Loans and advances (employment of funds)

One of the primary functions of the commercial banks is lending. Lending of funds
constitutes the main business of bank. The major portion of bank funds is employed by
way of advances. The bulk of its income is derived from loans and advances. Bank makes
loans and advances to traders, businessmen, industrialists and agriculturists to meet their
financial requirements.

Principles of sound lending: _

As observed, the employment of funds is not an easy task . L While, lending his
funds a banker is require to follow a cautious policy and conduct his business on the basis
of the well known principles of sound lending in order to minimize the risk . the main
principles of sound lending are ;

1)Safety: Safety is the first important of principle of sound lending . the very existence of
a bank depends upon the safety of its funds . Safety depends upon the security offered by
the borrowers and the repaying capacity and willingness of the borrower . banker should
see that the funds lent out by him would come back in normal course without being
forced to resort to legal action .

2)Liquidity : Liquidity refers to the ability of an asset to convert into cash without any
drastic reduction in its face value with in short time . the bulk of bank deposits or
repayable on demand or at short notice . to meet the demand of the depositors time , the
bank should keep its funds in liquid state . The banker should see that his advances are
given mainly for short term . again he should see that the 00000 securities, which he
accepts are easily realizable without much loss in the event of default of borrowers .

3)Profitability: Like all other commercial institutions banks are run for profit. Banks earn
profit to pay interest to depositor, to declare dividend to share holder meet establishment
charges and other expenses .
A banker should employ its funds in such a way that they will bring him adequate
and steady returns .

4)Purpose of loan : Purpose of the loan has assumed a special significance in the present
day concept of banking . Before 00000 loans a banker should enquiry about the purpose
for which it is needed .Loans granted for productive purpose increases the earning
capacity of the borrower and ensure prompt repayment . Loans for undesirable activities
should be discouraged .

5)Security : Customers may offer different kinds of securities viz., land and building ,
machinery , stocks, shares , debentures , goods , documents of title to goods etc to get
advances . The security of the customers are insurance and banker can fall back upon
them in times of necessity . Therefore , he should ensure that the security are adequate,
marketable and free from encumbrances . Securities, which could be marketed easily,
quickly without loss, should preferred .
6)Diversification of risk: An element of risk is always present in every advance, to be on
the safer side , there should be spread of advances. This means banker should not lend a
major portion of its loanable funds to any single borrower or to an industry or to one
particular region . Therefore , a banker should follow a wise policy of “ Do not lay all the
eggs in the same basket “The bank must advances to a large number of customer spread
over a wide area and belonging to different industries .

7)Public policy or national interest : Banking industry as a significant role in the

economic development of a country . Therefore a banker should identify his lending
business with national policies . He should granted advances to those sectors . Which
require development in the countries planning programs . Bank credit should be made
available to the neglected sectors of the economic activity and to the under privileged
sections of the society .

CONCLUSION : To conclude that a sound credit is one , where timely repayment is

assured . This largely depends on the earning and repaying capacity of the borrower . So
great emphasis is on the productivity of the loan .

Forms of bank advances: Bank advances take the form of loan , overdrafts , cash credit
and discounting of bills .

Classification of bank advances: From the point of view of securities , bank advances
may be classified as 1) Secured advances and 2) Unsecured advances

1) Secured advances:
Usually , a banker secures his advances by (a) stock exchange security (b) goods ,
(c)document of title to goods and (d) other security such as real estate, plant and
machinery ,gold bullion , gold ornaments , life policies , fixed deposit receipt assignment
of 000 supply bills etc .

General principles of secured advances

While granting advances against collecting securities a banker should bear in maid the
following points.
1.ready reliability :the collateral security accepted by the banker must be readily
realizable in case the borrower fails to repay the advances on the due date. Generally,
government and semi government securities and goods, which are necessaries of life, are
preferable, as they are readily marketable

2. Stability or prices: The security accepted must be fairly stable in price government
and semi government securities and goods, which are necessaries of life, are stable in
prices and they can be considered as good collateral securities .

3) Yield: It is preferable for the banker to accept that security which yields a study
income stock exchange securities yield a regular income and they are preferable . This
income may act as supporting factor as it reduces the interest burden of the borrower and
repayment will be bit easier.
4)Absence of disability : The banker must see that the security offered does not suffer
from any disability For instance , fully paid shares of a joint stock company are not
subject to any disability .

5) Validity of title: The banker must confirm that the customer a valid title to the security
offered. It as to be remembered that, if the customer’s title to the securities funds
defective, banker cannot enforce the security in the event default.

6) Absence of prior charges: The security taken should be free from encumbrance. There
should not be any prior charge against the security offered. The banker prefers normally
the first charge against the security.

7) Valuation: The security obtained against the advance should be properly valued and
the value should have stability. The amount of loan that may be given by a banker is
dependent on the value of the security offered . therefore, the banker should see that
securities offered could be valued easily .For instance of value of stock exchange
securities can be easily ascertained by referring to stock exchange quotations published in
newspaper . Again the banker should obtain the expert opinion about the intrinsic value
of securities like gold ornaments, buildings ,machinery etc.

8) Adequate margin: The banker must see that adequate margin is maintained against the
securities to cover the fall in prices of securities. Adequate margin should be left to cover
(a) the advance made (b) to cover the interest and other charges.

9) Cost of supervision: It is in the interest of the banker to prefer a security which

requires less supervision. For ex: Stock exchange securities are preferable to goods,
which are stored in the go down of the borrower, require constant supervision .

10) Right method of creating charge :Charge means the mode in which a creditor can
established his rights against the defaulting debtor . Banker as a creditor must ensure that
the method of charging is perfect. It is always in his interest to prefer pledge to other
methods , such as hypothecation ,mortgage assignment etc .

11)Documentation : The banker should also get proper documentation of title deeds in his
favour . say , agreement of pledge, mortgage deed to letter of hypothecation are properly
prepared and get them signed by borrower .

12)Other aspects :The security obtained should be readily transferable , so that he can sell
the property without any difficulty . Again, the goods obtained, as security should be
durable in nature of non-perishable character.

Unsecured advances:
Unsecured advances are the advances for which the banker as no collateral or tangible
securities. They may take the form of (a) advances on the mere personal security of the
borrowers. (b) Advances against guarantees and (c) Discounting of bills of exchange.
A clean advance is not supported by equalent value of assets, it is sanctioned solely on
the personal credit worthiness of the borrower. The banker has to be very conservative
and cautious in allowing clean loans. A prudent banker should strike a balance between
enterprise and prudence. The creditworthiness of a customer is the sole security to a
banker.
Precautions:
01. Character refers to the customer’s reputation for honesty, fairplay and regularity
sound business habits.
02. Capacity means the competence and the abilities of the borrowers. He must have the
required ability to utilize the loan for a productive purpose.
Qualities of leadership, executive control, intellectual alertness, knowledge of business
and experience in business. Able customers expected to repay the loan well in time.
03. Capital. A review of the capital invested by the customer is working funds and the
operation of bank accounts could help in assessing his financial strength. He should be
competent to produce adequate assets to redeem his loan. The banker should request the
borrower to produce financial statements so as to up rise his credit and business standing.
04. Circumstances refer to the general trends in the trade. The banker must have a clear
idea about the economic trends of the business. The banker should keep the keen watch
over the loan account of the borrower. Any changes in the status of the borrower or in his
business condition should be constantly reviewed.

Methods of creating charge on security

Creating a charge of a security indicates the procedure by which a banker
establishes his right as a lender on the particular security offered by the borrower.
“There are several methods by which banker can create charge on the securities.
They are:

Lien: A banker has a general lien. Lien refers to his right to retain any property of
his customer for the general balance due from the customer. Lien is automatic; no
agreement is necessary for the creation of a lien in favor of the banker. Lien
doesn’t involve the transfer of ownership of the property from the customer to the
banker. Lien is always possessory in character; it does not confer on the creditor
the right of sale. But a banker’s lien is a general lien exception to this general
principle. It confers on the banker right of sale in case the customer fails to repay
the debts.

Pledge: Section 172 of the Indian contract Act 1872 defines pledge as a bailment
of goods as security for payment of a debt or performance of a promise. Pledge is
a contract involves the pledger and pledge. A pledge is a method of creating a
charge on a movable property. In a pledge the delivery of the property by the
pledger (borrower) to the pledgee (banker) is essential. The delivery can be actual
or constructive. In pledged the ownership of the property remains with the
pledger. The pledgee can sell the property pledged after giving a reasonable
notice
 in case the pledger fails repay the debts on the due date. Generally a pledge is
supported by a memorandum of deposit, which contains the particular of the
property pledged, the purpose of the deposit, the amount of advances etc.

Hypothecation: Hypothecation is a method of creating an equitable charge of a

movable property in favor of a creditor. It as a contract involves two contractual
parties, the hypothecator (borrower) and the hypothecatee (the banker). Generally,
the borrower has done hypothecation by executing a document called letter of
hypothecation in favor of the lender. Hypothecation is an equitable charge on a
movable property. In the case of hypothecation neither the possession of the
property nor the ownership of the property is transferred from the borrower to the
lender. In fact, both the possession and the ownership of the property remain with
the borrower. Generally, the letter of hypothecation gives the hypothecatee the
right to ask for the transfer of possession of the property from the borrower on
demand.

Mortgage: A mortgage is the transfer of the interest in a specific immovable

property by one person to another person for the purpose of securing an advance
of money. It is a method of creating charge on a specific immovable property. In a
mortgage, the possession of the mortgaged property need not be transferred to the
mortgagee. Usually it remains with the mortgagor. The interest in the mortgaged
property is transferred from the mortgagor to the mortgagee subject to reverting
on the repayment of the advance. There are several types of mortgages allowed
under the Indian law. They are:
a) Simple mortgage.
b) English mortgage.
c) Mortgage by conditional sale.
d) Usufructuary mortgage.
e) Equitable mortgage.
f) Anomalous mortgage.

a) Simple mortgage: Simple mortgage is mortgage in which the mortgagor,

without transferring the possession of the mortgaged property, binds
himself personally liable to pay the debt. The mortgagee shall have the
right to sell the mortgaged property with the order by the court. The
bankers prefer this type of mortgage.

b) Legal or English mortgage: Is mortgage in which the mortgagor transfers

the legal right in the property to the mortgagee on the condition that on the
repayment of the mortgage money, the mortgagee will retransfer the legal
right in the mortgaged property to the mortgagor. In case the mortgagor
fails to repay the mortgagee money on the due date, the mortgagee has the
right to sell the mortgaged property even without the intervention of the
court.
 c) Mortgagee by conditional sale: Is a mortgage in which the mortgagor
ostensibly sells the mortgaged property on the condition that the ostensible
sale will become an absolute sale if the mortgage money is not paid by the
mortgagor on the agreed date. The bankers do not prefer this type
mortgage, as there no personal covenant of the borrower for the repayment
of the mortgaged money.
d) Usufructuary mortgage: is mortgage in which the mortgagor transfers
the possession of the mortgaged property to the mortgagee and authorized
him to have the possession of the property until the payment of the
mortgage money, and in the mean time, to receive the rents and profits,
accruing from the mortgaged property in satisfaction of the mortgaged
money
e) Equitable mortgage: In which title deeds of the property deposited with
the creditor without executing and registering a mortgage deed. A
memorandum of deposit, which binds the borrower to create a legal
mortgage whenever the mortgagee to do so calls him upon, generally
supports it. In the case of an equitable mortgage, the mortgagee cannot sell
the mortgaged property without an order of the court. This type of
mortgage is popular with the banker and borrowers in India.
f) Anomalous mortgage: is a mortgage, which does not belong to any one
of the above class’s mortgages. It is a combination of different class of
mortgage. The bankers do not generally accept this type of mortgage.

SPECIALISED SEVICES BY BANKS:

Traveler’s cheques:-This is a service meant for tourism traffic, which

minimizes the risk of carrying heavy cash, while traveling. A person who intends to visit
several places can purchase traveler’s cheques issued by the banker. The traveler is
required to deposit a certain sum of money with a banker and ask for the issue of
traveler’s cheques. This is printed in different denominations At the time of purchasing
the traveler’s cheques, the purchaser is required to put his signature on all the traveler’s
cheques issued to him in the presence of a responsible official of the issuing bank.
The purchaser or the holder of the travelers cheques can encash them at the
various places which he visits with the drawee branches are correspondent
banks of the issuing bank or with other agencies with whom the issuing bank
has made necessary arrangements. The holder is required to sign the traveler’s
cheque once again in the presence of the responsible official of the drawee
branch or correspondent branch at the time of enchasing the cheques. The
drawee branch are correspondent bank will pay the amount for the travelers
cheque only when both the signature tally. The holder of the traveler’s cheque
need not carry any letter of identification or indication to be presented to the
drawee branch or correspondent bank for encashing the travelers cheques. If
the traveler’s cheque is lost , duplicate can be obtained by giving the
necessary indemnity to the bank.
Gift cheques:- This is a general utility service rendere3d by banks. Bank
issue gift cheques against payment in cash. Gift cheques are issued in fixed
denominations. They are issued to both customers and non customers. The gift
cheques are intended to be given by the purchaser to others as gifts on
occasions like birthday, wedding, etc. the gift cheques issued by the bank
encashable at any of the braches of the issuing bank. They can be encashed at
any time. Gift cheques are not negotiable. They are payable only to the
payees. If a gift cheque is lost, a duplicate gift cheque can be obtained by
giving an indemnity bond.

Credit card:-
Credit card is innovative product in the line of financial service. It acts as an
instant money and provide several benefits. A credit card is a card or
mechanism which enables card holders to purchase goods, travel and dine in a
hotel without making immediate payment, the holders can use the cards to get
credit from banks up to 45 days. The credit card relieves the customer from
botheration of carrying cash and ensures safety. A limit is set to the amount of
money; a card holder can spend a month using the card. At the end of every
month, the holder has to pay
Along with interest is charged for the outstanding amount, an average
consumer prefers this type of card for his personal purchase, as he is able to
defer payment over several months. There are three parties to a credit card.
1. Issuer:-The banks or the other issuing organization.
2. Cardholders:-Individual, corporate bodies and non individual
corporate bodies such as firm.
3. Member establishments:-shops and service organizations enlisted
by credit card issuer who accepts credit cards.

Benefits to credit card holders:-

a) Credit cards are simple and easy to carry.
b) A card is a convenient method of payment for goods and services.
c) Owing to revolving nature of credit, the customer can take advantage
of it .
d) Cash can be obtained at any branch of the issuer since ATM facility
is extended to cardholders.
e) Overdraft facility is given to cardholders who are entitled to spend
more than actual limit.
Teller system-
Teller system is an arrangement under which the teller (i.e. the employee of a
bank at the teller counter) is authorized to make payment for cheques up to a
limited amount without reference to the ledger balance or the specimen
signature. Only in case of doubt, the teller refers to the ledger balance or the
specimen signature. (Of course, the teller is expected to be conversant with the
accounts allotted to him and the specimen signatures of the concerned
customers.)
The teller system works only at certain selected branches of the bank. The
object of the teller system is to expedite payment of cheques for small amount.
Teller system is quite popular in several advanced countries of the world.
Even in India, of late, teller system has become quite popular.

Any time money (ATM) scheme or service:-

Recently, many commercial banks have introduced any time money scheme
or service. In India, banks like ICICI Bank, vijaya Bank, corporation Bank,
etc.have introduced any time money scheme or service. At present, ATM
facility is available in almost all important cities and towns. A T M has
revolutionized the withdrawal facility of the customer Any time money
scheme is a scheme or service under which a customer, through ATM card,
can withdraw money from his bank account, deposit money into bank
accounts, check the balance in his bank account, transfer money from his bank
account and order for cheque book or statements at his convenience, that is at
any time, day or night, seven days a week.
Setting up a mutual fund:-
In resent years, commercial banks in advanced countries have set up mutual
funds for mobilization of funds from the small and household sectors for
investment in stock market. Mutual funds are also setup by Indian commercial
banks in recent years, and they (i.e. mutual funds) have gained importance
among the Indian investors. Though the earliest mutual fund in India was
setup by unit trust of India as far back as in 1964, commercial banks in India
began setting up mutual funds only since 1987. the state bank of India, the
Canara bank, The bank of India, The Indian bank, The Punjab national bank,
The state bank of Hyderabad, the Vysya bank ltd., etc. have set up mutual
funds.
A mutual fund is an institutional device through which investors pool their
funds for investment in diversified investment proposals with a view to
enjoying the benefits of minimization of risks and optimum returns on
investments. In short, a mutual fund is an institutional device for collecting
funds from a large number of investors for investment on diversified
securities.
To the investors:-
1. Easy liquidity of investments.
2. Tax benefits.
3. High return on investments.
4. Safety of investments.
Debit cards:-Debit card an electronic product has become more popular
nowadays, just like credit cards, the debit card holder can present the card to
the merchants, sign sales slip and forget about it. The purchase amount
automatically debited to account of the card holder electronically and would
appear in the monthly statement of accounts. The customer has to open an
account with the bank and need to maintain credit balance in his account,
which is not generally required in case of credit card. This system requires a
terminal known as the “Point of sale terminal” at every point of purchase.