Lecture Retail and merchant banking – Lecture 21

Revise Lecture 21


Loans and Advances

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Overdraft


Loans and Advances
Overdraft
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Overdraft also is a credit facility granted by
bank.
A customer who has a current account
with the bank is allowed to withdraw more
than the amount of credit balance in it.
It is a temporary arrangement


Loans and Advances
Overdraft
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Overdraft facility with a specified limit may
be allowed either on the security of assets
or on personal security, or both.
If there is a prior agreement with the
account provider for an overdraft
protection plan and the amount overdrawn
is within this authorized overdraft, interest
is normally charged at the agreed rate.


Loans and Advances
Overdraft
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If the balance exceeds the agreed terms,
fees may be charged and higher interest
rate apply.
Overdraft is an efficient form of borrowing
as the customer pays interest only for the
time he uses the money. It gives him
flexibility.


Loans and Advances

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Discounting of Bills


Loans and Advances
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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

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Lending Policies


Loans and Advances

Lending Policies
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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
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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
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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
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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
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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

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Evaluation of Loan
proposals


Loans and Advances
Evaluation of Loan proposals
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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
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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:
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It needs to be performed to study the

prospects of the industry and it most
importantly includes a study of the

1.

Industry cycle

2.

Threat from substitutes

3.

Shifts in consumer demands


Loans and Advances
Evaluation of Loan
proposals
Operational Efficiency:
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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:
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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;

1.

Financial leverage

2.

Cost of capital


Loans and Advances
Evaluation of Loan proposals
Management Evaluation:
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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.


Lecture 22


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Negotiable
Instrument


Negotiable Instrument

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The term ‘negotiable instrument’ consists
of two parts, viz, ‘negotiable’ and
‘instrument’.
The word ‘negotiable’ means ‘transferable
by delivery’ and the word ‘instrument’
means ‘written documents by which a right
is created in favour of some person’


Negotiable Instrument

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It means an instrument possessing the
quality of negotiability is entitled to be
called a negotiable instrument.
In other words, negotiable instruments are
documents meant for making payments,
the ownership of which can be transferred
from one person to another many times
before the final payment is made.


Negotiable Instrument

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A negotiable instrument must possess two
features;

1. The right of ownership contained in the
instrument can be transferred from one
person to another by mere delivery if it is
payable to bearer, or by endorsement and
delivery if payable to order.