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Role of banks in international trade

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ROLE OF BANKS IN
INTERNATIONAL TRADE
Presented by: Muhammad Imran, ACA
Region Head – Audit & RAR (0332-4188830)
    Why Trade?
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       Non availability of specific factors of production in
        some countries. (Land, Labour, Capital and
        Entrepreneurship)

       Product differentiation in different countries.

       Differences in comparative cost between countries e.g.
        Law of comparative Advantage

       Scarcity and specialization. (Opportunity Cost)
    What is International Trade?
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       International trade is exchange of capital, goods, and services
        across international borders or territories. In most countries, it
        represents a significant share of gross domestic product (GDP).
        While international trade has been present throughout much of
        history, its economic, social, and political importance has been on the
        rise in recent centuries.

       Industrialization,   advanced      transportation,   globalization,
        multinational corporations, and outsourcing are all having a
        major impact on the international trade system. Increasing
        international trade is crucial to the continuance of globalization.
        Without international trade, nations would be limited to the goods
        and services produced within their own borders.
    Domestic V/S International Trade
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       International trade is in principle not different from domestic trade as the
        motivation and the behavior of parties involved in a trade do not change
        fundamentally regardless of whether trade is across a border or not. The
        main difference is that international trade is typically more costly than
        domestic trade. The reason is that a border typically imposes additional
        costs such as tariffs, time costs due to border delays and costs associated
        with country differences such as language, the legal system or culture.

       Another difference between domestic and international trade is that factors
        of production such as capital and labour are typically more mobile within a
        country than across countries. Thus international trade is mostly restricted to
        trade in goods and services, and only to a lesser extent to trade in capital,
        labor or other factors of production. Then trade in goods and services can
        serve as a substitute for trade in factors of production.
                                                                  Continued…
    Domestic V/S International Trade
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       Instead of importing a factor of production, a country can
        import goods that make intensive use of the factor of
        production and are thus embodying the respective factor. An
        example is the import of labor-intensive goods by the
        United States from China. Instead of importing Chinese
        labor the United States is importing goods from China that
        were produced with Chinese labor.

       Nutshell, differentiating factor are;
        A. Foreign Exchange Risk
        B. Political Risk
        C. Market Imperfection (MNCs are gift of this)
        D. Expanded opportunity set
    Gains From International Trade
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       International trade leads to mutual gain because it
        allows each country to specialize in the production of
        those things that it does best.
       Trade permits each country to use more of its resources
        to produce those goods that it can produce at a
        relatively low cost.
       With trade, it is made possible for the trading partners
        to consume a bundle of goods that it would be
        impossible for them to produce domestically.
       Trade encourages competition & efficiency.
    Top 20 Trading Nations (2009 Data)
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    Top Traded Commodities-Export (2009 Data)
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    Regulations Of International Trade
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       Traditionally trade was regulated through bilateral
        treaties between two nations. For centuries under
        the belief in mercantilism most nations had high
        tariffs and many restrictions on international trade.
       Liberalization (Free Trade) at global level; (2 World War)
                                                               nd


        A. General Agreement on Tariffs and Trade (GATT) and
        B. World Trade Organization (1994)
       Liberalization (Free Trade) at regional level;
        A. MERCOSUR in South America.
        B. North American Free Trade Agreement (NAFTA) between the United
        States, Canada and Mexico.
        C. European Union between 27 independent states
     Risks in International Trade
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        Buyer insolvency (purchaser cannot pay);
        Non-acceptance (buyer rejects goods as different from the agreed
         upon specifications);
        Credit risk (allowing the buyer to take possession of goods prior to
         payment);
        Regulatory risk (e.g., a change in rules that prevents the transaction);
        Intervention (governmental action to prevent a transaction being
         completed);
        Political risk (change in leadership interfering with transactions or
         prices);
        War and other uncontrollable events; and
        Unfavorable exchange rate movements (and, the potential benefit
         of favorable movements) – Hedging (Direct/indirect hedging
         through Banking Channels)
     Role of Banks (Commercial / Central)
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        It is impossible to be in international trade without
         involving your bank for all the services they provide
         such as advice on financial issues and the potential
         risks involved. It is true that one critical hurdle is the
         lack of information on international trade processes,
         documentation and banking procedures necessary to
         carry on with business abroad. For result oriented and
         cost effective international trade, you will very
         definitely need access to accurate and timely
         information and a sound knowledge of banking.
                                                       Continue ...
     Role of Banks (Commercial / Central)
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        Attractions for banks in international trade;
         A. Profitability                           Overview of International Trade
         B. Low Risk Nature-The Six ―S‖s A. Flow of goods from seller to buyer
         i. Short-Term                      B. Flow of Payment from buyer to seller
                                            C. In accordance with a contract of sale
         ii. Small
         iii. Secured                                 Documentary requirements
         iv. Self-Liquidating               Buyer - What documents does he needs?
         v. Specific                        Seller - With what documents will he be able to
         vi. Selective                      supply?
                                            Country of export - what documents are
         C. A large growing Market
                                            required under the regulations of the exporting
         D. Well spread over market         country?
         E. Easy to Monitor                 Country of import - what documents are
         F. Cross Selling information       required under the regulations of the importing
         G. Capital efficient               country?
                             Continue …
     Role of Banks (Commercial / Central)
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        Wants / needs and problem of trading partners
     Partner   Wants / Needs          Problems

     Buyer     1.   Contract          1.   Am I going to get the goods? (in good condition / in time)
     Wants          fulfillment.      2.   Does the settlement method safeguard these risks?
               2.   Convenience.      3.   Before we pay—how to check the goods are exactly those
               3.   Credit.                ordered?
               4.   Advice and        4.   Any credit terms available Prefers to delay paying for the
                    assistance             goods until they are sold.
                                      5.   From where can I get information on the exporter’s
                                           creditability
     Seller    1.   Contract          1.   Will I be paid?
     Needs          fulfillment.      2.   When will I be paid?
               2.   Convenience.      3.   How to minimize risk of non-payment?
               3.   Prompt payment.   4.   How to maintain secrecy of our supplier?
               4.   Advice and
                    assistance
     Role of Banks (Commercial / Central)
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         Basic agreement (International Trade – Sale Contract)
     1.    Preliminary Quotation & Commitment (Invoicing / order etc)
     2.    The Merchandise (goods to be imported / exported)
     3.    Packing (instructions regarding packing of imported /
           exported merchandise)
     4.    Method of Settlement (Immediate or Credit / Advance / LC
           Collection???)
     5.    Shipping Instructions (trans shipment – partial shipment etc)
     6.    Price and its components (INCOTERMS 2000)
     7.    Delivery Mode ,Period, Place (Sea, Air, Road – place of
           shipment and last date of shipment)
     8.    Documents (Invoice, packing list, inspection report, certificate
           of origin, BL/AWB etc)
                                                             Continue …
     Methods of Settlement
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        Considerations of trading partners;

          Partner     Consideration
          Buyer       1.   Goods in advance.
                      2.   Payment at the time of receipt of goods.
                      3.   Payment after receipt of shipping documents.
                      4.   Need bank finance.
          Seller      1.   Payment in advance.
                      2.   Payment at the time of shipment of goods.
                      3.   Payment after delivery of shipping documents.
                      4.   Need bank finance.

        Methods of settlement (Payments)

          Direct between buyer and seller (trading     Indirect through involvement of banks
          partners) / Clean Payments
          1.   Open Account / Extended Terms           1.   Documentary Collections
          2.   Advance Payments                        2.   Documentary Credits
     Clean Payments
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        Clean Payments are characterized by trust. Either
         the Exporter sends the goods and TRUSTS the
         Importer to pay once the goods have been received
         (Open Account / Extended Terms), or the Importer
         TRUSTS the Exporter to send the goods after
         payment is affected (Advance Payments).
     Documentary Collection
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        A method of payment used in international trade whereby the Exporter
         entrusts the handling of commercial and financial documents to banks and
         gives the banks instructions concerning the release of these documents to the
         Importer.
        Banks involved do not provide any guarantee of payment.
        Collections are subject to the Uniform Rules for Collections published by
         the International Chamber of Commerce. The last revision of these rules
         came into effect on January 1, 1996 and is referred to as the URC522.
        Documentary collection may be carried out in two following ways;
         A. Documents against Payment (DAP) / Sight Collection (SC) / Cash
         Against Documents (CAD)
         Documents are released to the Importer only against payment.
         B. Documents against Acceptance (DAA) / Term Collection (TC)
         Documents are released to the Importer only against acceptance of a
         draft/promissory note. Also known as a Term Collection. Due date can be
         from any document date (BL/AWB etc) or from acceptance of promissory
         note date.
     Documentary Collection
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      Parties to a Collection – General          International Terminologies (URC 522)
      1.    Importer                             1.   Drawee (Importer)
      2.    Importer’s bank                      2.   Collecting bank – of proceeds (Importer’s bank)
      3.    Bank in exporter’s country           3.   Remitting bank – of documents (Bank in exporter’s country)
      4.    Exporter                             4.   Drawee (Exporter)

     Mechanism of Documentary Flow
     The mechanics of a Documentary Collection are easily understood when separated into the following three steps:
           A. Flow of Goods
           After the Importer and the Exporter have established a sales contract and agree on a Documentary Collection as
           the method of payment, the Exporter ships the goods.
           B. Flow of Documents
           After the goods are shipped, documents originating with the Exporter (e.g. commercial invoice) and the transport
           company (e.g. bill of lading) are delivered to a bank (Remitting Bank). The role of the Remitting Bank is to send
           these documents accompanied by a Collection Instruction giving complete and precise instructions to a bank in the
           Importer’s country (Collecting/ Presenting Bank).
           The Collecting/ Presenting Bank acts in accordance with the instructions given in the Collection Order and releases
           the documents to the Importer against payment (DAP/SC/CAD) or acceptance (DAA/TC), according to the Remitting
           Bank’s Collection instructions.
           C. Flow of Payment
           Payment is forwarded by Collecting / Presenting Bank to the Remitting Bank for the Exporter’s account and the
           Importer can now present the transport/title document to the carrier in exchange for the goods.
     Documentary Collection
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     Documentary Collection – Governing Rules
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         International
     1.     URC-522 (Uniform Rules for Collections-ICC
            Publication no. 522)
     2.     INCOTERMS-2000(International Commercial Terms)
         Local
     1.     Foreign Exchange Manual-2002
     2.     SBP Prudential Regulations M-Series
     3.     Others i.e. (CBR Directives, Trade Policy, Contract Act,
            Sale of Goods Act, Negotiable Instruments/Bill of
            Exchange Act, Carriage of Goods by Sea Act, Marine
            Insurance Act, Bills of Lading Act etc)
     Documentary Credits / L.Cs
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         The LC in its modern shape appeared for the 1st time in 1840s in London
          for the settlement of trade transactions.
         A Documentary Credit (DC) is a written undertaking by a bank (Issuing Bank) given
          to the exporter (Beneficiary) at the request of the importer (Applicant) to effect
          payment (Reimbursement) up to a stated amount (Credit Amount) within a stated
          time period (Expiry date) against presentation of compliant documents (LC terms).
          In other words DC is a conditional payment undertaking from a bank.
         Parties to a DC/LC – General             International Terminologies (URC 522)
         1.   Importer                            1. L.C applicant (Importer)
         2.   Importer’s bank                     2. L.C Issuing bank (Importer’s bank)
         3.   Bank in exporter’s country          3. Advising / Nominated / Negotiating /
         4.   Exporter’s other bank (optional)       Presenting bank (Bank in exporter’s
         5.   Exporter                               country)
                                                  4. Confirming Bank (Exporter’s other bank
                                                     – optional)
                                                  5. Beneficiary (Exporter)
     Documentary Credits - Mechanism
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     The mechanics of a Documentary Credit / Letter of Credit are easily understood when separated
         into the following three steps;
        A. Issuance of Documentary Credit / Letter of Credit
        After the trading parties agree on a sale of goods where payment is made by Letter of Credit,
        the Importer requests that its bank (the Issuing Bank) issue a Letter of Credit in favour of the
        Exporter (Beneficiary).
        The Issuing Bank then sends the Letter of Credit to the Advising Bank. A request may be included
        for the Advising Bank to add its confirmation. The Advising Bank is usually located in the country
        where the Exporter does business and may be the Exporter’s bank, but does not have to be.
        Next, the Advising/ Confirming Bank verify the Letter of Credit for authenticity and sends it to
        the Exporter.
        B. Flow of Goods
        Upon receipt of the Letter of Credit, the Exporter reviews the Letter of Credit to ensure that it
        corresponds to the terms and conditions in the purchase and sales agreement; that the documents
        stipulated in the Letter of Credit can be produced; and that the terms and conditions of the Letter
        of Credit can be fulfilled. Assuming the Exporter is in agreement with the above, it arranges for
        shipment of the goods.
     Documentary Credits - Mechanism
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      C. Flow of Documents & Payments
      After the goods are shipped, the Exporter presents the documents specified in the
      Letter of Credit to the Advising/ Confirming /Negotiating Bank.
      Once the documents are checked and found to comply with the Letter of Credit (i.e.
      without discrepancies), the Advising/ Confirming Bank forward these documents to the
      Issuing Bank. The drawing is negotiated, paid or accepted as the case may be.
      In turn, the Issuing Bank examines the documents to ensure they comply with the Letter
      of Credit. If the documents are in order, the Issuing Bank will obtain payment from the
      Importer for payment already made to the Confirming Bank.
      Documents are delivered to the Importer to allow him to take possession of the goods
     Documentary Credits - Cycle
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     Documentary Credits – Governing Rules
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         International
     1.     UCP-600 (Uniform Customs and Practice for Documentary Credits -
            ICC Publication no. 600)
     2.     URR-525(Uniform Rules for Reimbursements, ICC-525)
     3.     International Standby Practices ICC-ISP 98
     4.     International Standard Banking Practices
     5.     INCOTERMS-2000(International Commercial Terms)
         Local
     1.     Foreign Exchange Manual-2002
     2.     SBP Prudential Regulations M-Series
     3.     Others i.e. (CBR Directives, Trade Policy, Contract Act, Sale of
            Goods Act, Negotiable Instruments/Bill of Exchange Act, Carriage
            of Goods by Sea Act, Marine Insurance Act, Bills of Lading Act etc)
     SWIFT Operations
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        It (Society for Worldwide Interbank Financial Telecommunications) is
         Cooperative Society under Belgium Law and owned and controlled
         by its members-share holders. It has a board of 25 Independent
         directors appointed by the shareholders who are responsible for
         overseeing and governing the company.

        The National Bank of Belgium, the central bank of the country in
         which SWIFT head quarters are located and which is under
         arrangement with central Banks of G-10 countries i.e. Belgium,
         Canada, France, Germany, Italy, Japan, The Netherlands, United
         Kingdom, Unites States, Switzerland, Sweden, and the European
         Central Bank’’.

        A new SWIFT member will pay a onetime entry fee and recurring
         service fees to SWIFT.
     SWIFT Operations - Benefits
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         Benefits of joining SWIFT;
     1.    Cost is much lower than telex message
     2.    Use of standard formats for messages results in
           consistency.
     3.    Improved accuracy.
     4.    Timely delivery.
     5.    Confidentiality and security.
     6.    Reduced risk.
     SWIFT Operations – Series
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     Series        Description                                 Examples

     Series 1 **   Deals in direct customer related            Single customer transfer i.e.MT103 (TT)
                   messages.
     Series 2 **   Deals in Financial Institution Transfers.   General Financial Institutions Transfer i.e.
                                                               MT202 (Imports)
     Series 3 **   Deals in Buying and Selling of Two          Forward Rate Agreement Confirmation i.e.
                   Currencies.                                 MT340 (Treasury)
     Series 4 **   Deals in Collections.                       Advice of payment i.e. MT400 (Collection
                                                               Payment)
     Series 5 **   Deals in sale /purchase of Securities.      Order to Buy i.e. MT500 (Treasury)

     Series 6 **   Deals in Precious Metal Trade.              Precious metal Trade Confirmation i.e. MT600

     Series 7 **   Deals in Documentary Credit Operations.     Issue of Documentary Credit i.e. MT700

     Series 8 **   Deals in Travelers Cheques.                 T/C Settlement Advice i.e. MT802

     Series 9 **   Deals in Miscellaneous Purpose Messages     Miscellaneous MT-999
     Pakistan’s Perspective
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     Pakistan’s     Open Account /                   Advance Payments                  Documenta          Documentary Credit / LC
     Perspectiv     Extended Terms                                                         ry
         e                                                                             Collection
     Export       Not allowed       till   Chapter-12 Para 24 of F.E.M -8th Edition-   D/A     and   All types of following LCs are
                  date.                    2002 and EPD Circular Letter #              D/P Both      allowed;
                                           03/EPP1(51)         Misc-2006       dated   Allowed       1. Sight
                                           Jan.20,2006;                                (Para    26   2. Usance
                                           Due diligence is required?                  F.E.M-2002    3. Transferable
                                           Ordering customer name & address.           Chapter       4. Revolving
                                           Remittance information.                     XII)          5. Packing Credit
                                           Bonafide / genuine trading parties.                       6. Clean Non-documentary
                                           BPRD Circular Letter No. 07 of 2009                       7. Conversion of usance to sight
                                           dated March 09, 2009 & M-2 (Anti                          8. Mix Payment
                                           Money Laundering Measures)
     Import       Chapter-13      Para     Chapter-13 Amended Para 17(i) & 30(i)       D/A     and   Following types of LCs are allowed;
                  17(i) of F.E.M 8th       of F.E.M -8th Edition-2002.                 D/P Both      1. Sight
                  Edition - 2002           F.E. Circular no. 4 dated April 25, 2005    Allowed       2. Usance
                  Amended vide F.E.        (Manufacturing / Industrial Sector).        (Para         3. Mix Payment
                  Circular # 15 of         EPD Circular Letter no.13/Policy-2004       23,21,18,1
                  Aug.15 2003)             dated Nov.10, 2004 50% Advance              7(i) F.E.M-   Following types of LCs are not
                  Documentary              Payment (against LC for capital good        2002          allowed (Chapter 13 para-14 & 18,
                  Requirements     for     excluding spare parts and other than        Chapter-      F.E.M 2002);
                  effecting settlement     capital goods – SBP approval required).     XIII)         1. Transferable
                  by the banks?            FE Circular No. 08 of 2008 dated July                     2. Revolving
                  Invoice                  08, 2008 (25% of the FOB or CFR value                     3. Packing Credit
                  Evidence of receipt      of the good to be imported.                               4. Clean Non-documentary
                  of      goods      in                                                              5. Conversion of usance to sight
                  Pakistan.
     INCOTERMS 2000
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        To provide a set of international rules for the interpretation of trade terms
         set forth by the International Chamber of Commerce in 1936.
        Since then, this set of international commercial terms has undergone revision
         in 1953, 1967, 1976, 1980, 1990 & the new revision was brought out in
         2000.
        The revised incoterms devote a more focused attention to the use of
         multimodal transport, above all what concerns the delivery of the goods
         from the exporter to the importer at whatever point in the transport chain,
         instead of focusing on the point when the goods cross the means of
         transport.
        To clarify rights & obligation of the parties (Buyer & Seller) to the contract
         of sale with respect to the delivery of goods sold.
        Incoterms allow us to establish some parameters to our international pricing
         strategies. A company choice of Incoterms in its policy will then have a
         direct influence on every other aspect of its export activity (distribution,
         shipping customs etc). For this reason it is of the utmost importance to know
         in detail these terms & what exactly they will imply.
     INCOTERMS 2000 - Groups
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     Group                   Description                     Abb. Terms                          Detail Terms
     E       The seller’s obligation is at its minimum:      EXW          EX Work (Named Place)
             the seller has to do no more than place
             the goods at the disposal of the buyer at
             the agreed place - usually at the seller’s
             own premises.
     F       The seller to deliver the goods to a            FAS          Free Alongside Ship (Name port of loading/shipment)
             nominated carrier as instructed by the
             buyer. F stands for Free.                       FOB          Free On Board (Named port of shipment)
                                                             FCA          Free Carrier (Named Place)
     C       The seller to contract for carriage on usual    CFR          Cost of Freight (Named port of destination)
             terms at his own expense. Therefore, a
             point up to which he would have to pay          CPT          Carriage Paid To (Named place of destination)
             transport costs must necessarily be             CIF          Cost, Insurance & Freight (Named place of destination)
             indicated after the respective ―C‖ term
             CFR      Karachi.      C      stands     for    CIP          Carriage & Insurance Paid to (Named place of destination)
             “Cost/Carriage”.
     D       The seller bears all costs & risks related to   DAF          Delivered at Frontier (Named place)
             the delivery of the goods at the agreed
             place or point of destination. D stands for     DES          Delivered Ex Ship (Named port of destination)
             “Delivered”.                                    DEQ          Delivered Ex Quay (Named port of destination)
                                                             DDU          Delivered Duty Unpaid (Named place of destination)
                                                             DDP          Delivered Duty Paid (Named place of destination)
     INCOTERMS 2000 – Risk Snapshot
32
     INCOTERMS 2000 – Price Determination
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     Seller’s Expense            FOB       CFR       CIF       FCA       CPT       CIP



     Cost of merchandise to be   $10,000   $10,000   $10,000   $10,000   $10,000   $10,000
     exported
     Export License / Custom     $500      $500      $500      $500      $500      $500
     formalities
     Packaging cost              $1,000    $1,000    $1,000    $1,000    $1,000    $1,000

     Loading cost                $150      $150      $150      $150      $150      $150

     Carriage / freight cost     Nil       $3,000    $3,000    Nil       $3,000    $3,000


     Insurance cost              Nil       Nil       $1,000    Nil       Nil       $1,000

     Price to be quoted          $11,650   $14,650   $15,650   $11,650   $14,650   $15,650
     Financing Facilities
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        Fund Based (Actual bank’s funds are involved /
         utilised by the borrower)
        Non Fund Based (Actual funds of the bank are not
         utilised by the borrower / commitment)
        Financing in PKR (Commercial Banks)
        Financing in FCY (Commercial Banks)
        Re-finance Scheme (SBP)
        Facilities.xlsx
35

				
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