Non- fund based business are those credit facilities which are provided by banks or financial institutions to the customers, where there is no outflow of funds from bank and customer also does not get any cash. It is the type of financing facilities where the bank has no direct exposure of funds. Instead of direct involvement of funds, bank facilitates a certain transaction.
Non- funded business in banking sector has emerged with the growth of trade. Banks provide non-funded facilities to the clients against certain charges and commissions. Since non funded loans can turn into the banks’ liabilities at any time in the future, they are also termed as contingent liabilities. If the clients of the banks or the principal debtors are unable to perform their duties to their party, the banks are forced to make payment to them and this is where the non-funded transaction turns into funded loan where the funds flow. Banks book the force loan in the name of the client in order to make payment to the beneficiary.
In funded facility, borrowers can use the fund of the bank but in non funded facility, initially, they do not receive direct fund from the bank. Under this facility, banks are not required to provide cash to the clients. If the clients of the banks cannot meet their liability of payment to their party, their liability is directly transferred to the banks and banks have to make payment to the third party. Hence, the liability of the bank is not principal but supplementary. Under non funded credit, the risk is lesser in comparison with the funded credit. When the non- funded borrower of the bank cannot fulfill the payment obligation, it turns into funded facility.
Letter of credit(LC) and bank guarantee fall under non funded credit facilities. Letter of credit involves LC advising, LC confirming, LC forward booking etc. whereas, bank guarantee involves facilities like bid bond, performance bond and advance payment. Bank and Financial Institution Act 2073 has defined non funded transaction as off-balance sheet item.
Condition of Non- Fund Based Business in Nepalese Banking Sector
Due to flexibility in collateral security and quick service delivery, there is rapid growth of non-fund based transaction in private banks. Slow service in government banks in past have still effected non funded business. However, gradual improvement in customer service has boosted competitive strength of government banks in non funded transaction.
Nepal Investment Bank Limited, Nabil Bank Limited, Himalayan Bank Limited, Agriculture Development Bank Limited, Nepal Bangladesh bank Ltd, Nepal SBI Bank Limited., NMB Bank Limited, NIC Asia Bank Limited etc. have emerged as the leading banks in non-funded business in Nepal. As per the annual reports of the banks 2074/75 Nepal Investment Bank has highest Fees and Commission income. This bank has earned 1.53 billion in Fees and Commission which contributes 34% to the net profit of the bank during that year.
RBB has earned Rs 1.23 billion, Nabil Bank has earned Rs 1.13 billion and Nepal bank has earned Rs 983 million and lie in 2nd,3rd and 4th position respectively in the same year. Likewise, ADBL, Everest Bank, NIC Asia Bank, NMB Bank, Nepal Bangladesh Bank and Nepal SBI Bank are ranked in 5th,6th,7th,8th 9th, and 10th position respectively. The annual reports of the bank 2074/75 also shows that top 10 LC commission earning banks are NIBL, Nabil, Himalayan Bank, Everest Bank, Siddhartha Bank, NMB Bank ,NIC Asia Bank, Nepal SBI Bank, Standard Chartered Bank and Prime Bank respectively. Among government banks Nepal Bank Limited has the highest exposure of Letter of Credit business In terms of Bank Guarantee, Nepal Bangladesh Bank has the highest commission income.
The bank has earned a total of Rs 597 million from LC and BG Commission where major portion is contributed through BG commission. Agriculture Development Bank has highest earning of Rs 308 million in BG commission after Nepal Bangladesh Bank. Other higher contributor banks through BG are NIBL ,NMB Bank, NIC Asia Bank, Nabil Bank, Sunrise Bank , Prime Commercial bank and NCC Banks Respectively. Among Government Banks Agricultural Development Bank Limited has ample volume of bank guarantee transaction.
Non -Fund Based Products in Nepalese Banking
1.Letter of Credits
3.LC Advising /Confirming services
4. Bills payable
5.Credit Information reports
7.Forward contracts and other derivative contracts
Importance of Non -Fund Based Business
Funded business involves higher risk in banking. Since the banks flow cash directly, it is dependent on liquidity position of the bank and credit risk is higher. On the contrary, non funded transaction are not affected by liquidity position of the bank in short term. Banks facing liquidity crunch can be benefited from non-funded transactions. Importance of non-funded business in banking can be depicted as follows:
* Increase commission based income
* Provide liquidity
* Assist in fund based credits such as trust receipt loan, demand loan, import-export loan etc.
* Increase in interest income
* Maintain long run relation between bank and clients
* Strengthen correspondent relation between national and international banks
* Raise banking boundary in national and international level
* Add other supplementary banking services
* Develop environment of mutual trust between beneficiary and bank
* Higher contribution in bank’s profit and lead to sustainable development
* Foreign currency earning
* Earning foreign exchange commission
* Facilitating country’s export and import
* Aid nation’s development and construction works
* Promote and uplift business
* Low bank risks
* To ensure successful business transactions
* Reduction of Financial Risk
Challenges of Non-Fund Based Transactions
* High demand of technically skilled human resource
* It may be difficult to deal with a bank in which there is no prior relationship.
* Adequate knowledge of national and international regulatory bodies
* Inexperienced staffs may raise issues and slow the process down
* Unhealthy and fierce competition amongst bans
* Provide over facility than the capacity of the clients
* Unclear and inadequate circulars and directive of the central bank
* Erroneous acts and policies of the government; for instance, unclear provision regarding Line of Credit in Public Procurement Act has affected Bank Guarantee transactions
* As the result of unhealthy competition between banks, some banks provide LCs and bank guarantees without any collateral/security; consequently, possibility of forced loan creations surge
* Higher claims on bank guarantees as the result of issuance of bank guarantees of the companies of near and dear ones/relatives
* Weak internal and external audit of non funded transactions
* Nepal Rastra Bank’s inadequate inspection and regulation
* Chances of fraud in LCs and bank guarantees
* Issuance of duplicate bank guarantees
* Significant focus not allocated by the management in non funded business
* Direct effect on bank due to dispute between client and beneficiary
* Elevation of bank risk due to solvency of the client
* Beneficiary can make claims mentioning various reasons
* Lack of uniformity in LC and bank guarantee commissions against banks
* Lack of central bank’s effort in generation of uniform commissions and collateral security in non-funded transactions in the banks
* Negative effects on the clients due to short of cooperation from advising, negotiating and confirming banks
* Costly transactions
* Challenging recovery due to surfacing forced loans due to lack of timely performance of clients
The rising trade and growing economy of Nepal reciprocates that there shall be increased volume of Non-fund based business in Nepal in coming years. On the other hand, the higher risk associated with funded- business, stringent policies of NRB in funded business such as unanimous balance sheets, implementation of BASEL 3 and tighten policies in retail loans of commercial banks has made the commercial banks to give equal importance of non-funded business in Nepal. It is also a high time for a paradigm shift in banking from traditional banking of accepting deposit and giving credits to adding other innovative products of banking that includes Non-funded business.
Following points are suggested in order to make the Non-funded business transaction in Nepal more effective.
* Nepal Rastra Bank should develop skilled and capable human resource to regulate and supervise non-fund based transaction operations to make it effective.
* Banks should acquire advanced technologies to process LCs and Bank guarantees.
* Government/Regulatory bodies should facilitate non funded business.
* Beneficiary should accept the bank guarantee by examining its authenticity.
* End of unhealthy competition in collateral/security coverage and commission is essential.
* Bank’s top management should give higher priority to non funded transactions.
* Customer service should be made simplified and accountable.
* Full fledge implementation of national and international policies, guidelines and practices.
* Regular national and international trainings should be provided to the employees. ( Kandel is Head /S.M. Nepal Bank Limited, Central Trade Finance Division)