Lecture Retail and merchant banking – Lecture 20

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

Loans and Advances

Q: Classification of Loans are?

Loans and Advances

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

perception, would not have access to

organized lending market or could not

afford to pay the interest at the commercial rate

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

Classification of Loans 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

banks were driven by the desire to excel themselves in what is know as priority

sector banking

Loans and Advances

customer who forms the core of this

business There is big competition among banks to secure bigger share of this

business

Loans and Advances

Classification of Loans

Commercial lending:

• At present, commercial loans are available for practically any kind of activity and also for both long and short tenures

• Based on customer profile, these loans

are of two types;

1. Corporate loans

2. Retail loans

Loans and Advances

Loans and Advances

• An advance is a credit facility provided by the bank to its customers

• It differs from a loan in the sense that the latter may be granted for a longer period, but the former are normally granted for a short period of time

Q: Bank grant short-term financial assistance by way of?

Loans and Advances

• Bank grant short-term financial assistance

by way of;

1. Cash credit

2. Overdraft

3. Discounting of bills

Loans and Advances

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 withdrawn

Loans and Advances

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

1. Advances against the Security of Goods

2. Advances against Life Insurance Policies

3. Advances against Stock Market

Securities

Loans and Advances

Cash Credit

4 Advances against Fixed Deposit Receipts

5 Advances against Book debts

6 Advances against Real Estates

7 Advances against Supply Bills

Lecture 21

Loans and Advances

Loans and Advances

Overdraft

• 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

• 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

• 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

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

Loans and Advances

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

and monitoring

Loans and Advances

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 the expertise available with the bank

Loans and Advances

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

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

1. Industry cycle

2. Threat from substitutes

3. Shifts in consumer demands

4. Regulatory environment

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;

1. Operating margins

2. Stability and growth of market share

3. Access to key raw materials

4. Benefit from economies of scale

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;

1. Financial leverage

2. Cost of capital

3. Working capital management

4. Interest rate risk management

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