What is the difference between fund-based and non fund-based credit facilities?

Fund-based and non fund-based credit facilities represent two distinct categories of financial assistance provided by banks and financial institutions. The fundamental difference lies in whether the lender actually disburses funds to the borrower or provides guarantees and assurances without immediate cash outflow.

Fund-based facilities involve actual disbursement of money from lender to borrower. These include term loans, working capital loans, overdrafts, and cash credits where banks transfer funds to borrower accounts. Interest is charged on disbursed amounts, and borrowers receive actual cash for business operations.

Fund-based facilities include:

• Term loans for capital expenditure and expansion
• Working capital loans for operational requirements
• Cash credit and overdraft facilities
• Bill discounting and invoice financing

Non fund-based facilities provide assurances, guarantees, or commitments without immediate fund disbursement. Banks issue letters of credit, bank guarantees, and performance bonds on behalf of customers, enabling business transactions without actual cash flow from the bank.

Non fund-based facilities comprise:

• Letters of credit for import/export transactions
• Bank guarantees for contract performance
• Standby letters of credit for international trade
• Performance and financial guarantees

Interest treatment differs significantly between these facilities. Fund-based facilities charge interest on outstanding amounts, whilst non fund-based facilities typically charge commission or fees for guaranteed services. Non fund-based facilities may become fund-based if guarantees are invoked.

Risk assessment varies between facility types. Fund-based facilities require immediate creditworthiness evaluation since funds are disbursed, whilst non fund-based facilities assess contingent liabilities and probability of guarantee invocation.

Both facility types contribute to overall credit exposure limits, affecting borrowers' total credit availability from financial institutions.