Bank Lending in India

Banks depends on deposits from public and depositors requires security of their deposits with adequate return. Bank lending is necessary to make profit.

Basic principles of bank lending

1. Safety - Bank needs to ensure the money lend by them will come back
2. Liquidity- Bank will design the maturity period to ensure the money is not locked for long time
3. Profitability - Bank will fix correct interest rated to make profit
4. Risk Diversification - Banks will concentrate on different sectors,regions to avoid risks

Loan Policy

The Credit Policy Committee (CPC) of bank will prepare the lending policy and the same has to be approved by the Banks board of directors.

Basic Guidelines for loan policy  are in the following areas

1. Credit Deposit Ratio

      Some portion of bank deposits should maintained as CRR/SLR and in some Non-SLR Investments and in remaining bank can lend out some portion of its deposits. The average CD ratio is 70 percent and it will differ across banks.

2. Targeted Portfolio Mix

      Banks need to monitor all major sectors of the economy. Bank needs to decide which sector to avoid. Portfolio mix keeping in view both risk and return.

3. Hurdle Ratings

      Major risk factors associated with borrowers. Banks have risk rating system to rate the risk factors of the borrowers. Minimum rating required for new borrowers.

4. Pricing Of Loans

      Higher the credit risk of a borrower the rate of interest will also high. Based on Credit risk banks will give rate of interest of interest. Pricing of loans is also dependent on competition between banks.

5. Collateral Security

      Banks usually gives loan against some securities, securities can be in the form of both physical and financial asset. This reduces risk of the bank.

Types Of Advances

 Advances classified as below

1. Fund Based Lending

   Direct Form of lending to the borrower in the form of cash. Some cases it will backed up by some security.

2. Non-Fund Based Lending

   Facilities such as Letter of Credit and guarantees fall under the category of non fund based lending.

No direct form of cash lending.

Fund Based Lending

Some important types of fund based lending

Working Capital Finance

Definition of Working capital is Current Asset - Current Liabilities. Working capital finance is utilized for expanding the manufacturing unit.

Working capital finance can avail in 2 ways 

i) Short term loan component and

ii) Cash Credit component

Short term loan is the normal loan with monthly EMI and tenure. 

Cash credit component is bank will give 20% of loan amount as cash in the account.  Borrower need to pay interest only for the withdraw amount from the cash credit component.

Eg : If  bank provides 1Lakh Rupees as Cash credit component and the borrower withdraw only Rs.10000 after one month means he need to pay interest only for the Rs.10000.

Project Finance

Project Finance loans mainly for the manufacturing and infrastructure sectors. Banks financing in fixed or floating rate.

Loans to Small and Medium Enterprises

  Loans by banks to Small and Medium Enterprises (SME). Banks encourages financing to small enterprise that have homogeneous profile.

Banks are not advised to insist on collateral security for loans upto 10 Lakhs for micro enterprises.

Rural and Agriculture Loans

Rural and Agriculture loan is for loans to farmers , SME in rural areas. For Farmers bank lend loan for farming, tractors,pump sets etc. 

RRB banks plays major role in agriculture loans.

Directed Lending

RBI requires banks to lend in some sectors of the economy called directed lending. Banks wont concentrate on profits.

Priority Sector lending like agriculture,SME, retail trades and small housing loans and education loans.

Differential Rate of Interest Scheme - Low rate of interest for low income groups. RBI has advised 4% rate of interest for borrowers with Rs.18000 as annual income in rural areas and Rs.24000 as annual income in Urban areas.

RBI requires bank to give export credit at low rate of interest for pre and post shipment requirements.

Retail Loan

Retail loans includes personal loans, home loans, car loans, credit cards and consumer loans.

Except Personal loan and credit card borrower needs to pay certain portion of the asset cost and remaining portion as loan.

International Loans extended by banks

Indian corporates raise foreign currency loans from banks based in India as well as abroad as per the terms and conditions of RBI or Government of India.