SLIDE 08-09

BANKS LENDING
FUNCTION

BANKS LENDING
FUNCTION
Let us imagine you have been recruited
by a new generation Bank into one of
the following positions/roles :
Manager Retail Assets/Loans
Manager
Analyst

Credit

Appraisal/Credit

Loan Manager
Manager Corporate Banking/Wholesale
Banking

BANKS LENDING
FUNCTION
Manager SME
Manager Credit Marketing
Then what are your role expectations ?
You should have the basic knowledge of a Banks
Lending Function.
Knowledge of various Loan / Credit Products
Credit Analysis & Evaluation/Loan Appraisal/Credit
Administration & Management
Legal
Aspects
Documentation etc.

of

Bank

Lending/Loan

OUTLINES/LEARNING
OBJECTIVES
IMPORTANCE OF BANKS LENDING FUNCTION
(For Banks & For the Nation/Economy)
NEED FOR LENDING
NEED FOR CREDIT

PRINCIPLES OF SOUND LENDING

TYPES OF CREDIT/LOAN FACILITIES
VARIOUS FORMS OF CREDIT

OUTLINES/LEARNING
OBJECTIVES
SEURED LOANS TYPES OF SECURITIES
PRINCIPLES OF A GOOD SECURITY
DIFFERENT
TYPES
OF
PRIME/COLLATERAL
SECURITIES
AND THEIR CHARACTERISTICS
STEPS IN THE CREDIT PROCESS
TYPES
OF
FINANCING
(SOLE
FINANCING/CONSORTIUM FINANCING/MULTIPLE
BANKING ARRANGEMENT/LOAN SYNDICATION)
CLASSIFICATION
OF
ADVANCES
PURPOSE OF SEGMENT REPORTING

FOR

PRUDENTIAL CREDIT EXPOSURE LIMITS

THE

BANKS CORE FUNCTIONS

ACCEPTING
MONEY

DEPOSITS

OF

GIVING LOANS OR LENDING

MAKING INVESTMENTS
PAYMENT AND SETTLEMENT
SERVICES

IMPORTANCE OF BANKS
LENDING FUNCTION
FOR THE BANK :
Lending is the principal activity & Loans are the
dominant asset of all Commercial Banks
Loans generate the largest share of operating
income.
Loans represent the banks greatest risk
exposure (Credit Risk, Int. Rate Risk &
Liquidity/Maturity Mismatch Risk).
Loan officers are among the most visible bank
employees.
A banks loan policy will often have a dramatic
impact on how fast a community/nation grows
and what types of business develop.

IMPORTANCE OF BANKS
LENDING FUNCTION
FOR THE NATION/ECONOMY :
CAPITAL FORMATION
ECONOMIC DEVELOPMENT/GROWTH OF
GDP
EMPLOYMENT GENERATION
GROWTH OF EXPORTS/FOREX EARNINGS
FINANCIAL INCLUSION & INCLUSIVE
GROWTH/POVERTY ALLEVIATION

NEED FOR LENDING

The two major application of Bank funds is
lending and investments in securities. Of
these the former has evolved as the prime
function of the banks both due to regulatory
prescriptions
as
well
as
for
profitable
sustenance.
A shrinkage in the loan portfolio leads to a
greater impact on the Net Interest Income
(NII) of the bank when compared to
shrinkage in any other asset in its
portfolio.

NEED FOR CREDIT

Demand side of the economy : The consumers
of goods and services who require funds for
consumption i.e., for acquiring assets like consumer
durables and non-durables and also for pure
consumption purposes.
The supply side of the economy : The
Corporates, Business Firms in the manufacturing,
trading and services sectors require funds for longterm investment (Capex) as well as for day-to-day
operations (Working Capital or Opex).
Thus the need for credit arises from the supply side
as well as the demand side of an economy.

BUSINESS OF LENDING - 1
Commercial Banks cannot exist without
performing the vital function of lending
Bank Loans/Finance is the primary source
of
financing
for
many
corporates/business houses
Returns come in the form of loan
interest, fee income/service charges,
investment income from new deposits
Banks also use loans to cross sell other
fee generating services

BUSINESS OF LENDING - 2
Based on Size of loans, lending can be
categorised into : Retail Lending and
Wholesale/Corporate Lending
Retail Lending : Lending by banks (to the
demand side of the economy) to NonCorporate Borrowers i.e., Individuals and Small
business enterprises.
Wholesale/Corporate Banking : Bank
finance (to the supply side of the economy) to
Corporate Customers and Institutional finance.

BUSINESS OF LENDING - 3
Retail Lending Features :
- The ticket size of these loans would be
small but the no. of accounts would be large
- The yield is normally high
- The risk for the bank is diversified
- The level of NPA is generally low
- Ease of processing the loan proposals
- Requires lot of monitoring time and cost

BUSINESS OF LENDING - 4
Wholesale/Corporate Lending
Features :

- The size of loans are large but the no.

of borrowers is relatively small
- Products could be quite complicated
and customised/structured to meet the
specific needs of the client
- The yield is normally low
- The risk for the bank is very high

BUSINESS OF LENDING - 5
- The level of NPA could be high
- Monitoring/Maintenance cost is low
- Follow up is easier since no. of accounts is
small
- Since ticket size is big, personalised
attention can be given to customers by
assigning relationship managers for a group
of borrowers
- Borrowers are highly demanding with high
bargaining powers, in a competitive era, at
times forcing banks to compromise on
prudent principles of lending

REQUIREMENTS FOR
LENDING
SOURCES OF FUNDS :
OWNERS CAPITAL : Small portion about 10 11% Post Basel
Deposits : The main source of funds (about 85%).
Borrowings : Small portion (about 3 5% of the total funds).

SOUND CREDIT/LOAN POLICY

GOOD SYSTEMS & PROCEDURES
DELEGATION
POWERS

OF

LOAN

SANCTIONING

TRAINED & SKILLED MANPOWER FOR

CREDIT
ANALYSIS,
SUPERVISION
&
MONITORING, CREDIT MAMAGEMENT &
RECOVERY

PRINCIPLES OF SOUND
LENDING - 1
The
cardinal
principles
lending are as follows :

of

Principle of Prudence & Safety

Principle of Liquidity
Principle
of
Profitability
(Yield/Spread)
Principle of Purpose (of the Loan)
Principle of Need (Need Based Loan
amount)

PRINCIPLES OF SOUND
LENDING - 2
Principle of Risk Diversification/ Risk
Spread
(Sectoral & Geographical
Spread)
Principle of Security/Surety/Margin
Government
of
India
Guidelines/National
Policies
and
Priorities
RBI
Guidelines/Prudential
Credit
Exposure and other lending norms
Banks own Loan/Credit Policy

WHAT IS AN IDEAL
ADVANCE
AN IDEAL ADVANCE IS ONE WHICH IS :
GRANTED TO A RELIABLE CUSTOMER
FOR AN APPROVED PURPOSE
IN WHICH THE
EXPERIENCE

CUSTOMER

HAS

ADEQUATE

SAFE IN THE KNOWLEDGE THAT THE MONEY

WILL BE USED TO ADVANTAGE
REPAYMENT
WILL
BE
MADE
WITHIN
A
REASONABLE PERIOD FROM TRADING RECEIPTS
OR OTHER KNOWN MATURITIES/ SOURCES.

TYPES OF CREDIT/LOAN
FACILITIES - 1
FUND BASED CREDIT FACILITIES (FB) vsNON-FUND BASED
CREDIT FACILITIES
(NFB)
SHORT
LOANS

TERM

LOANS

vs-

LONG

TERM

WORKING CAPITAL LOANS vs- TERM LOANS

SECURED LOANS vs- UNSECURED LOANS
REVOLVING CREDIT vs- NON-REVOLVING
CREDIT FACILITIES
LINE OF CREDIT/CREDIT LIMITS
DIRECTED CREDIT VS- NORMAL CREDIT

TYPES OF CREDIT/LOAN
FACILITIES - 2
LOAN COMMITMENTS
BRIDGE LOANS
ASSET BASED LENDING vs- CASHFLOW
BASED LENDING
FIXED RATE vs- FLOATING RATE LOANS
PRODUCTION/BUSINESS
LOAN
CONSUMPTION LOANS
CHANNEL FINANCING (Financing
Distributors)
SUPPLY CHAIN FINANCING

vsDealers/

COMPOSITE LOANS (COMBINATION OF TERM LOAN &

WORKING CAPITAL LOAN)

VARIOUS FORMS OF
CREDIT - 1
FUND BASED CREDIT FACILITIES
Credit facilities which envisage/call
for immediate outflow/outlay of
funds/cash by the lending bank.
NON-FUND
BASED
CREDIT
FACILITIES Credit facilities which
do
not
involve
immediate
deployment of funds by banks but
involve commitment of the bank to
pay in case the need arises.

VARIOUS FORMS OF
CREDIT - 2
FUND BASED FACILITIES WORKING
CAPITAL : Working capital loan for
financing acquisition of current assets
like Inventories and Receivables
(a) Demand Loans
(b) Overdraft/Cash Credit : Sanctioned
Limit and Drawing Power (DP)
(c)
Bill
Finance
Purchased/Discounted)

(Bill

FUND BASED FACILITIES TERM LOAN :

Term loan for acquisition of Fixed Assets
(Capital Expenditure)

VARIOUS FORMS OF
CREDIT - 3
NON-FUND BASED CREDIT FACILITIES :
(a)
Bank
Guarantee/Letter
Guarantee (BG/LG)
(b)
Deferred
(DPG)

Payment

of

Guarantee

(c) Letter of Credit (LC)

(d)
Bankers
Acceptance/Coacceptance facility (Bills)

SECURED LOANS UNSECURED

LOANS
Section 5 (n) of B. R. Act defines secured and
unsecured loans
Secured Loans Loans and advances made on
security of tangible assets (both
prime &
collateral) the market value of which is not less
than the amount of the loan or advance o/s at any
point of time
Unsecured Means a loans or advance not so
secured

Security taken as an
unwarranted situations

insurance

against

SECURED LOANS TYPES OF

SECURITIES
CLASSIFICATIONS OF SECURITIES FOR THE SECURED
ADVANCES :

(a) TANGIBLE SECURITY vs- INTANGIBLE SECURITY

(b) PRIME (PRIMARY) SECURITY vs- COLLATERAL
(SECONDARY) SECURITY
(c) MOVABLE, IMMOVABLE ASSET/SECURITY AND
DEBT SECURITY
(d) LIQUID vs- ILLIQUID ASSETS/SECURITIES
(e) SELF-LIQUIDATING vs- NON-SELF-LIQUIDATING
SECURITY
(f) GOVERNMENT SECURITIES vs- CORPORATE
SECURITIES

PRIME AND COLLATERAL

SECURITIES
PRIME (PRIMARY) SECURITY : Security (asset)

ag. which bank finance is made or the asset

which is created out of bank finance. Example :
Home or Flat purchased or constructed out of
Home Loan. Cash Credit facility ag. Stocks.
COLLATERAL (SECONDARY) SECURITY : Security
(asset) obtained over and above the prime
security. Used to reinforce the primary security.
Example : LIC policies or NSCs of the borrower
pledged to secure the Home Loan. Your
fathers house property offered as security for
your educational loan. Collateral Security can
be given by the borrower or the guarantor.

PRINCIPLES OF A GOOD
SECURITY
MAST Principle :
(a) MARKETABILITY (Liquidity)
(b) ASCERTAINABILITY
(c) STABILITY
(d) TRANSFERABILITY
OTHER FACTORS LIKE DURABILITY /NONPERISHABILITY AND IDENTIFICATION OF
SECURITY ARE ALSO CONSIDRED USEFUL

DIFFERENT TYPES OF
PRIMES/COLLATERALS
AND THEIR CHARACTERISTICS - 1
LAND AND BUILDINGS
Formalities :
(a) Legal Opinion on the Property/Title Investigation
(b) Nil Encumbrance Certificate (NEC) for last 13
years at least
(c) Valuation of Property from approved valuer
(d) Physical Inspection of Property
(e) Ownership
properties

Right

Freehold

(f) Creation of a valid/perfect mortgage

(h) Recovery in case of default

or

Leasehold

DIFFERENT TYPES OF
PRIMES/COLLATERALS
AND THEIR CHARACTERISTICS - 2
GOODS/COMMODITIES
Formalities :
Storage of Goods
Adequate Insurance on Goods ag. Risks e.g. fire,
theft, strike, riot etc.
Inspection of stocks/stock audit
Valuation of stock : lower of cost or market price
Adequate margin on stock
Care should be taken to see that goods are not
perishable, obsolete are readily saleable.
Recovery in case of default

DIFFERENT TYPES OF
PRIMES/COLLATERALS
AND THEIR CHARACTERISTICS - 3
DOCUMENTS OF TITLE TO GOODS :
All transport documents like Lorry Receipts,
Railway Receipts, Bills of Lading, Air way Bill,
Dock Warrant, Warehouse Keepers Certificate,
Delivery Orders etc.

Documents of titles to goods are taken as

security
in
case
of
financing
ag.
goods/commodities, either in the form of
Demand Loans or Bill Finance.

DIFFERENT TYPES OF
PRIMES/COLLATERALS
AND THEIR CHARACTERISTICS - 3
ADVANCES ag. MISCELLANEOUS SECURITIES
- Advance against Life Insurance Policies
- Advance against Shares/bonds/MF units
- Loan against Book Debts/Receivables
- Loan against Gold Ornaments
- Loan against Supply Bills
- Loan against Banks Own Term Deposits
- Loan against Trust Receipts

STEPS IN THE CREDIT PROCESS - 1

Banks Loan/Credit Policy : [Credit Philosophy, Credit
Culture (Values Driven, Current-Profit Driven, MarketShare Driven), Loan Objectives, Volume & Mix of Loans
(Sectoral & Geographical Exposure Limits), Loan
Evaluation/Credit Appraisal Procedures, Credit Files,
Norms on Security/Surety/Margin, Norms on Financial
Ratios, Risk Management policy, Loan Pricing, Loan
Monitoring & Recovery policy]
Business Development : (Market Intelligence, Market
Research, Credit Marketing/Scouting for good borrowers,
Initial Recommendations/Referrals by new and existing
Customers)
Obtain/Receive Formal Loan Application/Proposal :
[Loan Application in Standard/Prescribed format,
Business
Proposal/
Project
Report,
Promoters
Report/Background, Past & Projected Financials, Credit
Reports, Marketing & Distribution arrangement etc.]

STEPS IN THE CREDIT PROCESS - 2

Credit Investigation/Borrower Selection : [Know your
Borrower/Borrowers Due Diligence, Credit Screening/Credit
Filter, Pre-Sanction Inspection, Credit Checking/Verification
(CIBIL, Equifax, Market Reports from Customers, Suppliers,
Competitors, Existing Bankers/Financiers)]
Credit Analysis/Appraisal/Evaluation : [Building the
Credit File, Loan/Project/Viability & Bankability Appraisal
(Technical Appraisal/Feasibility, Economic and Commercial
Viability/Market Appraisal, Financial Viability/Appraisal, Legal
Appraisal,
Managerial
Competence),
Financial
Statements/Cashflow & Profitability analysis, Evaluate Prime
&
Collateral
Securities,
Surety,
Margin,
Qualitative
Analysis/Management Quality, Risk Assessment & Loan
Pricing, Loan Officer Recommendation for accepting/rejecting
loan proposal, Laying downs terms & conditions of Sanction
(Conditions
precedent,
Representation
&
Warranties,
Affirmative & negative/restrictive Covenants, Events of
Default), Final Sanction/Approval of Loan/Credit Facilities,
Structuring of Limits, Acceptance of terms & conditions of
sanction by the borrower(s)/guarantor(s)]

STEPS IN THE CREDIT PROCESS - 3

Loan Documentation : [Stamping, Execution, Attestation of
Loan Documents, Creation & Registration of Charge,
Preservation of Loan Documents, Periodical Renewal/Revival
of Loan Documents/ Acknowledgement of Debt]
Credit Delivery : [Loan Disbursement: One Shot or in Phases
in case of Term Loans/Project Financing, or a running account
in case Overdraft or Cash Credit or Bill Finance or regular
LC/LG facility]
Credit Monitoring & Supervision: Post-sanction/Disbursal
Inspection of Borrower/ Factory Visit/Inspection of Security,
Ensuring proper end use of money/asset creation]
Regular/Periodical follow up, supervision, control & monitoring
of credit facilities/Borrower business units/Assets & Securities,
Detection of early warning signals, corrective measures,
updating credit file, credit review and credit audit, Periodical
Stock and security inspection/audit, Credit Risk Management,
Credit Administration, Rehabilitation & Recovery]

TYPES OF FINANCING - 1
Sole Banking/Financing : Where all the credit needs of
a borrower are met by a single bank and where all the
financing needs is within the policy framework of the
financing bank.
Consortium Banking/Financing : Joint financing by
several banks to a single borrower on common
appraisal,
common
security
and
common
documentation. Common security is charged to all
participating banks on pari-passu basis. If the
requirements of a borrower grow beyond the comfort level
of the sole financing bank due to prudential norms or risk
perception for a particular segment/borrower, it would like
another bank to finance a part of that enterprise.
Sometimes, even borrowers may prefer not to depend on
one bank and avail facilities from various banks. If two or
more banks get into a formal arrangement to finance the
working capital/term loan needs of a borrower, it is called
consortium financing/arrangement.

TYPES OF FINANCING - 2
Consortium Financing (.. Contd): The
consortium banks decide on one of the members as
Lead Bank who not only arranges periodic
meetings of member banks but also takes lead in
assessment,
documentation,
charge
creation,
monitoring of the account etc.
Multiple
Banking/Financing
Arrangement:
Where the credit needs of a borrowing company are
met independently by different banks without any
formal agreement/arrangement amongst them. Each
bank finances against separate/independent
appraisal,
separate
securities,
separate
documentation etc. But the participating banks
share/exchange information about the account in
their mutual interest.

TYPES OF FINANCING - 3
Syndication of Loans : In loan syndication, a bank
generally called lead bank/lead arranger or
syndicator arranges a group of banks to form a
syndicate and this syndicate provides credit facilities
to
the
borrower
using
a
common
loan
documentation. The syndicator bank/lead arranger
may or may not provide credit facility, it charges
syndication fee from the borrower. Unlike consortium,
in a loan syndication, the financing/ member banks
may or may not share the risk of default. The
borrower deals only with the syndicator bank.

CLASSIFICATION OF ADVANCES
FOR THE PURPOSE OF SEGMENT
REPORTING - 1
As per Accounting Standards 17 on segment reporting,
banks to disclose in their financial statements, details of
their operations in four business segments and two
geographical segments.
These four business segments are : (a) Treasury to
include all investments in bonds, Govt. securities, foreign
exchange, money market instruments, etc., i.e., the entire
investment
portfolio
of
the
bank.
(b)
Corporate/Wholesale Banking to include all exposures
to Companies, Governments, Statutory Bodies, Partnership
Firms and Trusts etc., (c) Retail Banking to include
exposure to individuals and proprietary concerns up to
Rs.5 Crore and turnover not exceeding Rs.50 Crore,
(d) Other Banking Operations to include all other
banking operations not covered under above 3 segments.
Two geographic segments are (a)
Operations (b) International Operations.

Domestic

PRUDENTIAL CREDIT EXPOSURE

LIMITS

Exposure ceiling
borrowers :

on

credit

to

individual/group

- Single borrower exposure limit (SBL) : 15% of banks

capital fund. Additional exposure of 5% can be taken for
financing infrastructure projects
- Group borrower exposure limit (GBL) : 40% of banks
capital fund. Additional exposure of 10% can be taken for
financing infrastructure projects

Credit Exposure includes both funded and non-funded credit

limits, underwriting and similar commitments made by a bank
and also investments made by the bank in shares/debentures
issued by such borrowers

Capital Fund for this purpose means both Tier I and Tier II
Capital

Group means and includes all companies for which the

effective management/control is the same

KEY WORDS/TERMINOLOGIES/GLOSSARY - 1

SME, Credit Analysis, Credit

Appraisal, Retail Lending vsWholesale/Corporate
Lending,
Fund Based vs- Non-Fund Based
Credit Facilities, Working Capital
Loans vs- Term Loans, Loan
Commitments,
Revolving
vsNon-Revolving
Credit,
Asset
Based Lending vs- Cashflow
Based Lending

KEY WORDS/TERMINOLOGIES/GLOSSARY - 2

Secured vs- Unsecured Advances,

Security,
Prime
-vsCollateral
Security, Tangible vs- Intangible
Security, Credit Process, Credit
Filter, Borrowers Due Diligence,
KYC, Sole Financing, Consortium
Financing, Multiple Banking, Loan
Syndication,
Prudential
Credit
Exposure Limits Single Borrower
Limit (SBL) and Group Borrower
Limit (GBL)

Topics for Next Class All of you Should get

prepared before coming to the class

Legal Aspects of Bank Lending :

Different
Modes
of
Creating
Charge on Securities and Loan
Documentation