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Introduction
As in the case study that Mr. Raj has recently graduated and got placed in a private sector bank and is unaware of the banking sector and its operations. Being his reporting manager, you need to brief him with the Principles of lending and need to explain him in details. Lending in its most general sense is the temporary giving of money or property to another person with the expectation that it will be repaid. In a business and financial context, lending includes many different types of commercial loans. When people or organizations such as banks lend you money, they give it to you and you agree to pay it back at a future date, often with a extra amount as interest. Not all banks are created equal, but many of them focus on the same areas throughout the loan review process. Learn what documentation, projections and narratives you’ll need to prepare as well as tips to ensure you negotiate the best loan package available. The system weighs five characteristics of the borrower and conditions of the loan, attempting to estimate the chance of default and, consequently. The five Cs of credit are character, capacity, capital, collateral, and conditions.
Some of the important considerations to be kept in mind by a banker in this respect are discussed below:
Safety
Safety means that the borrower should be able to repay the loan and interest in time at regular intervals without default. Banks are trustee of public money. Banks deposits are always payable on demand. Bank has to maintain trust of depositor forever. As such the first and foremost principle of lending is to ensure safety of funds lent. Further, it is just not the capacity of the borrower to repay but also his willingness to repay.
Liquidity
The term liquidity refers to the extent of availability of funds with the banker for providing credit to borrowers. It is to be seen that money lent is not going to be locked up for a long time. This schedule that is drawn up by the banker has to adhere to the requirement that at any point of time the banker should possess liquidity to meet the withdrawals of the depositors. It is to be kept in mind that various deposits have various maturities and some of it would also be payable on demand. A banks inability to meet the demand of its depositors can lead to a run on the bank which is a threat to its basic survival.
Purpose
The purpose should be productive so that the money not only remain safe but also provides a definite source of repayment. Loans may be required for productive purposes, trading purposes, agriculture, transport, self-employment etc. If a loan is required for a non-productive or speculative purpose, the banker should be very much cautious in entertaining such proposals. It is very difficult to ensure that the loan has been utilized for the purpose for which it was sanctioned. All banks are profit-earning institutions. The ultimate objective of lending is to earn profits.
Profitability
Banks are not charitable institutions. All banks are profit-earning institutions. The ultimate objective of lending is to earn profits. Banks receive interest on loans and advances lent, and they pay interest to their depositors. This difference between the receipts and payments will be the banks gross profit. Banks further incur various expenses as any organization does.
Security
The security offered by a borrower for an advance is as like as the insurance to the banker. It serves as the safety valve for an unforeseen emergency. So another principle of sound lending is the security of lending. Security offered against loan may be various. It may be a plot of land, building, flat, insurance policies; term deposits etc. There may even be cases where there is no security at all. The banker must realize that is it only a cushion to fall back upon in case of need.
Diversification
A prudent banker always tries to select the borrower very carefully and takes tangible assets as security to safeguard his interests. While this is no doubt an adequate measure, there are other unforeseen contingencies against which the banker has to guard himself. Further if the bank lends large amounts to a single industry or borrower, then the default by that customer can affect the banking industry as a whole and will affect the basic survival of the industry.
National Interest
Even when an advance satisfies all the aforesaid principles, it may still not be suitable. The advance may run counter to national interest. Bank has a significant role in the economic development process of a country. They should keep in mind the national development plan/program while going for lending but maintaining safety, liquidity and profitability
The conclusion
In the concluding lines I would like to say that Mr. Ajay has to follow these points. But not all banks are created equal, but many of them focus on the same areas throughout the loan review process. Learn what documentation, projections and narratives you’ll need to prepare as well as tips ensure you negotiate best loan package available. Banks are not charitable institutions. All banks are profit-earning institutions. The ultimate objective of lending is to earn profits. Banks receive interest on loans and advances lent, and they pay interest to their depositors. This difference between the receipts and payments will be the banks gross profit. Banks further various expenses as any organization does. After accounting for all such expenses and provisions, banks have to earn reasonable amount as net profit so that dividends can be paid to its shareholders. The trust and confidence level of the customer and investor will be high with a bank that has good track record of profits and dividend rates. Hence its important that whatever the business the bank engages itself with, the business be profitable enough not just to cover its costs but to ensure generation of surplus funds or margin.
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