What are Funded Loans and Non-Funded Loans?

Today, banks have moved beyond being financial institutions just for the safekeeping of their customers’ money. With technological advancement, the banking system has undergone a drastic change. They are now fintech-enabled financial services companies. Apart from basic savings and current accounts, a bank’s portfolio now includes wealth management, depository, credit card, and mortgage services among other things. They have expanded their loan business to include financing facilities to cater to a wide range of enterprises. Whether it is an established business or a startup, loans granted by banks and other financial institutions help business owners grow and expand their businesses. Funded loans and non-funded loans are two of the credit facilities extended by banks to business enterprises.

What are Funded Loans?

Funded loans are credit facilities in which the funds of a bank or an NBFC are directly involved. In such loans, there is an actual transfer of funds from the bank to the borrower. Say, a business owner approaches a bank to secure financing in the form of a business start-up loan. After completing the requisite documentation, a loan is approved. Post-approval, the bank disburses the approved loan amount directly into the customer’s business account. Since there’s an actual transfer of money from the lender (bank) to the borrower (business entity), it is called a funded loan.

Types of Funded Loans

Business entities require financing for a variety of reasons depending upon the nature of the business. It could be a loan for a startup company to start its business operations. Or, it could be for purposes of expansion for an established business. Business loans differ based on purpose, loan duration, type of interest, borrowing amount, and flexibility of the loan. For funded business loans, the financed amount is directly credited into the borrower’s account.

Here are some of the common types of funded business loans in India:

• Term Loans: These are long-term business loans taken to purchase long-term assets like land, buildings, equipment, and machinery. Such loans have a fixed repayment schedule, with EMIs due every month or quarter.

• Start-Up Loan: These loans are becoming quite popular as many start-ups are flourishing in India. Since a start-up is a new business venture, it may not have the requisite credit history or turnover as a business entity. In such cases, the credit profile of the promoters is taken into consideration along with the business credit profile.

• Working Capital Loan: These are usually short-term loans (up to 12 months) used by individuals, entrepreneurs, startups, and MSMEs to meet their daily business requirements and operations. In this type of loan, the lender sets a limit for the business to take a loan and the amount can be utilized for specific business purposes, only.

• Overdraft/Cash Credit Facility: Commonly known as OD or CC, this facility allows borrowers to withdraw funds more than the account balance. An overdraft facility is offered against collateral/securities. The collateral are business assets like FDs, stock, machinery, building, investments, etc.

• Equipment Finance or Machinery Loan: Such funded loans are extended to businesses to finance the purchase of new equipment/machinery or to upgrade the existing one.

• Government Loans: The government has introduced many loan schemes to boost the business sector. These can be availed of by individuals, MSMEs, women entrepreneurs, and other entities engaged in trading, services, and manufacturing sectors. Some of the prominent government loans are MSME loans, Mudra Scheme, Startup India Loan, etc.

• Business Credit Card: When used responsibly, a business credit card can take care of immediate business requirements. The rewards earned on purchases can be redeemed for various benefits.

• Invoice Financing: This type of funded loan is quite beneficial for small businesses that face fund shortages due to the time lag between raised invoices and payments made. Lenders can finance up to 80% of the invoice amount to enable the entity to carry on daily operations. Once the invoice is cleared, the entity pays back the debt.

What are Non-Funded Loans?

Non-funded loans are credit facilities in which the funds of a bank or an NBFC are not directly involved. There’s no direct transfer of funds from the lender to the borrower’s account. The lender pays the amount to a third party on behalf of the borrower. In a non-funded loan, the lender commits to a third party that it shall take care of the financial obligation of the borrower to the third party in case the borrower is unable to do so.

• Bank Guarantee (BG): As the name suggests, in this type of non-funded loan, the bank guarantees to discharge any liability to the third party in the event of failure by the customer to discharge their contractual obligations.

  There are different types of bank guarantees that cover different situations.

  • Advance Payment Guarantee

  • Financial Guarantee

  • Bid Bond Guarantee

  • Deferred Payment Guarantee

  • Foreign Bank Guarantee

  • Performance Guarantee

   

• Letter Of Credit (LC): LC is a non-funded credit facility, most commonly used by businesses engaged in export and import. It is a legal document issued by the bank to the creditor (seller) that guarantees that the creditor shall receive the payment when certain conditions are met even when the debtor (buyer) is unable to pay.