Arjun Singh Rathore
I am having a cash credit (CC) limit of Rs.100.00 Lacs from X bank and I never use more than Rs.5.00Lacs at any given point of the year, how financially disciplined am I? In one financial year I save 11 Lacs as interest amount. But what a surprise despite of running my account so well with an annual turnover of more than 600.00Lacs and serving my monthly interest well in time, I have been charged with Rs.50,000/- as commitment fee.Can you Mr. Bank Manager explain me these charges.
Dear Sir,”The fee levied by a creditor on the borrower for future or unused credit is called commitment fee.” A commitment fee is a banking term used to describe a fee charged by a lender (Bank) to a borrower to compensate the lender (Bank) for its commitment to lend. Commitment fees typically are associated with unused credit lines or undisbursed loans in case of working capital (cash credit, secured overdraft, easy working finance, etc.,). The lender (Bank) is compensated for providing access to a potential loan through a commitment fee since it has set aside the funds for the borrower and cannot yet charge interest, except in case of term loans, where the lender (Bank) does not disburse the credit at one go to the borrower. In most of these cases, the loan disbursal is linked to the project completion stage.
Commitment, as the name itself explains, is a promise and undertaking for the accomplishment of a certain task and object. In banking when a customer applies for a working capital loan from a bank, he asks for a commitment from the bank that to run the daily affairs of his business, especially for the purchase of stocks or raw material, bank will make the funds, as per the limit sanctioned, available to meet his business commitments. The day a bank sanctions a particular limit in favour of his borrower, it is committed to keep that amount available to be utilised by the borrower as and when demanded or required. In general terms one can understand that a “Commitment fees” is being charged for some approved facility which can be drawn down in future on the same terms which have been agreed initially between the lender (bank) and the borrower. Banks usually charge some fees to provide this kind of facility which is usually called commitment charges/fees. So if that sanctioned amount is not utilised by the borrower, the bank suffers a loss by way of not earning any interest on that amount.
A commitment fee generally is specified as either a flat fee or a fixed percentage of the un-availed loan amount. The lender charges a commitment fee as compensation for keeping a line of credit open or to guarantee a loan at a specific date in the future. The borrower pays the fee in return for the assurance the lender will supply the loan funds at the specified future date and at the contracted interest rate, regardless of conditions in the financial and credit markets.
In most cases, if the borrower decides not to move forward with the loan, the commitment fee still is payable to the lender.
Legally, a commitment fee is different from interest, although the two often are confused. The key distinction between the two is that a commitment fee is calculated on the un-availed loan amount while interest charges are calculated by applying an interest rate on the amount of the loan that has been disbursed and not yet repaid.
Interest also is charged, and paid, periodically. A commitment fee, on the other hand, often is paid as a one-time fee at the closing of the financing transaction. A further commitment fee may be charged by a lender at the renewal of credit facilities. In the case of open lines of credit, a periodic commitment fee may be charged on the unused portion of the available funds.
In the case of a one-time loan, the commitment fee is negotiated between the lender (bank) and the borrower. The fee can be a flat amount, such as Rs.1,000/-, or a percentage of the loan amount, such as 1%.
For an open line of credit, a formula is used to calculate the average available amount of credit on a periodic basis, often quarterly. The fee is then calculated by multiplying the average unused commitment by the agreed-upon commitment fee rate and again by the number of days in the reference period. However, formula for determining the commitment charges may slightly vary from bank to bank.
Finally, to ensure the financial discipline and compensate for the probable loss that theBank may suffer by sticking to its commitment of keeping funds aside for your future use (and not investing them and earning on them) despite you as a borrower not sticking to your commitment of complete fund utilization. In other words, non-utilization of the working capital limit is also a violation on the part of the borrower for non-fulfilment of his asked/demanded working capital requirement resulting into the breach of would be commitment. Accordingly, banks are free to evolve their own guidelines in regard to commitment charge for ensuring credit discipline.
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