Credit Facility
Credit facility is the economic relationship between a lender and a borrower. A loan granting operation consists in the lender placing cash at the borrower's disposal for a specific purpose, and the borrower undertakes to use it under the terms and conditions specified in the agreement, return the amount of the loan used together with interest at specific repayment dates and pay commission on the loan. As a rule, the lender is a bank (J. Mbawuni, S. Nimako, 2015, pp. 1-3) .
The term credit facility is derived from the Latin word credere meaning to trust, to believe. Thus, credit means making assets available for use based on trust (K. Amoah-Binfoh, 2014, pp. 52).
The importance of credit facility
Lending is one of the basic forms of banking activity. Bank receivables on account of consumer and economic loans granted are the group of assets with a dominant share in the balance sheet total of commercial banks, generating the highest income and associated with the highest risk (K. Amoah-Binfoh, 2014, pp. 52-54). The Bank is the parent party of the loan relationship with the borrower: it determines the terms and conditions of the loan and is authorized to control its use. The loan plays an important role both as an instrument of financing the current activity of the company and a way of obtaining funds for investments. It has become an important element of economic life and is often necessary for running and developing an enterprise (K. Amoah-Binfoh, 2014, pp. 52-54).
Credit facility agreement
The credit agreement should be concluded in writing, and at the same time it should precisely define in particular (D. R. Van Deventer et al., 2013, pp. 694-699):
- parties to the agreement
- the amount of credit and its currency
- the purpose for which the credit was granted
- credit repayment terms and conditions
- the interest rate of the loan, as well as the conditions for its change
- the method of securing the repayment of the loan
- the scope of the bank's powers related to the control of the use and repayment of the loan
- the timing and method of transferring money to the borrower
- the amount of the commission (if the agreement provides for it)
- the conditions for amending and terminating the contract in the case of foreign currency loans, also the rules for determining the foreign currency exchange rate.
Types of credit facility
The distribution of credits may be made based on (G. Ekwere, D. Edem, 2014, pp. 36-38):
- the duration of the loan,
- the object of the credit (purpose),
- a form of credit,
- the method of securing the repayment of the loan,
- the currency of the loan,
- interest rate rule.
Credit facility functions
The credit has the following three functions S. A. Jones, 2018, pp. 489-505):
- issuance (consisting in putting money into circulation),
- stimulation (use of credit policy instruments for directions of economic development),
- income (credit used in production triggers a mechanism of income growth due to the development of manufacturing activity).
Granting credit facility
The Bank decides whether to grant a loan to a borrower. The decision is primarily influenced by the creditworthiness of the borrower. Also, the Bank decides to grant a loan to a borrower (T. Adrian, et al., 2009, pp. 238-240):
- the age of the borrower
- owned property
- form of employment
- number of dependants
- accommodation
If the borrower becomes uncreditworthy the bank can (T. Adrian, et al., 2009, pp. 238-240):
- reduce the amount of credit granted
- terminate the agreement
Foreign currency credit facility
The credit agreement should include rules for determining the exchange rate of the foreign currency (P V. Lakshmi, M. S. Murugan, 2009,pp.12). The repayment of such a loan may be made directly in a foreign currency. This right must not entail any additional costs for the borrower, e.g. the bank must not require the borrower to purchase currency to repay the loan (M. K. Kerfoot, et al., 2017, pp. 118).
Examples of Credit Facility
- Personal Loan: A personal loan is a type of loan that is given to an individual to meet their immediate financial needs. Generally, a personal loan is unsecured and has a fixed interest rate, meaning that the amount of the loan is not backed by any collateral or security. Borrowers must typically provide proof of income, employment, and credit history to qualify for a personal loan.
- Home Equity Loan: A home equity loan, also known as a second mortgage, is a loan taken out against the equity in a borrower's home. Equity is the value of the homeowner's interest in their property, which is the difference between the appraised value of the property and the amount of any outstanding mortgages or liens. Home equity loans are typically used for larger expenses, such as home repairs, debt consolidation, or college tuition.
- Line of Credit: A line of credit is a flexible form of credit that allows a borrower to draw money up to a certain limit and then repay it with interest. Unlike a loan, a line of credit is a revolving line of credit, meaning that the borrower can draw on it again after they have repaid it. Lines of credit are often used to finance large purchases, such as cars, home improvements, and business expenses.
Advantages of Credit Facility
The advantages of credit facility are numerous and include:
- Convenience - Credit facilities offer borrowers the convenience of accessing funds quickly without having to go through the lengthy process of applying for a loan. This can be especially helpful in times of financial emergencies. Moreover, it allows borrowers to have the flexibility to borrow an amount that fits their needs.
- Lower Interest Rates - Credit facilities typically offer lower interest rates than other forms of loans, making them more desirable for borrowers. This is especially true for those with good credit scores who are able to secure better rates.
- Easier Repayment - Credit facilities generally have more lenient repayment terms, making it easier for borrowers to manage their debt. This can be especially helpful for those with limited incomes or those who are unable to secure a loan from a traditional lender.
- Credit Improvement - Making payments on time and in full can help improve a borrower’s credit score over time. This can be beneficial in the long run as it can open up more borrowing opportunities in the future.
Limitations of Credit Facility
- The use of credit facility comes with certain limitations, such as:
- Risk of non-payment: The lender is exposed to the risk of non-payment by the borrower and thus, may incur a loss in the form of unpaid interest and principal.
- Time Intensive: The process of obtaining a loan can be time consuming, as the lender must review the borrower’s financial information and credit history.
- Risk of Default: There is a risk of borrower defaulting on the loan, which could result in the lender incurring a loss.
- Risk of High Interest Rates: The lender may charge high interest rates to compensate for the risk of default.
- Collateral Requirements: The lender may require collateral from the borrower to secure the loan, which may not be possible for the borrower to provide.
- Costs Associated with Loan: The borrower may be required to pay various fees and costs associated with obtaining the loan, such as origination or processing fees.
In addition to the traditional loan granting operation, there are other approaches related to Credit Facility:
- Asset-based lending - this type of loan is secured by the borrower’s assets, such as inventory or accounts receivable, which the lender can seize if the borrower defaults.
- Factoring - this is an arrangement in which a lender purchases a borrower’s accounts receivable at a discount and then collects on them.
- Lines of credit - this is a loan in which the lender agrees to make funds available up to a certain amount, and the borrower can draw down on the line whenever needed.
- Credit cards - these are a form of loan in which the borrower is issued a card and can use it to make purchases up to a certain credit limit.
- Equity financing - this is a form of loan in which the borrower sells a stake in their business in exchange for cash.
In sum, Credit Facility is a broad term that encompasses a variety of loan granting operations, from traditional loans to more creative financing arrangements.
| Credit Facility — recommended articles |
| Lombard loan — Non current liability — Evergreen Loan — Direct paper — Customer deposits — Unsecured Note — Cash bond — Capital Base — Creation of money |
References
- Adrian T., Burke C. R., McAndrews J., (2009), The Federal Reserve’s Primary Dealer Credit Facility, 238-240
- Amoah-Binfoh K., Velmurugan T., Charles R., (2014), The Impact of Credit Facilities Given by Rural and Community Banks to Farmers - A Special reference to Ghana, "Conference: Assessing and Developing Sustainable Business Model; Financial Perspective", SRM University, 52-54
- Bouteille S., Coogan-Pushner D., (2012), The Handbook of Credit Risk Management: Originating, Assessing, and Managing Credit Exposures
- Ekwere G., Edem D. (2014), Effects of agricultural credit facility on the agricultural production and rural development, 36-38
- Jones S. A., (2018), The Credit Facility Application: A Practical Guide to Risk Evaluation and Structuring, "Trade and Receivables Finance", 489-505
- Kerfoot M. K., Alicandri J. R., Perkins R. G., (2017), The ABCs of Fund Finance: Credit Facilities for Secondaries Funds and Funds of Funds, "Journal of Investment Compliance", 118
- Lakshmi P V.,Murugan M. S., (2009), A Market Study on Bank Credit Facilities to Small and Medium Enterprises,
- Mbawuni J., Nimako S., (2015), Predicting Clients’ Intentions to Acquire Credit Facilities, "Ghanaian Financial Market", 1-3
- Popli G.S., Puri S.K., (2013), Strategic credit managment in banks
- Reeve J., Warren C., (2006), Corporate Financial Accounting
- Van Deventer D. R., Imai K., Mesler M., (2013), Pricing and Valuing Revolving Credit and Other Facilities, "Advanced Financial Risk Management: Tools and Techniques for Integrated Credit Risk and Interest Rate Risk Management", 694-699,
Author: Dominika Pasek
