7 Factors Need Consideration before Sanctioning Banks Loans

7 Factors Need Consideration before Sanctioning Banks LoansPolicy means action or procedure conforming to or considered with reference to prudence or expediency.

Bank lending policy refers to the policy and guidelines adopted by a bank in order to make its lending process systematic and methodical. Banks deal with other people’s money.

They lend the money which they themselves borrow from the depositors.

Unless these deposits are prudently utilized banks are destined to incur losses.

Banks cannot effort to either keep the deposits idle in the vaults or lend the deposits and not recollect. Hence, it is essential that a proper lending policy is in place.

Commercial Bank will carefully analyze and consider 7 factors before sanctioning loans to its customers.

  1. Liquidity.
  2. Profitability
  3. Safety and Security.
  4. Purpose.
  5. Sources of Repayment.
  6. Diversification of Risk.
  7. Social Responsibility.

1. Liquidity

The term ‘liquidity’ implies the ability to produce cash on demand. A bank mainly utilizes ‘ its deposits for the purpose of granting advances.

These deposits are repayable on demand or on the expiry of a specified period. To meet the demand of the depositors in time, banks should keep their funds in the 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.

Related: Ideal Loans and Problem Loans: Causes of Problem Loans

2. Profitability

Like all other commercial institutions, banks are run for profit. 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 for bad and doubtful debts, depreciation, maintenance and improvements of property owned by the bank and sufficient resources to meet contingent loss.

So profit is an essential consideration.

A banker should employ his/her funds in such a way that they will bring him/her adequate return.

However, a banker should never provide undue importance to profitability.

Related: When Banks Required to Disclose Customers’ Information

3. Safety and Security

The banker should ensure that the borrower has the ability and the willingness to repay the advances as par agreement.

Closely allied to this point is that before granting a secured advance, he should carefully consider the margin of safety offered by the security and possibilities of fluctuations in value.

If it is an unsecured advance, its repayment depends on the creditworthiness of the borrower, and that of the guarantor.

As such, the cardinal principles which the banker should consider in case of unsecured advances are a 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.

Related: What is Bank Charge? Types of Bank Charges

4. Purpose

The banker has to carefully examine the purpose for which the advance has been applied for.

In case the advance is intended for productive purposes, it could be reasonably anticipated that cash flows arising for productive activities will result in prompt repayment.

Of course, the banker has to be careful to monitor the exact purpose for which the advance is actually utilized.

Related: Legal Mortgage and Equitable Mortgage – Advantages and Disadvantages

5. Sources of Repayment

Before giving financial accommodation, a banker should consider the source from which repayment is promised. In some instances, debentures which are to be redeemed in a few months’ time or a life insurance policy which is to mature in near future 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 undertake to repay out of the profits over a period.

In such cases, the rate at which the customer can reasonably hope to repay should be ascertained.

Related: Types of Bank Credits

6. Diversification of Risk

The security consciousness of a banker and the integrity of the borrower are ‘ not adequate factors to keep the banker on the safe side.

What is also important is the diversification of risk.

This means the banker should not lend a major portion of his/her loan-able fund to any single borrower or to an industry or to 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 survival of the bank becomes 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 a large number of customers spread over a wide area and belonging to different industries.

7. Social Responsibility

While admitting that banks are essentially commercial ventures, a bank should not forget the fact 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 of the project, rather than the security which the borrower can offer, should be considered in evaluating a loan proposal.

The identification of priority sectors for the purpose of extending bank credit should be considered as a positive development in the banking system, aimed at effectively discharging its responsibility towards society.

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