BASIC PRINCIPLES OF BANK LENDING Definitions of lending Disposing of money or property with the expectation that the same

thing (or an equivalent) will be returned . Credit is the provision of resources (such as granting a loan) by one party to another party where that second party does not reimburse the first party immediately, thereby generating a debt, and instead arranges either to repay or return those resources (or material(s) of equal value)
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Lenders - A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time To provide money temporarily on condition that the amount borrowed be returned, usually with an interest fee. Today ,the important types of banks, commercial and merchant banks, operating under the regulation of the Central Bank. The commercial banks engage in retail banking services through branch networks and operate with a broad deposit base consisting of demand and time deposit they provide short term lending. On the other hand, merchant banks are licensed to provide wholesale banking, take deposit and arrange syndicated loan facilities for long terms by pooling, sometimes, a consortium of banks, including other financial institutions, to finance capital intensive projects. From the foregoing, it is realized that banks are generally debtors; they borrow money in order to lend them out to make profit. No bank can ever survive by just being a custodian of deposit, but they exist by lending from the deposit on fixed interest charged. Money lent on interest is always supposed to be secured on some guarantees or security.

Since banks depend largely on lending, the need to adhere to the basic principles of lending is quite inevitable. The principles, if strictly followed, will guarantee depositors and shareholders funds, increase profitability and make a healthy turn over. Such advances in turn assist in the transformation of rural environment, promote rapid expansion of banking habit and improve and boost the nations economy.
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The basic considerations in bank lending are the character of the client seeking loan from the bank. The client must be an honest, upright customer whose record of transaction with the financial institution or in the society is remarkable. The information on the character of the borrower could be obtained through a completed form of his guarantor or his statement of account. For effective credit administration, the bank must assign functioning lending officers, properly trained on lending, to be responsible for evaluation of reports and collection and reporting findings to relevant senior schedule officers, for further consideration and final approval or rejection An internal credits/lending policy should be formulated, implemented and pursued vigorously by the bank to minimize the risk of default from borrowers. The successful banks operating within the financial system are those that consider and coordinate basic principles of lending and monitor the activities of borrowers regularly.

The major business of banking company is to grant loans and advances to traders as well as commercial and industrial institutes. The most important use of banks money is lending. Yet, there are risks in lending. While lending loans or advances the banks usually keep such securities and assets as a supports so that lending may be safe and secured. Suppose, any particular state is hit by disasters but the bank shall get advantages from the lending to another states units. Thus, the effect on the entire business of banking is reduced. So the banks follow certain principles to minimize the risk. Following are the important areas to be taken care while lending: Principles of good lending

Basic principles

General principles

Basic principles The success of banks depends upon the basic principles. These are the prime principles in lending as well as investment Safety Liquidity Profitability

Safety Normally the bank uses the money of depositors in granting loans and advances. Because of that while granting loans the banker should think about the safety of depositors money. The purpose behind the safety is to see the financial position of the borrower, whether he can pay the debt as well as interest easily. Ensuring safety means reducing risk associated with lending. The risk involved in lending money is the credit risk.ie the possibility of the borrower not repaying the amount back on the due date. It is necessary for the banks to maintain expert staff to appraise every credit proposal received by it. Market risk also there , it can be avoided by preferring high grade securities of short terns. Liquidity It is a legal duty of a banker to pay the total deposited money to the depositor on demand. So the banker has to keep certain percent cash of the total deposits in hand. Moreover the bank grants loan. It is also for the addition of short term or productive capital. Such type of lending is recovered on demand. A bank must have sufficient liquid assets to meet the demands of the depositors .The liquid assets must have posses certain characteristics. It must be convertible in to cash quickly and easily. The conversion must be without any loss of value or risk SLR : The Banking regulation act of 1949 , section 24 . states that every commercial bank have to maintain liquid assets in the form of cash , gold, and gilt edged securities which is not less than 25 % and not more than 40 % of NDTL ( Net Demand and Time Liabilities )
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Profitability Commercial banks are profit earning institutes; nationalized banks are also not an exception. They should have planning of deposits in a profitability way to pay more interest to the depositors and more salary to the employees. Before taking any decision the banker should make sure that it is profitable.

General principles Banks are following certain general principles in order to make a safe lending along with the basic principles . that are explained in detail in the following paragraphs.

Purpose of loan Safety Principle of Security Principle of National interest and suitability Pri Principle of diversification of risks

Purpose of loan Banks never lend or advance for any type of purpose that will lead to loose of money. The banks grant loans and advances for the safety of its wealth, and assurance of recovery of loan and the bank lends only for productive purposes. Before giving a loan the bank has to make sure that whether the purpose for which the loan has given is productive or not. Principle of diversification of risks A bank should be very careful while lending loans because if the bank lends to a non credit worthy customer, it will affect the survival of the bank. To diversify the lending risk they should lend loans to customers from different sectors such as agriculture, housing, educational, etc. Concentrating on a particular set of customers will adversely affect the bank.
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LATEST LENDING RATES (BASE RATES) In terms of RBI guidelines, Banks in India have switched to Base Rate system from Benchmark Prime Lending Rate (BPLR) system from July 01, 2010. Following is the updated list-

Banks

Base Rate (p.a%)

PUBLIC SECTOR BANKS State Bank of India Federal Bank State Bank of Mysore Corporation Bank Bank of India Punjab National Bank Bank of Baroda Union Bank Central Bank of India Indian Bank Uco Bank IDBI Bank Indian Bank Canara Bank Vijaya Bank Indian Overseas Bank 7.50% 7.75% 7.75% 7.75% 8.00% 8.00% 8.00% 8.00% 8.00% 8.00% 8.00% 8.00% 8.00% 8.00% 8.25% 8.25%

PRIVATE SECTOR BANKS

HDFC Bank ICICI Bank DCB Dhanalxmi Bank Bank of Rajasthan Karur Vysya Bank

7.25% 7.50% 7.75% 7.00% 8.00% 8.50%

PRIORITY SECTOR LENDING The Government of India through the instrument of Reserve Bank of India (RBI) mandates certain type of lending on the Banks operating in India irrespective of their origin. RBI sets targets in terms of percentage (of total money lent by the Banks) to be lent to certain sectors, which in RBI's perception would not have had access to organised lending market or could not afford to pay the interest at the commercial rate. This type of lending is called Priority Sector Lending. Financing of Small Scale Industry, Small business, Agricultural Activities and Export activities fall under this category. This is also called directed credit in Indian Banking system. Financing Priority Sector in the economy is not strictly on commercial basis as not only the general approach is liberal but also the rate of interest charged on such loans is less. Export finance is, in fact, available at a discount of 20% or more on the normal rate of interest to Indian corporates. Part of the cost of this concession is borne by RBI by means of refinancing such loans at concessional rate. Indian Banks, therefore, contribute towards economic development of the country by subsidizing the business activities undertaken by entrepreneurs in the areas which are consider "priority sector" by RBI. Principles of lending & Priority sector finance in Banks
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Cardinal principles of lending are Safety and liquidity , Profitability and diversifications of risks and Productive purpose and security
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Liquidity with a banker means Cash on Hand, Cash and Bank balances and Short term current assets to convert into cash Customer profitability analysis means Assess the profitability of customers business Banker can reduce risk in lending to a borrower by ensuring that there will be no default on account of lack of liquidity and lack of willingness to pay on the part of the borrower

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In bankers parlance, credit risk in lending refers to default of repayment by a borrower

The targets under priority sector lending The targets and sub-targets set under priority sector lending for domestic and foreign banks operating in India are furnished below :

Domestic banks (both public sector and private sector banks) Total Priority Sector advances Total agricultural advances SSI advances Export credit No target Export credit does not form part of priority sector Advances to weaker sections 10 percent of NBC 18 percent of NBC 40 percent of NBC

Foreign banks operating

32 percent of NBC

No target

10 percent of NBC 12 percent of NBC

No target

NBC denotes net bank credit Net bank credit The net bank credit should tally with the figure reported in the fortnightly return submitted under section 42(2) of the Reserve Bank of India Act, 1934. However, outstanding deposits under the FCNR(B) and NRNR Schemes are excluded from net bank credit for computation of priority sector lending target/ sub-targets. Priority sector comprise Broadly, the priority sector comprises the following : 1. Agriculture 2. Small scale industries (including setting up of industrial estates) 3. Small road and water transport operators (owning upto 10 vehicles). 4. Small business (Original cost of equipment used for business not to exceed Rs 20 lakh) 5. Retail trade (advances to private retail traders upto Rs.10 lakh) 6. Professional and self-employed persons (borrowing limit not exceeding Rs.10 lakh of which not more than Rs.2 lakh for working capital; in the case of qualified medical practitioners setting up practice in rural areas, the limits are Rs 15 lakh and Rs 3 lakh respectively and purchase of one motor vehicle within these limits can be included under priority sector) 7. State sponsored organisations for Scheduled Castes/Scheduled Tribes 8. Education (educational loans granted to individuals by banks)

9. Housing [both direct and indirect loans upto Rs.5 lakhs (direct loans upto Rs 10 lakh in urban/ metropolitan areas), Loans upto Rs 1 lakh and Rs 2 lakh for repairing of houses in rural/ semi-urban and urban areas respectively]. 10. Consumption loans (under the consumption credit scheme for weaker sections) 11. Micro-credit provided by banks either directly or through any intermediaty; Loans to self help groups(SHGs) / Non Governmental Organisations (NGOs) for onlending to SHGs 12. Loans to the software industry (having credit limit not exceeding Rs 1 crore from the banking system) 13. Loans to specified industries in the food and agro-processing sector having investment in plant and machinery up to Rs 5 crore. 14. Investment by banks in venture capital (venture capital funds/ companies registered with SEBI) Direct Finance for Agricultural Purposes Direct Agricultural advances denote advances given by banks directly to farmers for agricultural purposes. These include short-term loans for raising crops i.e. for crop loans. In addition, advances upto Rs. 5 lakh to farmers against pledge/hypothecation of agricultural produce (including warehouse receipts) for a period not exceeding 12 months, where the farmers were given crop loans for raising the produce, provided the borrowers draw credit from one bank. Direct finance also includes medium and long-term loans (Provided directly to farmers for financing production and development needs) such as Purchase of agricultural implements and machinery, Development of irrigation potential, Reclamation and Land Development Schemes, Construction of farm buildings and structures, etc. Other types of direct finance to farmers includes loans to plantations, development of allied activities such as fishery, poultry etc and

also establishment of bio-gas plants, purchase of land for agricultural purposes by small and marginal farmers and loans to agri-clinics and agri-business centres.

Indirect Finance to Agriculture Indirect finance denotes to finance provided by banks to farmers indirectly, i.e., through other agencies. Important items included under indirect finance to agriculture are as under : (i) Credit for financing the distribution of fertilisers, pesticides, seeds, etc. (ii) Loans upto Rs. 25 lakhs granted for financing distribution of inputs for the allied activities such as, cattle feed, poultry feed, etc. (iii) Loans to Electricity Boards for reimbursing the expenditure already incurred by them for providing low tension connection from step-down point to individual farmers for energising their wells. (iv) Loans to State Electricity Boards for Systems Improvement Scheme under Special Project Agriculture (SI-SPA). (v) Deposits held by the banks in Rural Infrastructure Development Fund (RIDF) maintained with NABARD. (vi) Subscription to bonds issued by Rural Electrification Corporation (REC) exclusively for financing pump-set energisation programme in rural and semi-urban areas and also for financing System Improvement Programme (SI-SPA). (vii) Subscriptions to bonds issued by NABARD with the objective of financing agriculture/allied activities. (viii)Finance extended to dealers in drip irrigation/sprinkler irrigation system/agricultural

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machinery, subject to the following conditions: (a) The dealer should be located in the rural/semi-urban areas. (b) He should be dealing exclusively in such items or if dealing in other products, should be maintaining separate and distinct records in respect of such items. (c) A ceiling of upto Rs. 20 lakhs per dealer should be observed. (ix) Loans to Arthias (commission agents in rural/semi-urban areas) for meeting their working capital requirements on account of credit extended to farmers for supply of inputs. (x) Lending to Non Banking Financial Companies (NBFCs) for on-lending to agriculture. Small Scale Industries (SSI) Small scale industrial units are those engaged in the manufacture, processing or preservation of goods and whose investment in plant and machinery (original cost) does not exceed Rs. 1 crore. These would, inter alia, include units engaged in mining or quarrying, servicing and repairing of machinery. In the case of ancillary units, the investment in plant and machinery (original cost) should also not exceed Rs. 1 crore to be classified under small-scale industry. The investment limit of Rs.1 crore for classification as SSI has been enhanced to Rs.5 crore in respect of certain specified items under hosiery and hand tools by the Government of India Tiny Enterprises The status of Tiny Enterprises is given to all small scale units whose investment in plant & machinery is upto Rs. 25 lakhs, irrespective of the location of the unit. Small Scale Service & Business Enterprises (SSSBEs) Industry related service and business enterprises with investment upto Rs. 10 lakhs in fixed assets, excluding land and building will be given benefits of small scale sector. For computation

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of value of fixed assets, the original price paid by the original owner will be considered irrespective of the price paid by subsequent owners. Indirect finance in the small-scale industrial sector include Indirect finance to SSI includes the following important items: i. Financing of agencies involved in assisting the decentralised sector in the supply of inputs and marketing of outputs of artisans, village and cottage industries. ii. Finance extended to Government sponsored Corporation/organisations providing funds to the weaker sections in the priority sector. iii. iv. Advances to handloom co-operatives. Term finance/loans in the form of lines of credit made available to State Industrial Development Corporation/State Financial Corporations for financing SSIs. v. vi. Funds provided by banks to SIDBI/SFCs by way of rediscounting of bills Subscription to bonds floated by SIDBI, SFCS, SIDCS and NSIC exclusively for financing SSI units. vii. Subscription to bonds issued by NABARD with the objective of financing exclusively non-farm sector. viii. ix. Financing of NBFCS or other intermediaries for on-lending to the tiny sector. Deposits placed with SIDBI by Foreign Banks in fulfilment of shortfall in attaining priority sector targets. x. Bank finance to HUDCO either as a line of credit or by way of investment in special bonds issued by HUDCO for on-lending to artisans, handloom weavers, etc. under tiny sector may be treated as indirect lending to SSI (Tiny) Sector. Type of investments made by banks are reckoned under priority sector Investments made by the banks in special bonds issued by the specified institutions could be reckoned as part of priority sector advances, subject to the following conditions: i. State Financial Corporations (SFCs)/State Industrial Development Corporations

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(SIDCs) Subscription to bonds exclusively floated by SFCs & SIDCs for financing SSI units will be eligible for inclusion under priority sector as indirect finance to SSI. ii. Rural Electrification Corporation (REC) Subscription to special bonds issued by REC exclusively for financing pump-set energisation programme in rural and semi-urban areas and the System Improvement Programme under its Special Projects Agriculture (SI-SPA) will be eligible for inclusion under priority sector lending as indirect finance to agriculture. iii. NABARD Subscription to bonds issued by NABARD with the objective of financing exclusively agriculture/allied activities and the non-farm sector will be eligible for inclusion under the priority sector as indirect finance to agriculture/ SSI, as the case may be. iv. Small Industries Development Bank of India (SIDBI) Subscriptions to bonds exclusively floated by SIDBI for financing of SSI units will be eligible for inclusion under priority sector as indirect finance to SSIs. v. The National Small Industries Corporation Ltd. (NSIC) Subscription to bonds issued by NSIC exclusively for financing of SSI units will be eligible for inclusion under priority sector as indirect finance to SSIs. vi. National Housing Bank (NHB) Subscription to bonds issued by NHB exclusively for financing of housing, irrespective of the loan size per dwelling unit, will be eligible for inclusion under priority sector advances as indirect housing finance.

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vii.

Housing & Urban Development Corporation (HUDCO) a. Subscription to bonds issued by HUDCO exclusively for financing of housing, irrespective of the loan size per dwelling unit, will be eligible for inclusion under priority sector advances as indirect housing finance. b. Investment in special bonds issued by HUDCO for on-lending to artisans, handloom weavers, etc. under tiny sector will be classified as indirect lending to SSI (Tiny) sector.

Weaker sections within the priority sector The weaker sections under priority sector include the following: 1. Small and marginal farmers with land holding of 5 acres and less and landless labourers, tenant farmers and share croppers. 2. Artisans, village and cottage industries where individual credit limits do not exceed Rs. 50,000/3. Beneficiaries of Swarnjayanti Gram Swarojgar Yojana (SGSY) 4. Scheduled Castes and Scheduled Tribes 5. Beneficiaries of Differential Rate of Interest (DRI) scheme 6. Beneficiaries under Swarna Jayanti Shahari Rojgar Yojana (SJSRY) 7. Beneficiaries under the Scheme for Liberation and Rehabilitation of Scavangers (SLRS). 8. Self Help Groups (SHGs) Actions taken in the case of non-achievement of priority sector lending target by a bank i. Domestic scheduled commercial banks having shortfall in lending to priority sector / agriculture are allocated amounts for contribution to the Rural Infrastructure Development Fund (RIDF) established in NABARD. Details regarding operationalisation of the RIDF such as the amounts to be deposited by banks, interest rates on deposits, period of deposits etc., are decided every year after announcement in

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the Union Budget about setting up of RIDF. ii. In the case of foreign banks operating in India which fail to achieve the priority sector lending target or sub-targets, an amount equivalent to the shortfall is required to be deposited with SIDBI for one year at the interest rate of 8 percent per annum. Time limit for disposal of loan applications All loan applications upto a credit limit of Rs. 25,000/- should be disposed of within a fortnight and those for over Rs. 25,000/- within 8 to 9 weeks. Rate of interest for loans under priority sector As per the current interest rate policy, in the case of loans upto Rs 2 lakh, the interest rate should not exceed the prime lending rate (PLR) of the bank, while in the case of loans above Rs 2 lakh, banks are free to determine the interest rate Priority sector lending monitored by the Reserve Bank Priority sector lending by commercial banks is monitored by Reserve Bank of India through periodical Returns received from them. Performance of banks is also reviewed in the various for set up under the Lead Bank Scheme (at State, District and Block levels). DIFFERENTIAL RATE OF INTEREST SCHEME Government of India had formulated in March, 1972 a scheme for extending financial assistance at concessional rate of interest @ 4% to selected low income groups for productive endeavours initially by public sector banks and then by private sector banks also .

The scheme known as Differential Rate of Interest Scheme (DRI) is now being implemented by all Scheduled Commercial Banks.

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Reserve Bank of India on 10th April 2008 has notified that borrowers with annual family income of Rs.18000 in rural areas and Rs.24000 in urban areas will now be eligible to avail of the facility as against the earlier annual income criteria of Rs.6400 in rural areas and Rs.7200 in urban areas, fixed by the Government of India in 1986.

The other terms and conditions of the DRI scheme remain unchanged. The target for lending under the DRI scheme will continue to be 1 per cent of the previous years total advances

Purpose This scheme offers need based financial assistance to those who intend taking up any productive activity and has been tailored for persons whose income is very low. This scheme is meant for :

a. Persons belonging to SC/STs, Adivasis engaged in agricultural operations and/ or allied activities b. Persons engaged in collection of forest products, fodder and selling these in markets. c. Persons engaged in Village and Cottage Industries on a very small scale. d. Indigent students aspiring to pursue higher studies. e. Physically handicapped persons. f. Institution of physically handicapped for their productive activities. g. Orphanages, Women's Homes where saleable goods are made. h. State Level Corporations working for welfare of SC/ST. i. Co-operative Societies, large sized multi-purpose societies organised specially for the benefit of tribal population in areas identified by Government of India. Eligibility Loans are granted to any person whose : a. Family income from all sources is not more than Rs.7,200/- p.a. in metropolitan/

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urban/ semi-urban areas or Rs.6,400/- p.a. in rural areas. b. Land holding does not exceed 1.25 acres of irrigated land or 2.5 acres of dry land. Land holding criteria does not apply to SC/ST borrowers. Security Hypothecation of assets created out of the loan only. Collateral security or third party guarantee should not be taken. Amount of Loan Composite loan upto Rs. 15,000/- & housing loan upto Rs.20,000/- . Rate of Interest 4.00% p.a Margin No margin money is required to be provided by the borrower Repayment Repayment period for term loan is up to 5 years Target Under the Scheme 1% of the previous years advances should be granted under the scheme. Out of total DRI advance 40% should be granted to SC/ST beneficiaries and not less than 66.66% Of the DRI advances should be routed through Rural and Semi-urban branches.

DRI Beneficiaries DRI Advances : DRI beneficiaries are those who are given loans and advances @ 4% p.a. for individuals engaged in cottage and rural industries viz. Basket makers, blacksmiths, broom makers, carpenters, cobblers, cycle repairers, fire wood sellers, fish vendors, glass bangle sellers, handicrafts, hawkers, leather farmers, mat makers, pan shops and tobacco merchants, papad makers, potters, roadside tea stall cum eating houses, rope makers, sellers of eatable's, tailors,

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teri-makers, vegetable vendors, home delivery service or article and commodities of daily use, driving one's own manual rickshaw or cycle rickshaw etc. and Persons belonging to SC/ST engaged on a very modest scale in agriculture and/or allied agricultural activities like dairy, poultry, goat rearing, bee keeping etc. Further, persons physically engaged in the field of cottage and rural industries and vocation such as spraying of pesticides and poor and needy students of merit going for higher education who do not get scholarships/maintenance grants from Government or educational authorities, physically handicapped persons pursuing gainful employment could also be financed under the scheme.

In addition to the individual beneficiaries mentioned above, the following institutional beneficiaries are also covered under DRI scheme.

1. Orphanges and Women's homes 2. Institutions for physically handicapped/mentally retarded 3. Co-operative Societies where the amount is lent on the same terms and conditions as are applicable to State owned Corporations for the Welfare of SC/ST. 4. State Corporations for SCs/STs. GEOGRAPHICAL DIVERSIFICATION The two principal objectives of diversification are 1. improving core process execution, and/or 2. enhancing a business unit's structural position. The fundamental role of diversification is for corporate managers to create value for stockholders in ways stockholders cannot do better for themselves1. The additional value is created through synergetic integration of a new business into the existing one thereby increasing its competitive advantage.

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Forms and Means of Diversification Diversification typically takes one of three forms: 1. Vertical integration along your value chain 2. Horizontal diversification moving into new industry 3. Geographical diversification open up new markets

Means of achieving diversification include internal development, acquisitions, strategic alliances, and joint ventures. As each route has its own set of issues, benefits, and limitations, various forms and means of diversification can be mixed and matched to create a range of options.
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Vertical Integration integrating business along your value chain, both upstream and downstream, so that one efficiently feeds the other

Horizontal Diversification moving into more than one industry; the new business usually somehow relates to the existing one, although a few conglomerates instead pursue a strategy of unrelated diversification

Geographical Diversification moving into new geographical area to overcome limited growth opportunities in the local market and/or to gain global leadership positions

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BIBLIOGRAPHY
1. E. Gup Benton & W . Kolari James, Commercial Banking 3rd Edition,Singapore ,John Wiley &sons (Asia) ,2005 . 2. Shekher K C & Shekher Lekshmy , Banking theory and practice 19th Edition, NewDelhi, Vikas Publishing House ,2007 . 3. Natarajan S & Parameswaran, Indian Banking 5th Edition ,NewDelhi, Sulthan Chand &Co ltd ,2007 . 4. Maheswari S. N & Paul R R,Banking theory &practice 3rd Edition ,NewDelhi, Kalyani publishers,2006 . 5. Venugopalan , Banking theory and practice, Calicut , Feroke publishers , 2007 WEBSITES 1. www.banknetindia.com Date 20/10/10 2. www.mybankersbank.com Date 23/10 /10 3 http://www.rbi.org.in Date 23/10/10

4. http://www.realtor.org/subprime_lending. Date 25/10/10

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TOPICS

PRINCIPLES OF BANK LENDING - PROFITABILITY -SAFETY SECURITY PRIORITY SECTOR LENDING & GEOGRAPHICAL DIVERSIFICATION DIFFERENTIAL INTEREST RATE SCHEMES

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