Non-Fund Based Limits (LC & BG): The Hidden Credit Risks Bankers Must Watch

Vinu: Manu, non-fund based limits like LC and BG don’t involve immediate cash outflow. Why are they still risky?

Manu: Because they can convert into fund-based exposure anytime. Once an LC devolves or a BG is invoked, the bank must pay.

Vinu: Let’s start with Letters of Credit (LC). What is the key risk?

Manu: Devolvement risk. If a borrower fails to pay ₹40 lakh LC on due date, the bank funds it immediately, turning it into a loan.

Vinu: What causes such devolvement?

Manu: Poor cash flow, overtrading, or delayed sales realisation. Sometimes, LCs are opened without matching working capital capacity.

Vinu: How should bankers assess LC limits?

Manu: Link them with actual purchase cycle and turnover. An LC limit of ₹2 crore for a ₹3 crore turnover business is excessive.

Vinu: What about Bank Guarantees (BG)?

Manu: BG carries invocation risk. If a ₹50 lakh performance guarantee is invoked, the bank must pay without delay, regardless of disputes.

Vinu: Do bankers underestimate BG risk?

Manu: Often. Especially in contract-based businesses where disputes and delays are common.

Vinu: How does margin play a role here?

Manu: Low or no margin increases exposure. If only 10% margin is taken on a ₹1 crore BG, the bank carries ₹90 lakh risk.

Vinu: Any red flags in non-fund limits?

Manu: Frequent LC devolvement, BG invocation history, and mismatch between sanctioned limits and actual business scale.

Vinu: How should these limits be monitored?

Manu: Track due dates, devolvement instances, and ensure timely adjustment. Also monitor whether underlying transactions are genuine.

Vinu: Final takeaway?

Manu: Non-fund limits are silent risks. They don’t show stress until they suddenly become funded liabilities.

Vinu: That makes their importance very clear.

Manu: Exactly. Hidden risks need sharper attention from bankers.

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