After studying this chapter you will be able to understand: Basic lending principles, safety issues, diversification of risk, benefits of diversification, loans and advances, classification of loans, advances,...
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- The persistent failures of banks to lend sensibly in Pakistan and in many other countries have brought the question of Safety In lending to the fore;
- Why do banks persistently lend so
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‘ One essential problem is the human and managerial challenge of motivating
employees of banks to cater to the interest of the owners (Shareholders) of the bank - The history of banking Is replete with
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- In some countries, there are well-defined
market rates for bribes for obtaining loans
from banks
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* Another aspect of the problems of banks concerns prudent levels of leverage
- A bank ts a financial intermediary with
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- Leverage, at the level of the bank, is dangerous regardless of the quality of
credit analysis which has gone into each loan
- High leverage generates high risk and
high returns If high returns are obtained, the bank takes the profits but it Is
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- Regulators have tried many policy
Initiatives aimed at obtaining a banking system which has controlled leverage,
high quality lending and thus, a reduced risk of failure
- These include capital adequacy requirements based on clumsy
measurement of risk, prohibition of lending
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* Ariskless loan Is one that Is fully
collateralised using actively traded assets ‘ These assets should be traded objects so
that a ‘market to market’ can be done
daily, to ensure that the collateral is always larger than the outstanding loan
- The value of the asset that is measured
when marking to market should be the
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Diversification of Risk
‘ Diversification in banking has been a topic of discussion in the literature for decades - |t effects on performance, risk, efficiency
and firm value have been examined extensively
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Benefits of Diversification
- One of the most common benefits
associated with respect to diversification Is a lower cost of capital
- Banks, with some level of global
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Benefits of Diversification
- Furthermore, the potential for more
efficient internal capital markets Is another of cited benefit to diversification
- Another benefit associated with activity diversification is the ability to gain
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Benefits of Diversification
- An example might be bank which collects Information credit information on potential borrowers With this information, the bank may be able to offer these potential clients Insurance products or underwriting
services at a lower cost because much of the information needed has already been collected when evaluating the loan
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Benefits of Diversification
- Benefits associated with market power
have also been advanced The argument Suggests that banks may diversify their
activities or their operations geographically to gain or maintain market share
* Finally, an important benefit that has been proposed by some Is the ability for
Trang 20Loans and Advances
- Lending money Is one of the two major activities of any bank
- The bank acts as an intermediary between the people who have the money to lend
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‘ Aloan Is granted for a specific time period - Generally, commercial banks provide
Short-term loans But term loans, |.e loans for more than a year, may also be granted - The borrower may be given the entire
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- Loans are generally granted against or In exchange of the ownership (physical or constructive)of various type of tangible items
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- Bank loans can be classified as follows
according to the activity being financed; 1 Priority sector lending
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Priority sector lending
- The Government of Pakistan, through the instrument of SBP, mandates certain types of lending on the banks operating in
Pakistan irrespective of their origin
- SBP sets targets in terms of percentage (of total money lent by the banks) to be lent to certain sectors which, In Its
perception, would not have access to
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Priority sector lending
- This type of lending is called priority sector lending
* Financing of small industry, small
business, agricultural activities and export activities fall under this category
- This ts also called directed credit in the
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Commercial lending
- Commercial lending is the mainstay of Pakistan banking, its bread and butter activity
* Historically, this activity had been
relegated to a secondary position as
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Commercial lending
‘ Today, many banks focus on commercial lending for improving their bottom lines ‘ Fresh and innovative products are being
launched to facilitate the corporate customer who forms the core of this
business There Is big competition among banks to secure bigger share of this
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Commercial lending
- At present, commercial loans are available for practically any kind of activity and also for both long and short tenures
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* An advance is a credit facility provided by the bank to Its customers
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- Further, the purpose of granting advances is to meet the day-to-day requirements of business
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* Bank grant short-term financial assistance by way of;
1 Cash credit >» Overdraft
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Cash Credit
- Cash credit is an arrangement whereby the bank allows the borrower to draw
amount up to a specified limit
- The amount is credited to the account of the customer The customer can withdraw
this amount as when he requires The
interest Is charged on the amount actually
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Cash Credit
Cash credit is granted as per the terms and conditions agreed upon with the
customers This type of financing Is similar to a line of credit
Advances against the Security of Goods 2 Advances against Life Insurance Policies 3, Advances against Stock Market
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Cash Credit
4 Advances against Fixed Deposit Receipts 5 Advances against Book debts