Loan: Meaning, Definition of Loan
Commercial banks are also established to earn profit like any other business organization. The main profit-earning activity of banks is to earn interest income or profit from extending loans of the funds mobilized as deposits.
As such loans are extended, interest and principal must be recovered on lime to keep the depositors’ money safe and maintain the revolving character of funds utilized as loans.
It is, therefore, imperative that commercial banks should not provide loans without properly analyzing the creditworthiness to ensure the recovery of money so lent.
Over time, some principles, procedures, and theories have been developed, innovated, and practiced. The main purpose of all of these is to facilitate lending in an easy but pragmatic way to ensure the revolving character of the funds to maximize profit earning.
At the outset, a loan officer must be clear about the meaning & definition of loans, the features and functions of loans, their types, and operational mechanisms.
To ensure the extent of risk and recoverability, the loan officer must consider all the possible information relating to the Ioan applicant and the socioeconomic viability of the project for which the loan is sought.
The loan officer then attempts to focus on the pricing of the loan after assessing the costs of funds and the expected rate of return from the loans.
At one time, a bank loan officer only had to track the fortunes of a handful of large, well-known companies as borrowers—the skills needed for this kind of analysis centered on understanding the qualitative aspects of a business.
While fundamental analysis on understanding continues to have a place in understanding an obligor’s credit quality, the nature of the credit business has changed. Narrowly focused, simplistic standalone credit analysis is no longer enough.
Meaning of Loan
In real life, individuals or institutions (business/non-business or government/non-government) face situations when they feel the necessity of collecting, achieving, or using something they may not have adequate purchasing power.
On the other hand, some individuals or institutions have surplus funds after fulfilling their recurring and investment requirements. By way of deposit, the bank takes these surplus funds into its custody.
The bank again temporarily transfers these funds for a specific duration in exchange for some interest/profits to those who do not have the required purchasing power but can utilize borrowed funds for some productive & profitable purposes/projects.
Here, “temporarily” means that the user will return the “provided purchasing power” as loans after some time, per the contract terms.
However, in banking, many types of financial facilities are extended to the clients to get the same return and interest. This “provided purchasing power” can be termed a loan, credit, or advance. These three terms have similarities as well as Some differences.
Banks can provide loans in different ways. Loans can be in cash or non-cash form. If any client takes advantage of the bank by using the bank’s goodwill by making a contract, this will be treated as a “goodwill loan.” L/C, traveler’s cheques, and traveler’s notes are the “goodwill loan” of a bank.
According to the Dictionary of Banking & Finance, loans are “the lending of a sum of money by a lender to a borrower to be repaid with a certain amount of interest.”
Timothy VV Koch defined loans as “a formal agreement between a bank and borrower to provide a fixed amount of credit for a specified period.”
The author states, “A loan may be defined as money lent at interest or on profit. It is only temporarily parting with one’s (an individual or an institution) resources to augment the purchasing power of the receiver of the such facility with a promise to return the same with interest/ profit or otherwise as mutually agreed upon.”
From the above discussion, we can easily say that a profit-oriented business organization will be called a loan if a bank gives its resources temporarily under certain conditions and for a specific duration. The terms loan, credit, and advance are occasionally used separately in different spheres.
The banking business depends on properly utilizing mobilized funds, mainly in loans. The funds given to the borrowers as loans must remain safe and recover as and when due. Depositors whose funds are extended as loans always keep a cautious eye on the bank’s lending activities.
Loan as a proxy to purchasing power helps potential investors raise their income by enhancing the volume and quality of their business, and the same, on the other hand, unquestionably plays a vital role in the bank’s existence by earning profit in terms of interest on loans.
For getting a facility to collect deposits, the security of loan funds must be ensured. A loan is not a grant or is a loan, not a value-less concept. Rather loan is the financial benefits provided to the persons/institutions who/which have repayment capability.
The body bank as the lender and the borrowers as the receivers of loans must bear a cooperative attitude of mutual partnership.
Lenders and borrowers spontaneously engage in loan activities for mutual interest. Lending to be effective must be on-time adequate, and available at a competitive price.
In a single word, banks, to survive, must always remain customer-friendly.
Similarly, to remain tension-free in arranging funds as and when they require, borrowers must always prove themselves to be bank friendly by making repayments of loan installments piously as and when they become due.