Types of Bank Financing

Principles of Good Lending

1. Safety 2. Liquidity 3. Profitability

1. Safety
Banks

Deposits

Loans and Advances

Borrower should be certain Utilisation should be correct Security should be easily realisable

2. Liquidity
Liquidity refers to the ability of an asset to convert into cash in short time. Bank
Repayment

Borrower

Repayment

Depositor Repayment must be made on time. Source of Repayment must be definite.

3. Profitability
Expenses of Banks
Pay Interest on Deposits Meet Expenses Provide Depreciation Declare Dividends, etc.

Expenses

Earn Profit for its Survival Lending rate is decided

Profits
Lending Rate

What is Loan Policy?

Lending decision is based on:
Amount of Credit The industries to be focused on The Geographic Area Type of Credit to offer The amount and the type of Security Type of proposal to finance Repayment schedule

A Policy Document which goes into all these areas is called as Loan Policy of Bank.

 Loan Policy provides a framework for Bank Lending. It should be Revised from time to time.

Loan Pricing
Loan Rate = Cost of Funds + Margin (including expenses and risk) Objective of Loan Pricing:
1. Maintaining Margins 2. Balancing Risk Reward Profile 3. Ensuring Market Rates

Rate of Interest can be Fixed or Floating Prime Lending Rate Benchmark rate

Credit Risk
Credit Risk is the risk of non-payment of the loan by the borrower. Three principles of credit risk:
Credit Evaluation Pricing of the Credit Monitoring of Credit

Management of Credit Risk is very important.

Mode of Creating Charge on Assets

Secured Advances : Lend Money on security of Tangible Asset like Land & Bldg. Mode of Creating Charge on above Assets: 1. Lien 2. Pledge 3. Mortgage 4. Hypothecation 5. Assignment

1. Lien
Bank
Retain The Property Until, debt is repaid

Property

Right of Bank to Retain the Properties belonging to the Borrower until the debt due is repaid. No Ownership, Only Possession No power to sell the goods Bank can retain all securities of customer in respect of the balance due from customer

2. Pledge
Bank (Pledgee)
Goods Returned on Repayment

Borrower (Pledger)

Movable Goods (Shares) A pledge occurs when goods of movable nature are delivered to the bank and goods pledged will be returned to the borrower on the repayment of loan.

3. Mortgage
Bank
Transfer of Interest No Possession Immovable Property

Transfer of immovable property for securing the loan. Possession and Ownership remains with the borrower. There is Transfer of Interest Eg. Land and bldg, plant and machinery. Mortgage deed is created.
Legal Mortgage-Transfer to Legal Title by paying Stamp Duty and Registration Charges Equitable Mortgage Transfer of Documents to Title Only

4. Hypothecation
Bank

Mortgage No Possession, No Ownership Movable Property

Mortgage of Movable property for securing loan. No Ownership or No Possession is passed to bank. Eg. Goods, Vechiles, Raw Material Banker can inspect the goods anytime

Lien
Bank Retains the Property No Ownership Only Possession

Pledge
Goods are Delivered to Bank No Ownership Possession is Compulsory Movable Property Eg. Share, Debentures, Securities

Mortgage
Transfer of Property

Hypothecation

Mortgage of Movable Property No Ownership

Transfer of Interest
No Possession Immovable Property E.g. Land & Bldg, Machinery

Movable and Immovable Property

E.g. Goods, Plant & Mach

No Possession
Movable Property E.g. Goods, Vehicles

5. Assignment
Bank (Assignee) Borrower (Assignor)

It is the transfer of any Existing or Future right Property or Debt by the borrower to the bank for loan. Actionable Claims e.g Debtors, Insurance Claims, Fixed Deposits

Actionable Claims (Debtors)

Types of Lending
Fund Based Lending Physical Outflow of Funds Non- Fund Based Activities / Services No Physical Outflow of Funds Fund Position remains Intact

Fund Position Changes

Services provided by the Banks as agent

Fund Based Lending: Types of Bank Loans

1. 2. 3. 4. Term Loans Cash Credit Overdraft Bill Discounting

1. Term Loans
Bank
Lumpsum amt is given Borrower

Lumpsum amount is given to the borrower for a certain period at an Credited to agreed rate of interest. Current A/c Interest is charged on full amt. Loan is repaid in installments
Issue Cheques

Types of Term Loans

1. Short and Medium Term Loans:
Granted for a period of 1 to 5 yrs. Interest is charged on total amount sanctioned Mostly given to meet working capital requirements

2. Long Term Loans:

Granted for more than 5 yrs. Loan Policy is made to protect the interest of banks. Time gap between Date of Sanctioning and its Disbursement

 Bridge Finance Loans from Commercial Banks to bridge the time gap for term loan from Financial Institution
Short term loans are taken to prevent delay in projects Its secured against mortgage of fixed assets.

Loan Syndication Two or More banks come together to finance a particular project.
Lead Bank co-ordinates with other Banks/FIs.

2. Cash Credit
Borrower is allowed to borrow money upto a certain sanctioned limit He can draw the loan as and when required. Withdrawals and Deposits can be made frequently. Interest is charged only on the withdrawn amount and not the loan amount sanctioned.

3. Overdraft
Is the facility to withdraw over and above the credit balance of current account. Account holder is permitted to withdraw and repay any no. of times up to the sanctioned limit. Interest is charged only on the amount overdrawn by the Borrower

4. Bill Discounting
Banks grant loans to customer by discounting the Bill of Exchange. Amount of bill after deducting the discount is credited to the account. Collects full amount from the Drawee of bill

Non-Fund Based Services

1. Collection of Cheques, Bills and Promissory Notes:
Deposit into the Customers A/c These Services are provided free of Charge

2. Collection of Dividend and Interest

Amount is credited to customers account

3. Execution of Standing Orders

To pay Rent, Telephone Bills, Loan Installments or more recurring payments

4. Remittance of Funds (Transfer of Funds)

a. Bank Drafts b. Mail Transfer c. Telegraphic Transfer

a. Bank Draft
Bank Branch1
Mumbai Issues Drafts

Commission is Charged

Customer
Sends by Courier

Bank Branch2
Delhi

Encashment

Payee

Bank draft is an order from one branch to another branch of the same bank to pay a specified sum of money to a person named therein.

b. Mail Transfer Bank sends money through the post. Bank transfers money through the post to any person at any place where bank has a branch c. Telegraphic Transfer The money is transferred urgently through telegraphic transfer. Payment of Nominal Charge

5. Safe Deposit Vault

Customers are given safe deposit lockers To keep their Valuables and Documents on Hire basis.

6. Issue of Letter of Credit (LC)

Importers and Exporters use this service of payment. Issue of LC Importer Issuing Bank (Buyer)
Letter of credit is issued by bank on request of buyer of goods or the Importer.

Exporter (Seller) Payment is made by bank to the seller on production of document mentioned on the letter.

7. Automated Teller Machine (ATM)

ATM card i.e. a plastic card is issued to a Saving and Current account holder To Withdraw or Deposit money At any Point of Time
Take Cash Upon Insertion of a Plastic Card

8. Tele Banking
Customers can access their accounts for Information or Transaction. Dial the Tele-Banking Number Enter the PIN

9. Internet Banking
Access to account Information and Transaction is given to customer Through world wide web network with the help of a PIN provided.

E.g. Air Reservation, Payment of Bills, Transfer of Money

10. Credit Cards

Credit cards are plastic cards issued to Account holders to buy Goods and Services from various Merchants. Bank makes the Payment to Seller Cardholder pays back over a specific period

11. Merchant Banking

Services relating to: Capital Market Finance to Companies E.g. Mutual funds, Raising Funds from Capital Market, M & A

Foreign Exchange
Foreign Exchange = Foreign Currency Currency of one Country is converted into Other Countrys Currency Transactions among the Residents of different Countries Encourages Foreign Exchange such as, Trade, Investment, Tourist, etc.

Foreign Exchange Market

Market for Purchase and Sale of Foreign Currencies Trading takes place through electronically linked network of banks, foreign exchange brokers and dealers Here, one currency is traded with another currency Facilitates International Trade and Investments

Participants in Foreign Exchange Market

1. Central Banks and Treasuries:
They carry out Buying and Selling of Countrys Foreign Exchange Reserves in order to alter the Exchange Rates (Intervention) 2. Foreign Exchange Dealers:
Banks and Non- Bank Agencies are important Participants They trade i.e. Buy and Sell foreign currency on continuous basis and earn Profits

3. Foreign Exchange Brokers:

They are Commission Agents Information on Rates of Exchange 4. Individuals and Firms:
International Firms Exporters, Importers, Multinationals, Tourist and more use foreign currency to facilitate transactions.

5. Speculators and Arbitragers:

They earn Profit through changes taking place in the exchange rates.

Types of Transactions
1. Spot Transaction 2. Forward Transaction 3. Swap Transaction

Spot Transaction
Interbank Purchase & Sale Immediate Delivery

Forward Transaction
Exchange of Currency

Swap Transaction
Simultaneous Purchase and Sale Different Value Dates Given Rate with one Party

Future Date

Spot Rate

Forward Rate

Foreign Exchange Rates

The price of One Currency expressed in Terms of Another Currency Statement to buy or Sell at a Specified Rate and Value Date is Called As Foreign Exchange Quotation Types of Quotations: 1. Inter-bank Quotation 4. Bid Quotation 2. Direct Quotation 5. Ask Quotation 3. Indirect Quotation

1. Inter-bank Quotation
Quotations stated by Banks trading in foreign exchange. Methods of Expression of Foreign Exchange Rates: American Terms Its expressed in terms of one U.S. dollar. Eg. $0.02174/Re 1 European Terms foreign currency rate is expressed in U.S. dollars. Eg. Rs 50/$1

2. Direct Quotation
Home Currency for a Unit of Foreign Currency Foreign Currency is kept Constant European Terms Eg. Rs.50/$1

3. Indirect Quotation
Foreign Currency for a Unit of Home Currency Home Currency is kept Constant American Terms Eg. $0.02174/Re. 1

4. Bid Quotation
Quotation in one Currency at which a dealer can Buy another Currency Bid price is less than Ask Price

5. Ask Quotation
Quotation in one Currency at which a dealer can Sell Another Currency Ask Price is more than Bid Price

Bid Price of Rs. 46/1$

Ask Price of Rs. 48/1$

Export Financing

Export Order

Mostly Credit Basis Order

Exporters Need Finance

Credit required

Export finance means the Credit required by Exporters for financing their Export Order

Import Financing
Importers also need finance for making payments for their imports.
Credit

Short Term

Long Term

30 days to 180 days

5 yrs to 20 yrs

Commercial Banks

ECGC, IDBI, Exim Bank

Types of Export Finance

1. Pre-Shipment Finance 2. Post-Shipment Finance

Pre-Shipment Finance
Finance required to meet various expenses before Shipment of Goods is called PreShipment Finance. Working Capital Finance provided before Shipment
Purchase Processing Manufacturing Packing

Also Known as Packing Credit

Features of Pre-Shipment Finance

1. Purpose: granted for specific purpose only. 2. Eligibility: granted only who produces a confirmed export order and or letter of credit in his own name. 3. Form of Finance: can be Funded or nonFunded Advance. 4. Amount of Finance: Depends on the
1. Amount of Export Order 2. Credit Rating of Exporter

5. Period of Loan:
5. Not Exceeding 180 days 6. Extension of additional 90 days may be Given

6. Rate of Interest:
5. 10% for 180 days, 6. 13% for upto 270 days 7. 2% extra, if loan remains unpaid till 360 days.

7. Documentary Evidence:
5. Evidence of Irrevocable Letter of Credit or 6. Confirmed export order

8. Security: provide personal bond from sureties known to the bank.

9. Loan Agreement: Exporter needs to sign the Loan Agreement 10.Maintenance of Accounts: separate account has to be maintained for pre-shipment advance.

Post Shipment Finance

Finance provided after the Shipment of Goods is called as Post Shipment Finance It bridges the gap between Date of Shipment and actual receipt of Payment.
To pay Freight and other Shipment Expenses. To pay Insurance Premium on shipment. To Participate in Fairs and Exhibition. To pay to Overseas agents. To pay various authorities like customs, port, inspection, etc.

Features of Post Shipment Finance

1. Purpose:
Date of Shipment
Working Capital Needs Realisation of Export Proceeds

1. Eligibility: only to Exporters who have Actually Shipped the Goods. 2. Form of Advance: Discounting the Export Bill 3. Amount of Advance: upto 100% of invoice value of goods exported

5. Period of advance:
5. Short term period - 90 days 6. Medium term - upto 5 yrs 7. Long term - 5 to 12 yrs.

6. Rate of Interest:
5. Short term rate of interest - on concessional rate 6. Medium and long term rate of interest RBI Directives

7. Documents: Documents evidence of Shipping Bill, Mates Receipt, Export bill, etc. 8. Loan Agreement: Make a loan agreement wit the bank.

Bank Backbone of Trade

International Trade- Vital Sector of Economy Financial Assistance to Export Sector at Lower Rate of Interest. New Schemes by Commercial Banks and FIs RBI relaxations in lending

Rural Financing
Agriculture is the backbone of Indian Economy.
Total Work Force

35% 65% Agriculture Others

Agriculture provided Employment to 65% of Total Work force in the Country

Rural Credit means Credit to Farmers

Source of Rural Credit in 1951

Institutional 7%

Source of Rural Credit

NonInstitutional 93%

Non- Institutional i.e. Moneylenders used to charge 18% to 50% rate of Interest Therefore, there was a need for Expansion of Institutional Credit

Expansion of Rural Credit

Co-operative Credit Societies Commercial Banks Regional Rural Banks NABARD

Rural Credit
Classified on the Basis of Time and Purpose: Categories on the basis of Time:
Short Term Credit
< 15 months Seeds, Fertilizers, Pesticides, Wages Money Lenders and Co-operative Societies Medium Term Credit 15months to 5 yrs. Purchase of Cattle, Equipments and Repairs of Well Co-operative Societies Long Term Credit Credit > 5 yrs For Improvement of Land, Digging Tubewells Commercial Banks

 Categories on the Basis of Purpose:

Productive Consumption Unproductive

Credit for Seeds, Fertilizers, Equipments, Wages Repaymentno problem

Credit for Own Consumption Draughts, Floods Banks give no Loans

Credit for social needs Marriages, Religious Functions, Festivals. Moneylenders

Institutional Structure of Rural Credit

Co-operative Credit Societies Commercial Banks Regional Rural Banks
NABARD

Co-operative Credit Societies

State Central
Primary

Primary Agricultural Credit Societies (PACS)

Started with Ten or more persons in the Village Value of each share is Rs 10 or Rs. 100 President, Secretary and Treasurer Staff members for day to day Functions Short term Loans upto 1 yr @ 10 to 12% Dividends were given to members Surplus was used for welfare of village people Failure Provide not only credit but also agricultural inputs and technical guidance to members.

Central Co-operative Banks

District Level Private individuals as shareholders who provide a. Finance and b. Management Objective: Lend PACS and Attract deposit from general public. Face problem of over staffing, inefficiency, losses, heavy overdues Takes assistance from state co-operative banks

State Co-operative Banks

Apex of the structure of each State 28 State Co-operative Banks with Branches in Country Obtain funds from a. Share Capital, b.Reserves, c.Deposits from General Public, d. loans and advances from NABARD NABARD constitute 50 to 90% of the working capital Advance loans to Central Co-operative Banks and coordinate and regulate its working Link between RBI and Central and Primary Co-operative Banks

Commercial Banks
Other Loans by Commercial Banks 5% Ancilliary Activities 15% Short Term Loans 45%
Term Loans 35%

Increased Branches to Rural and Semi-Urban Areas Started giving Loans to Farmers

Commercial Banks
IRDP Indirect Financing to Co-operatives
Marketing and Processing of Agricultural Produce Activities ancilliary to Agriculture Manufacturing firms e.g. pump sets, machinery Procurement, Storage and Distribution of Foodgrains

Rs. 50,000 Crores Next four yrs Budget of Banks

RBI Norms
1. Credit norms and scales of finance:
Finance to Marginal Farmers too

2. Margin of security:
Keep low margins on loans. Only 25% of Margin on the Loans

3. Securities against loans to cultivators:

Loans are production oriented. Hypothecation of crops as security for short term loan.

4. Recovery of Defaults:
Setting up of Rules and Procedure in case of crop failure.

5. Need for co-ordination:

No duplication of the Person and Security.

7. Regional and Rural Banks

Agriculture
Trade Commerce

Industry
Extending Credit to Farmers, Labourers, Artisans and Small Entrepreneurs.

Share Capital of RRB

Share Capital of RRB

Commercial Banks 35% State Government 15%

Central Government 50%

RRB vs Commercial Banks

RRBs are different from Commercial Banks: Area of RRBs are limited to specific region Grant direct loans and advances only to small and marginal farmers, rural artisans and labourer. Lending rate will be equal to prevailing lending rate of cooperative societies Many subsidies and concessions are provided Refinance facilities through NABARD.

Problems faced by RRB

Many RRBs have incurred substantial losses. Problems faced by RRBs, according to Narsimhan Committee:
RRBs have low earning capacity Increase in salaries and wages of employees lead to Higher Cost Area of operations is not clear

Short term Measures for RRBs:

Short term measures to improve RRBs:
RRBs are given freedom to open extension counters. Freed from service area obligation Increase non-target group financing from 40 to 60%. Relocate loss making branches Give loans to non-priority sector purposes Upgrade their activities to cover non fund activities.

NABARD
At Apex Level for Agricultural Credit To take over Agricultural Credit and Refinance Function of ARDC NABARD draws funds from Govt of India, RBI, World Bank and other agencies.

Capital

by RBI

by GOI

Appoints Chairman

Appoints 3 BOD

NABARD
NABARD is the single integrated agency for meeting the credit needs of all types of agricultural and rural development activities.

NABARD

Functions of NABARD
Apex Institution
Credit Requirements of Rural sector Supervise and Inspect the functioning of Cooperative Sector Co-ordinate the activities

Refinance Institution
Provide Short term credit Provide Medium term Credit Provide Long Term Credit Maintain funds for R&D

Activities of NABARD
NABARD is playing an energetic role in strengthening and reorganizing the cooperative structure in the country. Catalyst and promoting Self Help Groups (SHG) Provides grants to NGO. Introduced Kisan Credit Card.

Bank Guarantee
A contract to perform the promise or discharge the liability of a third person in case of his default.

Principal Debtor

Creditor

Bank Guarantee
Surety (Bank)

Types of Bank Guarantee

1. 2. 3. 4. Financial Guarantee Performance Guarantee Deferred Payment Guarantee Shipping and Railway Guarantee

1. Financial Guarantee: Bank guarantees its customers creditworthiness and his capacity to take up financial risks. They are for:
1. Tender Deposit 2. Excise duty or Custom Duty.

2. Performance Guarantee: Bank guarantee obligations relating to technical, managerial, administrative experience and capacity of the customer. Areas covered are:
1. For performance of machinery/goods supplied. 2. For satisfactory performance of turnkey projects.

3. Deferred Payment Guarantee:

Payment of specified amount over a period of time. Bank guarantee to the equipment manufacturer on behalf of its client
Equipment Manufacturer

Client
No Loan

Bank Guarantee

Bank

3. Shipping and Railway Guarantee:

Guarantee when the shipping documents are not received but the ship carrying the goods has arrived. The shipping company agrees to deliver the goods against the production of a bank guarantee.
Shipping Documents

Client

not Arrived

Shipping Company

Bank Guarantee

Bank

Prudential Norms
Prudential Norms are guidelines or norms on:
1. Income Recognition 2. Asset Classification 3. Provisioning regarding Non Performing Assets

What are Non Performing Assets? (NPA)

Loan

NPAs

Not Recovered

No Principal

No Interest

NPA- Non-Performing Asset is the loan amount which is not recovered from the borrower.

An asset, including a leased asset, becomes NPA when it ceases to generate income for the bank

Which Assets can be Termed as NPA?

1. Term Loan: Interest or Installment remains overdue for more than 90 days. 2. Overdraft:
a. the account remains out of order

Outstanding Balance > Sanctioned Limit

b. Outstanding balance < Sanctioned limit but no credits continuously for 90 days

3. Bills Discounted : the bill remains unpaid for more than 90 days.

4. Short duration crop Loan : Principal or Interest remains overdue for one crop season 5. Other Accounts: an amount to be received remains overdue for a period of more than 90 days. E.g. Derivative Transactions, Securitisation Transaction.

Assets Classification
Classification of NPAs: Sub-standard Asset : asset remains NPA for <= 12months. Doubtful Asset: Asset remains NPA for > 12 months. Loss Asset: NPA not Written off

Provisions of NPA

Asset Classification

Provision Required

1. Standard Assets

a. Direct advance to Agriculture and SME sector - 0.25% b. Commercial Real Estate Sector 1.00% c. Other Advances 0.40%

2. Non-Performing Assets: (overdue more than 90 days) a. Substandard (NPA upto 12 months)

a. 10% on Secured advances 20% on Unsecured advances

b. Doubtful (NPA for more than 12 months)

b. Secured upto 1 yr 1-3yrs Above 3 yrs Unsecured

20% 30% 100% 100%

3. Loss Assets:

100% Provision required

Income Recognition
In an account which has been categorised as NPA;
Fees, Commission and Similar income accrued during the year should be derecognised.

Income should be not be recognised on Accrual basis, but on realisation on cash basis

From the following information, find out the amount of provisions required to be made in the profit and loss account of Lord Krishna Bank Ltd. for the year ended 31st March, 2012

Advances Standard Sub-Standard (Secured) Doubtful Assets(Secured) Upto 1 year 1-3 years Above 3 years Loss Assets

Rs. Lakhs 300 200 90 60 40 30

From the following information, calculate the provision to be made against for NPA as on 31/3/2012 (Rs. Lakhs) Cash Term Bills Purchased Particulars Credits Loans and Discounted Standard 100 90 20 Sub-Standard 12 10 3 Doubtful Assets Upto 1 year 10 20 1-3 years 13 50 Above 3 years 5 60 Loss Assets 3 Total 143 230 23
Term Loans (Standard) includes Rs. 10 Lakhs for SME Sector and Rs. 20 Lakhs for Commercial Real Sector. All Sub-Standard Assets are Secured