is made in the books of service provider (when he is liable) or service receiver (when he is liable to pay service tax under reverse charge method).

o Tax is payable by GAR-7 challan using appropriate accounting code. E-payment is compulsory to those who are paying service tax of more than Rs 10 lakhs per annum. For others, e-payment is optional.

Due Dates of Service Tax

Monthly – 5th of each month6th In case of e-payment.

For March – 31st MarchReturn ( half yearly ) From 01st April to 30th September – 25th October

From 01st Oct to 31st March - 25th April

Form ST – 3 for Service tax return.