How to create sound lending? Discuss the principles of sound lending.
What is Sound Lending?
Sound lending means providing loans in a safe and responsible manner. It is based on sound borrowers, sound business practices, sound credit officers, sound credit standards, a sound regulatory framework, and the unbiased application of law.
How to Create Sound Lending?
Banks can create sound lending by prudent selection of borrowers. The bank should conduct a rigorous assessment before approving the loan. It should complete flawless loan documentation. The bank should also obtain sufficient and appropriate support from all concerned authorities.
Principles of Sound Lending
Have a look at the principles of sound lending:
Safety:
A bank lends money received from depositors. It must ensure the safety of that money. Safety depends upon-
- The security offered by the borrower, and
- The repaying capacity and willingness of the debtor to repay the loan with interest.
Liquidity:
Liquidity means the ability to convert assets into cash quickly without loss. Bank liabilities are repayable on demand or at short notice. So the bank must keep funds in a liquid form and prefer short-term lending against marketable securities.
Profitability:
Banks earn profit to pay interest to depositors, declare dividends to shareholders, and meet operating expenses. The main source of profit is the difference between interest earned on loans and interest paid on deposits. The bank must deploy funds to generate adequate returns.
Productive Purpose:
A banker must enquire about the purpose of the loan. Banks should refuse loans for undesirable activities such as speculation and hoarding. The bank should ensure the loan is for a productive and economically viable purpose.
Security
Security can be categorized into two types:
- Personal/Intangible Security: Borrower’s Liability, Guarantee of respectable third party
- Tangible Security: Primary Security, Collateral Security
Diversity of Advances:
The bank should not lend a large portion of funds to a single borrower, industry, or region. Concentration increases risk. It is good to spread loans to a large number of borrowers across different sectors and regions.
National Interest:
In modern banking, the purpose of the advance, the viability of the project, and the national interest are gaining importance. Loans to agriculture, small industries, and export-oriented industries serve the national interest even if security is limited.
Credit Operations & Management, Module: B, 7th Exam 2(a), 5th Exam Q3(c)
