Module 4
Module 4
Lending operations
Principles of bank lending :-
Bank lending involves the provision of funds by banks to borrowers for various
purposes. The principles of bank lending are fundamental guidelines that banks
follow to ensure responsible and prudent lending practices. These principles
are designed to manage risks and maintain the financial stability of the bank.
Here are some key principles of bank lending:
1. Creditworthiness Assessment:
Banks assess the creditworthiness of borrowers before extending
loans. This involves evaluating the borrower's financial health,
repayment capacity, and credit history.
2. Loan Purpose:
Banks typically lend for productive purposes, such as business
expansion, home purchase, or education. The purpose of the loan
should align with the borrower's ability to generate income and
repay the loan.
3. Risk Diversification:
Banks diversify their loan portfolios to spread risk. This involves
lending to different industries, sectors, and types of borrowers to
reduce the impact of adverse economic conditions on the bank's
overall loan portfolio.
4. Loan-to-Value Ratio (LTV):
Banks often set limits on the loan amount as a percentage of the
collateral's appraised value. This helps mitigate the risk of losses in
case of default.
5. Interest Rates:
Banks set interest rates based on factors such as the level of risk,
prevailing market rates, and the cost of funds. Interest rates
should be sufficient to cover the cost of lending and provide a
reasonable return to the bank.
6. Loan Tenure:
The loan tenure is determined based on the nature of the loan and
the borrower's ability to repay. Short-term loans are often
provided for working capital needs, while long-term loans are
suitable for capital investments.
7. Collateral:
Banks may require collateral as security for the loan. Collateral
provides a source of repayment in case the borrower defaults. The
type and value of collateral depend on the nature of the loan.
8. Regulatory Compliance:
Banks must comply with regulatory guidelines and prudential
norms set by financial authorities. These regulations may include
capital adequacy requirements, loan classification standards, and
reporting guidelines.
9. Monitoring and Review:
Banks continuously monitor the financial health of borrowers
throughout the loan tenure. Regular reviews help identify early
signs of financial distress and allow the bank to take appropriate
actions to mitigate risks.
10.Documentation:
Proper documentation is essential for all lending transactions. It
includes a clear and detailed loan agreement outlining terms and
conditions, repayment schedules, and other relevant information.
11.Ethical Practices:
Banks are expected to adhere to ethical standards in their lending
practices. Fair treatment of borrowers, transparency, and honesty
are important principles in maintaining trust and credibility.
By adhering to these principles, banks aim to balance the need for profitability
with the responsibility to protect depositors' funds and maintain financial
stability.
Kinds of lending :-
There are various types of lending, each designed to meet specific financial
needs and objectives. Here are some common kinds of lending:
1. Consumer Loans:
Personal Loans: Unsecured loans provided to individuals for
personal expenses, such as medical bills, travel, or debt
consolidation.
Auto Loans: Loans specifically for the purchase of vehicles, where
the vehicle itself often serves as collateral.
Student Loans: Loans designed to finance education expenses,
including tuition, books, and living costs.
2. Mortgage Loans:
Home Purchase Loans: Loans provided for the purchase of
residential properties.
Home Equity Loans: Loans where homeowners borrow against the
equity in their homes.
Refinance Loans: Loans taken to replace an existing loan with a
new one, often to obtain better terms or lower interest rates.
3. Commercial Loans:
Term Loans: Medium- to long-term loans used for business
expansion, equipment purchase, or other capital expenditures.
Working Capital Loans: Short-term loans to finance day-to-day
operational expenses of a business.
Trade Finance: Financing that facilitates international trade,
including letters of credit and export financing.
4. Small Business Loans:
Microfinance: Small loans provided to entrepreneurs in
developing economies to support small businesses.
SBA Loans: Loans guaranteed by the U.S. Small Business
Administration to help small businesses access financing.
5. Credit Cards:
Revolving Credit: Borrowers can use a line of credit up to a
specified limit and make payments based on the outstanding
balance.
6. Secured Loans:
Collateralized Loans: Loans secured by assets, such as real estate,
vehicles, or other valuable property.
Pawn Loans: Loans where borrowers use personal items as
collateral.
7. Unsecured Loans:
Signature Loans: Loans not backed by collateral, relying on the
borrower's creditworthiness and signature.
8. Peer-to-Peer Lending (P2P):
Loans facilitated directly between individuals through online
platforms, cutting out traditional financial institutions.
9. Corporate Bonds:
Companies issue bonds as a form of debt to raise capital. Investors
purchase these bonds, essentially lending money to the company,
and receive periodic interest payments.
10.Government Bonds:
Governments issue bonds to raise funds for various projects.
Investors purchase these bonds, and the government pays interest
until the bond matures.
11.Payday Loans:
Short-term, high-interest loans often used by individuals to cover
expenses until their next paycheck.
12.Islamic Finance:
Compliant with Islamic principles, where interest (riba) is
prohibited. Instead, financial transactions are structured to adhere
to Shariah law.
These are just a few examples, and the landscape of lending continues to
evolve with innovations in financial markets and changes in economic
conditions. The type of lending chosen often depends on the specific needs
and circumstances of the borrower or the entity seeking financing.
loans :-
Loans are financial instruments in which one party, typically a financial
institution like a bank, lends money to another party, usually an individual or a
business, with the expectation of repayment over time. Loans come in various
forms, each tailored to specific purposes and terms. Here are some common
types of loans:
1. Personal Loans:
Unsecured loans provided to individuals for personal use, such as
medical expenses, travel, or debt consolidation. These loans are
not backed by collateral.
2. Auto Loans:
Loans specifically for the purchase of vehicles. The vehicle itself
often serves as collateral for the loan.
3. Home Loans (Mortgages):
Loans used to finance the purchase of real estate. Mortgages can
be for home purchase, home equity, or refinancing existing
mortgages.
4. Student Loans:
Loans designed to help students pay for education-related
expenses, including tuition, books, and living costs. They often
have favorable repayment terms for students.
5. Business Loans:
Various types of loans designed to meet the financing needs of
businesses. This includes term loans for capital expenditures,
working capital loans for day-to-day operations, and business lines
of credit.
6. Credit Cards:
Revolving credit lines that allow individuals to make purchases up
to a specified limit. Borrowers can choose to pay the balance in
full each month or carry a balance with interest.
7. Secured Loans:
Loans that are backed by collateral, such as real estate, vehicles, or
other valuable assets. If the borrower defaults, the lender can
seize the collateral to recover the loan amount.
8. Unsecured Loans:
Loans that are not backed by specific collateral. Approval is based
on the borrower's creditworthiness, and interest rates are typically
higher than secured loans.
9. Payday Loans:
Short-term, high-interest loans intended to cover expenses until
the borrower's next payday. These loans often come with high fees
and are considered a form of short-term emergency financing.
10.Installment Loans:
Loans repaid over a fixed period with scheduled payments. Each
payment includes both principal and interest.
11.Lines of Credit:
Flexible forms of borrowing where a maximum credit limit is
established, and the borrower can access funds as needed.
Repayment terms vary based on the agreement.
12.Bridge Loans:
Short-term loans used to bridge a financial gap, such as the time
between buying a new home and selling an existing one.
13.Consolidation Loans:
Loans used to combine multiple debts into a single, more
manageable payment. This is often done to secure a lower interest
rate or simplify repayment.
14.Government Loans:
Loans provided or guaranteed by government entities, such as
Federal Housing Administration (FHA) loans for homebuyers or
Small Business Administration (SBA) loans for small businesses.
The terms and conditions of loans, including interest rates, repayment periods,
and collateral requirements, vary based on the type of loan and the lending
institution. Borrowers should carefully consider their needs and financial
circumstances before taking out a loan.
Cash credit :-
Cash Credit (CC) is a type of short-term financing provided by banks to
businesses to meet their working capital needs. It is essentially a revolving
credit facility that allows a company to withdraw funds up to a predetermined
limit as needed. The borrower can use the funds for various business purposes,
and interest is charged only on the amount withdrawn, not on the entire credit
limit.
Here are some key features of Cash Credit:
1. Revolving Nature:
Cash Credit is a revolving credit facility, which means that as the
borrower repays the borrowed amount, the credit limit is
restored, and the funds can be used again.
2. Flexible Usage:
Businesses can use the funds from a Cash Credit facility for various
short-term needs, such as purchasing inventory, managing cash
flow fluctuations, or covering operational expenses.
3. Interest Calculation:
Interest is charged only on the amount actually utilized, not on the
entire credit limit. This makes it a cost-effective solution for
businesses that may not need the full credit limit at all times.
4. Collateral:
Cash Credit is often a secured form of financing, and the borrower
may need to provide collateral to secure the credit line. Common
types of collateral include inventory, accounts receivable, or other
business assets.
5. Renewal and Review:
Cash Credit arrangements are typically short-term and subject to
periodic renewal. Banks may review the financial health of the
borrowing business before renewing the credit facility.
6. Withdrawal Limits:
The bank sets a maximum limit for the Cash Credit facility based
on the business's creditworthiness, financial statements, and
collateral provided. The borrower cannot exceed this limit without
approval.
7. Interest Rates:
The interest rates on Cash Credit are variable and may be linked to
a benchmark rate, such as the bank's prime rate. The actual
interest charged may vary based on market conditions.
8. Minimum Repayment:
While Cash Credit provides flexibility, there is usually a minimum
repayment requirement. The borrower is required to make
periodic interest payments and, if possible, repay a portion of the
principal.
9. Monitoring and Control:
Banks closely monitor the utilization of Cash Credit to ensure that
it is used for legitimate business purposes. The bank may have the
right to review the borrower's financial statements and
operational performance periodically.
10.Use for Seasonal Requirements:
Cash Credit is often used by businesses with seasonal fluctuations
in cash flow. It provides them with the flexibility to access funds
when needed and repay when business conditions improve.
Cash Credit is a valuable financial tool for businesses to manage their short-
term funding requirements and maintain liquidity. However, it's important for
businesses to use this facility judiciously to avoid overborrowing and to ensure
timely repayment.
Over draft :-
An overdraft is a financial arrangement provided by a bank that allows an
account holder to withdraw or spend more money than is currently available in
their account. It is a form of short-term borrowing, and the account holder
essentially has a negative balance, up to an agreed-upon limit. Overdrafts are
often used to cover temporary financial shortfalls or unexpected expenses.
Here are key features of overdrafts:
1. Credit Limit:
The bank sets a credit limit for the overdraft, specifying the
maximum amount by which the account can go into a negative
balance. The credit limit is determined based on the account
holder's creditworthiness and relationship with the bank.
2. Flexibility:
Overdrafts provide flexibility, allowing account holders to access
additional funds when needed. It's a useful tool for managing cash
flow fluctuations or covering unexpected expenses.
3. Interest Charges:
Interest is charged on the overdrawn amount. The interest rate
may be variable and is typically higher than that of other forms of
credit, such as personal loans or lines of credit.
4. Repayment Terms:
Overdrafts are meant to be short-term solutions. Repayment is
expected when the account holder's funds are replenished, often
within a relatively short period. Some overdrafts may be
automatically repaid when the account receives additional
deposits.
5. Fees:
In addition to interest charges, banks may impose fees for using an
overdraft facility. These fees can include overdraft fees, per-
transaction fees, or daily fees for maintaining a negative balance.
6. Automatic Approval:
Some overdraft arrangements come with automatic approval,
allowing the account to go into overdraft without prior
authorization. Others may require explicit consent from the
account holder.
7. Security:
Overdrafts can be unsecured or secured by collateral, depending
on the agreement between the account holder and the bank.
Unsecured overdrafts are more common for smaller amounts,
while larger overdrafts may require collateral.
8. Usage for Various Purposes:
Overdrafts can be used for various purposes, including covering
bills, handling business expenses, or managing short-term financial
gaps. However, they are not suitable for long-term financing
needs.
9. Credit Score Impact:
While overdrafts themselves may not directly impact credit scores,
consistently relying on overdrafts without prompt repayment can
be a red flag to lenders and may affect creditworthiness.
It's important for account holders to be aware of the terms, fees, and interest
rates associated with overdrafts. While overdrafts provide a convenient way to
handle short-term financial challenges, they can become costly if not managed
responsibly. Account holders should aim to use overdrafts judiciously and
consider alternative financing options for more significant and longer-term
financial needs.
Bills discounting :-
Letters of credit :-
A Letter of Credit (LC) is a financial instrument widely used in international
trade transactions to provide a secure method of payment and reduce the risk
for both the buyer and the seller. It is a written commitment from a bank, on
behalf of the buyer (applicant), to pay the seller (beneficiary) a specified
amount under specific conditions, typically upon the presentation of specified
documents.
Here are the key elements and features of letters of credit:
1. Parties Involved:
Applicant (Buyer): The party who requests the letter of credit and
agrees to make payment.
Beneficiary (Seller): The party to whom the letter of credit is
addressed and who will receive payment upon complying with the
terms.
2. Types of Letters of Credit:
Commercial Letters of Credit: Used in the purchase and sale of
goods.
Standby Letters of Credit: Used as a backup payment method if
the buyer fails to fulfill their payment obligations.
3. Issuing Bank:
The bank that issues the letter of credit at the request of the
buyer. The issuing bank undertakes to honor the beneficiary's
claims upon compliance with the specified terms.
4. Advising Bank:
An intermediary bank, usually located in the seller's country, that
advises the beneficiary of the letter of credit. The advising bank
does not necessarily guarantee payment.
5. Terms and Conditions:
The letter of credit outlines specific terms and conditions that
must be met for the beneficiary to receive payment. These
conditions may include presentation of shipping documents,
inspection certificates, and compliance with other contractual
terms.
6. Confirmation:
In some cases, the advising bank may add its confirmation to the
letter of credit, providing an additional guarantee of payment. This
is known as a confirmed letter of credit.
7. Irrevocable vs. Revocable:
Most letters of credit are irrevocable, meaning they cannot be
modified or canceled without the consent of all parties involved.
Revocable letters of credit can be modified or canceled by the
issuing bank without notice to the beneficiary.
8. Documentary Requirements:
The beneficiary must present specified documents that comply
with the terms of the letter of credit. Common documents include
invoices, bills of lading, certificates of origin, and inspection
certificates.
9. Payment Process:
Upon presentation of complying documents, the issuing bank is
obligated to make payment to the beneficiary or accept a draft
(bill of exchange) for payment at a later date.
10.Transferability:
The letter of credit may be transferable, allowing the beneficiary
to assign the right to receive payment to another party, typically a
subcontractor or supplier.
11.UCP 600:
The rules governing international letters of credit are outlined in
the Uniform Customs and Practice for Documentary Credits (UCP
600), a set of guidelines developed by the International Chamber
of Commerce (ICC).
Letters of credit play a crucial role in facilitating international trade by providing
a secure mechanism for payment and reducing the risk of non-payment for
both buyers and sellers. They are particularly useful in situations where the
parties may not have an established business relationship or when there are
concerns about the creditworthiness of the buyer.