Loans and Advances

Primary function of commercial bank is that of a broker and dealer in societys money. They mobilize a large fraction of the liquid savings of the nation, and allocate them productively to industry, agriculture and households. Major portion of banks funds is employed by loans and advances through which they earn interest, discounts and concession fees. Principles of sound lending: Lending business has inherent risk and banks can afford to take only calculated risks. Company other pupils money. Another facet needs to have ready cash since it is under obligation to return customers money whenever demanded. So prudent and diligent handling of funds. Follow the general principles of sound lending: Principle of liquidity: Liquidity-implies ability to produce cash on demand. It also implies shiftability without loss. If security accepted is readily shiftable banker can obtain funds easily. E.g. Discounting of 1st class bill can be rediscounted with RBI. If security is in the form of land connected only after an interval. Principle of safety & security Safety of funds- means that the borrower repays the loan along with interest as per the agreement. Principle of profitability Since they are commercial ventures, they must ensure their lending operations are sufficiently profitable to cover their cost of funds, cost of interest and risk cost and leave sufficient income for full prudential provisioning, allocation to capital and reserves for expansion, growth and competitive viability. Principle of purpose Purpose of loan must be enquired before granting loan. Loans for productive purposes help to generate incremental income that result in prompt repayment. Principle of diversification of risks Do no keep all the eggs in one basket applies for bankers portfolio of loans &advances. Spread risk by granting loans to different trades, industries, sectors& regions. Risk may arise from change in government policies, natural calamities or technological breakthrough. Principle of social Responsibility: Contribute in the process of economic development help more entrepreneurs to run successful ventures. Also follows other principles.
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Methods of granting advances The main methods of granting loans and advances in India are classified as: Cash credit It is the most favored method for availing credit in India. Under this system, bank fixes a cash credit limit on an annual basis. Customer is at liberty to withdraw any amount as and when he needs. Current account is an active and running account to which deposit and withdrawals may be affected frequently. Features The bank fixes cash credit limit after studying borrowers financial capacity etc. Borrower has to provide security of tangible assets or guarantees. Borrower can withdraw from his account whenever and whatever amount he needs. Interest is charged only on actual amount withdrawn and for actual period utilized. In reality they roll over a period of time (made for 1 year).

Limitations for bank Lose interest on unutilized amount. Not in a position to verify end use of the cash.

Overdraft : It is a short term credit facility. It is given to a current account holder allowed to withdraw more money from his account (than what is actually available in credit). Features Bank either insists on a collateral security / grant on personal security of borrower. Can withdraw subject to maximum of sanctioned overdraft limit. Interest is charged on actual amount and actual period utilized. Sometime this agreement is due to course of business between bank & customer this facility can be discontinued / recast

Bill discounting: The facility for providing working capital. When customer provides bill of exchange as security banker deducts a certain amount (discount) from the face value of the bill & advances the rest of amount to customer. Also purchases bill outright at face value & less bank charges (only bills payable on demand).

Loan system :It denotes the granting of an advance in lump sum, usually on the basis of some acceptable securities. Credit is given for a definite purpose and for predetermined period. Working capital funds& also investment in long term bonds & open end securities. For trade & industry, government unit and also for consumers for a large of personal products like housing, automobile, education etc. Features Purpose of loan is defined- easy to monitor & control use of credit Provided at one go for a single transaction For additional funds must apply afush & negotiable terms or renew of existing loan. Repayment made in installments Interest paid on entire amount whether utilized fully or not. For the bank-operating cost are less than others.

Type of loans Category on the basis of period Short term loans- are loans for period not exceeding 1 year. It is given to meet working capital requirements, against security of movable assets like goods, commodities, shares debentures etc. Term loans- are medium & long term loans. Periods ranging from 1-8 or 10 years. On security of existing industrial assets/ assets purchased with the loan. It is given for purchase of capital assets- new industrial units, expansion, modernization or diversification. It involves risk since it is intended to be repaid out of future profits. Financial feasibility, technical feasibility & managerial competency must be studies. Banks can charge fixed rate of interest for entire period or different prime lending rates for different maturities, but uniformity of treatment & transparency must be maintained. Bridge loans-short term loans granted due to pending disbursement of sanctioned loans. It helps borrowers to meet urgent & critical needs. Repaid out of the amount of such loans or from funds raised in the capital market. Category on the basis of purpose of loan Composite loans-if a loan is take n for buying capital assets and for meeting working capital requirements. They are availed by small entrepreneurs, artisans & farmers. Consumption loans- banks started giving loans for consumption purposes like education, housing, medical needs& automobiles.

Secured advances-it is one which is made on the security of either assets or against personal security or other guarantees. An advance which is not secured is called an unsecured advance. Basic objective-to recover unpaid amount of loan through sale for securities. Securities should be identifiable (physical form as well as in value) be easily marketable, have stability (price must not fluctuate much) & title must be clear & easily transferable. Classification of securities Personal securities- They are also called intangible securities. Bank has personal right of action against borrower. E.g. promissory note, bill of exchange, security bond, personal liability of guarantor etc. Tangible securities- they are forms of impersonal security- land, buildings, & machinery. In event of loan recovery banks enforce or sell securities through court intervention. Primary securities- they are those which are created with the help of finance made available by the bank. E.g. machinery or equipment purchased with bank finance. Collateral security is security not financed out of bank advanced. It is additional security given by borrower when primary security is not enough to recover loan. E.g. land of factory given as security along with machinery purchased out of bank loan. Securities can be classified as liquid security, government security stock exchange securities and blue chip securities.

Modes of creating charges

Lien ---- means the right of the creditor to retain the goods and securities owned by the debtor until the debt due from him is repaid. The creditor gets only the right to retain the goods & not the right to sell. Lien can be either Particular lien----- the right can be exercised by a person who has spent his time, money or labor on the goods. E.g. car mechanic, tailor etc, can be exercised against only those goods for which charges have to be paid. General lien----- is enjoyed by the bank. Features of general lien It is blanket right is applicable in respect of all amounts which are due from the debtor. E.g. security handed over to the banker for machinery loan can also be sued by bank after its repayment for any other advance outstanding in his name. E.g. an overdraft taken by the borrower. The right is conferred by the Indian contract Act upon the bank. Still bank takes a letter from customer that goods have been entrusted as security & bank may exercise right of lien. Banks right of lien is tantamount to an implied pledge bank has the right to sell goods in case of default of customer. Negative lien is also possible. Here, the borrower has to give a declaration that the assets given are free from any charge or encumbrance. That no charge will be created on them nor will the borrower dispose f those assets w/o consent of banker.

Pledge----- is the bailment of goods as security for payment of a debt or performance of a promise when a borrower secures a loan through a pledge, he is called a pawner or pledger & the bank is called Pawnee or pledge. Features Goods can be pledged only the owner, joint owner (with consent of other joint owners), a mercantile agent or in some cases by an unpaid seller. Banker can retain goods for debt payment, interest accrued on it & expenses incurred for keeping goods safe. Goods can be retained for any subsequent advances also but not for any existing debt which is not covered by the pledge. In case of nonpayment banker has right or sell goods & recover amount of loan along with interest & expenses. In case of default, bank has right either to
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a) File a civil suit against pledger & retain goods as additional security or b) Sell the goods. Bank must give due notice of sale to the borrower before the sale. This right is not limited by law of limitation. Banks right of pledge prevails over any other dues including government dues except workers wages. Bank must take good care of goods & return after payment with accretion.

Hypothecation It is an extended idea o pledge whereby the creditor permits debtor to retain possession of goods, either on behalf of or trust for himself. It is a charge made on movable property in favor of secured creditor without delivery or possession created only movable property like stocks, machinery, vehicles etc., and borrower binds himself to give possession of goods to bank whenever the latter desires. It is a convenient device in situations where transfer of possession is either inconvenient or impracticable. E.g. buses & taxies given as security by taxi operators but are used by them. Agreement is made through hypothecation deed bank cannot take possession without the borrowers consent but after taking possession, bank is free to exercise right of a pledge & sell assets without courts intervention.

Assignment
Assignment of a contract means transfer of contractual right and liabilities to a third party. Transferor or borrower- is called the assignor & transferee or banker is called the assignee. Borrower can assign any of his rights, properties or debts to the bank as security for a loan. Might be existing or future. Generally actionable claims are assigned by the borrower. Actionable claim--- is a claim to any debt, other than a debt secured by mortgage of immovable property, or by hypothecation or pledge of movable property. E.g. usually borrower may assign book debts, money due from government or semi-govt organizations or life insurance policies. Notice of assignment of debtor is not registered under law (sec 130 of transfer of property Act, 1881). But in the interest of the assignee, it is better to give notice to debtor because in the absence of notice, assignee is bound by any payments which debtor might make to the assignor in ignorance of assignment. E.g. LIC policy is assigned by borrower in favor of his bank has security of r a loan, bank should give notice to LIC.