L12

Principles of Good Lending

 Learning outcomes
• Understanding lending
• Exploring the various principles of lending
 Important news
• https://bfsi.economictimes.indiatimes.com/ne
ws/banking/bank-lending-hit-as-corporates-he
ad-to-bond-st-fintech-firms-poach-retail-borro
wers/86391816
 MCQ
• Have you ever borrowed money ?
a. Yes
b. No
 Introduction
• A banker follow certain basic principles of lending while doing
carrying out their lending and credit operations. Banks deals
with public money accepting deposit and lend to their
borrowers to earn profit.
• Banks follow some fundamental principles of lending in order
to ensure safety, security and profitability on money it lend.
• Lending is one of the most important functions performed by
the commercial banks and is major source of income of bank.
• Borrower may differ in terms of their purpose of advance,
activities, financial health, repayment capacity, risk so some
important principles / considerations are followed by bank
before taking lending decision.
 Important Principles of Lending

• These basic principles of bank lending affect bank’s

loan policies, credit operations to a great extent. Here
are some important principles of lending :
• Safety
• Liquidity
• Purpose
• Profitability
• Security
• Diversity or Risk Spread
• National Interest, Suitability
 MCQ

• These basic principles of bank lending does

not include:
a. Safety
b. Liquidity
c. Security
d. Accumulation
 Cont... 1. Safety
• Safety is the most important fundamental principle of lending.
• Banks deal with public money so safety of money from public is
first priority of bank. When a banker lends, he must be sure
about that the money is in safe hand and will definitely come
back at regular interval as per repayment schedule without any
default.
• Safety of funds depends on nature of security, character of
borrower, repayment capabilities and financial health of the
borrower.

Live example-SBI extends Covid 19 Emergency Credit Line (CECL)

for borrowers @7.25 percent
 2. Liquidity
• Bank lend public money which is repayable on demand by depositors so
bank lends for a short period.
• A banker must ensure that money will come back on demand or as per
repayment schedule.
• The borrower must be able to repay the loan within a reasonable time
after demand for repayment is made.
• ‘Liquidity’ has as much importance as ‘safety’ of funds. The reason behind
it is that a bulk of their deposit is repayable on demand or at a very short
notice.
• Banker must ensure that money is locked up for a long time. If loan
becomes illiquid, it may not be possible for bankers to meet their
obligations vis a vis depositors.

SLR by banks as per RBI directives

 MCQ
Bank lend public money which is
a. Repayable on demand by depositors so bank
lends for a short period.
b. Not repayable on demand by depositors so
bank lends for a short period.
c. Repayable on demand by depositors so bank
lends for a long period.
d. Not repayable on demand by depositors so
bank lends for a long period.
 Important link-credit appraisal video
• https://www.youtube.com/watch?v=XC1Gbkk
5rtM
 3. Purpose
• The underlying purpose for which an applicant
is seeking a loan should be productive. The
purpose of loan helps in determining level of
risk and also impact interest rate on loan.
• Purpose of loan should be productive in order
to ensure safety of funds while it should be
extended for short term to ensure liquidity.

appraisal of loan by banks

 4. Profitability
• Banks accept deposits from public and lend it to make
profit. Banks also incur expenses to maintain deposits such
as rent, stationary, premises rent, provision for
depreciation of their fixed assets, bad loans. After
incurring such expenditures, a bank must earn some profit
like other financial institutions.
• So a banker must extend the advance in such a way that it
is profitable for bank and also at competitive lending rate.

Live examples-Banks profits

https://www.icicibank.com/annual-report-microsite/stand
alone-profit-and-loss-account.html
 5. Security
• A banker avoid lending to a borrower without any security.
• Security act as an insurance to lender bank in case of
default by the borrower. 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.
• It is only to provide against such contingencies that he
takes security so that he may realize it and reimburse
himself if the well-calculated and almost certain source of
repayment unexpectedly fails.
 MCQs
• Security act as an insurance to lender bank in
case of
a. default by the depositor
b. default by the borrower
c. both
d. none
 6. Spread or diversity
• 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.

• For example, if bank has advanced too large a

proportion of his funds against only one type of security,
it will run a big risk if that class of security steeply
depreciates. If the bank has numerous branches spread
over the country, it gets a wide assortment of securities
against the advances.
 7. National Interest, Suitability

• Even when an advance satisfies all the aforesaid

principles, it may still not be suitable. The advance
may run counter to national interest.
• The Central Bank (RBI) may have issued a directive
prohibiting banks to allow the advance. The law-
and-order situation at the place where the
borrower carries on his business may not be
satisfactory. There may be other reasons of a like
nature for which it may not be suitable for the
bank to grant the advance.
Thanks

Q/A
 Test yourself
• What is liquidity?

• How safety is different from diversity?