Lecture Retail and merchant banking – Lecture 21

After studying this chapter you will be able to understand: Overdraft, discounting of bills, lending policies, evaluation of loan proposals, negotiable instrument.

Revise Lecture 21

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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

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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

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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

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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

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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

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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

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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

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proposals

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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

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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;

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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

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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

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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

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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

Lecture 22

• Negotiable Instrument

Negotiable Instrument

• 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

• 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

• 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

Negotiable Instrument

2 The transferee taking the instrument in

good faith and for consideration gets a good title to the same even though the title of the transfer is defective

Negotiable Instrument

• The essential characteristics of a

negotiable instruments are;

1 Payable to order or bearer:

• It must be payable either to order or

bearer

2 Freely transferable:

• An instrument payable to order is

negotiable by endorsement and delivery and an instrument payable to bearer is negotiable by mere delivery

Negotiable Instrument

3 Presumption as to holder:

• Every holder of negotiable instrument is

presumed to be holder in due course

4 Title of holder in due course:

• A holder in due course i.e the person who becomes the possessor of negotiable

instrument before maturity, for valuable

consideration and in good faith, gets the instrument free from all defects in the title

of transferor

Negotiable Instrument

5 Presumption as to considerations:

• Every negotiable instrument is presumed

to have been made, drawn, accepted,

endorsed, negotiated or transferred for considerations

Negotiable Instrument

Promissory notes

• According to the definition;

• A document of promise in writing by a

person to pay a certain sum of money

unconditionally to a certain person or

according to his order is called promissory note

Negotiable Instrument

• The characteristic features of a promissory note are;

1. A promissory note must be in writing,

duly signed by its maker and properly

stamped as per the Pakistan stamp Act

2. It must contain an undertaking or promise

to pay

3. The promise to pay must not be

conditional

4 It must contain a promise to pay money only

5 The parties to a promissory note, i.e the maker and the payee, must be certain

6 It may be payable on demand or after a certain date

7 The sum payable mentioned must be

certain or capable of being made certain It means that the sum payable may be in

figure or may be such that it can be

calculated

• A promissory note does not require any

acceptance because the maker of the

promissory note himself promise to make the payment

• There are primarily two parties involved in

a promissory note;

1. Maker / drawer

2. Drawee /payee

Negotiable Instrument

• In course of transfer of a promissory note

by payee and others, the parties involved may be the;

• The endorser: the person who endorses the note in favour of another person

• The endorsee: the person in whose favour the note is negotaited by endorsement