Credit Facilities Overview
Fund-based Facilities Non-fund based Facilities
Fund-based credit involves the actual Non-fund based credit refers to facilities
drawdown and transfer of cash from the where no immediate funds flow from the
bank to the borrower. Examples of such bank to the borrower, at least initially.
facilities include term loans, cash credits, Examples include letters of credit and bank
and export credits. guarantees.
Fund-based facilities lead to higher Such facilities are often used in commercial
risk-weighted assets for the bank and transactions when one contracting party
therefore are subject to a higher overall seeks to mitigate against the risk of
capital charge compared to non-fund based non-payment or non-performance on the
facilities. part of the other contracting party.
Banks are required to set aside a certain A capital charge is also applicable on
percentage of capital for every unit of non-fund-based facilities.
credit they extend to a borrower. This
requirement is referred to as a “capital
charge”. It serves as a cushion to absorb
unexpected credit losses and hence protect
deposit holders and other creditors of the
bank.
Fund-based facilities earn interest income Non-fund based facilities initially earn only
on any funds drawn down, as well as fees commission or fees for the bank.
on the commitment amount.
Secured versus Unsecured Facilities
A secured facility is a facility that is made available against an asset (such as land,
equipment, or stock). In the event of borrower default, the bank takes possession of the
asset and sells it to recover its dues.
Unsecured credit does not have any security related to the facility. In the event of
borrower default and subsequent liquidation, unsecured creditors are repaid after
secured creditors, and hence have a lower recovery expectation — that is, a higher loss
given default (LGD). Note that unsecured bank lenders tend to be on par with other
unsecured creditors.
Secured facilities tend to carry a lower interest rate charge than unsecured facilities,
due to the former’s lower LGD.
As a lender, you need to ensure that the security is unencumbered and that the market
value of the security is higher than the amount of the credit. This measure is needed to
cover any fees, enforcement charges, and unpaid interest in recovery or bankruptcy
proceedings. It also acts as a buffer against fluctuations or deteriorations in the value of
the security over time. The difference between the loan amount and the security amount
requested by the bank is referred to as margin.
Offering security can be advantageous to the borrower, as the lending bank may be
willing to relax some other provisions (such as certain covenants) of the facility
agreement. For less credit-worthy borrowers, offering security may be the only way
they are able to borrow funds.
Maturity, Repayment Profile, and Average Maturity
Credit facilities can be classified by maturity as short-term, medium-term, and long-term.
Facilities with tenors of up to three years are short-term facilities. Short-term facilities are
usually geared to a borrower’s working capital requirements. Medium-term facilities are
defined as those that have a maturity greater than three years, and up to seven years.
Long-term facilities are of longer duration (usually 7-10 years). Medium- and long-term
facilities may be used to finance capital expenditures, import of capital goods, project
financing, and so on.
Long-term loans tend to have pre-defined repayment or amortisation schedules, and can
have fixed or floating interest rates. Because the classifications are flexible, officials must
check their own bank’s guidelines in this regard.
Longer-term credit facilities are deemed riskier than shorter-term credit due to the greater
potential for negative events to impact the repayment of the loan over time, and the lack of
ability to forecast such events. To compensate for this greater risk, longer-term credit
facilities tend to have higher interest charges.
A bank’s credit exposure over the duration of a long-term loan is a function of the
agreed-upon repayment profile or amortisation schedule. A five-year loan that is fully
repayable in one single payment at maturity is more risky than a five-year loan of the same
amount which is being repaid in semi-annual instalments.
