Credit Operations and Risk Management in Commercial Banks

Repayment a bank has to go with it for earning profit and economic upliftment as well. As such the
banks are required to follow certain basic principles of lending which are known as the principles of
sound lending. Risk involvement may be kept at minimum if the lending principles are followed. To do
the lending business profitably the following principles may be followed.
A) Safety:
The very survival of a banker and for the matter of that safety of bank depends on his/her loans and
advances. The ideal position is when all the loans and advances positions are fully secured. Thus safety
of the advances should be the first principle of lending. Now the question is how to ensure safety of
lending? To ensure the safety of lending the following most essential elements of the borrower may be
considered:-

Five
FiveCs
Cs Five Ps Five Ms Five Rs
C=Character/conduct P= Person M- Man R= Reliability
C=Capacity / capability P-Purpose M= Management R-Respectability
C=Capital P= Product (s) M= Money R-Responsibility
C=Conditions P= Place M= Materials R=Resources
C=Collateral P= Profit M- Market R=Returns

B) Purpose:
(The bank should not lend money for any purpose for which a borrower may want. So another
important point to be studied by a banker before lending is the purpose for which the loan is required
and also the resources from which the borrower is expected to repay) Loans may be required for
productive purposes, trading purposes, agriculture, transport, self-employment etc. purpose of the loan
should be productive. The purpose of loans helps the banker to determine his course of action as
regards lending. Funds borrowed from obviously for a productive use may be spent on unproductive or
speculation purpose. Banker should, therefore, take follow-up measures to ensure end use of fund
exactly for the same purpose for which it is borrowed.
C) Liquidity:
/The banker while making advances must see to it that the money lent is not locked up for a long time
because, majority of commercial bank liabilities are payable either on demand or after short notice. So
the banker should be sure that loan would be liquid. Thus liquidity of money lent is another important
principle of lending Liquidity means availability or readiness of bank funds on short notice. The liquidity
of advance means its repayment on demand on due date or after a short notice. The loan must have fair
chances of repayment according to repayment schedule. Otherwise, the liquidity position of a bank may
be threatened. Liquidity also means conversion of assets into cash without loss. Even in the case of fully
secured advances if it is feared from the beginning that the advances would be recovered by selling the
securities, it cannot be considered a good advance. It must, therefore, be ensured that the advances will
be repaid from the resources other than the securities kept with the bank. So a commercial banker
should normally grant short term advances which could be recalled in time to satisfy the demand of the
depositors. A bank cannot afford to lend short period funds for a long term lending. That is why a
sizeable portion of bank advances are granted for the working capital requirement of the borrower
rather than to meet fixed capital requirement i, e., construction of building or purchase of fixed assets.
D) Security:
The security offered by a borrower for an advance is insurance to the banker. It serves as the safety
value for an unforeseen emergency) So another principle of sound lending is the security of lending.
Security offered against loan may be various. The securities may vary from gold and silver to goods of
various types, immovable properties(land, building etc.), life insurance policies, stock exchange
securities, promissory notes, third party guarantee etc. As all these securities are of different types, they
call for particular attention and care on the part of the banker who has to see it that the title he/she get
on them is not unsafe. Not only this, the security accepted by a banker to cover a bank advance must be
adequate, readily marketable, easy to handle and free from any encumbrance. There may be cases
where there is no security except the personal security of the debtor. Whatever be the security, a
banker must realize that it is only a cushion to fall back upon in case of need, and its adequacy alone
should not form the sole consideration for judging the suitability of a loan. However, security for bank
lending is necessary.
E) Profitability:
Commercial banks obtain funds from shareholders and if dividend is to be paid on such shares it can
only be paid by earning profits. Even in the case of public sector banks although they work on service
motive they also have to justify their existence by earning profits. This is not possible unless funds are
employed profitably. In other words/banking is essentially a business which aims at earning a good
profit. The working funds of a bank are collected mainly by means of deposits from the public and
interest has to be paid on these deposits. They also have to meet their establishment charges and other
expenses. From out of the profit the banker has to pay interest on deposits, salary to the staff, meet
other expenses, build up reserves etc. /So the banker should not enter into a transaction unless fair
return from it is assured) The banker would not give undue importance to this aspect because a
particular customer may offer a higher rate of interest but an advance made to him may turn to a bad
debt. Therefore, for the sake of profitability, the other two principles safety and liquidity can not be
sacrificed.
f) Spread/Dispersal/Diversification:
The advances should be as much broad based as possible and must be in conformity with the deposit
structure. The advances should not be in one particular direction/ industry/ activity or one or few
borrowers because any adversity faced by that particular industry will have serious adverse affect on the
bank. Again, advances should not be given in one area alone. There should be spread of advances
against different securities, industries/activities, borrowers, areas etc. which will enable the banker to
spread the risks and considerably look into the safety of advances. Here the principle is "Do not put all
the eggs in the same basket".
g) National interest/social benefit:
Bank has a significant role in the economic development process of a country. They should keep in mind
the national developmental plan programs while going for lending but maintaining safety, liquidity and
profitability."
3.0 MODERN CONCEPT OF LENDING PRINCIPLES:
Modern concept of lending presupposes a well developed loan proposal/loan case/project. It will cover
as many as six pertinent factors like Managerial, Organizational, Technical, Marketing, Financial and
Economic Socio economic. These are technically known as feasibility or viability study of a loan
proposal / loan case/project. By studying all these six factors if a banker is satisfied about the viability of
a loan proposal / loan case / project, then he /she can finance it i.e., grant for lending otherwise not.
Managerial feasibility
Managerial feasibility will ensure the character/conduct, capacity/ capability to run the project /activity,
sincerity / honesty / integrity, education, experience, reputation of the borrower.
Organizational feasibility
Organizational feasibility will see under what type of organization the activities will be undertaken,
whether it is under proprietorship/sole trader ship or partnership or private limited company, public
limited company or cooperative societies or any state corporation.
Technical side
Technical side will take care of location of business/activities/project, construction of building / shed etc.
requirements to be used like power, fuel, water, materials etc.
Marketing side
Marketing side will ensure about the marketability of the product(s) out of activities/business/ project.
Financial aspect
Financial aspect will tell total requirement of fund for the business/activities/projects and how much will
be required from bank, what amount will be given by the borrower himself cash inflow and cash
outflow, sale forecasts, balance sheet, profit and loss account etc.
Economic aspect
Economic aspect will look into socio-economic benefit out of the business/activities/project If it is found
that fund can be provided to a particular activity/business/project then sanction will be given. After that
proper documentation will be done by the banker. This is an integrated approach of lending by bank
which covers safety, liquidity, purpose, security, profitability etc.
A sound banker should follow sound principles of lending; conversely, to be a sound banker, Sound
principles of lending should be followed.
4.0 DIFFERENT STAGES OF CREDIT OPERATION:
Credit operation starts with application submitted by the customer to the Relationship Manager/ Credit
Marketing Division and ends with recover / adjustment of the facility. However, the different stages of
credit operation being practiced in commercial banks are as under:
1st stage: Application received from the customer by Marketing Department/ Relationship Manager.
The assessment originates from relationship manager.
2nd stage: Sending application and other relevant papers to Credit Risk Management (CRM) Unit of
Head Office for analysis.
3rd stage: After analysis if it is found feasible and complied with credit policy of the bank, CRM unit
place the credit proposal with recommendation of Head Office Credit Committee and the Credit
Committee under delegated authority approves the credit proposals.
4th stage: Executive Committee of the Board approves the credit proposals which are beyond the
delegated authority of credit committee. The Board of Directors reviews the proposals approved by the
Executive Committee.
5th stage: Upon receipt of approval / sanction letter from Head Office, the branch / RM will arrange
completion of the documentation formalities as per sanction terms.
6th stage: After completion of documentation formalities, the branch / RM will send a security
compliance certificate to Credit Administration Department (CAD) under CRM. The Head of CAD will
conduct concurrent audit periodically to physically verify the documents, possession, and confirmation
of title of property documents, if necessary.
7th stage: Thereafter the approval for disbursement of the facility is to be sent by CAD to the branch
RM.
8th stage: After disbursement, follow up and monitoring of the loan account is the final stage of credit
operation till adjustment of the same.
Segregation of duties of different division under CRM for ensuring smooth operation of credit function
has been discussed in Chapter-6.