Lending money is one of the primary functions of the bank. Lending of funds to
individuals, traders, businessmen and industrial enterprises, is one of the
important activities of commercial banks. Interest earns on these loans and
advances are the major source of income of the banks. Interest given on deposits
is lower than the interest received on such loans and advances. Amount
deposited by the customers forms the main source of loans and advances. Banks
lend money in various forms for various purposes. Operation and expansion of
business and commercial activities depend a great deal on the availability of
loans/advances from commercial
banks. The term loan refers to the amount borrowed by one person from
another. The amount is in the nature of loan and refers to the sum paid to the
borrower. Thus from the view point of borrower, it is borrowing and from the
view point of bank, it is lending. Loan may be regarded as credit granted
where the money is disbursed and its recovery is made on a later date. It is a
debt for the borrower. While
granting loans, credit is given for a definite purpose and for a predetermined
period. Interest is charged on the loan at agreed rate and intervals of payment.
Advance on the other hand, is a credit facility granted by the bank. Banks
grant advances largely for short-term purposes, such as purchase of goods
traded in and meeting other short-term trading liabilities. There is a sense of
debt in loan, whereas an advance is a facility being availed of by the borrower.
However, like loans, advances are also to be repaid. Thus a credit facility
repayable in installments over a period is termed as loan while a credit facility
repayable within one year may be known as advances. However, in the present
lesson these two terms are used interchangeably.
Merits of Granting Loans and Advances
Loans and advances are utilized for making payment of current liabilities,
wages and salaries of employees, and also the tax liability of business.
Loans and advances from banks are found to be economical for traders and
businessmen, because banks charge a reasonable rate of interest on such
loans/advances. For loans from money lenders, the rate of interest charged is
very high. The interest charged by commercial banks is regulated by the
Reserve Bank of India which is comparatively low.
Bank loans and advances are found to be convenient as far as its repayment
is concerned. This facilitates planning for future and timely repayment of loans.
Otherwise business activities would have come to a halt.
Banks generally do not interfere with the use, management and control of the
borrowed money. But it takes care to ensure that the money lent is used only for
business purposes. Loans and advances by banks generally carry element of
secrecy with it. Banks are duty-bound to maintain secrecy of their transactions
with the customers. This enhances peoples faith in the banking system.
3. For Individuals: For individual loans serve various purposes such as
a. For children Education
b. For Children Marriage
c. For House Building
d. For Purchasing of Car, Jewellery, Furniture, Land and Other Assets
e. For Investing Somewhere Else in Profitable Avenues
4. Others:
Overall development of the society, depends on the these loans and advances to
a great extent. Consumption pattern of the consumer has been increased
In case of secured loans, the bank should carefully examine and value the
security. There should be sufficient margin between the amount of loan and the
value of the security. If adequate margin is not maintained, the might become
unsecured in case the borrower fails to pay the interest and return the loan. The
amount of loan should not exceed 60 to 70% of the value of the security. If the
value of the security is falling, the bank should demand further security without
delay. In case he fails to do so, the loan might become unsecured and the bank
may have to suffer loss on account of bad debt.
8. National Interest:
Banks were nationalised in India to have social control over them. As such, they
are required to invest a certain percentage of loans and advances in priority
sectors viz., agriculture, small scale and tiny sector, and export-oriented
industries etc. Again, the Reserve Bank also gives directives in this respect to
the scheduled banks from time to time. The banks are under obligations to
comply with those directives.
9. Character of the Borrower:
Last but not the least, the bank should carefully examine the character of the
borrower. Character implies honesty, integrity, credit-worthiness and capacity of
the borrower to return the loan. In case he fails to verify the character of the
borrower, the loans and advances might become bad debts for the bank.
The above are thus the basic principles of sound lending observed by
commercial banks. Basic principles be reviewed and modified as per the need
and requirement of the current scenario.
Types of Loan
Commercial banks lend money in four different ways:
I. Loans
Loan is the amount borrowed from bank. The nature of borrowing is that the
money is disbursed and recovery is made in installments. While lending money
by way of loan, credit is given for a definite purpose and for a pre-determined
period. Depending upon the purpose and period of loan, each bank has its own
procedure for granting loan. However the bank is at liberty to grant the loan
requested or refuse it depending upon its own cash position and lending policy.
There are two types of loan available from banks:
(a)Demand Loan:- A Demand Loan is a loan which is repayable on demand by
the bank. In other, it is repayable at short-notice. The entire amount of demand
loan is disbursed at one time and the borrower has to pay interest on it. The
borrower can repay the loan either in lump sum (one time) or as agreed with the
bank. Such loans are normally granted by banks against security. The security
may include materials or goods in stock, shares of companies or any other asset.
Demand are raised normally for working capital purposes, like purchase of raw
materials, making
payment of short-term liabilities.
(b)Term Loans : Medium and long term loans are called term loans. Term loans
are granted for more than a year and repayment of such loans is spread over a
longer period. The repayment is generally made in suitable instalments of a
fixed amount. Term loan is required for the purpose of starting a new business
activity, renovation, modernization, expansion/ extension of existing units,
purchase of plant and machinery, purchase of land for setting up of a factory,
construction of factory building or purchase of other immovable assets. These
loans are generally secured against the mortgage of land, plant and machinery,
building and the like.
II. Cash Credit
Cash credit is a flexible system of lending under which the borrower has the
option to withdraw the funds as and when required and to the extent of his
needs. Under this arrangement, the banker specifies a limit of for the customer
(known as cash credit limit) up to which the customer is allowed to draw. The
cash credit limit is based on the borrowers need and as agreed with the bank.
Against the limit of cash credit, the
borrower is permitted to withdraw as and when he needs money subject to the
limit sanctioned.
It is normally sanctioned for a period of one year and secured by the security of
some tangible assets or personal guarantee. If the account is running
satisfactorily, the limit of cash credit may be renewed by the bank at the end of
year. The interest is calculated and charged to the customers account. Cash
credit, is one of the types of bank lending against security by way of pledge
or /hypothetication of goods.
Pledge bailment of goods as security for payment of debt. Its primary purpose
is to put the goods pledged in the possession of the lender. It ensures recovery of
loan in case of failure of the borrower to repay the borrowed amount.
to realize his dues from the buyer at a distant place immediately or after the
lapse of the agreed period of time, the bill of exchange facilitates this task with
the help of the banking institution. Banks invest a good percentage of their
funds in discounting bills exchange. These bills may be payable on demand or
after a stated period. In discounting a bill, the bank
pays the amount to the customer in advance, i.e. before the due date. For this
purpose, the bank charges discount on the bill at a specified rate. The bill so
discounted, is retained by the bank till its due date and is presented to the
drawer on the date of maturity. In case the bill is dishonoured on due date the
amount due
on bill together with interest and other charges is debited by the bank to the
customers.
9.5 Nature of Loan
Commercial banks grant loans for different periods- term for different purposes.
According to their nature
banks Loan and Advances can be divided into following categories
(1) Short-Term Loans
Short term loans are granted by banks to meet the working capital needs of
business. The working capital needs refer to financial needs for such purposes
as, purchase of raw materials, payment of wages, electricity, taxes etc. Such
loans are granted by banks to its borrowers to be repaid within a short period of
time
not exceeding 15 months. Short term loans are normally granted against the
security of tangible assets like goods in stock, shares, debentures, etc.
(2) Long Term Loans
Medium and long term loans are generally known as term loans. These loans
are granted for more than 15 months. In case of medium term loan, the period
ranges from 15 months to less than 5 years. Medium term loans are generally
granted for repairs, expansion of existing units, modernization/renovation etc.
Such loans
are sanctioned against the security of immovable assets.
Procedure of Obtaining Loans and Advances
We have studied in this unit that banks provide financial assistance to its
customers in the form of loans, advances, cash credit, overdraft and through the
discounting of bills. The procedure of applying for and of loans and advances
differs from bank to bank. However, the steps which are generally to be taken in
all cases are as follow:
(I) Filling Up of Loan Application Form
Each bank has separate loan application forms for different categories of
borrowers. When you want to borrow money from a bank, you will have to fill
up a loan application form available with the bank free of cost. The loan
application form contains different columns to be filled in by the applicant. It
includes all information required about the borrower, purpose of loan, nature of
facility (cash-credit, overdraft etc)required, period of repayment, nature of
security offered, and the financial status of the borrower. A running business
limit may be required to furnish additional information in respect of :
- Assets and liabilities
- Profit and loss for the last 2 to 3 years.
- The names and addresses of three persons
(which may include borrowers, suppliers, customers and bankers) for reference
purposes.
(II) Submission of Form Along With Relevant Documents
The loan application form duly filled in should be submitted to the bank along
with the relevant documents.
(III) Sanctioning of Loan
The bank scrutinizes the documents submitted and determines the credit
worthiness of the applicant. If it is found to be feasible, the loan is sanctioned. If
the loan is for Rs 5000 or less, normally the Branch Manager himself can take
the decision and sanction the loan. In case the amount of loan is more than Rs
5000, the application is considered at regional, zonal or head office level,
depending on the amount of loan.
(IV) Executing the Agreement
When the loan is sanctioned by the bank and the borrower is informed about
it,he will have to execute an agreement with the bank regarding terms and
condition for the amount of loan raised.
(V) Arrangement of Security for Loan
The borrower will now arrange for security against the loan. These securities
may be immovable properties, shares, debentures, fixed deposit receipts, and
other documents, like Kisan Vikas Patra, National Savings Certificate, as per
agreement. When the borrower completes all the formalities, he is allowed to
get the
amount of loan/advance/ over draft as sanctioned by the bank. In case of
discounting of bills, the bank credits the amount of bill to the customers
account before the realization of the bill and thus, makes available the fund. In
case, the bill is dishonoured on due date, the amount due on the bill together
with interest and
other charges are payable by the party whose bill is discounted.
Activity B:
1 Familiarize yourself with the important documents, like application form for
loan, including procedure involved in getting Short term and long-term loan.
9.7 Classification of Loan
Due to the unequal distribution of wealth, India has arrived at a situation where
the affluent class gets richer and richer and the underprivileged becomes poorer.
To bridge this financial gap and to satisfy their day to
day requirements, Bank plays a vital role by offering various loans to the
finance seekers. Hence every borrower should have prior knowledge on the
various Bank Loans in India, which are eligible for meeting their financial
objectives.
I. Personal Loans
A personal loan is a short-term loan to assist you with your finances. This
payday loan is secured against a future pay check. These loans have become
quite popular today, and now this is the main way to get financial assistance in
the form of a cash advance. A personal loan is a type of debt which is made for
personal, family, or household use, and which is neither a business loan nor a
long-term mortgage loan. The lender loans money to the borrowers. The
borrowers pay back this amount, usually but not always in regular installments.
This service is generally provided at a cost, which is referred to as interest on
the debt. With a personal loan one can meet his financial requirements. Be it any
ceremony in the family, a surprise gift or a grand vacation, personal loans
provide a helping hand. The personal loan helps to take care of all kinds of
expenses in a short time period. This type of loan usually covers travel
expenses, holiday expenses, medical expenses, marriage expenses, honeymoon
expenses or any other personal type expenses. A personal
loan can be further classified into a secured and an unsecured loan. The main
difference between the two is that one is obtained with collateral and the other
without the collateral. But the purpose of the loan remains the same that is to
realize personal needs.
Types of Personal Loans
There are basically two types of Personal Loans. They are:
Secured Loan: - Wherein the loan involves the attachment of collateral - say,
your property or any fixed/ movable asset- against the sum of money borrowed.
Secured loan is obtained by pledging collateral such as a house, a car, property
or anything of value, on failure of repayment of loan amount the borrower runs
the risk of confiscation of the collateral. But at the same time a secured personal
loan will come to a borrower at a low APR(Annual Percentage Rate) and a
larger amount of loan will be sanctioned due to the collateral laid out to the
lender in the form of security. Since the lender has some amount of security to
claim back on his loan amount he easily offers loan to the borrower. The higher
the value of collateral, the higher amount of loan can be obtained from bank.
Risk of losing our pledged asset or security is only our responsibility, in case
when we unable to pay installments which are decided by bank.
Unsecured Loan: - When the loan is not secured against any collateral or
security. But consequently the lender would charge a higher rate of interest,
taking into account the high risk involved in lending the sum without security. If
borrower fails to make regular payments of installments, bank can follow the
prescribed legal procedure for recovering the loan amount.
term loans; fresh loans; relaxed security and margin norms; treatment of
converted/
rescheduled agriculture loans as current dues; non-compounding of interest in
respect of loans converted/ rescheduled; and moratorium of at least one year.
Micro, Small and Medium Enterprises Development
With the enactment of the Micro, Small and Medium Enterprises Development
(MSMED) Act, 2006, the services sector has also been included in the definition
of micro, small and medium enterprises, apart from extending the scope to
medium enterprises. The Act sought to modify the definition of micro, small
and
medium enterprises engaged in manufacturing or production and providing or
rendering of services. Some of the major measures by RBI/ GOI to improve the
credit flow to the MSE sector are as under:
Institutions to Meet Needs of the Evolving Economy
Recognizing the important role of exports in maintaining the viability of
external sector and in generating employment, the Reserve Bank had sought to
ensure adequate availability of concessional bank credit to exporters. It took the
lead role in setting up the Export Import Bank of India (EXIM Bank) in January
1982. In recent years, with the liberalization of real and financial sectors of the
economy, interest rates on export credit have been rationalized. When India
embarked upon the era of planned development, the primary need was to
facilitate adequate flow of credit to the industrial and other sectors according to
the priorities. A major task undertaken by the Reserve Bank was to put in place
the necessary institutional mechanism to complement the planning efforts. This
was crucial especially in the context of an underdeveloped and evolving
financial system. In the absence of a well-developed capital market, the Reserve
(CFSP) for North Eastern Region in January 2006. The report includes, among
other things, suggestions for expanding the banking outreach, simplification of
system and procedures for opening bank accounts, land collateral substitutes,
currency management, funds transfer and payment facilities and revised human
resources incentives in the region. The Report addressed important issues
pertaining to financial inclusion, improving CD ratio, providing hassle-free
credit. The Reserve Bank has also formulated scheme for setting89 up banking
facilities (currency chests, extension of foreign exchange and Government
business facilities) at centers in the North-Eastern region, which are not found
to be commercially viable by banks. The State Governments would make
available necessary premises and other infrastructural support. The Reserve
Bank, as its contribution, would bear the one time capital cost and recurring
costs for a limited period of five years.
Financial Inclusion
The Reserve Banks approach to customer service focuses on protection of
customers rights, enhancing the quality of customer service, and strengthening
the grievance redressal mechanism in banks and also in the Reserve Bank. The
Reserve Banks initiatives in the field of customer service include the setting up
of a
Customer Redressal Cell, creation of a Customer Service Department and the
setting up of the Banking Codes and Standards Board of India (BCSBI), an
autonomous body for promoting adherence to selfimposed codes by banks. In
order to strengthen the institutional mechanism for dispute resolution, the
Reserve Bank in 1995 introduced the Banking Ombudsman (BO) scheme. The
BO is a quasi-judicial
authority for resolving disputes between a bank and its customers. The scheme
covers grievances of the customers against commercial banks, urban
cooperative banks and regional rural banks. In 2006, the RBI introduced a
revised BO scheme. Under the revised scheme, the BO and the attached staff are
drawn from
the serving employees of the Reserve Bank. The new scheme is fully funded by
the RBI and covers grievances related to credit cards and activities of the selling
agents of banks also. Under the BO scheme, both the complainant and the bank,
if unsatisfied with the decision of the BO, can appeal against the decisions of
the
BO to the appellate authority within the Reserve Bank.
Introduction: Bank Services
When we talk about bank services, we as a customer make it a hallmark if the
basic services are provided conveniently and in a good manner by a genuine
banker . Though there is a wide range of services which a bank offers, that
defining each one is difficult but some of the basic and traditional services are
illustrated
here:
1. To keep a record of customer deposits
2. To collect cheques drawn on other banks by customers
3. Payment of self drawn cheques of customers
4. To provide remittance facilities by issue of drafts, mail transfer and
telegraphic transfers
5. To issue performance and financial guarantees
Other than these there are certain other services which a bank has to provide:
Advances: E.g. Overdraft, cash credits etc
Secured Advances:
Secured advances are those which can be taken against certain security of
tangible assets like land building etc.
According to banking regulation Act 1949 Sec. 5(i) (n) Secured loand or
advances means a loan or advance made on the security of assets the market
value of which is not at any time less than the amount of or advances.
This definition highlights two essential features of secured advances
Advances must be made against tangible security.
Market value of security must not be less than the amount of loan granted.
Type of security offered varies from place to place like agricultural produce is
considered as security in agricultural centers. In metros government bonds and
stock exchange securities are offered
Types of Securities
Primary Security : Asset which has been bought with the help of bank finance
Collateral Securities: In narrow sense collateral securities can be said as
securities deposited by third party to secure advance for the borrower and in
wider sense any type of security on which the creditor has a personal right of
action on debtor in respect of advance.
Forms of Advances
Advances can be broadly classified into four types:1) Loan:
When a banker provides a lump sum amount for a certain period of time at an
agreed rate of interest, it is term as loan. The ensure amount is given by bank in
cash or by credit in account of the concerned person and the person has to repay
this loan in installment with the predefined rate of interest.
Loan can be of two types:
Demand Loan: - It is for a short period of time and usually granted to meet
working capital needs of the borrower.
Terms Loans: - These are for medium term or long term and are for purchase of
vehicle and meet capital expenditures respectively.
2) Cash Credit:
Letter of Credit : When Party A supplies goods to Party B, the payment terms
may provide for a Letter of Credit.
In such a case, Party B (buyer, or opener of L/C) will approach his bank (L/C
Issuing Bank) to pay the beneficiary (seller) the value of the goods, by a
specified date, against presentment of specified documents. The bank will
charge the buyer a commission, for opening the L/C.
The L/C thus allows the Part A to supply goods to Party B, without having to
worry about Party Bs credit-worthiness. It only needs to trust the bank that has
issued the L/C. It is for the L/C issuing bank to assess the credit-worthiness of
Party B. Normally, the L/C opener has a finance facility with the L/C issuing
bank.
The L/C may be inland (for domestic trade) or cross border (for international
trade).
Guarantee: In business, parties make commitments. The beneficiary of the
commitment wants to be sure that the party making the commitment (obliger)
will live up to the commitment. This comfort is given by a guarantor, whom the
beneficiary trusts.
Banks issue various guarantees in this manner, and recover a guarantee
commission from the obliger. The guarantees can be of different kinds, such as
Financial Guarantee, Deferred Payment Guarantee and Performance Guarantee,
depending on how they are structured
Loan Syndication: This investment banking role is performed by a number of
universal banks
Non-Fund-based Services For Individuals
Sale of Financial Products such as mutual funds and insurance is another major
service offered by universal banks.
Financial Planning and Wealth Management are offered by universal banks.
Executors and Trustees: a department within banks help customers in
managing succession of assets to the survivors or the next generation.
Lockers: a facility that most Indian households seek to store ornaments and
other
valuables