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Basic Definitions

Letters of Credit

Letters of Credit: Letters of credit are commonly used to reduce credit risk to sellers in both domestic and international sales arrangements. By having a bank issue a letter of credit, in essence, one is substituting the bank's credit worthiness for that of the customer.

There are two basic forms of letters of credit: Standby and Documentary. Documentary letters of credit can be either Revocable or Irrevocable, although the first is extremely rare. Irrevocable letters of credit can be Confirmed or Not Confirmed. Each type of credit has advantages and disadvantages for the buyer and for the seller. Charges for each type will also vary. However, the more the banks assume risk by guaranteeing payment, the more they will charge for providing the service.


A standby letter of credit (SLOC) is a legal document that guarantees a bank's commitment of payment to a seller in the event that the buyer–or the bank's client–defaults on the agreement. ... A standby letter of credit can also be abbreviated SBLC.


A documentary letter of credit is bank's promise to pay a seller on behalf of the buyer as long as the seller complies with precisely defined terms and conditions specified in the credit. Parties of the transaction are applicant, beneficiary and assurance of payment.


A Medium Term Note (MTN) is a negotiable debt instrument that promises to pay the bearer or registered owner an amount or a number of amounts in the future. As permitted by applicable securities laws, this instrument entitling the owner to a set of future cash flows, can be bought and sold to anyone.


A bank guarantee is a type of financial backstop offered by a lending institution. The bank guarantee means that the lender will ensure that the liabilities of a debtor will be met. In other words, if the debtor fails to settle a debt, the bank will cover it.


Private Placement Programs, also called “High Yield Investment Programs”, are private (non-public) investment programs which are based on the purchase or sale of bank financial instruments. In most cases MTNs are mainly used. These instruments are bought fresh-cut with a high discount on their base value to later be resold at a higher price in the secondary market. These programs are offered to investors with high spending capacity. A very special aspect of these programs is that the largest part of the returns is allocated to humanitarian causes.


PPPs are not well known publicly, and only a very small group of investors that own significant funds or Bank Instruments have access to them. Programs can typically only be joined by invitation only. These programs have been issued for the past 60 years to finance humanitarian projects and international trade.

What does KYC CIS mean?

The KYC-CIS FORM exists jointly as to Know Your Client based on the Client Information Sheet. It is used for both Individuals and Corporations. ... Due diligence includes collecting financial information on the customer, including details of wealth and how this has been accumulated.

Know Your Customer (KYC) standards are designed to protect financial institutions against fraud, corruption, money laundering and terrorist financing. KYC involves several steps to: establish customer identity; understand the nature of customers' activities and qualify that the source of funds is legitimate; and.

CIS (Client Information Sheet) Known as CIS, the Client Information Sheet is the document that identifies the Investor with all their data.

This document will be essential in order to present the operation at the Trader's office and therefore initiate a process of "Due diligence".

What is meant by fractional banking?

Fractional reserve banking is a system in which only a fraction of bank deposits are backed by actual cash on hand and available for withdrawal. This is done to theoretically expand the economy by freeing capital for lending.

How does fractional reserve make money?

Because banks are only required to keep a fraction of their deposits in reserve and may loan out the rest, banks are able to create money. A lower reserve requirement allows banks to issue more loans and increase the money supply, while a higher reserve requirement does the opposite.

How Does a Credit Default Swap Work?

How Does a Credit Default Swap Work?
A credit default swap is a financial derivative contract that shifts the credit risk of a fixed income product to a counterparty in exchange for a premium. Essentially, credit default swaps serve as insurance on the default of a borrower. As the most popular form of credit derivatives, buyers and sellers arrange custom agreements on over-the-counter markets which are often illiquid, speculative, and difficult for regulators to trace.

What Is an Example of a Credit Default Swap?
Consider that an investor buys $10,000 in bonds with a 30-year maturity. Because of its lengthy maturity, this adds a layer of uncertainty to the investor because the company may not be able to pay back the principal $10,000 or future interest payments before expiration. To ensure themself against the probability of this outcome, the investor buys a credit default swap.

A credit default swap essentially ensures that the principal or any owing interest payments will be paid over a predetermined time period. Typically, the investor will buy a credit default swap from a large financial institution, who for a fee, will guarantee the underlying debt.

How Does a Commercial Line of Credit Work?

Business lines of credit are one of the most popular and most misunderstood financing products for small businesses. This article helps you understand how a line of credit works and gives you an idea of the qualification requirements. More importantly, it helps you decide if a commercial line of credit is the right solution for your business. We also discuss three alternative solutions that have many of the benefits of a line of credit. However, these solutions offer more flexibility and are easier to get. The article covers the following:

  1. How do lines of credit work?
  2. Types of lines of credit
  3. Qualification requirements
  4. Understanding loan covenants
  5. Alternative solutions

How do lines of credit work?

A line of credit is a financing solution that allows a company to draw up to a predetermined amount of money. To get funds, you simply request a draw from the line. You can pay the line back at any time, which increases your funds availability. Most simple revolving lines of credit operate much like a conventional credit card operates.

Lending institutions restrict how you can use the line of credit. Obviously, since it is a business line, it can be used only for commercial purposes. Companies use these facilities to cover short-term needs such as paying suppliers, covering payroll, and handling other corporate expenses.

The cost of using a line varies based on the size of the line and the risk. The financing fee is paid on the outstanding balance. It is usually variable and tied to the prime rate. Additionally, lines may have other fees such as maintenance fees and availability fees. These fees vary by institution.

Lastly, many banks require that your company repay the full balance of the line every so often (e.g., every year). This practice, often referred to as “resting the line,” is something to keep in mind if you are considering this type of a product.

Types of lines of credit

There are a number of ways to classify lines of credit. The most common way to classify them is based on whether the banks hold collateral directly or not.

a) Secured lines

A secured line of credit can use personal and corporate collateral to secure the repayment of a loan should the business owner default on payments. This security allows lenders to foreclose on assets if necessary.

Banks can use different asset types as collateral, including accounts receivable, machinery, inventory, cash, certificates of deposit, securities, and real estate. The lender usually secures its position by filing a UCC lien (or similar instrument) against the pledged assets.

b) Unsecured lines

An unsecured line, on the other hand, does not have specific collateral that is pledged as security for the line of credit. While this approach gives your assets some protection, the protection is far from perfect. This last point is very important and is often missed by business owners.

Most unsecured lines are usually guaranteed by the company and by the owner personally. You could argue that the loan is secured by your guarantees. These guarantees often allow the bank to sue your company and the business owner personally in case of default. Obviously, if the lender wins the lawsuit, it could foreclose on your corporate and/or personal assets. In reality, no line of credit or business is ever completely unsecured.

Qualifying for a line of credit

The first thing to understand is that qualifying for a business line of credit is not easy. Lenders have various criteria that you and your company have to meet in order to qualify. The bottom line is that banks lend money based on the three C’s: Cash flow, Collateral, and Credit score. You and your company must have all three.

Role of the Small Business Administration

Most small business lines of credit are backed by the Small Business Administration (SBA) and are offered through the SBA (7a) Program. These programs are designed to help small business owners who need funds to operate and grow their businesses.

The SBA itself does not make loans. Instead, it acts as a guarantor to lending institutions, who, in turn, make these loans. Most business owners think that these guarantees protect them from problems if they default on the loan. This notion is incorrect.

The SBA guarantee acts as second-level protection for the bank. If the business defaults on the line of credit, the bank first tries to collect from the business and the owner. This collection can be done by pursuing pledged collateral and through other avenues. The SBA guarantee makes the bank whole (up to 90% of the loan) only if the lender is unable to collect from the client.

1. Company assets and income

Most banks and lending institutions examine your company’s income and assets as the first part of their review process. They can provide a line of credit only if your company has a means to repay it.

These requirements vary by bank. However, most banks want to see two years’ worth of operating profits. They also want to see assets such as accounts receivable, machinery, inventory, and real estate. In general, banks can provide financing for up to 50% of your assets.

2. Reasonable financial ratios

As part of the underwriting process for the line of credit, the bank reviews certain financial ratios. These reviews vary by situation, but banks usually look at the following:

  • Debt service coverage ratio: Measures if your company’s income is sufficient to pay the principal and interest of your debt
  • Fixed charge coverage ratio: Measures if your company is able to pay the interest of your debt after paying for your fixed costs
  • Current ratio: Measures your company’s liquidity and its ability to pay short-term obligations. It’s based on current assets and liabilities
  • Other ratios: Each financial institution has its own set of underwriting criteria and ratios that they review

3. Guarantees

Most corporate lines of credit require that they be guaranteed by the company, owners/major shareholders, or both. Guarantees may include that collateral be pledged and usually allow the lender to file a lien on specific assets.

a) Personal guarantees

Many lenders require that business owner or major shareholders guarantee the facility personally. Usually, individuals who own 10% to 20% (or more) of the business have to sign guarantees. The personal guarantee allows the lender to pursue the owner’s personal assets if the business defaults on the line of credit.

b) Corporate guarantees

Lenders require that the company guarantee the line of credit that it’s taking. They may want some or all of the company assets to secure the line. Also, if the company is a subsidiary of a larger company, the lender often requires a guarantee from the parent company as well.

4. Personal background and credit search

As part of their underwriting process, lenders often perform background checks on the business owner and major guarantors. They often check the personal background, professional history, personal credit, and assets of these key individuals.

Lenders go through this process to determine the assets and character of guarantors. Character is actually very important. Companies don’t run themselves. They are operated by owners, managers, and employees. How a person conducts their private life often reflects how they conduct their business life as well. As you may imagine, this process is done to exclude business owners who don’t have great credit or who have few assets.

Understand loan covenants

Business lines of credit usually have covenants. Covenants are rules and conditions that your company has to comply with if it wants to open the facility and to keep it operational. These vary by bank, but here is a list of some common covenants:

a) Net worth

Some lenders may require that your company keep a minimum net worth. This requirement protects lenders from having the assets of your company go too low, which would prevent lenders from recovering their funds.

b) Monthly certification

Some business lines of credit require a monthly certification process. In this case, your company needs to disclose the current state of accounts, inventory, and other assets. Funds availability is tied to the assets listed in the certificate.

c) Confession of judgment clause

This covenant stipulates that the bank is able to file a judgment without having to go through a trial. As you can imagine, this clause facilitates the lender’s collection efforts. Read more information here.

d) Liquidity

Lenders may require that your company comply with the minimum performance of a number of liquidity ratios such as the current ratio, the quick ratio, or the cash conversion cycle.

e) Debt

Most lenders require that your company perform above certain minimums for the debt service coverage ratio, the fixed charge ratio, and similar ratios.

f) Material changes

Lastly, many lenders have a material changes clause that acts as a catchall clause. Basically, it covers a number of events that could have a negative impact on your business.

Benefits and drawbacks of a line of credit

Lines of credit have some distinct advantages, including:

  1. They can improve your cash flow quickly
  2. They can be flexible as long as you don’t reach the limit
  3. They can be used to pay for important and emergency expenses
  4. They are cheaper than most alternative solutions

However, like any business solution, lines of credit are not perfect and also have a number of disadvantages:

  1. They are hard to get
  2. They are not an option for startups or companies with less than two years of trading history
  3. Covenants can be hard to meet
  4. Once you reach the limit, it’s hard to increase it quickly
  5. Purchase orders are not considered collateral – this restriction can limit growth

Assuming your company qualifies for a line of credit, the decision to use one comes down to your main business objective. If you cannot meet the qualification requirements, obviously a line is not an option.

Often, the decision is a matter of cost vs. flexibility. Lines of credit can be inexpensive, but they often lack the flexibility that growing small businesses need. Other options tend to be more expensive but are also more flexible.

Are there better alternatives?

The problem with lines of credit is that few small and growing companies can get them. Government-backed lines of credit, such as 7(a) loans, may be easier to get than conventional financing. However, they are not easy to get. And even if you can get a line, increasing the limit is often difficult and time consuming. Here are two alternatives that can help growing companies that need financing:

1. Invoice factoring

Invoice factoring allows you to finance slow-paying accounts receivable. Most companies have low cash flow because commercial clients take 30 to 60 days to pay their invoices. Small businesses owners often can’t wait that long for payment. They risk running low on funds and being unable to pay company expenses.

You can improve your cash flow quickly by factoring your invoices. This solution finances invoices that are payable in up to 90 days. Instead of waiting for a payment, you get funds directly from the factoring company. This funding provides you with immediate working capital.

The transaction settles once your client pays their invoice on their regular schedule. The line is flexible and can grow with your business, as long as your commercial clients are creditworthy.

Qualifying for a factoring line is easier and faster than qualifying for a commercial line of credit. The most important requirement is that you must work with creditworthy commercial clients. This requirement is important, as your client’s ability to pay invoices is what supports the transaction. This solution is ideal for small and growing companies that can’t qualify for conventional loans. Learn more about factoring.

2. Sales ledger financing

Sales ledger financing is a solution that works like a line of credit that is tied to a company’s accounts receivable. Companies can draw funds at any time up to their limit. This solution is usually available to companies that have outgrown factoring but aren’t ready for a bank line of credit.

One important advantage of sales ledger financing is that the line is flexible and can grow with your business. Furthermore, sales ledger lines have fewer covenants than lines of credit and are easier to maintain. This solution is available to companies that invoice a minimum of $250,000/month and have a good portfolio of customers.

What is arbitrage in simple words?

What is arbitrage in simple words?

The simultaneous buying and selling of securities, currency, or commodities in different markets or in derivative forms in order to take advantage of differing prices for the same asset. "profitable arbitrage opportunities"

What does arbitrage mean in business?

Arbitrage is an investment strategy in which an investor simultaneously buys and sells an asset in different markets to take advantage of a price difference and generate a profit.

Proof of funds?

Proof of funds refers to a document that demonstrates the ability of an individual or entity to pay for a specific transaction. A bank statement, security statement, or custody statement usually qualify as proof of funds.

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The Standby Letter of Credit: What It Is and How To Use It
A standby letter of credit (SLOC) is a legal document that guarantees a bank's commitment of payment to a seller in the event that the buyer–or the bank's client–defaults on the agreement. ... A standby letter of credit can also be abbreviated SBLC. 

"Irrevocable letter of credit" (ILC), as used in this clause, means a written commitment by a federally insured financial institution to pay all or part of a stated amount of money, until the expiration date of the letter, upon presentation by the Government (the beneficiary) of a written demand therefor.

The Richest Man in Babylone
This book deals with the personal successes of each of us. Success means accomplishments as the result of our own efforts and abilities. Proper preparation is the key to our success. Our acts can be no wiser than our thoughts. Our thinking can be no wiser than our understanding.

Very much like Bank Guarantee, a Standby Letter of Credit can be used by Buyer as collateral to secure a Loan or Credit Facility or to make purchases in foreign business transactions. SBLCs are very flexible instruments for all types of business.

eBook: Almanack by Charles T. Munger.pdf

"Acquire worldly wisdom and adjust your behavior accordingly. If your new behavior gives you a little temporary unpopularity with your peer group ... then to hell with them." - Charles T. Munger

eBook: Thinking Outside The Bowl

Use this service to leverage your capital or standby letter of credit in order to participate in a private placement program or capital enhancement program (trade).