B.Com-IV Semester(Group-A&B - PowerPoint Presentation

1. B.Com-IV Semester(Group-A&B)Management of Banking & InsuranceUnit-IVLending: Principles of Sound Lending

2. The commercial banks act as financial intermediaries between the saving public and investors. The financial resources mobilised by banks are lent to various productive sectors in the form of loans and advances. A bank faces several risks in granting loans and advances. Therefore, banks follow a cautious policy and follow the principles of sound lending of funds. The loans and advances should be repaid as per the terms and conditions on due time. If there are delays in payment of principal or interest, the loan becomes non-performing assets(NPAs). Bad and doubtful debts reduce the profitability of banks and adversely affect the capital base. Hence, while making loans and advances, some general principles of lending are followed by banks.

3. Principles of Sound Lending:1. Liquidity: When a loan is granted, the banker asks the customer to provide a tangible collateral security. The security must have the attributes of convertibility into cash and convertibility without loss of time.2. Safety: Safety of funds is the highest consideration which a bank has while granting loans and advances to its customers. It may not be possible always for the bank to obtain tangible security, but the bank must always look to the certainty of repayment by the borrower.3. Profitability: The rate of interest charged by the bank on loans and advances must be higher than that allowed on deposits.The difference between the borrowing and lending rates of interest constitutes an important source of income to the banker.

4. 4. Short-Period Accommodation: The banker cannot afford to lock up his funds in providing long-term accommodation, e.g., fixed capital for industries since his own deposits are repayable on demand or at short notice. If the banker uses his resources in providing long-term accommodation, his loans and advances cannot be called back in times of emergency. 5. Diversification of risks: A banker should not invest all his funds in the same industry or in the same group of industries, because his own security depends on the prosperity of that industry or group of industries, i.e., not putting all eggs in the same basket.

5. Other principles of Sound Lending:The businessman who requires a loan from a bank gives an application for loan giving details. The bank in turn examines the loan application to find out the following informations:1. Financial Position of the Borrower: The banker should examine the balance sheet supplied by the borrower firm with his own independent enquiries from the referees named by the borrower as to his financial position, credit standing and recent business dealings.2. Purpose of the Loan: The banker should see the purpose for which money is borrowed, for that determines the source from which repayment may be expected.

6. 3. Amount of the Loan: The banker should see that the loan asked for is not unduly large, having regard to his own resources of the borrower. He should lend small loans to a large number of customers rather than large loans to a small number of individuals.4. Period of the Loan: The banker should not lend for unduly long periods since his own deposits are repayable on demand, he cannot afford to lock up his funds for long periods.5. Collateral Security: The banker must take the precautions necessary for the particular type of security offered. The basic consideration is that the security can easily be sold in the market in the event of default by the borrower. He should not lend upto the full value of the security, but should keep a proper margin of safety.

7. 6. Borrowing Powers: In the case of companies, local authorities and statutory companies, he has to examine their borrowing powers and limits, if any. 7. Collection of Information: The banker should collect information regarding the 3Cs- character, capacity and capital of the applicant.8. Possibilities of repayment by the borrower: The banker should enquire into the possibilities of repayment of loans and advances by the borrower.9. Appraisal of the Project/ Credit Proposal: The project appraisal may be described as detailed evaluation of the project regarding its technical feasibility, economic viability and managerial competence to manage the project

8. Types of Loans and AdvancesLoans and advances constitute the most important revenue of investment of banker’s resources and are the main source of profit. Other sources of income such as commission and bank charges are comparatively small. Commercial banks generally provide accommodation to trade and industry by discounting their bills of exchange and by granting them term loans, overdrafts and cash credits.So,there are three forms of loans and advances: 1- Loans 2- Overdrafts 3- Cash Credit 4- Discounting Bills of Exchange

9. 1- Loans: When an advance is made in a lumpsum amount to a borrower without liberty to him of repaying with a view to making a subsiquent withdrawal, it is called a loan. The whole amount of the loan is paid to the borrower in cash or is credited to his current account and interest is charged on the full amount of the loan. 2- Overdrafts: When a customer requires a temporary accommodation, he may be allowed to overdraw his current account up to an agreed limit. The customer has to pay interest atleast at half the rate on the amount of overdraft allowed to him, even though he may not draw the amount.

10. 3- Cash Credit: A cash credit is similar to an overdraft. Usually cash credit is allowed against either a bond of credit by one or more sureties or certain other securities. This is a favourite mode of borrowing by large commercial and industrial concerns in India on account of the advantage that the whole amount need not be drawn at once and can be drawn as and when required. 4- Discounting Bills of Exchange: The banker may provide accommodation to the customer by discounting bills of exchange. A person selling goods may draw on the buyer a three months bill (demand/usance bill or documentry bill e.g. bill of lading,railway receipt) for the amount of sale. By this, the buyer is given credit for three months and the seller, if he so desires, can realise cash immediately by discounting the bill with the banker.

11. Secured vs. Unsecured LoansLoans and advances of commercial banks are generally secured loans against collateral security mortgaged/pledged with the banker or against the personal security of the borrower with a guarantee given by a third party. Unsecured loans are not very popular in India because of the possible risks of their recovery when they become due and also because bankers do not have the means of knowing the credit-worthiness of their borrowers.Although most of the loans granted by banks in India are secured loans. Sometimes loans are granted without any collateral security. These loans are granted on the personal security of the borrower. Such lending is essentially a credit transaction in which in return for an immediate payment, future obligation to re-pay is received. Credit is the exchange of a present right for the promise of a future payment.

12. Confidence is the basis of credit. It is the confidence in the ability and willingness of the borrower that induces a person to part with money, goods or services in return for a promise to make payment at a later date.Besides the above, banks may lend against a variety of securities such as immovable property, life insurance policies, documents of title to goods, book debts, etc.In industrial localities, loans and advances are made against raw material and finished goods, whereas in countryside, against agricultural products, while in cities, against government bonds and stock exchange securities.

13. ADVANCES AGAINST Various SECURITIESA major part of bank advances are granted only for productive purposes. Banks normally do not grant any advance for consumption purpose. Advances against miscellaneous securities such as bank's own fixed deposits receipts, NSCs, life insurance policies, shares etc. are still granted on a restricted scale. The policies in this regard may differ from bank to bank. Advances Against Bank’s own Deposits: Deposits of the bank may be broadly divided into two categories as under:  Demand Deposits.  Term Deposits. Demand deposits are payable on demand and as such no advance against such a deposit may normally be required.  

14. Term deposits are payable after a fixed period and may generally be accepted under three different schemes:1. Fixed deposits where a fixed amount is accepted for an agreed term and the interest.Term deposits are payable after a fixed period and may generally be accepted under trest is payable, every quarter. 2. Reinvestment plan where a fixed amount is accepted for an agreed term and interest accrued every quarter is further invested. The depositor is paid a lump‑sum amount after expiry of the agreed term.3. Monthly recurring deposit where a monthly instalment is accepted for an agreed term and a lump‑sum amount is paid to the depositor after its expiry. ,

15. Different banks may have different nomenclature for these deposits but the essential features of all term deposits remain the same. For First Party Advances i.e. when Advance is Granted to the Depositor himself : Maximum Amount of Advance: Reasonable margin should be maintained on advangranted against deposits. Banks are free to determine the margin on a case to case basis. Most of the banks are now prescribing a margin ranging from 5% to 25% on the value of deposit.Rare of Interest: Banks are free to charge interest rates without reference to the prime lending rate Form of documents : The facility may be availed either as a demand loan or as an overdraft limit.

16. Security & documents: The original term deposit receipt or pass book as required will have to be deposited with the bank. Few banks also obtain other documents.Other terms and conditions:  1. Advances granted to individuals against deposits in joint name where the loanee is also one of the depositor or advances to a partnership firm against the deposit in the name of a partner and other such cases shall be considered as first party advances for this purpose and will be governed as per the terms and conditions stated above..  

17. 2.Necessary instructions to the bank to transfer quarterly interest on deposit to loan account must invariably be given in case of fixed deposits Banks do not grant any credit facilities against deposit receipts of other banks. The repayment of loan/advances granted against deposits must be done before the maturity of deposit otherwise banks are required to apply the proceeds of deposits on maturity for liquidation of outstanding in the loan account. The banks have now been permitted to renew the deposit and advance there against on the date of maturity of pledged deposit. 

18. ADVANCES AGAINST LIFE INSURANCE POLICIES Life insurance policies are considered as one of the best securities available for bank advances and are readily accepted as collateral security. Need based advance is also granted against life insurance policies on a restricted basis. A life insurance policy has three different values attached to it as under: 1.Insured value: The face value of the policy equivalent to the sum assured. 2. Paid- value: The value which has been already paid by the assured against the policy. 3. Surrender value: The value of the policy which the LIC of India will be prepared to pay should be surrendered to it and the contract of insurance under the policy is cancelled. . .

19. The surrender value may thus be considered as the market value of a life policy and it usually depends on the period for which the policy has already run and is fixed as a percentage of paid up value. LIC of India has issued priced manual giving detailed instructions for calculation of surrender value under its different schemes. The general terms and conditions of advances against life policies are as under Maximum Amount of Advance : 90% of the surrender value. Rate of interest: Rate of interest differs from bank to bank. Form of advance: Demand loan or overdraft.

20. Securities and documents: 1.Life insurance policies are to be assigned in favourof the bank granting the advance. The assignment is in the form of legal assignment for which a notice in the prescribed form is given to LIC of India by the assured. The original policy along with the notice of assignment is sent by the bank to LIC for registration of assignment. The original policy after necessary assignment is retained by the bank.   2. Other documents as per the bank's policy. 

21.  Other terms and conditions: 1. Life insurance policies issued u/s 6 of the Married Women's Property Act, 1874 are not acceptable as security.2. In case of default the bank may surrender the policy to LIC after giving reasonable notice to the assured.3. On repayment of loan the policy should be reassigned by the bank in favour of the assured and notice of reassignment must also be got issued from the bank. 

22. Advances against Government Securities, NSCs, Post Office Term Deposits etc: Government securities are generally issued in the form of stocks and promissory notes. For securities which are held in the form of stocks, the owner is only given a certificate to the effect that his name has been registered as an owner of certain amount of stock in a specified loan in the Public Debt Office. These stocks are transferable only by submitting a special transfer form obtainable from a public debt office. Public Debt Office will transfer the stock and issue a fresh certificate in favour of the transferee.

23. The security issued in the form of promissory notes are transferable by endorsement and delivery just like any other negotiable instrument and are not required to be sent to Public Debt Office at the time of each transfer unlike stocks. These securities have a stable value and are easily marketable and constitute good security for bank advances NSCs are freely acceptable as security for bank advances. Premature encashment of these certificates before three years has now been stopped by post office and any short‑term requirement of funds against the certificates will be met by banks only.

24. The general terms and conditions of advances against Government securities, NSCs etc. are given below: (i) Banks should satisfy themselves as to the acceptability of the credit needs of the borrower and end use of funds lent and they should not be guided solely by availability of the security.(ii) The interest rate should be as per the directives issued on interest rates by the RBI.(iii) Adequate margin should be maintained to cover the defaults, if any, in repayment of the principal and interest.(iv) They should follow the procedure prescribed by the Public Debt Office of the RBI, postal authorities, etc.,when advances against Government securities are granted. 

25. Advances against Relief Bonds: Relief Bonds issued in different series in demat form are‑eligible for sanction of loans against them subject to the following terms: (i) The banks will satisfy themselves as to the acceptability of the purpose, genuineness of the credit, need of the borrower and end use of funds lent.(ii) The rate of interest will be in accordance with the directives on interest rates issued by the RBI from time to time.(iii) Adequate margin will be kept to cover defaults, if any, in repayment of the principal and interest at the appropriate rate