Non funded facilities are those facilities in which bank’s funds are not involved and the bank provides their services as an agent of its customer. For example bank guarantees like performance guarantee, bid bonds, financial guarantees, money retention guarantees, advance mobilization guarantees.
Non-Funded Credit Facilities –
(a) Trade Finance Intermediaries – banks can act as intermediaries for documents & funds flow in international transactions as transfer through banks is more secure.
(b) Letter of credit – it is also-called Documentary Credit (DC). The bank lends its guarantee of payment to the buyer. The bank also guarantees payment to the seller provided the ships the goods & complies with the terms of an agreement. Here seller takes credit risk on the bank instead of the buyer. The importer gets credit from the bank & doesn’t have to make advance payment.
(c) Cash in advance – buyer pays seller before shipment of goods. This is most advantageous to the seller &least advantageous to the buyer.
(d) Open account or credit – this means that payment is made on an agreed upon future date. This is very risky for a seller unless he has a very strong relationship with the buyer or the buyer has an excellent credit rating. There are no guarantees & collecting-payment often becomes a tedious affair.
(e) Cash Management Services (CMS) – It has no credit risk for the bank. It is a pure administrative service for the corporate. The client maintains only one account with the bank. Cash management encompasses receivables management; payables .management & liquidity management. Banks are using better technologies for cash management by connecting to ERP systems.
Non funded facilities are a contingent liability, which is that they can become a potential liability on the outcome of a future event. They are like guarantees and documentary credits where the bank does not give any cash but take risk of the companies and charge commission.