Loans and Advances

Cardinal Principles of Lending

Are Safety, Liquidity, Profitability and diversification of risks, productive purpose and security.

Safety: is the most important principle of good lending. The banker should ensure that the enterprise or business for which loan is sought is sound one and capable of carrying it out successfully.

Liquidity: Liquidity with banker means Cash on Hand, Cash and Bank Balances, Short term current assets to convert into cash.

Profitability: Customer profitability analysis means exercise before opening a new branch

Productive Purposes: Loans for non-productive and speculative purposes cannot be granted.

Diversification of Risks:

Security:

Banker can reduce risk in lending to a borrower by ensuring that there will be no default on account of lack of liquidity and lack of willingness to pay on the part of the borrower.

In Bankers parlance, credit risk in lending refers to default of repayment by a borrower.

Non-Fund Based Limits

Bank Guarantees

Letters Of Credit

Working Capital

1.    Gross Working Capital = total assets

2.    Net Working Capital = current assets – current liabilities

3.    Major Current Assets are Marketable investments and cash/receivables/ inventories

4.    The major Sources of Working Capital for investments in current assets are Trade credits, Unsecured Loans, Deposits, Bank borrowing, advance payments, Net Working Capital.

5.    Working capital means – requirements for day to day transactions.

6.    Working capital needs are estimated by Cash Budget Method.

	Term Loan			Working Capital Finance
1	The  term  loans  are  utilized  for			Working  capital  finance  is  for
	establishing,	expanding	or	operating  purposes  resulting  in
	modernizing a manufacturing unit by			creation   of   current   assets   for
	acquisition of fixed assets.			production and sale of the finished

.

goods

2     Term Loans are usually of medium The WCF is generally availed of a or long term duration and are cash-credit Hypothecation accounts repayable in quarterly/half yearly with frequent drawings and installments over an agreed period repayments within the time fixed

of time.

and is payable on demand.

Estimation of Working Capital Needs

The Operating Cycle Method:

While assessing working capital requirement creditors will not be set off against stock.

The borrower will submit age-wise list of sundry creditors and sundry debtors as well as stock statement.

Only those debtors will be considered which are outstanding for less than the period specified (up to 180 days) on case to case basis.

Total Outstanding (Creditors – Debtors) ; if debtors are in excess, the bank could consider financing the surplus debtors as per banks policy.

The borrower will have to hypothecate his entire book debts to the bank. The bank will not finance the borrower’s book debts, if creditors exceed

debtors.

The Projected Networking Capital

·

The Projected turnover Method the bank as a matter of policy and based on RBI guidelines assess the working capital including village industries, tiny industries with fund based working capital limit up to Rs. 4 crore by the turnover method.

·         20%  of minimum of their projected sales turnover

·         Drawing power may be worked out through stock statements, unpaid stocks are not to be financed as it would result in double financing.

·         5% should be contributed by borrowers.

The Cash Budget System: (if fund based limits in excess of Rs. 10 Crore) Advantages

1.    Borrower plans to advance cash requirements.

2.    Banker is able to spot danger signal quickly and corrective measures could be taken.

3.    Banker can plan his resources to meet credit requirements.

	Cash Budget	Cash Flow
1	It deals with Cash transactions only	It deals with cash and no-cash funds
2	Cash budgets for short periods	Cash flow statement are for quarterly
		or half yearly.
3	It is projection in the future	It is historical

.

Credit Management (273)

Credit Management is the management of the credit portfolio of bankers and financial institutions. It includes

i.    Capital Adequacy Norms

ii.    Risk management including ALM

iii.    Exposure norms

iv.    Risk pricing policy and credit risk rating

v.    Asset Classification, Credit decision-making and loan review mechanism

Credit decisions are affected by Credit Risk/Market Risk / Operational Risk. Credit Risk is defined as the possibility of losses associated with diminution in

the credit quality of borrowers or counter parties. Such risks are Principal / Interest amount may not be paid.

Funds may not be forthcoming from clients upon invocation of L/C Funds/Securities settlement may not be affected in securities trading.

Market Risk is defined as on possibility of loss to a bank caused by changes in market variables –

Liquidity Risk

Interest Risk

Foreign Exchange Rate Risk

Commodity price Risk

Equity Price Risk

The Operational Risk arises from human or technical error or acts of commission and commission.

Standard Asset

Sub-standard

Non-performing

Loss making

Exposure ceiling for banks in providing advances / loans to borrowers - 15% of capital funds for single borrower and 40% in a borrower’s group.

Non-Performing Assets

A loan is classified as non-performing when the interest and/or installment of principle remain overdue for a period of more than 90 days.

Various Committees on Credit Disbursements (276)

Tandon Committee (1974) - RBI advised all banks in August 1975 to implement the first two methods for borrowers having credit limit in excess of Rs. 10 lakhs.

1^st Method: Working Capital Gap = Current Assets – Current Liabilities Net Working Capital = 25% of Working Capital Gap +75% MPBF

.

2^nd Method: Total current Assets 25% of this be NWC MPBF = Current assets – 25% of CA – current Liabilities

3^rd Method: MPBF = Current assets – Core Assets – NWC 25% - Current Liabilities

Chore Committee (1979)

Laxminarayan Committee (1973)

Nayak Committee

Vaz Committee (1993)

Shetty Committee – For Consortium Advances

Kannan Committee (1997) – To assess the complain received from the mercantile community - the method of Tandon Committee for assessment of inventory and receivable and insistivity for 1.33 current ratio were not providing them enough credit.