Discuss the Principle of Lending.
Posted by Ripon Abu Hasnat on Wednesday, May 27, 2015 | 0 comments | Leave a comment...
1. Safety
"Safety first" is the most important principle of good lending. When a banker lends, he must feel certain that the advance is safe; that is, the money will definitely come back. The banker ensures that the money advanced by him goes to the right type of borrower and is utilized in such a way that it will not only be safe at the time of lending but will remain so throughout, and after serving a useful purpose in the trade or industry where it is employed, is repaid with interest.
2. Liquidity
It is not enough that the money will come back; it is also necessary that it must come back on demand or in accordance with agreed terms of repayment. The borrower must be in a position to repay within a reasonable time after a demand for repayment is made. This can be possible only if the money is employed by the borrower for short-term requirements and not locked up in acquiring fixed assets, or in schemes which take a long time to pay their way.
3. Purpose
The purpose should be productive so that the money not only remain safe but also provides a definite source of repayment. The purpose should also be short termed so that it ensures liquidity. Banks discourage advances for hoarding stocks or for speculative activities.
4. Profitability
Equally important is the principle of 'profitability' in bank advance like other commercial institutions, banks must make profits. Firstly, they have to pay interest on the deposits received by them. They have to incur expenses on establishment, rent, stationery, etc. They have to make provision for depreciation of their fixed assets and also for any possible bad or doubtful debts. After meeting all these items of expenditure which enter the running cost of banks, a reasonable profit must be made; otherwise, it will not be possible to carry anything to the reserve or pay dividend to the shareholders
5. Security
It has been the practice of banks not to lend as far as possible except against security. Security is considered as insurance or a cushion to fall back upon in case of an emergency. The banker carefully scrutinizes all the different aspects of an advance before granting it. At the same time, he provides for an unexpected change in circumstances which may affect the safety and liquidity of the advance.
6. Spread
Another important principle of good lending is the diversification of advances. An element of risk is always present in every advance, however secure it might appear to be. In fact, the entire banking business is one of taking calculated risks and a successful hanker is an expert in assessing such risks. He is keen on spreading the risks involved in lending, over a large number of borrowers, over a large number of industries and areas, and over different types of securities.
7. National Interest, Suitability, etc.
Even when an advance satisfies all the aforesaid principles, it may still not be suitable. The advance may run counter to national interest. The Federal / Central Bank (e.g Reserve Bank of India, RBI) may have issued a directive prohibiting banks to allow the particular type of advance.
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