BASIC PRINCIPLES OF BANK LENDING Definitions of lending Disposing of money or property with the expectation that the same thing (or an equivalent) will be returned . Credit is the provision of resources (such as granting a loan) by one party to another party where that second party does not reimburse the first party immediately, thereby generating a debt, and instead arranges either to repay or return those resources (or material(s) of equal value) Lenders - A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time To provide money temporarily on condition that the amount borrowed be returned, usually with an interest fee. Today ,the important types of banks, commercial and merchant banks, operating under the regulation of the Central Bank. The commercial banks engage in retail banking services through branch networks and operate with a broad deposit base consisting of demand and time deposit – they provide short term lending. On the other hand, merchant banks are licensed to provide wholesale banking, take deposit and arrange syndicated loan facilities for long terms by pooling, 1
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Principles of bank lending & Priority sector lending
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BASIC PRINCIPLES OF BANK LENDING
Definitions of lending
Disposing of money or property with the expectation that the same thing (or an equivalent) will
be returned . Credit is the provision of resources (such as granting a loan) by one party to another
party where that second party does not reimburse the first party immediately, thereby generating
a debt, and instead arranges either to repay or return those resources (or material(s) of equal
value)
Lenders - A loan is a type of debt. Like all debt instruments, a loan entails the redistribution
of financial assets over time
To provide money temporarily on condition that the amount borrowed be returned, usually
with an interest fee.
Today ,the important types of banks, commercial and merchant banks, operating under the
regulation of the Central Bank. The commercial banks engage in retail banking services
through branch networks and operate with a broad deposit base consisting of demand and
time deposit – they provide short term lending. On the other hand, merchant banks are
licensed to provide wholesale banking, take deposit and arrange syndicated loan facilities for
long terms by pooling, sometimes, a consortium of banks, including other financial
institutions, to finance capital intensive projects. From the foregoing, it is realized that banks
are generally debtors; they borrow money in order to lend them out to make profit. No bank
can ever survive by just being a custodian of deposit, but they exist by lending from the
deposit on fixed interest charged. Money lent on interest is always supposed to be secured on
some guarantees or security.
Since banks depend largely on lending, the need to adhere to the basic principles of lending is
quite inevitable. The principles, if strictly followed, will guarantee depositors and shareholders’
funds, increase profitability and make a healthy turn over. Such advances in turn assist in the
transformation of rural environment, promote rapid expansion of banking habit and improve and
boost the nation’s economy.
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The basic considerations in bank lending are the character of the client seeking loan from the
bank. The client must be an honest, upright customer whose record of transaction with the
financial institution or in the society is remarkable. The information on the character of the
borrower could be obtained through a completed form of his guarantor or his statement of
account.
For effective credit administration, the bank must assign functioning lending officers, properly
trained on lending, to be responsible for evaluation of reports and collection and reporting
findings to relevant senior schedule officers, for further consideration and final approval or
rejection
An internal credits/lending policy should be formulated, implemented and pursued vigorously by
the bank to minimize the risk of default from borrowers. The successful banks operating within
the financial system are those that consider and coordinate basic principles of lending and
monitor the activities of borrowers regularly.
The major business of banking company is to grant loans and advances to traders as well as
commercial and industrial institutes. The most important use of banks money is lending. Yet,
there are risks in lending. While lending loans or advances the banks usually keep such
securities and assets as a supports so that lending may be safe and secured. Suppose, any
particular state is hit by disasters but the bank shall get advantages from the lending to another
states units. Thus, the effect on the entire business of banking is reduced. So the banks follow
certain principles to minimize the risk. Following are the important areas to be taken care
while lending:
Principles of good lending
Basic principles General principles
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Basic principles
The success of banks depends upon the basic principles. These are the prime principles in
lending as well as investment
Safety
Liquidity
Profitability
Safety
Normally the bank uses the money of depositors in granting loans and advances. Because of
that while granting loans the banker should think about the safety of depositor’s money. The
purpose behind the safety is to see the financial position of the borrower, whether he can pay
the debt as well as interest easily. Ensuring safety means reducing risk associated with lending.
The risk involved in lending money is the credit risk.ie the possibility of the borrower not
repaying the amount back on the due date. It is necessary for the banks to maintain expert staff
to appraise every credit proposal received by it. Market risk also there , it can be avoided by
preferring high – grade securities of short terns.
Liquidity
It is a legal duty of a banker to pay the total deposited money to the depositor on demand. So
the banker has to keep certain percent cash of the total deposits in hand. Moreover the bank
grants loan. It is also for the addition of short term or productive capital. Such type of lending
is recovered on demand. A bank must have sufficient liquid assets to meet the demands of the
depositors .The liquid assets must have posses certain characteristics.
It must be convertible in to cash quickly and easily.
The conversion must be without any loss of value or risk
SLR : The Banking regulation act of 1949 , section 24 . states that every commercial bank
have to maintain liquid assets in the form of cash , gold, and gilt edged securities – which is
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not less than 25 % and not more than 40 % of NDTL ( Net Demand and Time Liabilities )
Profitability
Commercial banks are profit earning institutes; nationalized banks are also not an exception.
They should have planning of deposits in a profitability way to pay more interest to the
depositors and more salary to the employees. Before taking any decision the banker should
make sure that it is profitable.
General principles
Banks are following certain general principles in order to make a safe lending along with the
basic principles . that are explained in detail in the following paragraphs.
Purpose of loan Safety
Principle of Security
Principle of National interest and suitability
Pri Principle of diversification of risks
Purpose of loan
Banks never lend or advance for any type of purpose that will lead to loose of money. The
banks grant loans and advances for the safety of its wealth, and assurance of recovery of loan
and the bank lends only for productive purposes. Before giving a loan the bank has to make
sure that whether the purpose for which the loan has given is productive or not.
Principle of diversification of risks
A bank should be very careful while lending loans because if the bank lends to a non credit
worthy customer, it will affect the survival of the bank. To diversify the lending risk they
should lend loans to customers from different sectors such as agriculture, housing, educational,
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etc. Concentrating on a particular set of customers will adversely affect the bank.
LATEST LENDING RATES (BASE RATES)
In terms of RBI guidelines, Banks in India have switched to Base Rate system from
Benchmark Prime Lending Rate (BPLR) system from July 01, 2010. Following is the updated
list-
Banks Base Rate (p.a%)
PUBLIC SECTOR BANKS
State Bank of India 7.50%
Federal Bank 7.75%
State Bank of Mysore 7.75%
Corporation Bank 7.75%
Bank of India 8.00%
Punjab National Bank 8.00%
Bank of Baroda 8.00%
Union Bank 8.00%
Central Bank of India 8.00%
Indian Bank 8.00%
Uco Bank 8.00%
IDBI Bank 8.00%
Indian Bank 8.00%
Canara Bank 8.00%
Vijaya Bank 8.25%
Indian Overseas Bank 8.25%
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PRIVATE SECTOR BANKS
HDFC Bank 7.25%
ICICI Bank 7.50%
DCB 7.75%
Dhanalxmi Bank 7.00%
Bank of Rajasthan 8.00%
Karur Vysya Bank 8.50%
PRIORITY SECTOR LENDING
The Government of India through the instrument of Reserve Bank of India (RBI)
mandates certain type of lending on the Banks operating in India irrespective of their
origin. RBI sets targets in terms of percentage (of total money lent by the Banks) to be
lent to certain sectors, which in RBI's perception would not have had access to organised
lending market or could not afford to pay the interest at the commercial rate. This type of
lending is called Priority Sector Lending. Financing of Small Scale Industry, Small
business, Agricultural Activities and Export activities fall under this category. This is also
called directed credit in Indian Banking system.
Financing Priority Sector in the economy is not strictly on commercial basis as not only the
general approach is liberal but also the rate of interest charged on such loans is less. Export
finance is, in fact, available at a discount of 20% or more on the normal rate of interest to Indian
corporates. Part of the cost of this concession is borne by RBI by means of refinancing such
loans at concessional rate. Indian Banks, therefore, contribute towards economic development of
the country by subsidizing the business activities undertaken by entrepreneurs in the areas which
are consider "priority sector" by RBI.
Principles of lending & Priority sector finance in Banks
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Cardinal principles of lending are Safety and liquidity , Profitability and diversifications
of risks and Productive purpose and security
Liquidity with a banker means Cash on Hand, Cash and Bank balances and Short term
current assets to convert into cash
Customer profitability analysis means Assess the profitability of customer’s business
Banker can reduce risk in lending to a borrower by ensuring that there will be no default
on account of lack of liquidity and lack of willingness to pay on the part of the borrower
In banker’s parlance, credit risk in lending refers to default of repayment by a borrower
The targets under priority sector lending
The targets and sub-targets set under priority sector lending for domestic and foreign banks
operating in India are furnished below :
Domestic banks (both public sector
and private sector banks)
Foreign banks operating in India
Total Priority Sector
advances
40 percent of NBC 32 percent of NBC
Total agricultural
advances
18 percent of NBC No target
SSI advances No target 10 percent of NBC
Export credit Export credit does not form part of
priority sector
12 percent of NBC
Advances to weaker
sections
10 percent of NBC No target
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NBC denotes net bank credit
Net bank credit
The net bank credit should tally with the figure reported in the fortnightly return submitted
under section 42(2) of the Reserve Bank of India Act, 1934. However, outstanding deposits
under the FCNR(B) and NRNR Schemes are excluded from net bank credit for computation of
priority sector lending target/ sub-targets.
Priority sector comprise
Broadly, the priority sector comprises the following :
1. Agriculture
2. Small scale industries (including setting up of industrial estates)
3. Small road and water transport operators (owning upto 10 vehicles).
4. Small business (Original cost of equipment used for business not to exceed Rs 20