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Master Circular
Guarantees, Co-Acceptances &Letters of Credit
Contents
1.Guarantees ..
.............................................................................1
1.1Issue of Guarantees ..
.............................................................................1
1.1.1 Broad Guidelines
...............................................................................1
1.1.2 Purpose
...............................................................................1
1.1.3 Maturity
...............................................................................1
1.1.4 Volume
...............................................................................1
1.1.5 Secured Guarantees
...............................................................................2
1.1.6 Unsecured Guarantees
...............................................................................2
1.1.7 Deferred Guarantees
...............................................................................2
1.2 Guarantees in respect of Commodities covered
under Selective Credit Controls...............2
1.3 Safeguards in Issuance of
Guarantees...............................................................3
1.4 Payment under Bank Guarantees - Immediate
Settlement of Cases...........................4
1.5 Delay in Obtaining Certified Copies of
Judgments..................................................5
1.6 Correspondence with Government
Departments............................................5
2. Co-acceptance of Bills
...............................................................................6
2.1 Irregularities in Co-acceptance of
Bills...................................................6
2.2 Safeguards
...............................................................................7
3. LCs
...............................................................................7
3 Guidelines for Grant of LCs
facility.........................................7
3.2 LCs for Commodities Covered under Selective
Credit Controls.........................8
3.3 Safeguards in Opening of LCs
......................................................................8
3.4 Payment under LCs - Immediate Settlement
of.................................................9
4. Other Common Guidelines
.............................................................................10
4.1 Credit Exposure Norms and Statutory/Other
Restrictions on Non-fund Based Limits.......10
Appendix.......................................................................................................10
Master Circular
Guarantees, Co-Acceptances & Letters of Credit
1. GUARANTEES
1.1 Issue of Guarantees
1.1.1 Broad Guidelines In view of the risks
involved in the business of issuance of
guarantees, the Primary (Urban) Co-operative
Banks (PCBs) should extend guarantees within
restricted limits so that their financial
position is not impaired. The banks should
follow certain broad guidelines in respect of
their guarantee business as indicated in the
following paragraphs.
1.1.2 Purpose
(i) As a general rule, banks may provide only
financial guarantees and not performance
guarantees.
(ii) However, the scheduled banks may issue
performance guarantees on behalf of their
constituents subject to exercising due caution
in the matter.
1.1.3 Maturity
It would be desirable for PCBs to confine their
guarantees to relatively short-term maturities.
Guarantees should not be issued for periods
exceeding ten years in any case.
1.1.4 Volume
The total volume of guarantee obligations
outstanding at any time may not exceed 10 per
cent of the total owned resources of the bank
comprising paid up capital, reserves and
deposits. Within the overall ceiling, proportion
of unsecured guarantees outstanding at any time
may be limited to an amount equivalent to 25% of
the owned funds (paid up capital + reserves) of
the bank or 25% of the total amount of
guarantees, whichever is less.
1.1.5 Secured Guarantees
Banks should preferably issue secured
guarantees. A secured guarantee means a
guarantee made on the security of assets
(including cash margin), the market value of
which will not at any time be less than the
amount of the contingent liability on the
guarantee, or a guarantee fully covered by
counter guarantee/s of the Central Government,
State Governments, public sector financial
institutions and/or insurance companies. Banks
should generally provide deferred payment
guarantees backed by adequate tangible
securities or by counter guarantees of the
Central or the State Government or public sector
financial institutions or of insurance companies
and other banks.
1.1.6 Unsecured Guarantees
Banks should avoid undue concentration of
unsecured guarantee commitments to particular
groups of customers and/or trades. The banks'
Board of Directors should fix suitable
proportions for issuance of unsecured guarantees
on behalf of any individual constituent so that
these guarantees do not exceed a -(a) reasonable
proportion of the total obligations in respect
of unsecured guarantees provided by the bank to
all such constituents at any time, and (b)
reasonable multiple of the shareholdings in the
bank.
1.1.7 Deferred Guarantees
(i) Banks, which intend issuing deferred payment
guarantees in respect of their borrowers for
acquisition of capital assets should ensure that
the total credit facilities including the
proposed deferred payment guarantees do not
exceed the prescribed exposure ceilings (ii) The
proposals for deferred payment guarantees should
be examined having regard to the
profitability/cash flows of the project to
ensure that sufficient surpluses are generated
by the borrowing unit to meet the commitments as
a bank has to meet the liability at regular
intervals in respect of the instalments due. The
criteria generally followed for appraising a
term loan proposal for acquisition of capital
assets should also be applied while issuing
deferred payment guarantees. 1.2 Guarantees in
respect of Commodities covered under Selective
Credit Controls PCBs should not issue, either to
a Court or to Government, or any other person, a
guarantee on behalf of or on account of any
importers guaranteeing payment of customs duty
and/or import duty, or other levies, payable in
respect of import of essential commodities
without taking, as security for issue of such
guarantees, a cash margin equivalent to at least
one half of the amount payable under the
guarantee. The term "essential commodities"
shall mean such commodities as may be specified
by the Reserve Bank of India from time to time.
1.3 Safeguards in Issuance of Guarantees
While issuing the financial guarantees, the
banks should observe the following safe guards :
(i) The bank guarantees should be issued in
security forms serially numbered to prevent
issuanceof fake guarantees.
(ii) Guarantees above a particular cut off
point, as may be decided by each bank, should be
issued under two signatures in triplicate, one
copy each for the branch, beneficiary and
Controlling Office/Head Office. It should be
binding on the part of the beneficiary to seek
confirmation of the Controlling Office/Head
Office as well for which a specific stipulation
be incorporated in the guarantee itself.
(iii) The guarantees should not normally be
allowed to the customers who do not enjoy credit
facilities with the banks but only maintain
current accounts. If any requests are received
from such customers, the banks should subject
the proposals to thorough scrutiny and satisfy
themselves about the genuine need of the
customers. The banks should be satisfied that
the customers would be in a position to meet the
claims under the guarantees, when received, and
not approach the bank for credit facility in
this regard. For this purpose the banks should
enquire into the financial position of the
customers, the source of funds from which they
would be in a position to meet the liability and
prescribe a suitable margin and obtain other
security, as necessary. The banks may also call
for the detailed financial statements and
Wealth-tax/ Income-tax returns of the
customer to satisfy themselves of their
financial status. The observations of the banks
in respect of all these points should be
recorded in banks' books. (iv) Where the
customers enjoy credit facilities with other
banks, the reasons for their approaching the
bank for extending the guarantees should be
ascertained and invariably, a reference should
be made to their existing bankers with whom they
are enjoying credit facilities. (v) Banks, when
approached to issue guarantees in favour of
other banks for grant of credit facilities by
another bank, should examine thoroughly the
reasons for approaching another bank for grant
of credit facilities and satisfy themselves of
the need for doing so. This should be recorded
in bank's books. When it is considered necessary
to issue such guarantees, the banks concerned
should ensure that the relative guarantee
document, beyond a stipulated amount, should not
be signed singly but by two authorised officials
jointly after obtaining proper sanction and
authority and proper record of such guarantee
issued being maintained. The credit proposals
should be subjected to usual scrutiny by the
lending bank ensuring that the proposals conform
to the prescribed norms and guidelines and
credit facilities are allowed only if the bank
is satisfied about the merits of the proposal
and the availability of another bank's guarantee
should not result in a dilution of the standards
of evaluation of the proposal and financial
discipline in lending.
1.4 Payment under Bank Guarantees - Immediate
Settlement of Cases
(i) Government of India and Reserve Bank of
India have been receiving a number of complaints
on non-payment or delay in payment of bank
guarantees upon invocation.
(ii) Probably reluctance on the part of banks to
honour their commitment in respect of invoked
guarantees stems from their fear of difficulty
in realising the amount due from their
constituents on account of such guarantees. It
is possible that in their anxiety to boost up
their profitability, banks go out of the way to
issue bank guarantees on behalf of constituents
without subjecting the proposals to proper
scrutiny and assessing the capacity and
creditworthiness of their constituents to pay
the amounts to the banks in case the guarantees
are invoked. Dilution of security (i.e., non-obtention
of adequate margin) may be another factor
responsible for banks not receiving the dues in
respect of invoked guarantees from their
clients.
(iii) The above aspects may inhibit banks to pay
the beneficiaries promptly when guarantees are
invoked and they adopt dilatory tactics in
respect of invoked guarantees. It is absolutely
essential for banks to appraise the proposals
for guarantees also with the same diligence as
in the case of fund based limits and obtain
adequate cover by way of margin so as to prevent
the constituents to develop a tendency of
defaulting in payments when invoked guarantees
are honored by the banks.
(iv) The bank guarantee is a commitment made by
the issuing bank to make payment to the
beneficiary (albeit at the behest of the bank's
constituent). Failure on the part of the bank to
honour the claim legitimately made on it
projects distorted picture of its functioning.
(v) In fact some strictures were passed by
Courts in the past against banks for not
honoring the guarantee commitments promptly. In
this connection, an extract of a judgment
pronounced by the Humble Supreme Court, in a
case on the issue of injunctions obtained by
parties from courts restraining payment of
invoked guarantees is appended: "We are
therefore, of the opinion that the correct
position of law is that commitment of banks must
be honored free from interference by the courts
and it is only in exceptional cases, that is to
say, in case of fraud or in case where
irretrievable injustice would be done, if bank
guarantee is allowed to be encased, the court
should interfere."
(vi) The primary (urban) co-operative banks
should, therefore, honor bank guarantees issued
by them promptly on their invocation as
reluctance on their part to honor commitments in
respect of invoked guarantees tend to bring the
banking system into disrepute.
1.5 Delay in Obtaining Certified Copies of
Judgements
(i) The Ministry of Finance has advised that
some of the Departments such as Department of
Revenue, Govt. of India, are finding it
difficult to execute judgements delivered by
various courts in their favour as banks do not
honour their guarantees unless certified copies
of the court judgements are made available to
them.
(ii) Keeping in view these difficulties, banks
may follow the following procedure :
(a) Where the bank is a party to the proceeding
initiated by Govt. for enforcement of bank
guarantee and the case is decided in favour of
the Govt. by the Court, bank should not insist
on production of certified copy of the judgement
as the judgement order is pronounced in open
court in the presence of the parties/their
counsels and the judgement is known to the
bank.
(b) In case the bank is not a party to the
proceeding, a signed copy of the minutes of the
order certified by the Registrar/Deputy or
Assistant Registrar of the High Court duly
attested to be true copy by Govt. Counsel should
be sufficient for honouring the obligation under
the guarantees unless the guarantor bank decides
to file any appeal against the order of the High
Court.
1.6 Correspondence with Government
Departments
(i) The Constitution of India states that
all executive action relating to Union of India
shall be, and shall be stated to be, in the name
of President of India. However, the business of
the Government of India is transacted through
several ministries/departments and even though
documents such as guarantees reflect the
President of India as one of the parties,
correspondence is not to be exchanged with the
President of India but with concerned Government
Ministry/Departments.
(ii) The banks should, therefore, ensure that
any correspondence relating to guarantees
furnished by the banks in the name of the
President of India favouring the Government
Departments should not be addressed to the
President of India causing avoidable
inconvenience to the President's Secretariat.
2. CO-ACCEPTANCE OF BILLS
2.1 Irregularities in Co-acceptance of Bills
(i) Banks have been co-accepting bills of their
customers. On many occasions these bills turn
out to be accommodation bills drawn by groups of
sister concerns on each other where no genuine
trade transaction takes place. Such bills on
maturity are not honoured by the drawees and the
banks which have co-accepted the bills have to
make payment of these bills and thereafter, they
find it difficult to recover the amount from
thedrawers/drawees of bills. This happens
because the financial position and capacity of
the parties to honour the bills, in the event of
need, is not gone into by the banks co-accepting
the bills.
(ii) There have also been cases where the
particulars regarding co-acceptance of bills are
not recorded in the bank's books with the result
that the extent of co-acceptance can not be
verified during inspections and the Head Office
becomes aware of the co-acceptance only when a
claim is received from the discounting bank.
2.2 Safeguards
In view of the above, banks should keep in view
the following safe -guards :
(i) While sanctioning co-acceptance limits to
their customers, the need therefor should be
ascertained and such limits should be extended
only to their customers enjoying other limits
with the bank.
(ii) Only genuine trade bills should be
co-accepted and the banks should ensure that the
goods covered by bills co-accepted are actually
received in the stock accounts of the borrowers.
(iii) The valuation of the goods as mentioned in
the accompanying invoice should also be verified
to see that there is no over valuation of
stocks.
(iv) The banks should not extend their
co-acceptance to house bills/accommodation bills
drawn by group concerns on one another.
(v) The powers to co-accept bills, beyond a
stipulated limit, must be exercised by two
authorised officials jointly.
(vi) Proper records of the bills co-accepted for
each customer should be maintained so that the
commitments for each customer and the total
commitments at a branch can be readily
ascertained and these should be scrutinised by
internal inspectors and commented upon in
their reports.
(vii) Proper periodical returns may be
prescribed so that the Branch Managers report
such co- cceptance commitments entered into by
them to the controlling offices. Such returns
should also reveal the position of bills that
have become overdue and which the bank had to
meet under the co-acceptance obligation. This
will enable the controlling offices to monitor
such co- cceptances furnished by the
branches and take suitable action in time, in
difficult cases.
3. LETTERS OF CREDIT (LCs)
3.1 Guidelines for Grant of LCs Facility
Primary (urban) co-operative banks should not
normally grant LC facilities in respect of
parties who maintain only nominal current
accounts. In case of borrowers maintaining only
current accounts, who approach for opening of
LCs, banks should invariably ascertain from the
existing bankers of the borrowers the reasons as
to why they are not extending LC facilities to
the concerned borrowers. Banks should open LCs
in respect of such parties only after making
proper enquiries in regard to the antecedents of
the borrowers
from the bankers with whom the parties are
enjoying main limits, their financial position
and their ability to retire the bills. They
should also prescribe a suitable margin and
obtain other security, as necessary.
3.2 LCs for Commodities Covered under Selective
Credit Controls There is no restriction for the
banks in opening LCs for import of essential
items. However, banks are not permitted to open
inland LCs, providing a clause therein which
would enable other banks to discount usance
bills under sthe LCs.
3.3 Safeguards in Opening of LCs Before opening
LCs, banks should ensure that :
(i) LCs are issued in security forms only;
(ii) large LCs are issued under two authorised
signatures where one of the signatures for LCs
should be from the Head Office/Controlling
Office. As the need for large LCs may not arise
overnight, with the availability of courier
service, speed post service etc., this procedure
may not result in delay. In the LCs itself a
column maybe provided to indicate the authority
who had sanctioned it together with the
particulars thereof;
(iii) LCs are not issued for amounts out of
proportion to the borrowers' genuine
requirements and these are opened only after
ensuring that the borrowers have made adequate
arrangements for retiring the bills received
under LCs out of their own resources or from the
existing borrowing arrangements;
(iv) where LCs are for purchase of raw
materials, borrowers do not maintain unduly high
inventory of raw materials in relation to the
norms/past trends. Where such LCs are to be
opened on D/A basis, credit on the relative
purchase is duly taken into account for the
purpose of working out drawing power in cash
credit accounts;
(v) in the case of borrowers having banking
arrangements on a consortium basis, the LCs are
opened within the sanctioned limit on the basis
of the agreed share of each of the banks.
Member-banks should not, however, open LCs
outside the sanctioned limits without the
knowledge of the lead bank/other banks;
(vi) if there is no formal consortium
arrangement for financing the borrower, LCs
should not be opened by the existing bank or a
new bank, without the knowledge of the other
banks;
(vii) LCs for acquisition of capital goods
should be opened only after banks have satisfied
themselves about tying up of funds for meeting
the relative liability by way of providing for
long term funds or term loans from financial
institutions/banks;
(viii) in no case, working capital limits should
be allowed to be utilised for retiring bills
pertaining to acquisition of capital assets.
(ix) Banks should not extend any non-fund based
facilities or additional/ad-hoc credit
facilities to parties who are not their (the
bank’s) regular constituents for their
production finance requirements; nor should they
discount bills drawn under LCs or otherwise for
beneficiaries who are not their regular clients.
In case it becomes unavoidably necessary to
provide such a facility to a party not being a
regular client, banks should invariably seek the
prior concurrence of the existing banker of the
borrowers and also make proper enquiries in
regard to the antecedents of the borrowers,
their financial position and ability to retire
the bills etc. in time.
3.4 Payment under LCs - Immediate Settlement of
Claims
(i) There have been a few instances where LCs
were opened by officials of banks in an
unauthorised manner. In certain cases the LCs
transactions were not recorded in the books of
the branch by officials issuing them, while in
some other cases the amounts of LCs were much in
excess of the powers vested in them for the
purpose. Subsequently when the banks come to
know about the fraudulent issue of LCs, they
disclaim liability on the ground that these are
transactions involving a conspiracy / collusion
between the beneficiary and the constituent.
(ii) It may be appreciated that if the bills
drawn under LCs are not honoured, it will
adversely affect the character of LCs and the
relative bills as an accepted means of payment.
This could also affect the credibility of the
entire payment mechanism through banks and
affect the image of the banks. It is, therefore,
necessary that all the banks should honour their
commitments under LCs and make payments promptly
leaving no opportunity for any complaints in
this regard. Needless to say that banks should
take suitable action against the concerned
officials as well as the constituents on whose
behalf the LCs are opened and the beneficiaries
of LCs, if a criminal conspiracy is involved.
4. OTHER COMMON GUIDELINES
4.1 Credit Exposure Norms and
Statutory/Other Restrictions on Non-fund Based
Limits (i) Primary (urban) co-operative banks
are required to strictly observe exosure noms
and statutory/other restrictions prescribed for
non-fund based limits (e.g. LCs, guarantees, co-
cceptances, etc.) as detailed in the Master
Circular on ' Exposure Norms and Statutory/Other
Restrictions .
(ii) The exposure ceilings and other
restrictions particularly prescribed for -a)
total credit exposure including non-fund based
limits, b) unsecured guarantees, c) advances to
bank's Directors, d) loans and advances to
relatives of Directors, e) advances to nominal
members,
must be strictly observed.
4.2 Banks should ensure that the systems evolved
for recording the details of off-balance sheet
transactions are properly followed by all
branches. These records should be periodically
balanced and internal inspectors should verify
the same and offer critical comments.
4.3 Banks should ensure that unauthorized LCs
are not issued.
4.4 Banks must lay down clear instructions for
their branch staff in respect of loan accounts
where such non-funded facilities become funded
on account of devolvement of bills covered under
the bank's LCs or due to invocation of
guarantees issued by the bank. The banks must
evolve proper guidelines to ensure that,
accounts where non- funded limits become
"funded", are closely monitored and goods
covered under devolved bills remain under bank's
control/hypothecation, particularly where
maladies are suspected. In cases of goods
covered under import LCs, banks must also ensure
immediate submission of custom's copy of the
Bill of Entry and take measures as prescribed in
the guidelines issued by Foreign Exchange
Department.
4.5 A number of banks adopt the practice of
parking the dues of the borrower in respect of
devolved LCs and invoked guarantees in a
separate account which is not a regular
sanctioned facility. As a result, these are not
reflected in the principal operating account of
the borrower. This renders application of
the prudential norms for identification of NPAs
difficult. It is, therefore, advised that if the
debts arising out of devolvement of LCs or
invoked guarantees are parked in a separate
account, the balance outstanding in that account
also should be treated as a part of the
borrower’s principal operating account for the
purpose of application of prudential norms on
income recognition, asset classification and
provisioning.
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