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Principles of Sound Lending
1. Safety
2. Liquidity
3. Profitability
4. Diversification
5. Object of loan
6. Security
7. Margin Money
8. National Interest
9. Character of the
• Forms of Lending (Advances)
• Banks lend for working capital requirements
in the form of:
• 1. Loans
• 2. Cash credit
• 3. Overdraft
• 4. Purchase and discounting of bills of
• Distinction between Loan and Cash Credit
(a) Amount: In case of loan a fixed amount is sanctioned,
whereas in case of cash credit a limit is fixed.
(b) Period: Loan can be granted for a short, medium and
long-term but cash credit is granted only for a short
period up to one year only.
(c) Withdrawal: The entire amount of loan is credited to
the customer’s account. In case of cash credit the
customer can withdraw the amount upto the limit when he
(d) Interest: In case of loan, interest is payable on the
entire loan, whereas in case of cash credit, interest is
payable only on the amount actually withdrawn and for
the period the amount is withdrawn.
(e) Repayment: Ordinarily a loan is repayable in one lump
sum. However, it may be paid in installments also. On the
other hand in case of cash credit, the borrower may
repay any surplus amount from time to time.
Types of Loans and Advances
• Loans and advances are of different types.
These can mainly be classified on the following
On the Basis of Object or Purpose
For which purpose a loan is being taken? It may
be for the following purposes:
(a) Commercial Loans: This loan is taken to meet
short term requirement of capital e.g., working
(b) Consumer Loan: This loan is taken to finance
household goods like fridge, T.V.,scooter etc.
(c) Agricultural Loan: Such a loan is taken by the
farmers to meet their short term requirements
like buying seeds, fertilisers, insecticides etc.
• On the Basis of Time
(a) Short Term Loan: Such a loan is taken for a
period of less than one year. For example, to
meet working capital requirements.
(b) Medium Term Loan: Such a loan is taken
for a period ranging from 1 year to 3 years.
For example, to purchase equipments for
professionals or furniture etc.
(c) Long Term Loan: Such a loan is taken to
meet long-term requirements from 3 years
to 20 years or more. For example, loans to
purchase land, building, plant and machinery
etc. However, banks provide long-term loans
to a very limited extent only.
On the Basis of Security
(a) Secured Loan: Such a loan is granted on the
security of tangible assets, Sec. 5 (a) of the
Banking Regulation Act, 1949, defines a
�secured loan or advance’ as a loan or
advance, made on the security of assets, the
market value of which is not at any time less
than the amount of such loan or advance.
(b) Unsecured Loans: Such a loan is granted
without any security. According to Sec. 5 (a)
of the above Act an unsecured loan or
advance means a loan or advance not so
On the Basis of Form
(i) Loan,
(ii) Cash credit, and
(iii) Overdraft.
Characteristics of Good Security
A good security should have the following
1. Free from encumbrances
2. Easy marketability
3. Easy storability
4. Durability
5. Free from price fluctuations
6. Easy ascertainment of value
7. Earning of income
8. Free from heavy cost of handling
9. Free from disabilities
Precautions to be Taken by the Bankers
Character of the Borrower
Experience in the Business
Title of the Borrower
Purpose of the Loan
Proper Valuation of Goods
Nature of Goods
Proper Storage
Care in a Rented Godown
Take Possession of Goods
Godown Keys
Adequate Insurance
Periodical Inspection
Strict Supervision Over the Release of Goods
Short-period Advances
Bank’s Name Board
Directives of Reserve Bank
Advances Against Documents of Title to Goods
• Documents, which in the ordinary course of trade, are
regarded as proof of the possession or control of the goods
are called “documents of title to goods.” Thus, the documents
of title actually represent goods. They can be transferred by
mere delivery or by endorsement. The delivery of these
documents actually amounts to a symbolic delivery of goods
represented by them. Banks find it easy to deal with these
documents than physically dealing with goods. Hence, these
documents are very popular among banks. The following are
the important documents of title to goods:
• 1. Bill of lading
• 2. Dock warrant
• 3. Warehouse keeper’s certificate
• 4. Delivery order
• 5. Railway receipt and lorry receipt
The banker has to take the following precautions while
accepting the documents of title to goods as
пЃ± Integrity and Honesty of the Borrower
пЃ± Certificate Regarding Packing
пЃ± Depositing of all Copies of Bill of Lading
пЃ± Documents Without Onerous Conditions
пЃ± Blank Endorsement
пЃ± Insurance
пЃ± Trust Receipt
пЃ± CleanDocuments- documents containing objectionable
remarks about packing
пЃ± Control-customer fails to get delivery of goods, the
banker should takeover the goods in its control, store
them and later on dispose of them
Advances Against Stock Exchange Securities
• Shares and debentures which are regularly
purchased and sold in the stock exchange may
be accepted as security by the bank. A stock
exchange is an organized market where
securities are purchased and sold. The
securities traded on the floor of a stock
exchange include the following:
(a) Bonds issued by the Central and State
(b) Securities issued by semi-Government
authorities like port trusts, electricity
boards,improvement trusts, etc.; and
• (c) Shares and debentures issued by the
Precautions to be Taken in Advancing Against
Choice of Securities
Valuation of Securities
Adequate Margins
Debentures and Preference Shares-should
prefer preference shares and debentures to
equity shares because the fluctuations in the
prices of debentures and preference shares are
• Partly-paid Securities
• Transfer of Securities-the bank must get the
transfer deed signed by the borrower.
• Notice to Company
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