Loans And Advances

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Presidency College
Hebbal – Kempapura, Bengaluru – 560024
www.presidencycollege.ac.in
Loans And Advances
Chapter 4

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Loans and Advances
• Banking is essentially a business dealing with money and credit.
Like every other business activity, banks are profit oriented.
Principles of Sound Lending
1. Safety
• Principle of Safety:
• The banker should ensure that the borrowers are men of
integrity (Honesty)and repaying capacity.
• The loans / advances should be done based on collateral
securities in addition to the personal security of the borrowers.
2. Liquidity
Principle of Liquidity
• Sufficient liquid resources must be maintained ( CRR) to meet the
demand of depositors.
• The loans should be given for short- term ( To meet the working
capital requirements) as it can be recovered fast
• If loans are given for medium-term/ long –term, the banker
should make it liquid by insisting on their repayments in
periodical installments.

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• Principle of Profitability:
A banker has to employ funds profitably so as to earn
sufficient profits to meet its day to day expenses e.g
Interest, dividends, salaries, rent and to pay dividends to its
share holders.
• Principle of Security:
• Collateral securities must be acceptable and adequate.
• Sufficient margin must be kept to cover interest and
other charges or fall in the prices of securities.
• Principle of Purpose:
• Loans must be given for productive purposes so that the
chances of recovery are good, for e.g Financing of Trade,
industry and agriculture
• Loans should not be given for unproductive or risky
purposes where the chances of recovery are less. E.g
Financing of pleasure tours, speculative purposes,
domestic expenses, repayment of ancestral debts

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• Principle of diversification :
Loans should be spread over a large number of
borrowers and over a large number of industries,
over a wide geographical area and over different
types of securities.
• Principle of Public Policy / National
Interest:
While lending national policies should be given
priority e.g Make in India policy, promotion of
cottage industries etc
Loans should be given which promote national
development – financing small industries, new
entrepreneurs, small agriculturists, export –
oriented industries etc

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Contd….
• Sources of Repayment
• Diversification of Risks: should not lend a
major portion of his loanable funds to any
single borrower or to an industry or to one
particular region.
• Recent concept of Sound lending

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Secured and Unsecured Advances
• Loans and advances may be made either on the
personal securities of the borrower or on the
security of some tangible assets. The former is
called unsecured or claim or personal advances
and the later is called secured advances.
• Unsecured Advances
The General capacity of the customer is security
itself. In case of his default to repay the banker’s
position is unsafe and can rank equal with
unsecured creditors to realize the assets of the
borrower. So, to safeguard his position, a banker
lends on personal security coupled with the
guarantee of one or more persons

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The confidence is judged by three considerations,
character, capacity and capital usually referred to as
the three C’s
• Competence/ Capacity: Capacity of the borrower must
be considered in credit analysis. Not only technical skill
but also managerial ability is necessary while assessing
the capacity. It includes his ability to run the business
successfully and repay the advance.
• Character : of the borrower is his honesty, good business
habits and reputation in the business circles.
• Capital: In addition to the character and capacity of a
borrower, bank looks into another aspect i.e capital. A
bank provides mainly the working capital requirements
of the business. A borrower should have sufficient capital
to conduct the business and adequate plant and
machinery to carry out normal production.

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Secured Advances
• Section 5(i) of the Banking Regulation Act 1949
Defines secured advances as Secured loans or
advance means a LOAN OR ADVANCE MADE ON
THE SECURITY OF ASSESTS THE MARKET VALUE
OF WHICH IS NOT ANY TIME LESS THAN THE
AMOUNT OF LOAN OR ADVANCE.
• Two Essential features of Secured loans:
a. The advance must be made against tangible
security.
b. The market value of the security must not be less
than the amount of loan granted.

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Securities may be classified
• Primary Security: The security deposited by the
borrower himself as cover loan is called the primary
security. For Example a machinery has been bought
with the help of bank finance. The machinery
constitutes the primary security to the banker.
• Collateral Security: The term collateral Security is used
to two senses. It refers to the securities deposited by
the third party to secure advance for the borrower. In a
wider sense it denotes any type of security on which
the creditor has a personal right of action on the debtor
in respect of the advance.

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FORMS OF BANK ADVANCES / FORMS OF BANK
LENDING / DIFF KINDS OF BORROWING
FACILITIES GRANTED BY BANKS
• Bank advances take the form of:
• Loans
• Overdrafts
• Cash credits
• Discounting of bills
• Purchasing bills
• Letters of credit

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Loan
• It is a financial arrangement under which an advance is
granted by the bank to a borrower on a separate
account called the loan account.
• Loans are of various types:
• Short – Term Loan / Demand Loan – Which is payable
on demand e.g money at call and short notice.
• Medium – Term Loan: Loan granted for 3 – 5 years is
termed as Medium Term Loan.
• Long- Term loan: A loan granted for more than 5 years.
• Interest is charged on the whole amount of the loan
sanctioned, irrespective of the amount actually
withdrawn by the borrower.

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Over drafts:
• Is a financial arrangement under which a current account
holder is permitted to over draw upto the credit limit.
• Interest on overdraft is charged only on the actual amount
overdrawn by him.
• If the borrower does not utilise 95% of the overdraft
amount, then he will have to pay commitment charges 1%
p.a
Cash credits:
• In this system a borrower is provided a lump sum under a
separate account called cash – credit account.
• In case of cash credit, the borrower need not withdraw the
entire amount in one lump sum, but can withdraw the
amount in installments as and when required.
• Cash credit is given against hypothecation or pledge of
industrial or agricultural products. If the borrower does not
utilize 95 % of the cash credit limit, then he has a right to
charge 1% commitment charge.

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Bill Discounting:
It is an arrangement under which a banker takes a bill of
exchange maturing within a short period ( 60 days or 90 Days)
from an approved customer and pays him or credits his current
account immediately with the present value of the bill ( Face
value – discount charges).
• On the due date of the bill, the bank receives the face value of
the bill from the acceptor of the bill.
• Incase the bill is dishonored by the acceptor, the banker
recovers the amount from the customer who has discounted
the bill.
• The bill discounted may be a documentary bill ( B.O.E
accompanied by title to goods) or a clean bill ( B.O.E which is
not accompanied by document of title to goods)
• The interest for this financial accommodation is called
discount and is charged on the face value of the bill.

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Purchasing of bills :
• is a financial arrangement under which a bank takes a
demand bill ( a bill payable on demand or sight or on
presentation) from an approved customer and pays
him or credits his current account immediately with
the face value of the bill minus the discount charges
and receives the face value of the bill immediately on
the presentation of the bill to the drawee.

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• Letter of Credit: A commercial letter of credit is a
letter issued by a bank in the importers country, at
the request of the importer, in favor of the
exporter, informing him that the issuing bank
undertakes to accept the bill of exchange drawn by
the exporter up to amount of the goods exported
by him ( exporter) to the importer specified
therein ( in the letter of credit),

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Types of Letter of credit
• Documentary Letter of Credit: A letter of credit issued by the
issuing banker on the condition that a bill drawn under the letter
of credit must be accompanied by the relevant shipping documents
such as bill of lading, marine insurance policy etc. It safeguards the
interests of the issuing banker as he acquires the property in the
goods covered by the shipping documents
• Clean Letter of credit : letter of credit issued by the issuing
banker with out insisting that the bill drawn must be accompanied
by shipping documents is termed as Clean Letter of Credit
• Revocable Letter of Credit :A letter of credit which can be
cancelled by the issuing banker without prior consent of all the
parties ( Exporter, importer ). This letter of credit is risky for the
exporter.
• Irrevocable Letter of Credit: A Letter of Credit which cannot be
cancelled by the issuing banker is termed as irrevocable Letter of
credit . It is beneficial for the exporter.

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College • Confirmed Letter of credit : If a Letter of credit contains an
undertaking, both from the issuing bank as well as the
negotiating bank in the exporters country , to honor the bill
drawn by the exporter.
• Unconfirmed Letter of credit : If a letter of credit does not
contain an undertaking from the negotiating bank in the
exporters country to honor the bill, it is termed as
Unconfirmed Letter of Credit.
• Fixed Letter of Credit: If a Letter of credit is issued for a
fixed amount and for a fixed period, it is termed as Fixed
Letter of Credit. The exporter is given the benefit to draw bills
upto a fixed amount within a specified period.
• Revolving Letter of Credit: If the letter of credit is
automatically renewed after the bills negotiated under it are
duly honored, it is called revolving Letter of credit. ( In other
words a fresh letter of credit need not be obtained when the
credit given under the earlier letter of credit has been fully
utilized)

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Types of Loans
• Education loans
• Housing loans
• Vehicle loans

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Educational loans Features
• Need for educational loan
• Cover: College fees,exam, lab, practical fees etc.
• Applicant of the loan: student, parents, spouse,sibbling.
• Courses covered :full time, part time, UG,PG
• Eligibility, documents required: citizenship, completed higher
secondary schooling, admission letter, fee structure, mark sheets, IT
documents, IT returns
• Loan financing, collateral requirement
The banks can finance up to 100% of the loan depending on the
amount. Currently, for loan up to Rs 4 lakh, there is no margin money
required. For studies in India, 5% of the required money has to be
financed by the applicant. On the other hand, for studies overseas, the
required margin money increases to 15%.
• Interest: 1.35-3%
• Repayment: relaxation period of one year from the time of completion
of course.
• Precautions: scrutinizing the terms and conditions of educational
loans.

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Housing loans
Banks extend home finance loans, either directly or through
home finance subsidiaries. Such long term housing loans are
provided to individuals and corporations and also given as
construction finance to builders. The loans are secured by a
mortgage of the property financed. These loans are extended
for maturities generally ranging from five to fifteen years and
a large proportion of these loans are at floating rates of
interest.

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Risks of Housing loans
• Large investment
• Long term advances
• High inflation rates
• High stamp duty
• Defective titles
• High delinquency rate
• Keen competition

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Reasons for the popularity of Housing finance
• Increase in middle income group people.
• “Save and buy attitude been replaced by “Buy and
repay”attittude.
• Low cost construction techniques.
• Reduction of interest rates.
• Expansion of loan period.
• Corporate borrowers started accessing the capital market for
their financial requirements leaving surplus cash in the hands of
bankers.
• High risk involved by lending to industries, if they come across
recession.
• Entry of foreign players.
• Tax relief for housing loans.
• RBI initiatives

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Housing financial products
• Purchase of homes.
• House construction loans.
• House extension loans.
• Home improvement loans.
• Flexible repayment loans.
• Flexible loan installment plans.
• Home conversion loan.
• Home furnishing loan.
• Housing repayment or Refinance loan.
• Housing loan transfer plan.

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Vehicle loans
Vehicle Finance : This is finance which is made available for
the specific purpose of buying a car or a two-wheeler or
other automobile. The interest rate for used cars can go close
to the personal loan rates. However, often automobile
manufacturers work out special arrangements with the
financiers to promote the sale of the automobile. This makes
it possible for vehicle-buyers to get attractive financing terms
for buying new vehicles.

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Vehicle loan features
Purpose: Vehicle loans are offered to purchase four or two
wheelers.
Eligibility: Minimum gross salary/income of Rs.75,000p.a.
and private banks have fixed an amount of 1,20,000 p.a. for
this facility.
Loan amount: New vehicle- 90% of the invoice value with
no ceiling on maximum amount. Some private sectors have
fixed the maximum limit to Rs. 20 lakhs for new vehicle and
3 lakhs for used cars.
Old vehicle- 75% of the original value or
negotiated purchase price of the vehicle, which ever is least.
Repayment period: Maximum repayment period is 72
months in public sector banks and 5 years in private banks.

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NPA
M a n a g e m e n t

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Fig1:AssetClassificatio
n
Assets
Performing
Assets
Standard
Assets
Non Performing Assets
(NPA)
Sub -Standard
Assets
Doubtful
Assets
Loss
Assets

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Performing
Asset
• Anaccountdoesnotdiscloseany
problemsandcarrymorethannormalrisk
attachedtothebusiness
• Allloanfacilitieswhichareregular !

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non Performing
Assets
• NonPerformingAssetmeansaloanoran
accountof borrower,whichhasbeen
classifiedbyabankorfinancialinstitution
assub-standard,doubtfulorlossasset,in
accordancewiththedirectionsor
guidelinesrelatingtoassetclassification
issuedby RBI.

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introductio
n
• Earlier assets weredeclaredasNPAafter
completionof theperiodforthepayment of
totalamountof loanand30days grace.
• Inpresentscenarioassetsaredeclaredas
NPAif noneof theinstallmentispaidtill
180daysi.e. sixmonthsinrespectof a
termloan.

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WitheffectformMarch31, 2004 anon-performingasset
(NPA) shell be a loan or an advance where;
interestand/or installmentof principalremainoverduefora
periodof morethan90daysinrespectof aTerm Loan,
theaccountremains'outof order'foraperiodof morethan90
days,inrespectof anoverdraft/cashCredit(OD/CC),
thebillremainsoverdueforaperiodof morethan90daysin
thecaseof billspurchasedand discounted,
introductio
n

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cAtegories o f nPA
Standard Assets : Arrears of interest and the principal
amount of loan does not exceed 90 days at the end of financial
year
Substandard Assets : Which has remained NPA for a period
less than or equal to 12 months.
Doubtful Assets : Which has remained in the sub-standard
category for a period of more than 12 months
• D1 i.e. up to 1 year : 20% provision is made by the bank
• D2 i.e. up to 2 year : 30% provision is made by the bank
• D3 i.e. up to 3 year : 100% provision is made by the bank
Loss Assets : where loss has been identified by the bank or
internal or external auditors or the RBI inspection but the
amount has not been written off wholly.

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reAsons behind rise in
nPA
• Lackof properpre-enquiry bythebankfor
sanctioningaloantoa customer
.
• Nonperformanceof thebusinessorthepurpose
forwhichthecustomerhastakenthe loan.
• Willful defaulter.
• Loanssanctionedforagriculturepurposes.
• Changeingovt.policiesleadsto NPA.

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Ef f Ec t s o f NPA oN bANks
f
I
• Restrictiononflowof cashdonebybankdue
totheprovisionsof fundmadeagainstNPA.
• Drainof profit.
• Badeffecton goodwill.
• Badeffectonequityvalue.

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f A c t o r s ImPActINg rIsE IN
NPAs
External factors :
• Ineffective legal framework & weak
recovery tribunals
• Lack of demand / economic recession or
slowdown
• Change in Govt. policies
• Wilful defaults by customers
• Alleged political interferences

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f A c t o r s ImPActINg rIsE IN
NPAs
Internal factors :
• Defective Lending process
• Inappropriate / non –use of technology like
MIS , Computerization
• Improper SWOT analysis
• Inadequate credit appraisal system
• Managerial deficiencies
• Absence of regular industrial visits & monitoring
• Deficiencies in re-loaning process
• Alleged corruption
• Inadequate networking & linkages b/w banks

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BANKER – SIDE
DefectiveSanction
Nopost-sanction
supervision,etc
Delayinreleases
Directedlending
Slowdecision
makingprocess
• BORROWER-
SIDE
• Lackof Planning
Diversionof Funds
Disputes within
• Nocontribution
Nomodernization
• Improper
monitoring
IndustrialRelations
Why LoAN AccouNts g o bAd

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tyPEs o f
NPA
• Gross NPA :
•Gross NPAs are the sum total of all
loan assets that are classified as
NPAs as per R B I guidelines as on
Balance Sheet date. Gross NPA
reflects the quality of the loans made
by banks. It consists of all the non
standard assets like as sub-
standard, doubtful, and loss assets.
• Gross NPAs Gross NPAs
Gross Advances

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• NetNPA:
NetNPAsarethosetypeof NPAsinwhich
thebankhasdeductedtheprovision
regardingNPAs.NetNPAshowstheactual
burdenof banks.
Net NPAs Gross = NPAs – Provisions
Gross Advances - Provisions

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Causes
•
•
•
•
•
•
•
NPA arises due to a number of factors or causes like:-
Speculation : Investing in high risk assets to earn high income.
Default : Willful default by the borrowers.
Fraudulent practices : Fraudulent Practices like advancing loans to
ineligible persons, advances without security or references, etc.
Diversion of funds : Most of the funds are diverted for unnecessary
expansion and diversion of business.
Internal reasons : Many internal reasons like inefficient management,
inappropriate technology, labour problems, marketing failure, etc. resulting
in poor performance of the companies.
External reasons : External reasons like a recession in the economy,
infrastructural problems, price rise, delay in release of sanctioned limits by
banks, delays in settlements of payments by government, natural
calamities, etc.

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Non
Performi
ng
Assets
Substandard
Assets
Doubtful
Assets
Loss
Assets

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Sub-Standard Assets:Anassetwhichhasremained NPA
for a period less thanor equal to12 months.
Doubtful Assets: An asset that has remained in the
substandardcategoryforaperiodof 12months.
Loss Assets: An asset where loss has been identified by
the bank or internal or external auditors or the RBI
inspectionbuttheamounthasnotbeenwrittenoff wholly
.

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• Standard Assets
• DirectadvancestoagricultureandSME at0.25%,
• CRE at1%
• Otherloansandadvancesat 0.40%
• SubstandardAsset
• Ageneralprovisionof 15% ontotaloutstanding
The‘unsecuredexposures’whichare
‘substandard’toattractadditionalprovisionof
10%, i.e., atotalof 25% ontheoutstanding
balance.

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• Doubtful Assets
• 100%of theextenttowhichtheadvance
isnotcoveredbytherealisablevalueof
thesecurity
• Forthesecuredportion,provisiontobe
madeas follows, dependinguponthe
periodforwhichtheassethasremained
doubtful

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• Loss Assets
• Write Off or provision of 100% of
outstanding

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NPA MANAgeMeNt StrAtegieS
• Indian Banks are pursuing variety of
strategies to control NPAs, which can be
studied under two broad categories as
under :
– a. Preventive Management
– b. Curative Management

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NPAMANAgeMeNt StrAtegieS
a. Preventive Management - It is rightly
said that prevention is better than cure.
• Developing ‘Know Your Client’ profile
(KYC
• Monitoring Early Warning Signals
• Installing Proper Credit Assessment and
Risk Management Mechanism
• Reduced Dependence on Interest
• Generating Watch-list/Special Mention
Category

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NPAMANAgeMeNt StrAtegieS
b. Curative Management
• Re-phasement of loans
• Pursuing Corporate Debt Restructuring (CDR
• Encouraging rehabilitation of potentially viable
units
• Encouraging acquisition of sick units by healthy
units
• Entering compromise schemes with borrowers /
Entering one time settlement

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NPAMANAgeMeNt StrAtegieS
• Using Lok Adalats for compromise
settlement for smaller loans in “doubtful”
and “loss” category.
• Using Securitization & SARFAESI Act
• Using Asset Reconstruction Company
(ARC)
• Approaching Debt Recovery Tribunals
(DRTs).
• Recovery Action against Large NPAs
• Circulation of Information of Defaulters-
Strengthening Database of Defaulters

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Methods of Creation of charge
• There are different methods of creating charge on
securities. The term charge refers to have a legal hold
on immovable properties. However banks make
advances against various goods and immovable
properties, and will have different types of legal hold
on securities.
The forms of Legal hold are:
a. Lien
b. Pledge
c. Hypothecation
d. Mortgage.

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PLEDGE
• The Pledge (in Banking) refers to the mode of creating a charge
over movable security to avail the secured debt from any banks or
financial institutions/companies.
• In other words, Pledge is the process of creating a charge over
movable assets/ property of borrower against the availed loan by
the banks or financial institutions/ companies/ lenders.
• In case of a pledge, the property/goods/assets on which the
charge has to be created is kept with the lender itself. Moreover, if
borrowers default during repayment of loans, the lender/ banks
have rights to sell the property by sending a prior notice to the
borrower for recovery of advance/loan.

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Points to remember in pledging
• Pledge is defined in section 172 of the Indian Contract Act.
• The lender/ bank is known as pledgee whereas the borrower is called
pledger.
• The possession of pledged goods/ assets is with the lenders/banks itself
whereas ownership of goods/property remains with the borrower.
• If the borrower defaults or unable to repay the debt/ loan, the lender has
rights to sell the pledged goods without the intervention of court for the
recovery of debt by issuing a prior notice to the borrower.
• The banks/lender has to take care of pledged goods as the goods will
have been returned (original condition) to the borrower after repayment
of debt.
• Even if the bank/lender as a pledgee has a priority in custody over
pledged goods but the lender doesn’t have rights to sell the goods in any
circumstances until the borrowers deny/ unable to repay the loan.

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Hypothecation
• Hypothecation is used for creating charge against the
security of movable assets, but here the possession of the
security remains with the borrower itself. Thus, in case of
default by the borrower, the lender (i.e. to whom the goods /
security has been hypothecated) will have to first take
possession of the security and then sell the same. The best
example of this type of arrangement are Car Loans.
• In this case Car / Vehicle remains with the borrower but the
same is hypothecated to the bank / financer. In case the
borrower, defaults, banks take possession of the vehicle after
giving notice and then sell the same and credit the proceeds
to the loan account.

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Other examples of these hypothecation are loans against stock
and debtors. [Sometimes, borrowers cheat the banker by partly
selling goods hypothecated to bank and not keeping the desired
amount of stock of goods. In such cases, if bank feels that
borrower is trying to cheat, then it can convert hypothecation to
pledge i.e. it takes over possession of the goods and keeps the
same under lock and key of the bank].

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College
Mortgage
1. is defined in Section 58 of the "Transfer of Property Act 1882". It is
the transfer of an interest in specific immovable property for the
purpose of securing payment of money advanced by way of loan.
2. is used for creating charge against immovable property which
includes land, buildings or anything that is attached to the earth or
permanently fastened to anything attached to the earth (However, it
does not include growing crops or grass as they can be easily
detached from the earth). The best example when mortage is created
is when someone takes a Housing Loan / Home Loan. In this case
house is mortgaged in favour of the bank / financer but remains in
possession of the borrower, which he uses for himself or even may
give on rent.

56. Reaccredited by
NAAC with A+
Presidency
Group
Presidency
College
Commercial banks towards priority Lending
1. Every bank should train a band of senior- and middle-level
employees in the art of lending to the priority sector, both agriculture
and small-scale industry and they should continue to be encouraged
to upgrade their skills in the latest developments in this area of
lending.
2. Instead of making available priority-sector lending facilities in all
branches, every bank should set up specialised branches in all
potential centres and extend priority-sector lending through these
branches alone where trained manpower should be deployed to
facilitate proper sanction and monitoring of these loans and
advances.

57. Reaccredited by
NAAC with A+
Presidency
Group
Presidency
College
3. The staff working in those specialised branches lending to the priority
sector can be provided with appropriate incentives based on the level of
lending to the priority sector at each of these branches.
4. A certain percentage of profit can be exempted from income-tax for those
banks reaching these levels of lending to the priority sector.
5. Any other incentive could be thought of to provide impetus for lending to
the priority sector.
6. All subsidies now provided to banks for lending to certain priority sectors
should be withdrawn, and in its place, appropriate fiscal incentives should be
provided so as to minimise paperwork and misuse of the subsidy system.
7. In order to encourage the staff of commercial banks to improve lending to
the priority sector, the bank managements, particularly in the public sector,
should also change their attitude and follow the basic principle followed by
banks all over the world that “error of judgment is not negligence”.