PRINCIPLES OF

LENDING

PRESNTED BY
PROF GOPAL
 PRINCIPLE OF
LENDING
• The business of lending, which is main
business of the banks, carry certain
inherent risks and bank cannot take more
than calculated risk
• whenever it wants to lend. Hence, lending
activity has to necessarily adhere to
certain principles.
• Lending principles can be conveniently
divided into two areas (i) activity, and (ii)
individual.
 lendin
g

Activit individual
y

5 ‘C’s of Proces
safet Security
liquidity the s of
y Appraisal
diversity stabilit profitability borrowe Lendin
y r g
 LIQUI
DITY
• Liquidity is an important principle of bank lending.
Bank lend for short period only because they lend
public money which can be withdrawn at any time by
depositors.
• They therefore advances loans on security of such
assets which are easily marketable and convertible
into the cash at short notice.
• A bank chooses such securities in its investment
portfolio which possess sufficient liquidity. It is
essential because if the bank needs cash to meet the
urgent requirement of its customers, it should be in
position to sell some of the securities at a very short
notice without disturbing their market prices much.
• There are certain securities such as central, states
and local govt. bonds which are easily saleable
 SAFE
TY
• The safety of funds lent is another principle
of lending.
• Safety means that the borrower should be able
to repay the loan and interest in time at regular
intervals without default.
• The repayment of the loan depend upon the
nature of the security, character of the
borrower, his capacity to repay and his financial
standing.
• Like other investment bank investments
involves risk but the degree of risk varies with
the type of the securities of the central govt.
are safer than those of the state govt. and
local bodies.
 DIVER
•
SITY
In choosing its investment portfolio a
commercial bank should follow the principle of
diversity.
• It should not invest its surplus funds in a
particular type of securities. It should choose the
shares and debentures of different types of
industries situated in different regions of the
country. The same principle should be followed
in the case of state govt. and local bodies.
• Its aim at minimizing risk of the investment
portfolio of a bank. it also applies to the
advancing of loans to varied types of firms,
industry, business and trades.
 STABI
• Another important
LITY
principle of bank’s investment
policy should be to invest in those stocks and
securities which possess a high degree of stability in
their price.
• The bank cannot afford any loss on the value of its
securities. It should therefore invest it funds in the shares
of reputed companies where the possibility of decline in
their prices is remote. Govt. bonds and debentures of
companies carry fixed rates of interest.
• Their value change with change in the market rate of
interest. But the bank is forced to liquidate a portion of
them to meet its requirement of cash in cash of financial
crisis.
• Otherwise they run to their full term of 10 years or more
 PROFITA
• BILITY
This is the cardinal principle for making investment by
a bank. Its must earn sufficient profits.
• It should therefore invest in such securities which
was sure a fair and stable return on the funds
invested.
• The earning capacity of securities and share depends
upon the interest rate and the dividend rate and the
tax benefits they carry.
• It is largely the govt. securities of the centre, state
and local bodies that largely carry the exemptions of
their interest from taxes.
• The bank should invest more in such securities rather
than in the shares of new companies which also carry
tax exemption. This is because shares of new
 SECURED
ADVANCES
• Cardinal principle of sound banking is to
ensure safety of funds lent by banker to his
customers.

• The banker therefore relies on primarily on

the 3 C’s of borrower.

• Secured advances are those advances which

provide absolute safety to the banker in
means of charge created on the tangible
assets of the borrower in favor of the banker.
 MODES OF CREATING
CHARGE :
LIEN
confer
• Section 171 of the Indian Contract Act the s
right of general lien on the banker.
• The banker is empowered to secure all securities of the
customers, in result of the general balance due from him.

• The ownership of stock securing is

not transferred from the customer to the
banker.
 NEGATIVE
LIEN
• The borrower gives a declaration to the
banker that his assets mentioned therein are
free from any charge or encumbrance.
• He also gives an undertaking that he shall not
create any charge or dispose them off
without permission of the banker.
• The borrower cannot dispose of the assets or
create any charge there on without the
consent of the banker.
 PLEDG
E
• Sec. 172 of the Indian Contract Act – 1872 defines
pledge as ‘bailment of goods as security
for payment of debt or performance of a promise.
• Pledge is used when the lender (pledgee) takes actual
possession of assets (i.e. certificates, goods ). Such securities
or goods are movable securities. In this case the pledgee
retains the possession of the goods until the pledgor (i.e.
borrower) repays the entire debt amount. In
case there is default by the borrower, the pledgee has a right
to sell the goods in his possession and adjust its proceeds
towards the amount due (i.e. principal and interest amount).
Some examples of pledge are Gold /Jewellery Loans,
Advance against goods,/stock, Advances against National
Saving Certificates etc.
• The person who offer security is called – PLEDGER
• To whom it is offered is called – PLEDGEE
 HYPOTHECATIO
• N:
It 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.
• 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
 MORTGAG
E:
• Sec. 58 of the transfer of property Act 1882
defines mortgage as –
• It 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.
• In this case transfer is called “MORTGAGOR”
• Transferee is called – “MORTGAGEE”
• Principle money & Int. thereon is called – “MORTGAGE
MONEY”
• Instrument is called – “MORTGAGE DEED”.
 FORMS OF
MORTGAGE
• Simple Mortgage
• Mortgage by condition sale
• English Mortgage
• Mortgage by deposit of title or
deed mortgage equitable
• Anomalous mortgage
 DIFFERENCE BETWEEN PLEDGE,
HYPOTHECATION AND
Pledge MORTGAGE
Hypothecation Mortgage

Type of Security Movable Movable Immovable

Possession of the Remains with lender Remains with Usually Remains with
security (pledgee) Borrower Borrower

Gold Loan,
Advance against Car / Vehilce Loans,
Examples of Loan NSCs, Adv against Adv against stock and Housing Loans
where used goods (also given debtors
under
hypothecation)
 PRIORITY
SECTOR
• Priority sector refers to those sectors of the
economy which may not get timely and
adequate credit in the absence of this
special dispensation.
• Typically, these are small value loans to
farmers for agriculture and allied activities,
micro and small enterprises, poor people for
housing, students for education and other
low income groups and weaker sections.
 CATEGORIES UNDER
PRIORITY SECTOR
• (i) Agriculture
• (ii) Micro and Small
Enterprises
• (iii) Education
• (iv) Housing
• (v) Export Credit
• (vi) Others
 TARGETS AND SUB-
TARGETS FOR
Categories BANKS
Domestic commercialUNDER
banks /
Foreign banks with 20 and above
Foreign banks with less
than 20 branches (As

PRIORITY
Credit Equivalent of Off-SECTOR
branches (As percent of ANBC or percent of ANBC or Credit
Equivalent of Off-Balance
Balance Sheet Exposure, Sheet Exposure,
whichever is higher) whichever is higher)
Total Priority Sector 40 32

Total agriculture 18 No specific target.

Advances to Weaker 10 No specific target.

Sections
 'DIRECT FINANCE' FOR
AGRICULTURAL
(i) Loans to individual farmersPURPOSES
[including Self Help Groups (SHGs) or
Joint Liability Groups (JLGs), i.e. groups of individual farmers]
engaged in Agriculture and Allied Activities, viz., dairy, fishery,
animal husbandry, poultry, bee-keeping and sericulture.
(ii)Loans to corporate including farmers' producer companies of
individual farmers, partnership firms and co-operatives of farmers
directly engaged in Agriculture and Allied Activities, viz., dairy,
fishery, animal husbandry, poultry, bee-keeping and sericultureup to
an aggregate limit of `2 crore per borrower.
(iii)Loans to small and marginal farmers for purchase of land for
agricultural purposes.
(iv) Loans to distressed farmers indebted to non-institutional
lenders.
(v)Bank loans to Primary Agricultural Credit Societies (PACS),
Farmers’ Service Societies (FSS) and Large-sized Adivasi Multi
Purpose Societies (LAMPS) ceded to or managed/ controlled
by such banks for on lending to farmers for agricultural and
 'INDIRECT FINANCE' TO
AGRICULTURE
(i) If the aggregate loan limit per borrower is more
than
`2 crore in respect of para. (4) (ii) above, the entire
loan will be treated as indirect finance to
agriculture.
(ii) Loans upto `5 crore to Producer Companies set up
exclusively by only small and marginal farmers
under Part IXA of Companies Act, 1956 for
agricultural and allied activities.

(iii)Bank loans to Primary Agricultural Credit Societies

(PACS), Farmers’ Service Societies (FSS) and Large-
sized Adivasi Multi Purpose Societies (LAMPS).
 ENTERPRISES
UNDER PRIORITY
SECTOR
• Bank loans to Micro and Small
Manufacturing and Service Enterprises,
provided these units satisfy the criteria for
investment in plant machinery/equipment
as per MSMED Act 2006.
Manufacturing sector

Enterprises Investment in plant and machinery

Micro Enterprises Do not exceed twenty five lakh rupees

Small Enterprises More than twenty fivelakh rupees but does not
exceed five crore rupees
Enterprises Investment in equipment

Micro Enterprises Does not exceed ten lakh rupees

Small Enterprises More than ten lakh rupees but does not exceed two
crore rupees
 LOAN LIMIT FOR
EDUCATION
UNDER
• Loans to individualsPRIORITY
for educational purposes
including vocationalSECTOR
courses upto `10 lakh for
studies in India and `20 lakh for studies
abroad are included under priority sector.
 UNDER
PRIORITY
• SECTOR
Loans to individuals up to `25 lakh in
metropolitan centres with population
above ten lakh and `15 lakh in other
centres for purchase/construction of a
dwelling unit per family excluding loans
sanctioned to bank’s own employees.
 UNDER
PRIORITY
Weaker Sections category:- SECTOR
• Priority sector loans to the following borrowers are considered under

(a)Small and marginal farmers;

(b) Artisans, village and cottage industries where individual credit limits do not
exceed `50,000;
(c) Beneficiaries of Swarnjayanti Gram Swarozgar Yojana (SGSY), now
National Rural Livelihood Mission (NRLM);
(d) Scheduled Castes and Scheduled Tribes;
(e) Beneficiaries of Differential Rate of Interest (DRI) scheme;
(f) Beneficiaries under Swarna Jayanti Shahari Rozgar Yojana (SJSRY);
(g)Beneficiaries under the Scheme for Rehabilitation of Manual
Scavengers (SRMS);
(h) Loans to Self Help Groups;
• (i) Loans to distressed farmers indebted to non-institutional lenders;
• (j) Loans to distressed persons other than farmers not exceeding `50,000
per borrower to prepay their debt to non-institutional lenders;
 THE RATE OF INTEREST
FOR LOANS
UNDER
PRIORITY
• The rate of interest on various priority
SECTOR
sector loans will be as per RBI’s directives
issued
from time to time, which is linked to Base
Rate of banks at present. Priority sector
guidelines do not lay down any preferential
rate of interest for priority sector loans