Loans and Advances– Banks extend credit to different categories of borrowers for a wide variety of purposes. Bank credit is provided to households, retail traders, small and medium enterprises (SMEs), corporate, Government undertakings, etc. in the economy.
Principles of Lending
- Safety: The repayment of loans depends on the borrowers’ capacity to pay. Hence, the banker has to be satisfied before lending that the business for which money is sought is a sound one. Bankers may insist on security against the loan on which they fall back on if repayment does not happen. The security must be adequate, readily marketable.
- Liquidity: To maintain liquidity, banks have to ensure that money lent out by them is not locked up for long time. Hence, they design a loan maturity period. If loans become excessively illiquid, it may not be possible for bankers to meet their obligations toward depositors.
- Profitability: To remain in business, a bank earns profit on its investment through appropriate fixing of interest rates on both advances and deposits.
- Risk diversification: To mitigate risk, banks should lend to a diversified customer base. This diversification is done with regard to of geographic location, nature of the business, etc.
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