Banks follow the following Principles of lending:
Principles of lending – Any banking institution’s lending procedure is founded on fundamental concepts like security, liquidity, variety, stability, and profitability.
1.Liqudity:
A bank chooses investments with adequate liquidity for its investment portfolio. It is important because, in order to raise the funds necessary to meet its clients’ urgent needs, the bank needs to be able to sell off a portion of the securities rapidly without having to make major adjustments to market price. Certain assets, such bonds issued by local, state, and federal governments, can easily sold without affecting their market value. Get Online CA Consultation
Debentures and shares of large industrial businesses are also included in this group. Nevertheless, it is challenging to sell common company shares and debentures without reducing their market values. Consequently, government securities, debentures, and shares of respectable industrial enterprises should be purchased by banks.
2.Safty:
The security of the funds lent is another prerequisite for lending. The ability of the borrower to make principal and interest payments on time and on schedule without going into default is referred to as safety. Repayment of the loan depends on the kind of security provided, the borrower’s character, his capacity to repay the loan, and his financial circumstances.
Like other assets, bank investments are not without risk. On the other hand, danger varies according to security. State and local governments’ securities are not as safe as those held by the federal government. State and local governments also have safer investments than corporate entities. The reason for this is that the federal government has significantly more resources than local, state, and private sector organisations.
In actuality, the value of industrial concerns’ shares and debentures is determined by their earnings, which might fluctuate based on the state of the economy in the country. The bank should consider the government’s capacity to pay back its debts while making investments in government securities. Peace and stability in politics. In addition to peace and security, this requires political stability.
3. Stability:
It is quite safe to invest in the securities of a government that generates a lot of tax revenue and has a large borrowing capacity. The same applies to the securities of a wealthy municipality or local body, as well as the state government in a wealthy region. When making investments, the bank should select securities, shares, and debentures from these local organisations, governments, and industrial concerns in order to uphold the idea of safety.
As a result, the bank considers the type of security to be very important when deciding which loan to approve. Even so, it still needs to consider the borrower’s creditworthiness, which is based on his moral fibre, capacity for repayment, and financial standing. The project for which the loan is approved must, above all, be both technically and financially feasible in order for bank funds to be secured.
4. diversification:
The diversification concept ought to be followed by a commercial bank when choosing its investment portfolio. Instead of investing all of its excess capital in a single type of securities, it ought to diversify its holdings. It ought to choose bonds and stocks from different sectors of the economy with locations across the country. Local groups and state governments ought to follow the same guidelines. Reducing risk in an investment portfolio is the aim of diversification for banks.
Lending money to a variety of companies, sectors, and occupations falls under the definition of diversity. A bank should follow the maxim “Don’t put all your eggs in one basket.” It should spread its risks by lending money to several businesses and trades dispersed across the country’s various regions.
Stability: Purchasing equities and other assets with very steady pricing need to be a key component of a bank’s investment plan. The bank cannot bear any decline in the value of its holdings. As a result, it ought to invest its funds in shares of respectable companies where a price decline is unlikely.
Fixed interest rates apply to government bonds and corporate debentures. Their value fluctuates along with the market interest rate. However, due to the financial crisis, the bank is compelled to liquidate some of them in order to satisfy its cash needs. Otherwise, they complete their full term of 10 years or longer and are not significantly impacted by fluctuations in the market rate of interest. As a result, bank investments in debentures and bonds are safer than those in company shares.
Corporate debentures and government bonds have fixed interest rates. Their worth varies in tandem with the rate of interest in the market. But in order to meet its cash needs, the bank had to sell some of them because of the financial crisis. If not, they finish their entire term—ten years or more—and are not greatly harmed by changes in the market interest rate. Consequently, bank investments in bonds and debentures are more secure than those in stock in companies.
FAQs-
“Principles Of Good Lendings” Liquidity, or assurance for the future, is an additional crucial element of banking lending. The Bank Will Consider Potential Security Measures Prior to Granting a Loan.
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“Principles Of Bank Lendings” Any banking organization’s loan process is built upon core principles such as profitability, diversity, stability, security, and liquidity.
“Principles Of Good Lendings” Liquidity, or assurance for the future, is an additional crucial element of banking lending. The Bank Will Consider Potential Security Measures Prior to Granting a Loan.
Disperse.
Examining, processing, etc., a credit request.
Observation and Reaction.