Banking Concepts and Loan Principles

Creditworthiness and Risk Management

• Creditworthiness of a borrower considers character, repayment capacity, and financial standing.
• Bank safety relies on the project’s technical feasibility and economic viability.
• Banks invest in various financial securities, with government securities being the least risky.
• Corporate securities are riskier than those of state governments.
• Robust risk management systems are essential for banks to safeguard their interests and those of depositors.
• As risks have multiplied, risk management has become a critical banking function.

Liquidity Management

• Maintaining sufficient liquidity is vital for banks to meet withdrawal demands from depositors.
• Technological advancements allow customers to access funds via ATMs or online banking, increasing the need for liquidity.
• Central banks require banks to maintain a portion of deposits as reserves and to invest in safe securities to ensure liquidity.
• Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) are tools employed by the Reserve Bank of India to manage liquidity.

Profitability and Loan Recovery

• Banks must generate profit for sustainability while serving societal needs and promoting economic development.
• Interest rates on loans are set based on the Marginal Cost based Lending Rate (MCLR) to cover costs, risk, and profit margins.
• Effective loan recovery and adherence to repayment schedules are crucial for maintaining profitability.
• Basel accords guide banks on managing unexpected losses from credit defaults.

Purpose of Loans and Economic Development

• Banks allocate deposits to productive activities to spur economic growth, avoiding funding for speculative ventures.
• Economic development is driven by producing goods and services and increasing consumer demand.
• Risk diversification is critical when providing credit to prevent undue exposure; this is achieved by spreading credit across sectors and demographics.

Types of Borrowers

• Banks provide loans to diverse customers, necessitating varied approaches and care levels.
• A company’s Memorandum of Association (MOA) and Articles of Association (AOA) clarify its borrowing rights and business scope.
• Limited Liability Partnerships (LLPs) provide limited liability benefits while maintaining partner flexibility in structure.

Types of Credit Facilities

• Credit facilities offered by banks include:
  • Term Loans: Loans with a specified repayment period, primarily for fixed assets.
  • Bridge Loans: Short-term loans for interim financing, awaiting permanent funds.
  • Working Capital Loans: Fund day-to-day business operations, covering expenses like salaries and materials.
  • Demand Loans: Callable loans without notice, used primarily for short-term requirements.
  • Non-fund Based Credits: Products like Letters of Credit (LC) and Bank Guarantees (BG) facilitate transactions without direct funding.

Specialized Loan Categories

• Project Finance: Long-term loans for infrastructure and industry, previously exclusive to development banks but now offered by commercial banks too.
• Export Credit: Loans to exporters, often supported by government subsidies and guarantees for risk mitigation.
• Retail Loans: Target individual consumers, including home, vehicle, and personal loans, as well as credit cards.
• Agricultural Credit Products: Loans for farming activities and associated businesses including dairy and poultry.

Factors Affecting Borrower Repayment Capacity

• Character: Integrity of the borrower significantly influences default likelihood.
• Commitment: A borrower’s dedication to their profession or business is crucial for overcoming challenges.
• Capacity: Assessing technical qualifications and experience is essential for evaluating potential success in business.
• Cash Flow: Positive cash flow and profitability are necessary for loan repayment capabilities.
• Capital: Borrowers must invest a portion of capital indicating commitment, acting as a buffer against losses.
• Conditions: External macroeconomic factors significantly affect borrower performance and should be considered in credit analysis.
• Collateral: Adequate security is a prerequisite for loans, ensuring financial safety for lenders.

Test your knowledge on banking fundamentals, particularly the creditworthiness of borrowers, the safety of bank funds, and the importance of project viability. This quiz covers key concepts related to bank lending and investment in financial securities. Join now to reinforce your understanding of these essential banking principles!