ch2 principles of credit management

8/3/2019 Ch2 Principles of Credit Management

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The principles of credit management isnothing but sound lending.

The sound lending is based on

(1) Activity (2) Individuals.

Activity consists:(a) Ensuring Safety (b) Providing

Liquidity(c) Generate profit (d) Purpose

(e) Adequate security (f) Risk Management.


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Safety The Banker should lend to reliable customer who can repay

the loan within prescribed period. Banks try to ensure principle of safety by obtaining

collateral.

In post- nationalization period has given new dimensions tothe principle of safety . Now the emphasis on collateral security has eased. Banks assume the role of being forerunners in contributing

to socio-economic development. Consequently , bankers have begum to concentrate more on

business aspects of borrowers. The viability of business is now important than the

collateral. The principle of good lending therefore is that borrowers

should create surplus to repay the loan.


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Safety Post-nationalization lending to non

traditional sectors and neglected areas Project viability and project capacity to

generate income is more important

Concept of development Bankingreplaced the principles of commercialBanking


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Providing Liquidity Liquidity with Bank is very important. Any point of time Bank should able to meet the withdrawal of deposits

and provide the credit to borrowers . While lending the Bank should see that borrower should generate

adequate surplus to repay the loan

The liquidity of borrower ensured the liquidity of banker.

Advances should be reasonably liquid.

Liquidity also refer the quality of assets which would be easilyconvertible into cash without any loss of value. Thus the concepts of liquidity entails the banker to look for easy sale

ability and absence for risk of loss on sale of assets which has beentaken as collateral.


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Generate Profit Bank operate for earning the profit as any other enterprises. The ultimate

aim of lending is to earn profit

Bank receive the interest income on loan and pay interest to depositors.

Bank also incurs the expenditures on establishment/wages/operatingexpenses.

After accounting all expenses the bank has to earn the profit

Bank should earn the profit to pay the dividend and continue to survive.The confidence level of investors and customers will be high with the bankwhich has a proven track record of profit and dividend rate.

Interest rate are based on competition and regulatory frame work.

Credit management has to be framed accordingly. The banks are lending various types of borrowers, it is better that bank

should carry out customer profitability analysis.

This approach helps the banker to attracts more customers and retainexisting one.


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Purpose Lend to productive purposes.

Should not lend for speculative purpose

Bank should watch the utilization of loan.

Bank should grant consumption+ Productive purpose

loan for small borrwers.


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Adequate Security Grant the loan based on adequate security.

Banker should check the nature of security. Check

whether it is adequate the loan grated.

The security should be free from charges.

The collateral security should be utilized only under

extreme circumstances. Apart from collateral, the bank has also to consider other

factors such as capital of the borrowers, character and

capacity.


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Risk Management Diversify the portfolio

Exposure to industry/group/individuals.

Loan policies and fair credit practices.

In US the federal laws and regulations protects consumers fromdishonest lenders.

The regulations regulate the disclosure of credit information,

credit discrimination or denial, credit dispute, errors in credit

billing and protection against collector harassment.

The creditors are required to send the statements on all credit

accounts which have a debit or credit balance at the end of the

billing cycle.


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IndividualCharacter:i. Appraise the personal character of borrowers.

ii. Honesty, attitude, willingness to repay the loan.

iii. There is no stipulated gaudiness character of the

person.

iv. It may not be possible some time to judge theborrowers, bank may collect the information

from various sources.


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Capacity Borrower should have the potential to repay the loan from

his own resources.

It includes the borrowers success in running a business or

managing cash flow

Examine the capacity of physical assets, plant and

equipments.

Labor Management skills and ability to handle the situation.

Banks generally insist upon their prospective borrowers to

submit financial statement to determine the credit

worthiness.


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Capital The banker ahs to asses the financial strength of the

borrower and his net worth.

The borrower's equity capital that firm can liquidate forthe payment of debt.

Borrowers capital in relation to debts is easy to compute.

Liquid assets, share/ other investments.


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Condition The banker need to evaluate condition in which borrower

is operating his business.

For this purpose ,Social, technology, economic and

political conditions. (STEP) analysis has to be carried out. Growth prospects: the competitiveness of the firm , the

market potentials of the products, and growth prospectsdetermine the ability of the borrowers of repay the loan.

The changes in interest rate, recession and legal

environment may adversely affect the repayment capacityof the borrowers. These factors should also taken in toconsideration.


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Collateral safety of the fund can be achieved by retaining the

proper security.

The quality of the assets that are pledge shouldbe properly examined.

The valuation of collateral requires expertise inproperty.

If the repayment is not coming, bank can takeoverthe assets


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Compliance The loans given to borrowers should be in accordance to

the bank's rules and procedures as stipulated.

The banker has to check whether all formalities have been

met by the borrowers.

The loan has to be given in compliance of regulatory

framework.

Bank must see that the borrowers compliance all

stipulated conditions.

Compliance of the statuary requirements.


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The concept is more prevalent in USA. Equal creditopportunity Act prohibits:

The credit application can not request the information

pertaining the consumer sex, race, color, religion, or nation

origin. Deny of credit must notify within 30 days, the reasons for

denials.

Another protective Act in the US is Fair Credit Reporting

Act. Under this Act the Banker has to give the Reasons for deny

of credit


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The credit Bureau is maintains the credit history.

The consumer right to know the source of

information used by the Bank

If credit Bureau learns that the information isinaccurate, the information may be corrected or

deleted.

Generally the banks are using the credit Bureau

information for examining the creditworthiness.


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Based on Working Group on lenders Liability Law the fair practicescodes are issued to improve the quality of banking services.

Loan application from for priority sector advances should indicateprocessing fee and repayment options.

Acknowledgement should be given for the application.

The reasons for rejection should be conveyed to applicant. Lender should ensure proper assessment of credit of the borrowers.

Lender should ensure timely disbursement of loan sanctioned.

Post disbursement supervision should be constructive.

Consent or objection for transfer of borrower account should be

conveyed within 21 days.

ch2 principles of credit management

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