Banks Lending

Elements of lending decisions

Increasing loan portfolio Maintaining loan quality Ensuring profitability Ensuring liquidity Regulatory requirements Capital constraint

Loan Policy
It is normally a written document authorized by Board It is a guideline for lending decision

Contents of loan policy

Loan objectives
Banks priorities among the conflicting objectives of liquidity, profitability, assets quality

Composition of loan portfolio by sectors, geographical areas, size of the loan etc Credit appraisal procedure Credit administration
It contains loan sanctioning power of officers at various hierarchical levels.

Contents of loan policy

Other matters
Type of collateral bank can accept as security Margin on various securities Credit monitoring system Credit to deposit ratio bank should maintain Loan agreement and method of communication of sanction Procedure for rescheduling / restructuring

Method of maintaining credit file for each loan a/c.

Credit appraisal procedure

Collecting basic information about the borrower and purpose of loan Financial appraisal
Past financial statements Cash flow statements Various ratios / net worth Various financial projections Collateral offered Qualitative measures like integrity of borrower

Credit appraisal procedure

Due diligence
Checking the details given by borrowers like address, borrowers workplace, industrial relations etc

Recommendation for acceptance or rejections of proposal

Sanction letter
Once the loan is sanction, borrower is informed by sanction letter which contains - Nature / type of credit facility - Interest payable - Repayment terms - End use of the loan / credit - Prime and collateral security - Details of personal / third party guarantee - Penal provision in case of default - Details of processing charges

Pricing of Loans
Loan pricing is different from product pricing because
Every loan has different risk profile Loan pricing is also influenced by relationship of borrower with bank (How far the borrower is profitable to the bank)

Loan price = Cost of funds + Servicing cost + Risk premium + Desired profit

Cost of funds
What is cost of funds?
Is it the average cost of the deposits and borrowings? Is it the cost of the fund bank has borrowed specially to finance particular loan?

It depends upon availability of funds with the bank and banks investment policy

Servicing cost
Cost incurred to provide service for credit and non credit facilities avails by the borrower For e.g. loan administration cost

Risk factor
Credit scoring is followed Credit scoring include following criteria and borrower is rated as per these criteria
Financial condition Availability of inputs / infrastructure Management efficiency Sources of alternate finance Extent of debt Business environment / Govt. policy Stability of income Types of collateral / guarantee

Profit margin
Based on expected return on equity It depends upon market expectations and shareholders required return