TYPES OF BANK CREDIT

TYPES OF BANK CREDIT

The following are different types of bank credit:

1. LOAN AND ADVANCES
A) OVERDRAFTS: These are the most common and simplest forms of credit facilities. They are usually granted for working capital purposes and the amount outstanding is expected to fluctuate over the life of the facilities, depending on the borrower‟s working capital financing needs, at any material time.

Overdrafts permit the borrower to use those amounts required on a day to day basis, thus saving unnecessary interest charges. In accordance with general banking practice, overdrafts are repayable on demand and can be cancelled at the bank‟s option without prior notice to the borrower. The overdraft limit is usually communicated to the customer and this limit serves as the bank‟s reference point in all drawings by the beneficiary.

B) ADVANCES: An advance is a short-term credit which is granted for a definite period, usually between 30 and 180 days. They are usually granted for specific purposes, for example, payment of various collections, refinancing of maturing loans, project bridging finance, refinancing of letters of credit for project equipment imported etc. The exact maturity date of an advance is normally determined at the onset and this makes it possible for the project to have a lower interest charge on the advance due to the reduced risk (money rate and credit risk).

Short-term loans are also used in financing seasonal increases in working capital and also in temporary accommodations of a project capital expenditure needs, and other long-term commitments, pending final negotiation of long-term loan. Most times, short term loans are usually renewed at maturity. Banks predominantly extend substantial amounts of short-term loans to farming, manufacturing, small-scale project etc.

Short-term loans may be secured or unsecured. Banks extend secured loans to borrowers who have a high debt/equity ratio, or projects that have not established a record of satisfactory performance and stable earnings or generated enough sales revenue in relation to their capital. Large exposures are also often secured.

Unsecured loans, although disallowed by banking laws in Nigeria, are granted in exceptional cases to projects that are properly financed, have adequate capital and net worth, competent management, stable earnings, a record of prompt payment of obligations, and a bright future. Unsecured loans, however, often crystallize into bad debts in the Nigerian banking scene.

C) MEDIUM- TERM LOANS: These constitute important sources of intermediate funds for projects and businesses. Medium-term loans are usually granted for specific purposes such as investments, equipment financing, housing, share acquisitions, agricultural financing, construction etc.

A medium-terms loan is a facility with an original maturity of more than one year or a loan granted under a formal agreement (revolving credit or credits) on which the original maturity of the commitment is in excess of one year. Medium-term loans have maturities of between 1 and 5 years.

They are negotiated between a borrower and a lender and are most prevalent in industrial projects characterized by heavy fixed capital requirements. Most of the loans however are made to small projects and businesses which rely on these sources, due to their limited access to the capital market.

Medium-term loans provide flexibility for the user and are amortized in fixed instalments on a monthly, quarterly, semi-annual or even annual basis, as the case may be. The interest rates on this type of loan amongst other factors depend on the general level of interest rates prevailing in the market, the amount and maturity of the loan and the credit standing of the borrower. Generally, the interest rates is higher than in ordinary advances or short-term loans due to higher money and credit risks and the fact that it is less liquid.

Medium-term loans are usually supported by a loan agreement between the bank and the borrower. This agreement outlines the terms and conditions of the loan, and other important features such as:

1) Preamble which contains the parties to the loan and the purpose of the loan

2) Amount of loan

3) Tenor. The maturity of the loan is usually well specified.

4) Repayment schedule; term loans generally specify that a repayment schedule be in the form of an annuity.

5) Interest rate- this is usually specified and may range from fixed rates to floating rates

6) Security/ guarantee. There are usually specifications for collateral.
When a revolving credit agreement that does not require collaterals is converted into a term loan, the borrower may then have to secure the loan according to the conditions of the loan agreement.

7) Representations and warranties

8) Covenants of the borrower: This usually includes affirmative covenants, the negative covenant and other restrictive clauses. An example of a restrictive clause/negative clause are restrictions on the borrower from special actions such as increasing its dividend payments, making loans to its officers and /or directors and purchasing or leasing fixed assets etc.

9) Events of default/acceleration clause

10) Miscellaneous matters
Usually, a borrower is expected to execute series of promissory notes corresponding to each repayment date. Enforcement of repayment is thus facilitated and the parties tend to have a greater faith in the agreement

ADVANTAGES OF TERM LOANS
(i) Term loan affords the borrower the advantage of trading on its equity. This concept assumes that the profits on the borrowed funds exceed the cost of borrowing.

(ii) With a term loan, it is possible for the borrower to negotiate the provisions of the initial lending agreement directly with the lender.

D) LONG-TERM LOANS: Banks in Nigeria do not usually provide much of long-term loans. This is due to the nature of their deposit liabilities from where the loans are granted. Recently, however banks have been engaging in long-term lending through syndicated loan arrangements.

Long-term loans are usually provided by investment banks, development banks and various international lending agencies.

Long-term loans are granted for periods exceeding five years, and are usually provided for fixed capital requirements. They are amortized in fixed instalments like medium-term loans.

The interest rate on this type of loan is tied to market rates and usually is higher than other rates in the market, due to the higher risk exposures.

(2) SPECIAL CREDITS
These are special types of credit facilities extended by banks in favour of various projects and businesses. They are usually non-fund based and are classified as credit since they entail some risks on the part of the bank/financial institution providing the facility

(1) Public Works Bond: these are three types of public works bond.

(a) The Bid Bonds or Tender Bonds: The essence of bid bonds is to ensure that the party, to whom a project or contract has been awarded, will execute the contract successfully. The bid bond is called for the employer as soon as the contractor fails to accept the award. This is because failure to accept the terms of the contract may result in an additional cost of rewarding the contract to another contractor.

(b) Advance Payment Guarantees: most times, a bank is required to issue a guarantee on an advanced payment made to a contractor by the employer, prior to the commencement of the contract. The guarantee is in terms of the contractor‟s financial and technical standing.

(c) Performance bonds: banks issue this type of bond on behalf of their clients who have contracts. The bond provides a guarantee on the contractor‟s capability of handing the contract, his financial standing and credit rating.

(2) Customs and Excise Bonds: this type of bond is issued a by the bank to guarantee a third party ( usually a government organ) with regards to an importer‟s capability of making payment of customs duties (for imports) and excise duties ( for manufactured goods in Nigeria). As soon as the customer defaults, the bank would be held liable to pay the sum guaranteed.

(3) Bills of lading indemnities: A bill of lading is a quasi-negotiable document which confers title to goods. Banks usually issue a bill of lading indemnity to their customers, in cases where the goods imported into the country arrive before the importer (customer) receives the bill of lading. This indemnity issued will thus assist the customer in clearing the goods.
The bill of lading indemnifies the shipping company against any loss or subsequent claims on the ownership of the goods covered by the indemnity and usually the bank is primarily liable on the indemnity.

(3) DOCUMENTARY CREDITS
A documentary credit or letter of credit is a written commitment of one bank addressed to an identifiable party to pay the seller of goods or services, an agreed sum of money on condition that the seller produces documents evidencing that the goods have been shipped or that he has performed the services required of him. There are different types of documentary credits. These include: the revocable documentary credits, the irrevocable and confirmed credits. Others are revolving credits, red clause, „bank to bank‟ credit and stand-by letters of credit. For our purpose we shall concentrate on the following types.

a) Revocable Documentary Credit

b) Irrevocable, Unconfirmed Documentary Credit

c) Irrevocable Confirmed Documentary credit.

i. Revocable Documentary Credit: A revocable documentary credit allows the issuing bank to amend or cancel the credit without notice to the beneficiary (the seller) before he is paid.

ii. Irrevocable, Unconfirmed Documentary Credits: this represents a commitment by the issuing bank (usually the buyer‟s bank) to pay the seller, if the terms of the credit are met and it is usually not amended or cancelled without the seller‟s consent.

iii. Irrevocable and confirmed documentary credit: this type of documentary credit offers the best security for payment to the seller assuming he fulfils his part of the contract. In the arrangement, another bank (the confirming bank) commits itself to paying the seller, if all the conditions of the credit are fulfilled.

Documentary credits could also be categorized according to the terms of payment. Here, we could distinguish between sight credit, acceptance credits, deferred payment credit, red clause‟ credit and revolving credits.

(i) Sight credit- this is a situation where the beneficiary receives payment on presentation and examination of the documents.

(ii) Acceptance credit- In this type of credit, the beneficiary draws a time draft either on the issuing or confirming bank or on the buyer or another bank, as specified in the documentary credit. As soon as it is accepted by any of the parties above, the issuing and confirming bank guarantee payment of the instrument at maturity to any confide holder.

(iii) Deferred credit– in this form of credit, the issuing or confirming bank issues a written promise to make payment on due date. This contrasts with the acceptance credit since in the latter case; a draft is accepted upon presentation of properly confirmed documents. Here, there is an obvious advantage since the draft being a negotiable instrument, could be easily discounted.

(iv) “Red- clause” credit- this is a special type of advance credit. It authorizes the advising bank to advance a part of the credit amount to the beneficiary to enable him mobilize the merchandise.

(v) Revolving credit– this form of payment, arises where a buyer intends to place orders in excess of his requirements. The revolving credit is established stipulating intervals of delivery and thus guaranteeing payment of each delivery, assuming the terms of the credit are maintained.

The process of establishing a documentary credit involves two banks and two parties: the importer and exporter. It should be noted that banks adopt normal credit evaluation methods in granting these special credits. The basic requirements, most time, are the same as in normal loans and advances.

The two banks involved in documentary credit transactions consists of, first, the importers‟ bank also known as the opening (establishing) bank. There is also the confirming or notifying bank that is the exporter‟s bank.

REFERENCES

Bajcom, W. R. (1952). The ESUSU- A credit Institution of the Yoruba, “Journal of the Royal Auth, Institute LXXXII, I, PP 63-69.

Adekanye, f. (1986), The Element of Banking in Nigeria. U.K, Bedforddure, Gralam Burn.

Agene, C. E. (1995), the Principles of Modern Banking, Abuja, Gene Publications.

Ahmad, N.H., and Arih M. (2007), Multi-country study of Bank credit risk Determinants, International Journal of Banking and Finance, 5 (1), 135 – 152

Jhingan, M.L (2002), Macro Economic Theory: the Credit Creation 10th Edition, Delhi, Vrinda Publications (p) LTD.