What are the differences between Funded and Non-Funded Commitment in the banking sector?

 In the banking sector, funded and non-funded commitment are types of financial agreements between a bank and a borrower. The main differences between the two are as follows:

1.     Funded Commitment: In a funded commitment, the bank provides the borrower with the actual funds needed to finance the project or activities. For example, if a borrower applies for a loan to buy a house, the bank provides the funds to the borrower upon approval of the loan application. The borrower can use the funds to buy the house and then repay the loan to the bank over time, along with interest.

2.     Non-Funded Commitment: In a non-funded commitment, the bank does not provide the borrower with the actual funds needed to finance the project or activities. Instead, the bank provides a promise to provide funds later, if certain conditions are met. For example, a bank might issue a letter of credit to a borrower, which guarantees payment to a supplier once certain conditions are met, such as the delivery of goods or services.

3.     Risk: In a funded commitment, the bank takes on the risk of providing the funds to the borrower. If the borrower is unable to repay the loan, the bank may lose the funds that is provided. In a non-funded commitment, the risk is generally lower because the bank is not providing actual funds to the borrower.

4.     Fees: Banks typically charge fees for both funded and non-funded commitments, but the fees may structure differently. For a funded commitment, the bank may charge an organization fee and interest on the loan. For non-funded commitment, the bank may charge a fee for issuing the commitment, by may not charge interest until funds are provided.

 

Overall, the main difference between funded and non-funded commitments in the banking sector is that funded commitments involve the actual provision of funds, while non funded commitments involve a promise to provide funds at a later date, subject to certain conditions.