Topic 7 Loans and Advances

LOANS AND ADVANCES:
Profit is the pivot on which the entire business activity rotates. Banking essentially is a business
dealing with money and credit. Like every other business activity, banks are profit oriented. A
bank invests its funds in many ways to earn income. The bulk of its income is derived from loans
and advances.
The most profitable of all assets is bank loans and advances. This asset is universally sought after
by banks. Bank loans and advances may be made to businessmen either by the system of
overdrafts of an agreed amount or by discounting bills of exchange. Loans and advances carry a
high rate of interest because of the risk involved, low liquidity and the difficulty of shifting them.
They involve great risk to the bank because of the possible failure of the borrowers and in
extreme cases because of their insolvency and liquidation. Again, these loans and advances have
a low liquidity and low shift ability in the sense that they cannot be converted into cash easily as
and when the bank requires additional cash to meet withdrawals, nor is there any possibility of
shifting them to other banks or institution.
Actually, all bank failure may be ascribed to faulty policies regarding loans and advances. From
the point of view of safety of the bank and its liquidity, loans and advances are poor assets. But
the high yield of these assets compensates for the difficulties associated with them. These assets,
thus, have low liquidity but high yield.
There are four main stages in a lending process. The credit officer will first market for potential
business opportunities
(Stage 1 – Marketing) Having identified the potential borrowers, he will then do a credit
analysis. To be effective, he must know what the sound lending principles are
(Stage 2 – Credit Analysis). Once the loan has been approved, monitoring is necessary
(Stage 3 – Loan Administration).If the borrower fails to fulfill his obligations, the credit officer
will have to study the possible remedial action needed to be adopted, i.e. the remedial
management
(Stage 4 – loan recovery).
Stage 1: Business Development and Marketing
Through the selling cycle, lenders initiate the lending process.
Stage 2: Sound Lending Principles/Credit Analysis
Apart from considering the five C’s of lending:
Character
The character of the borrower indicates two things: the ability to pay versus the willingness to
pay. The ability to pay refers to the borrower’s financial credibility to pay. A good character is
one that has the ability to pay and a willingness to pay. The lender should check on the
borrower’s character.
Capacity
Capacity refers to the sources of repayment, i.e. the cash flow. The borrower must be able to
meet all his financial obligations on the due dates.
Capital
Capital represents the degree of commitment and the ability to sustain this commitment during
bad times.
Conditions
Condition refers to the macroeconomic environment. For example, if the loan is needed for
setting up a retail business in a particular area, then the lender must make a study of the
economic conditions (the degree of propensity to spend by residents in that locality).
Collateral
Collateral is the lender’s second line of defense. If the payback is derived from cash flows, then
the collateral will not be liquidated for repayment.
The following have to be considered:

(a) Quantitative: Be able to read and analyse the financial statement (e.g. cash flows and ratios of
a company).
(b) Qualitative: Be able to understand the environment and trend of business.
(c) Documentation Process: Be able to execute proper documentation on the collateral held.
(d) Legal aspect of security: Be able to understand the procedures involved in taking debentures
or a lien on fixed deposits and how to perfect a legal charge.
(e) Relationship Income: Be able to analyse the profitability of the business.
(f) Capital Adequacy: Be able to maintain a minimum ratio of equity capital to total risk-
weighted loan assets.
Stage 3: Monitoring
A review is to be carried out on a yearly basis. Upon re-approval, should there be changes to
certain terms and conditions, an Offer Letter will be sent to the borrower for his acceptance of
the renewed facility.
Stage 4: Remedial Management
(a) Winding up – winding-up action taken on the company.
(b) Enforcement of guarantees – to take legal action against the guarantors.
(c) Receivership – to appoint receivers and managers.
(d) Foreclosure – eventual recovery by auctioning a landed property.
SECURED AND UNSECURED ADVANCES:
Loans and advances may be made either on the personal security of the borrowers or on the
security of some tangible assets. The former is called unsecured or clean or personal advances
and the latter is called secured advances.
The Banking Regulation Act defines unsecured loan as unsecured loan or advance means a loan
or advance not so secured,
SECURED ADVANCES:
Secured advances mean loans made on the security of tangible assets of land building, machinery
goods and documents of title to goods. Such loans provide absolute safety to a banker by
creating charge on the assets in favorable of him.
The advances must be made against tangible security. The market value of the security must not
be less than the amount of loan granted.
FORMS OF ADVANCES
Loans
Cash credit system
Overdraft
Bills purchased and discounted.

Topic 7 Loans and Advances

Uploaded by

Copyright:

Available Formats

Topic 7 Loans and Advances

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Topic 7 Loans and Advances

Uploaded by

Copyright:

Available Formats

LOANS AND ADVANCES:

Stage 1: Business Development and Marketing

Through the selling cycle, lenders initiate the lending process.

Stage 2: Sound Lending Principles/Credit Analysis

Apart from considering the five C’s of lending:

The following have to be considered:

(b) Qualitative: Be able to understand the environment and trend of business.

(e) Relationship Income: Be able to analyse the profitability of the business.

Stage 4: Remedial Management

(a) Winding up – winding-up action taken on the company.

(b) Enforcement of guarantees – to take legal action against the guarantors.

(c) Receivership – to appoint receivers and managers.

(d) Foreclosure – eventual recovery by auctioning a landed property.

SECURED AND UNSECURED ADVANCES:

Cash credit system

Bills purchased and discounted.

You might also like