Corporate Banking is offered to corporates as opposed to individuals (retail banking). It is the lending arm of the bank as against deposit mobilization arm of the bank (retail banking). It offers services to large, small & medium firms ranging from issuing loans to more complex matters such as helping in managing currency exposures. Corporate/wholesale and SME (small & medium enterprises) banking fall under its ambit.
Corporate banks are becoming less common. They are increasingly being divided into product & operations. Hence their functions are split between transaction banking & product management.
Relationship chain (relationship management) faces the customer & comprises the front office. Credit management evaluates credit proposals generated by relationship chain & comprises credit chain. It has approval authority at various levels.
Transaction banking is not a customer facing role. Its job is to ensure product & service delivery to the customers. Product management is responsible for customizing the product according to customer needs. It is divided into product sales & product design.
Corporate Banking is divided into fund-based (line of credit) & non-fund based facilities. Fund based facilities are the ones in which bank lends money. Hence they are also called loan products. Banks earn through either interest or commissions.
In non-fund based facilities, banks give guarantee to the customer. Examples are letters of credit & guarantees. They do not involve actual lending of funds. In case the customer defaults, they may become contingent liabilities. The primary source of income in these cases is fees & commissions.
Both fund-based & non-fund based facilities can be classified based on purpose, maturity, revolving/one off and security.
- Working capital funding – these are credit products for funding daily operations.
- Capital expenditure funding – these consist of credit products for financing capital expenditure like plant & machinery, factory building etc.
- General corporate purpose – these loans are fund based & short term in nature & are used to fund a cash flow mismatch, or for any general purpose which is not part of daily operations.
- Long term facilities – they are credit facilities (fund as well as non-fund based) with maturities > 1 year.
- Short term facilities – they are repayable on demand or within 1 year.
- Revolving – they are immediate sources of funding as & when required. They are open ended or revolving facilities in the form of cash credits or overdrafts.
- One-off – they are one-time loans. They are required for long term needs such as project financing, or short term needs such as inventory financing.
- Secured – they have collateral & carry low interest rate than unsecured loans.
- Unsecured – they don’t have any collateral & carry higher interest rates than secured loans.
- Working Capital Loans – they are generally of short duration (< 1 year). The duration may be longer if the working capital gestation period is longer e.g. Boeing.
- Overdraft Facility – revolving loans against current account are called overdrafts or ODs which are unsecured in nature. The borrower can overdraw funds beyond available balance upto an agreed limit. Interest is payable only on the money used for the duration of withdrawal compounded daily. In some countries, a commitment fee is levied on the unutilized limits. ODs are not good for the banker since it is difficult to control the end use of funds, ensure repayment & there are high administrative costs. ODs affect the bank's liquidity.
- Cash Credit (CC) Facility – A bank assesses the average value of inventory & receivables of a business. Based on these assets as security, a bank issues 60-70% of asset value as limit on cash credit facility. Just like an OD, borrower can draw on this limit. The buffer of 30-40% which is kept by the bank is called Margin. The riskier the asset, the higher the margin. The interest on CC is usually linked to a benchmark rate & decided periodically. CC is secured in nature unlike OD which is unsecured in nature.
- Working Capital Demand Loans (WCDL) – this is a short term revolving loan facility given for the working capital requirement of the company. A bank will quote a rate on WCDL depending on its current cost of funds to which the customer must agree. WCDL limit is fixed but the borrower must negotiate the rate with bank every time he borrows. WCDL is more common with medium & large companies which have large working capital requirements unlike CC which is common with small companies. Banks prefer WCDL more than CC since they have more control over the terms & interest rates which is useful in an environment where interest rates are fluctuating.
- Long term loans – banks provide these long term loans to finance expansions, buy real estate or machinery.
- Trade finance – Corporate banking facilitates international trade. Banks provide loans to the seller to bridge his funding requirements till he gets paid. This is similar to a working capital loan.
- Pre-shipment loans – this is working capital for purchasing raw materials, processing & packaging of export commodities. Most common form is packing credit where the exporter gets concessional interest rates.
- Post-shipment loans – these loans help exporters bridge their funding requirements when they export on deferred payment basis i.e. credit.
- Bill Discounting is an example. It provides liquidity to the exporter. The bank will discount the trade bill which is accepted & endorsed to the bank by the buyer. The bank will advance the exporter a portion of the face value of trade bill.
- Forfaiting is the process when exporter has an agreement with the bank to discount his entire medium term receivables (not a single bill but all his bills).
- Factoring is the process when exporter has an agreement with the bank to discount his entire short term receivables (not a single bill but all his bills).
- Bill discounting & factoring can also happen for domestic transactions.
- Bank has recourse to the seller since in case of non-payment by the buyer after credit period expiration; the seller must compensate the bank.
- Bill discounting is always with recourse.
- In factoring, a bank can discount bills with/without recourse & even with partial recourse. This is called Assignment of Receivables.
- Trade Finance
- Intermediaries – banks can act as intermediaries for documents & funds flow in international transactions as transfer through banks is more secure.
- International trade payment mechanisms
- 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 he ships the goods & complies with the terms of agreement. Here seller takes credit risk on the bank instead of buyer. The importer gets credit from the bank & doesn’t have to make advance payment.
- Cash in advance – buyer pays seller before shipment of goods. This is most advantageous to the seller & least advantageous to the buyer.
- 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 very strong relationship with the buyer or the buyer has excellent credit rating. There are no guarantees & collecting payment often becomes a tedious affair.
- 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.
This is undertaken by the bank to determine whether to make a loan to the client or not. This function analyzes the credibility of the client. Based on the evaluation, a credit rating is given which impacts the amount, rate, tenor, security, and frequency of monitoring.
Credit evaluation involves qualitative & quantitative analysis of a company. Qualitative analysis is about subjective parameters which cannot be expressed in numbers such as promoter’s reputation, industry outlook, past track record, and extent of competition etc. Quantitative analysis includes comparing the financials over a period of time to evaluate performance based on which a credit line is defined for each client. It gives the maximum amount of exposure/risk the bank is willing to take on the client.
This is where the bank structures the loan i.e. decides the various loan parameters. It comes after credit evaluation is completed.
Bank should ensure that the collateral is intact & also the proper end-use of funds. It should also inspect the inventory to determine that the working capital requirement is realistic & the company has adequate insurance cover to guard against any unforeseen events that might affect the bank.
A typical monitoring report will also have an ageing analysis to specify whether any loans or interest payments are overdue and for how long. It classifies the loans on the basis of maturity. Such reports are generated by the core banking solution in a bank.
Through a Bank Guarantee, the bank guarantees the performance of a contract or the non-happening of an event such as an event of default to the beneficiary. Bank guarantees can be financial or performance in nature.
Performance guarantee is given when the guarantor or issuing bank guarantees the ability of the applicant to perform a contract to the beneficiary’s satisfaction. Financial guarantees are used to secure a financial commitment such as a loan, security deposit etc.
For example, if a supplier takes advance payments to supply high value goods then he must provide performance guarantee to the buyer.