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After studying this chapter you will be able to understand: Loans and advances, classification of Loans are? advances, bank grant short-term financial assistance by way of? Overdraft, evaluation of loan proposals.
Revise Lecture 20 • Loans and Advances Loans 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 and those need money to carry out business transactions Loans and Advances • • • A loan is granted for a specific time period Generally, commercial banks provide short-term loans But term loans, i.e loans for more than a year, may also be granted The borrower may be given the entire amount in lump sum or in installments Loans and Advances Q: Some of the securities against which the banks lend are? Loans and Advances Commodities Debts Financial instruments Real estate Automobiles Consumer durable goods Documents of title Loans and Advances Q: Classification of Loans are? Loans and Advances Classification of Loans • Bank loans can be classified as follows according to the activity being financed; Priority sector lending Commercial lending Loans and Advances Classification of Loans 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 Loans and Advances Classification of Loans 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 is also called directed credit in the Pakistan banking system Loans and Advances • Discounting of Bills Loans and Advances • • • Banks provide short-term finance by discounting bills, that is, making payment of the amount before the due date of the bill after deducting a certain rate as discount The party gets the funds without waiting for the date of maturity of the bills In case any bill is dishonoured on the due date, the bank can recover the amount from the customer Loans and Advances • Lending Policies Loans and Advances Lending Policies • • While lending decisions are crucial for a bank, it is neither feasible nor desirable for the top management to review and clear every single loan proposal that the bank receives Furthermore, for most of the loan proposals, whichever industry they may belong to, the modus operandi remain the same, analyzing, selecting, sanctioning Loans and Advances Lending Policies • • Hence the top management needs to set the standards Standards relating to the exposure limits for individual / company/ industry, credit quality of the borrowers, lending rate, risk level, etc, enable decentralized decision making by the lending officers Loans and Advances Lending Policies Volume of Loans • • The policy should specify the targeted composition of the loan portfolio, such composition being in terms of industry, location, size, interest rate or security Decisions regarding the loan portfolio will depend on the size of the bank, the credit requirements in its operational areas and Loans and Advances Lending Policies Geographical Distribution • • There are various locations from where a bank conducts its operations Of these locations, some may be weak credit demand areas with a considerably high deposit potential and vice versa Loans and Advances Lending Policies Geographical Distribution • • While operating in any area, the bank should have the requisite funds and expertise to meet the credit demands The policy should, thus, state the key trade areas of the bank for extending credit Loans and Advances • Evaluation of Loan proposals Loans and Advances Evaluation of Loan proposals • • The policy document shall specify a process for evaluation of loan proposals, which will enable uniform evaluation across areas / people Evaluation involves a careful selection of the borrowers by understanding their creditworthiness Loans and Advances Evaluation of Loan proposals • • While evaluating the proposal, bank should assess not only the ability of the client to pay back the loan but also his willingness to repay They need to consider the following variables while evaluating a loan proposals; Loans and Advances Evaluation of Loan proposals Industry level credit analysis: • It needs to be performed to study the prospects of the industry and it most importantly includes a study of the Industry cycle Threat from substitutes Shifts in consumer demands Loans and Advances Evaluation of Loan proposals Operational Efficiency: • The company level credit rating is conducted to assess the operational efficiency of the client company The critical aspects that are to be evaluated in this process fall into the following categories; Loans and Advances Evaluation of Loan proposals Financial Efficiency: • Repayment of the loan by the clients depends greatly on their financial soundness Hence financial analysis becomes an imperative part of credit risk analyst It includes an analyses of; Financial leverage Cost of capital Loans and Advances Evaluation of Loan proposals Management Evaluation: • • The management evaluation throws light on the willingness of the client to repay It includes a study on the performance of the promoter, top management and also the performance of group companies under the same management ... kind of activity and also for both long and short tenures Based on customer profile, these loans are of two types; Corporate loans Retail loans Loans and Advances • Advances Loans and Advances •... belong to, the modus operandi remain the same, analyzing, selecting, sanctioning Loans and Advances Lending Policies • • Hence the top management needs to set the standards Standards relating to the... mainstay of Pakistan banking, its bread and butter activity Historically, this activity had been relegated to a secondary position as banks were driven by the desire to excel Loans and Advances Classification