Unit 3

Question 1

Bank lending is relevant to all sectors in the economy

Answer 1

my  Primary sector - Includes agriculture, mining and fishing  Secondary sector - Includes various industries  Service sector - Includes retail, tourism, banking, entertainment and I.T. services

Question 2

Bank lending principles

Answer 2

1. Principle of Safety
2. Principles of liquidity
3. principles of security
4. Principle of profitability
5. Principle of diversity
6. Principle of national interest

Question 3

Principle of Safety

Answer 3

 “Safety first” is the cardinal principle of sound lending.  When a bank lends, it must ensure that the advance is safe; i.e. the money will definitely be returned back

For example, if a borrower invests in an unproductive or speculative venture, or if the borrower himself is dishonest, the advance would be insecure.

Question 4

Principle of Liquidity

Answer 4

 Paying the deposited money on demand of customers is called liquidity in banking terms  This is possible when the money lent by banks comes back on demand or according to pre-agreed terms of repayment.
 The borrower must be in a position to repay within a reasonable time after a demand for repayment is made.  This is more likely if the money is employed by the borrower for short-term requirements and not locked up in assets or schemes which take a long time to repa

Question 5

Principle of security

Answer 5

 It has been the practice of banks not to lend as far as possible except against security.  Securities can be : Personal security or Collateral security  This is considered as a cushion to fall back upon in case of an emergency.  For instance: the security offered must be  adequate,  readily marketable, and  easy to hand

Question 6

Principle of Profitability

Answer 6

 Equally important is the principle of ‘profitability’.  Banks have to pay interest on the deposits received by them
 They have to incur expenses on maintaining their establishments.  They have to make provision for depreciation and also for, possible bad or doubtful debts.  Therefore a reasonable profit must be made by the bank to remain a going concern.  Otherwise, it will not be possible to transfer any funds to the reserve or to pay dividend to the shareholders

Question 7

5. Principle of Diversity

Answer 7

Another important principle of good lending is the diversification of advances.  It is important to spread the risks involved in lending over o a large number of borrowers, o a large number of industries and areas  The advantage in diversification is , in case of non-recovery of funds due to slump in one sector the funds can be collected from the vibrant sector of the economy  “Do not put all the Eggs in one basket”

Question 8

Principle of National Interest

Answer 8

The advance should not be utilized against national interest or existing government regulations, etc.  It should also not be against the banks’ policy / motto.  For example, NABARD (National bank for Agriculture and Rural Development) lends more towards rural projects (agriculture).
 It may not be suitable to change the area of its operation to power project.  Such things need to be considered along with the other principles of lending.

Question 9

two groups on the basis of Funding

Answer 9

1. Fund Base Credit 2. Non Fund Base Credit

Question 10

1. Fund Base Credit

Answer 10

(i) Loan: – It refers to credit facility that is repayable in a definite period. (e.g. Term Loan , Demand Loan)

(ii) Cash Credit: – It refers to credit facility in which borrower can borrow any time with in the agreed limit for certain period for their working capital need.  It secured by way of Hypothecation of Stock(goods) and Debtors and all other current Assets of the business generated during the course of business.

(iii) Over Draft: – An overdraft allows a current account holder to withdraw in excess of their credit balance up to a sanctioned limit.  It secured by way of Mortgage of immovable properties and pledge of F.D., Bonds, Shares securities , Gold & silver and any physical asset and Hypothecation of Stock and Debtors and all other current Assets of the business generated during the course of business.

(iv) Packing Credit: – It is a credit facility which sanctioned to an exporter in the Pre-Shipment stage.  Such credit facilitates the exporter to purchase raw materials at competitive rates and manufacture or produce goods according to the requirement of the buyer and organize to have it packed for onward export.

(v) Some other fund based credit facilities are Bill Discounted , Bill Purchased , Advance against hypothecation of Vehicles ( Transport Loan) , House Building Loan , Consumer Loan , Agriculture Loan -Farming -Non Farming , Consortium Loan , Lease Financing , Hire Purchase ,

Question 11

2) Non-Fund Base credit

Answer 11

is a credit facility where there is no involvement of direct outflow of Bank’s fund on account of borrower rather the outflow of Bank’s fund on account of Third party on behalf of borrower. Types of it are as follow:
(i) Letter Of Credit: – When a buyer or importer wants to purchase goods from an unknown seller or exporter. He can take assistance of bank in such buying or importing transactions.
 Bank issues a LETTER OF CREDIT in addressed to the supplier or exporter after it, supplier or exporter will supply the goods to such unknown buyer or importer. A signed Invoice with Letter Of Credit is presented to the bank of buyer/importer and the payment is made to the seller/exporter DIRECTLY by the bank.
(ii) Bank Guarantee: – It is a guarantee issued by a banker that, in case of an occurrence or non-occurrence of a particular event, the bank guarantees to fulfil the loss of money as stipulated in the contact.  It may of various types like Financial Guarantees, Performance Guarantees and Deferred Payment Guarantee.
(iii) Buyer Credit: – It is the credit availed by an Importer from overseas lenders (i.e.
Banks & Financial Institutions) for payment against his imports. (for goods they are importing)  The overseas bank usually lends the Importer based on letter of credit, bank guarantee issued by the importer bank.
7 (iv) Suppliers Credit: – Under such credit facility an exporter extends credit to a foreign importer to finance his purchase.  Usually the importer pays a portion of the contact value in cash and issues a Promissory note as evidence of his obligation to pay the balance over a period of time.

Question 12

Securities for lending

Answer 12

1. Personal security and 2. Collateral security.

Question 13

Personal security

Answer 13

 Personal security constitutes the acquaintance and guarantee of the borrower in securing the loan from a bank  Loans advanced under this category are called clean loans  For E.g. Loans are provided usually to respectable customers with whom the bank is well acquainted  Good faith is the foundation on which the loans are granted, banker do not insist on any security at all

Question 14

Collateral security

Answer 14

Collateral security constitutes physical securities executed by the borrower in favor of the banker before advancing loans  For example, tangible assets both movable and immovable  Movable assets: Eg inventory of goods, warehouse receipts, shares etc  Immovable assets: Eg Land, building, plant and machinery etc  Borrowers can execute collateral security in any one of the ways:
Hypothecation  Pledge  Mortgage

Question 15

Types of collateral security

Answer 15

Stock exchange securities
Good and title to goods
Bills of exchange
Life of insurance policy
Property

Question 16

Stock exchange securities

Answer 16

 Securities such as equity shares and debentures and bonds issued by reputed industrial houses are accepted for providing loans  Advancing loans against stock exchange security is advantageous as 1. It can be easily sold at stock exchange 2. There is an easy transfer of ownership 3. Also there is no or minimum loss on sale of such securities

Question 17

Goods and titles to goods

Answer 17

Titles to goods against which loans are granted include  warehouse certificates,  railway receipts,  loading bills,  dock warrants, etc.
 Goods are hypothecated to the banker although goods physically remain under the custody of the borrower  Further it is also possible for the borrower to make sale of those goods

Question 18

Bills of exchange

Answer 18

 These are another important type of securities accepted by the banker  Loans are provided either by the way of purchasing or discounting the genuine commercial bills ,in possession of the traders
 For instance, there is no possibility of any loss being suffered by the bank as the value of these exchange bill is not subject to change  Bills serve as an ideal security for the banker since it is possible for the banker to rediscount the bill with central bank

Question 19

Life of insurance policy

Answer 19

Banks also advance loans against the security of life insurance policies  Lending against these policy is attractive for the banker as the surrender value of the policy can be easily found out from the life insurance corporation  The banker should not lend more than the surrender value of the policy  For instance, endowment policies are recommended the most  As the policy provides coverage to the insured for a specific period, at the end of which sum assured plus the accrued bonus is paid to the insurance holder.

Question 20

Property

Answer 20

Property include both movable as well as immovable assets  Movable assets example, gold, silver, finished goods, stocks and shares, bills of exchange etc  Immovable assets example, land, buildings, plant and machinery, etc  Lending against movable properties is advantageous since it is possible for the banker to dispose off the assets easily.

Question 21

WORKING CAPITAL

Answer 21

 Working capital loans are short-term with a repayment period of a few months.

Question 22

TERM LOANS

Answer 22

Term loans, on the other hand, can be short, medium, or long term.  Their duration is usually between one to ten years, but some term loans could extend up to 30 years.

Question 23

CREDIT APPRAISAL TECHNIQUES

Answer 23

Credit appraisal is a process of appraising the credit worthiness of an applicant for a loan.

income,  age,  experience,  number of dependents,  repayment capacity,  past and existing loans,

Question 24

CREDIT MANAGEMENT

Answer 24

Credit management is the process of  Granting credit,  Setting the terms it’s granted on,  Recovering this credit when it’s due,  Ensuring compliance with company credit policy, among other credit related functions.

Question 25

OBJECTIVES OF CREDIT MANAGEMENT?

Answer 25

Safeguarding Customer Risk.
 Settlement of Outstanding Balances.  Improving Cash Flow.

Question 26

Credit Facility

Answer 26

Credit Facility is an agreement with bank that enables a person or organization to be taken credit or borrow money when it is needed

Question 27

non fund credit : letter of credit

Answer 27

When a buyer or importer wants to purchase goods from an unknown
seller or exporter. He can take assistance of bank in such buying or importing transactions.
Bank issues a LETTER OF CREDIT in addressed to the supplier or exporter after it, supplier
or exporter will supply the goods to such unknown buyer or importer. A signed Invoice with
Letter of Credit is presented to the bank of buyer/importer and the payment is made to the
seller/exporter DIRECTLY by the bank.

Question 28

non fund base credit : bank guarantee

Answer 28

in case of an occurrence or non occurrence in a particular event, the bank guarantees to fulfill the lose of money as stipulated in the contract

Question 29

buyers credit

Answer 29

credit availed by an importer from overseas lender (bank or financial inst) for payment against his imports.
the overseas bank lends the importer on the basis of letter of credit and bank guarantee issued from the importer bank.

Question 30

Suppliers Credit:

Answer 30

nder such credit facility an exporter extends credit to a foreign importer
to finance his purchase. Usually the importer pays a portion of the contact value in cash and
issues a Promissory note as evidence of his obligation to pay the balance over a period of time.
The exporter thus accepts a deferred payment from the importer and may be able to obtain cash
payment by discounting or selling such promissory note created with his bank.

Question 31

fund based credit: cash credit

Answer 31

It refers to credit facility in which borrower can borrow any time with in
the agreed limit for certain period for their working capital need. It secured by way of
Hypothecation of Stock(goods) and Debtors and all other current Assets of the business
generated during the course of business.

Question 32

fun based credit: overdraft

Answer 32

An overdraft allows a current account holder to withdraw in excess of their
credit balance up to a sanctioned limit. It secured by way of Mortgage of immovable properties
and pledge of F.D., Bonds, Shares securities , Gold & silver and any physical asset and
Hypothecation of Stock and Debtors and all other current Assets of the business generated
during the course of business.

Question 33

fund based credit: packing credit

Answer 33

It is a credit facility which sanctioned to an exporter in the Pre-Shipment
stage. Such credit facilitates the exporter to purchase raw materials at competitive rates and
manufacture or produce goods according to the requirement of the buyer and organize to have
it packed for onward export. It secured by way of Hypothecation of Stock of goods and Debtors
and all other current Assets of the business generated during the course of business.