Chapter- 06

Management of Loan and

Advances
 *Loan
-If a bank gives its resources temporarily under
certain conditions and for a specific duration,
it will be called loan.
-According to the dictionary of Finance and
Banking, loan can be defined as, “the lending
of a sum of money by a lender to a borrower
to be repaid with a certain amount of
interest.”
 *Loan and Advances
• The loan refers to the amount borrowed by one
person from another.
• Advance on the other hand is a credit facility granted
by bank . Bank granted advance for short term
purpose. Such as purchase of goods trade in and
meeting other short-term trading liabilities.
• Thus a credit facility- repayable in installments over a
period is termed as loan.
• While a credit facility -repayable installments within
one year may be known as advance.
 *Loan Vs Investment
SL. Points of Loan Investment
No Differences
.
1 Transaction Debt transactions Mostly equity transactions
type
2 Contacts Direct Indirect and Impersonal
3 Knowledge of Known to lender, borrower Except debenture, not known in other
maturity period and other parties type of instruments.
4 Term May vary from several days Depends on the investment policy of
to even 40 years the bank
5 Negotiation Based on view of both Not negotiable
bankers and borrowers
6 Purpose of the Lending banks are expressly Instruments purchasing/investing
raised funds informed banks are not aware
7 Income sources Only interest and penal Dividends, right share, bonus share,
interest capital gain. Debenture-interest
In money lending, penal interest is punitive interest charged by a lender to a borrower if
installments are not paid according to the loan terms.
 Contd.
SL. Points of Loan Investment
No. Differences

8 Operation area Mostly within the Wider, both national and

command area international as well
9 Intensity and Except prime customer, Depends on the types of
extent of risk some default, most of the instruments, but less than
loan faced default risk loan
10 Volume of fund Except industrial loan most Vary from bank to bank
of the loan are smaller
volumes
11 Shift-ability Shift-ability Shift-ability is relatively easier
Very much difficult
12 Termination Successful termination Terminated at the willingness
depends on the willingness of the bank.
of the borrowers
 *Functions of bank loans
Functions of bank loans

Provided to Business
Provided to individuals organizations
a)Consumption loan a)Working capital loan
b)House loan b)Seasonal deficit loan
c)Automobile loan c)Economic cycle
d)Probate loan requirement loan
e)Education and Medical loan d)Asset replacement loan
f)Holiday tour loan e)Fixed asset acquisition
g)Wedding and Social loan
ceremony loan f)Bridge loan
g)Export-Import loan
*Classification of bank loans:
a)Based on users
I) Individual
-consumption
-housing
-education and medical loan
ii) Industry
Working capital loan Fixed capital loan

Distribution
One term
Installment
iii) Businessman
-working capital loan
- export – import loan
iv) Farmer
-non-crop loan
- crop loan
- farming equipment
v) Landless
-poultry/small business loan
- housing
- medical
b) Based on term
-short-term
- medium-term
- long-term
c) Based on security
-unsecured
- fully-secured
- partly secured
*Sources of credit information
Sources of information
Internal sources External sources

1. Filled in application
2. Interview Govt. or regulatory
3. Financial statements authority
4. Bank’s own record 1.Income tax
office/revenue board
Others 2.Govt. gazette
1.Inspection/Investigation 3.Record from the Govt.
2.Market report 3.Newspaper other office
4. Credit information bureau 4.Registrar from joint
5. Audit firm 6.Other bank’s record stock companies
7. Trade journal
8. Trade directories
*Characteristics of the business which usually gets
bank loan; Business with less
than average
profitability

Expanding
Repeat customers
businesses
Usual clients of bank
loan

Moderately young Relatively smaller

business houses business units
*Method of loan pricing;
# Loan price: The price of loan is the interest rate
the borrowers must pay to the bank, in addition
to the amount borrowed (principal).
Price of loan(interest rate charge) = Base rate +
Risk premium.
Component of base rate-
-Interest expense
- Administrative expense
- Cost of capital
Method of loan pricing;
a)Interest based pricing
 Variable rate:
=Caps and floors
=Prime times
=Quantity based
 Fixed rate:
=Prime rate
=General rate
b) Interest free pricing
 Compensating balance of deposit
 Fees, charges etc.
*Consideration of loan pricing;
a)Internal
 Amount of loan able fund
 Cost of bank fund
 Administrative and transactional cost
 Expenses for credit investigation and credit analysis
 Security maintenance expenses
 Supervision and collection expenses of loan
 Quantum and cost of risk
 Cost of default loan
 Bank-customer relationship
 Earning possibility from alternatives other
than lending
 Shareholder’s expectation of the rate of
dividend
b) External
Guidance of the Govt. and bank regulatory
agencies
Numbers of competitors and their capacity to
control the market
Nature of loan pricing by the competitors
Possibility of cost of raising funds through
other alternatives.
*Principles of sound lending
Principles of sound lending

Qualitative factors Quantitative factors

1. Purpose of the loan

2. Safety 1.Liquidity
3. Social responsibility 2.Profit and
4. Business ethics profitability
5. Spread and risk 3.Business solvency
diversification 4.Adequacy of the
6. National interest collateral
7. Recovery possibility
 *Bank loan policy
Bank loan policy is the compilation of some wise decisions,
which helps the loan officer in every steps of the loan
process to execute his/her duty efficiently and properly.
A bank's loan policy also establishes minimum credit
standards in booking new loans, policies and procedures
in treatment of past-due and delinquent loans, and
more generally, the type of customer a bank wants as a
borrower.
 *Steps in loan operations
1.Receiving loan application
a. Inviting and receiving loan
application
b. Checking whether the loan
applications are properly filled
in with all information required
3. loan/credit analysis
2.collecting loan information
a. Interview
b. Collecting statement of
accounts and other
information relating to the
business
c. Collecting related
information from other
sources

a. Analyzing the collected information

b. Making reports on the basis of credit or loan analysis
4. loan/credit final decision 5. loan documentation
a. Making decisions basing on the a. Preparation of loan
credit or loan analyzing agreement
b. Sanctioning or rejecting loan b. Collecting loan
application documentation
c. Determining securities and
other terms and conditions
through discussion

6. loan/credit agreement

a. Signing loan agreements by the bank and the loanee for

loan is sanctioned
b. Starting disbursement of loan / loan installment
7. Accounts of loan or credit transaction
a. Recording loan transaction
b. Making separate file for each of the loan cases

8. Review and monitoring of the loan agreement

execution
a. Giving notice of installment dues
b. Reporting on the periodical inspection of the business
units/factory of the loanee
c. Classification of the loans according to risks involved
9. Loan / credit recovery

a. Conducting loan recovery operations

b. Indentifying the problem loan
c. Taking legal steps against willful defaulters
*Credit analysis
The analysis of the eligibility for getting loan in the light of
applications.
Steps of credit analysis;
1. Collecting loan information of the applicant
2. Collecting business information for which loan is sought
3. Collecting the primary risk related information
4. Assembling all credit information together
5. Analyzing sensitive risky credit information
6. Analyzing refined and very essential risk information
7. Making decision on the basis of loan analysis
8. Design the appropriate loan structure according to the
positive decision.
*Different methods/ 5 C’s
1.Character
techniques of 2.Capacity
3.Capital
credit analysis; 4.Collateral
5.condition

CAMPARI
1.Character PARSAR
2.Amount Credit 1.Purpose
3.Means analysis 2.Amount
4.Purpose 3.Reason
5.Accountability 4.Sources of
6.Risk 5 R’s
repayment
7.Insurance 1.Responsibility
5.Ability
2.Reliability
6.Risk
3.Respectability
4.Resources
5.Return possibility
*Loan supervision activities
The process through which lending institutions disburse loan to the
right people, ensure proper use of the credit and more importantly
make the borrower capable to repay the loan by improving his
financial condition is called supervision.
Ways of loan supervision;
1. Personal contact
2. Periodical report
3. Financial reports
4. Trends of deposit balance
5. Collection of information from those having business
transaction
6. Collection of variation of statement of planned and actual
fund.
*Frequently used security in bank;
1.Personal surety
2.Immovable assets security
3.Pledge
4.Marketable securities
5.Documents of title of goods (Bill of lading,
railway receipt, truck receipt, warehouse receipt,
bill of exchange)
6.Certificate of fixed deposit
7.Insurance
8.others
 *What is problem/distressed loan
Loan can be divided into two types-
-Ideal loan
- Problem loan
Willingness to repay + ability to repay= Ideal loan
Unwillingness to repay + ability to repay= Problem loan
Willingness to repay + Inability to repay= Problem loan
Unwillingness to repay + Inability to repay= Problem loan
*Good loans Vs Problem loans
Sl Points of Good loans Problem loans
No differences
.
1. Meaning Repayments made Failed to make
on time repayment on time
2. Quantum of Generally the lion Not more than one-
loan share fourth of total loan

3. Repayment 100% repayment Partial adherence to the

schedule schedule is adhered repayment schedule
to, with approved
exception, if any
4. Nature of Most of the clients Unknown/ non-prime
clients are prime clients customer
Sl Points of differences Good loans Problem loans
No.
5. Partiality in sanction Sanction to the Relatives, friends,
right borrower recommended ones of
without any powerful person
nepotism
6. Nature of terms Mostly traditional Times, terms and conditions
and follow able are relatively strict and
difficult to follow
7. Credit analysis and
identification of right
borrower
8. Taking bold steps
9 Intensity of supervision
10. Security

11 Profit-loss
*indicators of problem loans ; page-196

*causes of problem loans; page-199

*Managing problem/distressed loan;
Steps to be taken for problem loans
A. legal steps through court
 General recovery suit
 Recovery suit by liquidation
B. Steps by bank itself
 Preventive steps
-discussion and advice
-arrangement of new loan
-additional collateral
-advice for inventory control
-accountability of loan officer
 Curative steps
-change of loan repayment schedules
-additional loan facilities
-adjusting financing structure
END OF the CHAPTER