Committed Facility

Definition

A committed facility is a financial agreement between a bank and a borrower whereby the bank agrees to provide a specified maximum amount of funds over a certain period at a predetermined interest rate. This arrangement usually involves a set of terms and conditions that the borrower must adhere to for the facility to remain valid. In the UK, these interest rates are often based on an agreed margin over the London Inter Bank Offered Rate (LIBOR). The total cost to the borrower is the interest rate plus the cost of mandatory liquid assets.

Examples

Example 1: Corporate Loan

A large corporation enters into a committed facility with a major bank to access up to $50 million over the next three years at an interest rate of LIBOR + 2%. This gives the corporation the flexibility to draw funds as needed, provided they comply with the terms outlined in the agreement.

Example 2: Real Estate Development

A real estate development company secures a committed facility from a financial institution to cover potential shortfalls in their project financing. The bank commits to providing up to $10 million at an interest rate of LIBOR + 3%, ensuring the developers have funds available when required.

Frequently Asked Questions (FAQs)

What is the difference between a committed facility and an uncommitted facility?

A committed facility guarantees the borrower will have access to funds up to a specified limit, provided the conditions of the agreement are met. An uncommitted facility does not obligate the bank to provide funds and gives them the discretion to approve or decline funding requests.

What conditions usually come with a committed facility?

Typical conditions include maintaining certain financial ratios, periodic financial reporting, restrictions on additional borrowing, and maintaining insurance on collaterals.

Can the terms of a committed facility change?

Yes, terms can change based on renegotiations between the borrower and the lender, amendments to the credit agreement, or based on changes in the borrower’s creditworthiness.

How is the interest rate for a committed facility typically calculated?

The interest rate is generally based on a margin above a benchmark rate like LIBOR, plus additional costs such as mandatory liquid asset cost.

What are the advantages of a committed facility for businesses?

Secured access to funds, ensuring liquidity.
Predictable interest expenses aiding in budget planning.
Financial flexibility allowing for coping with unforeseen capital needs.

What happens if a borrower breaches terms of the committed facility?

If terms are breached, the lender has the right to terminate the facility or demand immediate repayment of funds drawn.

Uncommitted Facility

An uncommitted facility is a line of credit where the lender is not obligated to provide funding. Approvals are based on each individual request.

Revolving Bank Facility

A revolving bank facility provides a borrower with a set amount of capital that can be borrowed, repaid, and borrowed again. It is similar to a credit card for businesses.

London Inter Bank Offered Rate (LIBOR)

A benchmark rate that some of the world’s leading banks use to charge each other for short-term loans.

Mandatory Liquid Asset

Funds that financial institutions are required to hold in reserve to ensure they have liquidity in case of sudden demand.

Online References

Suggested Books for Further Study

“Principles of Corporate Finance” by Richard A. Brealey, Stewart C. Myers, and Franklin Allen
“Commercial Lending: Principles and Practice” by Adrian Cudd and Jane Wallace
“Bank Management and Financial Services” by Peter S. Rose and Sylvia C. Hudgins
“Financial Institutions Management: A Risk Management Approach” by Anthony Saunders and Marcia Millon Cornett

Accounting Basics: “Committed Facility” Fundamentals Quiz

### What is a committed facility in banking terms? - [x] An agreement between a bank and a customer to provide funds up to a specified maximum at a specified interest rate. - [ ] A spontaneous approval of occasional funding. - [ ] A purchase order financing tool. - [ ] A one-time loan agreement with no further obligations. > **Explanation:** A committed facility is a formal agreement guaranteeing access to funds up to a specific limit, ensuring financial stability for the borrower. ### What cost components are typically included in a committed facility interest rate in the UK? - [x] LIBOR + mandatory liquid asset cost - [ ] Borrower’s credit score + administrative fees - [ ] Fixed annual percentage rate - [ ] Capital requirement + insurance fees > **Explanation:** The interest rate for a committed facility in the UK is often based on the London Inter Bank Offered Rate (LIBOR) plus a mandatory liquid asset cost. ### Which term is used for a credit line that does not obligate a bank to provide funds? - [ ] Committed facility - [x] Uncommitted facility - [ ] Revolving facility - [ ] Bridging loan > **Explanation:** An uncommitted facility does not require the bank to provide funds, differing from the guaranteed funding of a committed facility. ### What advantage does a committed facility offer to businesses? - [x] Predictable access to necessary funds - [ ] Guaranteed revenue generation - [ ] Risk-free investment opportunity - [ ] Immediate loan approval without terms > **Explanation:** A committed facility provides businesses with assured access to funds when needed, fostering financial planning and stability. ### What happens if a borrower violates the terms of the committed facility agreement? - [ ] The agreement automatically renews. - [x] The lender may terminate the facility or demand immediate repayment. - [ ] The interest rate is reduced. - [ ] Collateral is not required. > **Explanation:** Breaching the terms can lead to termination of the facility or immediate repayment demands from the lender. ### In which scenario is a revolving bank facility most similar to a committed facility? - [ ] When no repayment is required - [x] When a set amount can be borrowed, repaid, and borrowed again - [ ] When funds are provided without borrower obligations - [ ] When guaranteed finance is subject to no margin rates > **Explanation:** Both a revolving facility and a committed facility allow borrowing up to a set amount with flexibility, though they differ in structure. ### Where is the London Inter Bank Offered Rate (LIBOR) primarily used? - [x] To set benchmark interest rates for financial instruments and loans - [ ] To manage everyday bank operations - [ ] For retail banking savings products - [ ] As a measure of creditworthiness > **Explanation:** LIBOR serves as a global benchmark for setting interest rates on various financial products, including loans like committed facilities. ### What essential requirement must a facility have to be considered 'committed'? - [ ] Must be for a fixed term of at least 10 years - [x] Specified maximum amount of funds with conditions from the lender - [ ] No predetermined agreements - [ ] Inflation-adjusted interest rates > **Explanation:** A committed facility involves a pre-agreed maximum fund amount and conditions set by the lender, ensuring secure funding for the borrower. ### How is the interest rate for a committed facility typically structured? - [ ] Based on prime rate plus service charges - [ ] Dependent on borrower's performance only - [x] A margin over an index rate like LIBOR, plus additional costs - [ ] Fixed globally by banking regulations > **Explanation:** It’s structured as a margin above a benchmark index rate like LIBOR, including mandatory liquidity costs. ### What financial measure ensures liquidity for financial institutions in a committed facility? - [x] Mandatory liquid assets - [ ] Floating interest rates - [ ] Short-term debt instruments - [ ] Equity capital > **Explanation:** Mandatory liquid assets are reserves financial institutions must hold to ensure they have liquidity to meet potential demands.

Thank you for exploring the intricacies of committed facilities with us and tackling our challenging quiz! Continue striving for excellence in your financial knowledge.