Policy means action or procedure conforming to or considered regarding prudence or expediency. Bank lending policy refers to the policy and guidelines to make its lending process systematic and methodical. Banks deal with other people’s money. They lend the money which they borrow from the depositors.
Unless these deposits are prudently utilized, banks are destined to incur losses. Banks cannot keep the deposits idle in the vaults or lend the deposits and not recollect them.
Hence, a proper lending policy must be in place. Commercial Bank will carefully analyze and consider seven factors before sanctioning loans to its customers.
7 Factors for Banks Loans
Liquidity
The term ‘liquidity’ implies the ability to produce cash on demand. A bank mainly utilizes’ its deposits to grant advances.
These deposits are repayable on demand or the expiry of a specified period. To meet the depositors’ demand in time, banks should keep their funds in a liquid state.
Money locked up in long-term loans cannot be received back in time and so are less liquid.
So a bank should confine its lending to short-term loans only.
Profitability
Like all other commercial institutions, banks are run for profit, and even government-owned banks are no exception to this.
Banks earn profit to pay interest to depositors, declare a dividend to shareholders, meet establishment charges and other expenses, provide for reserve and bad and doubtful debts, depreciation, maintenance, improvements of property owned by the bank, and sufficient resources to meet contingent loss.
So profit is an essential consideration. Banker should employ their funds in such a way that they will bring them adequate returns.
However, a banker should never provide undue importance to profitability.
Safety and Security
The banker should ensure that the borrower has the ability and willingness to repay the advances as per the agreement.
Closely allied to this point, he should carefully consider the margin of safety offered by the security and the possibilities of fluctuations in value before granting a secured advance.
If it is an unsecured advance, its repayment depends on the creditworthiness of the borrower and that of the guarantor.
The cardinal principles that the banker should consider in case of unsecured advances are character, capacity, and capital (popularly known as the 3C’s) or reliability, responsibility, and resources (popularly known as the 3 R’s) of the borrower and the guarantor.
Purpose
The banker has to carefully examine the purpose for which the advance has been applied.
If the advance is intended for productive purposes, it could be reasonably anticipated that cash flows arising for productive activities will prompt repayment.
Of course, the banker has to be careful to monitor the exact purpose for which the advance is utilized.
Sources of Repayment
Before giving financial accommodation, a banker should consider the source from which repayment is promised. In some instances, debentures to be redeemed in a few months or a life insurance policy to mature soon may be offered as security.
Advances against such security give no trouble.
Sometimes customers may apply for loans for additional working capital for their business and repay the profits over a period.
In such cases, the rate the customer can reasonably hope to repay should be ascertained.
Diversification of Risk
A banker’s security consciousness and the borrower’s integrity are ‘not adequate factors to keep the banker safe.
What is also important is the diversification of risk.
This means the banker should not lend a major portion of their loanable fund to any single borrower or industry or one particular region.
Otherwise, an adverse change in the economy may affect the entire business.
In such a case, repayment will be highly difficult, and the bank’s survival will become questionable. Therefore a bank should follow the wise policy of “do not put all the eggs in a single basket.”
The bank must advance moderate sums to customers spread over a wide area and belonging to different industries.
Social Responsibility
While admitting that banks are essentially commercial ventures, a bank should not forget that it is not enough that only people of means are given bank finance.
Through productive effort, bank finance should make people creditworthy and turn them into people of means.
Technical competence of the borrower, operational flexibility, and economic viability, rather than the security the borrower can offer, should be considered in evaluating a loan proposal.
Identifying priority sectors to extend bank credit should be considered a positive development in the banking system, aimed at effectively discharging its responsibility towards society.