Bank advances and loans

Lending business is a risky activity. As  banks' main function is lending, they must follow certain principles in order to protect their funds. The basic principles that  banks follow while lending are....

1.safety: Banks need to consider the borrowers capacity to pay, willingness to pay , and income generation of the person or business entity . This is a safety check that bank needs to consider while lending

 

2.Liquidity: Lent amount is to be paid in proper repayment schedules and inflow towards the loan or advance must be proper in order to fulfil the demand of their depositors

 

3.Profitability: The activity of lending is done in order to make some profit out of it.

 

4.Purpose: The loans must be grant for some income generation purpose and not for speculation or some anti social activity. This purpose must be genuine.

 

5.Diversification of risks: Banks need to diversify their risk by lending to different type , sectors and areas of business.

 

6.Security: Security on the loan is the primary criteria for the bank . All secure loans are safe and can be recovered even the borrower is a defaulter.

Different types of lending..................

Fund based advances: Fund based advances are those where the bank give money as loans or advance. These are for business entities and individuals. These are like term loans and working capital loans. Those may be secure or unsecure loans.

Working capital loans: These  are generally unsecure loans but vary from bank to bank and borrower to borrower

Sub-prime lending

Sub-prime lending usually refers to the practice of giving loans to those who do not qualify for regular loans at market interest rates because of their poor credit history. Due to the increased risk associated with the takers, sub-prime loans are offered at a rate higher than market rates. 

These loans are risky for both, those who are giving and those who are taking, because these combine high interest rates, bad credit history, and often, murky financial situations of the takers.

 

 

Mortgage

A mortgage is a way to use one's real property, like land, a house, or a building, as a guarantee for a loan to get money. Many people do this to buy the home they use for mortgage: the loan provides them the money to buy the house and the loan is guaranteed by the house.

                                                     

Types Of Accounts In Bank

Traditionally banks in India have four types of deposit accounts, namely Current Accounts, Saving Banking Accounts, Recurring Deposits and, Fixed Deposits.

What is  a Current Account ?  Who uses current accounts? Current Accounts in Banks

 

Current Accounts are basically meant for businessmen and are never used for the purpose of investment or savings.  These deposits are the most liquid deposits and there are no limits for number of transactions or the amount of transactions in a day.  Most of the current account are opened in the names of firm / company accounts.   Cheque book facility is provided and the account holder can deposit all types of the cheques and drafts in their name or endorsed in their favour by third parties.  No interest is paid by banks  on these accounts.  On the other hand, banks charges certain  service charges, on such accounts.   

 

Features of Current Accounts :

 

(a) The main objective of Current Account holders in opening these account is to enable them (mostly businessmen) to conduct their business transactions smoothly.

(b) There are no restrictions on the number of times deposit in cash / cheque can be made or the amount of such deposits;

(c)  Usually banks do not have any interest on such current accounts.   However, in recent times some banks have introduced special current accounts where interest (as per banks' own guidelines) is paid

(d) The current accounts do not have any fixed maturity as these are on continuous basis accounts

 

 

What is a Savings Bank Account ?  Who uses Saving Bank Accounts ?

 

These deposits accounts are one of the most popular deposits for individual accounts.  These accounts not only provide cheque facility but also have  lot of flexibility for deposits and withdrawal of funds from the account.   Most of the banks have rules for the maximum number of withdrawals in a period and the maximum amount of withdrawal, but hardly any bank enforces these.   However, banks have every right to enforce such restrictions if it is felt that the account is being misused as a current account.  Till 24/10/2011, the interest on Saving Bank Accounts was regulared by RBI and it was fixed at 4.00% on daily balance basis.   However, wef  25th October, 2011, RBI has deregulated Saving Fund account interest rates and now banks are free to decide the same within certain conditions imposed by RBI.    Under directions of RBI, now banks are also required to open no frill accounts (this term is used for accounts which do not have any minimum balance requirements).  Although Public Sector Banks still pay only 4% rate of interest, some private banks like Kotak Bank and Yes Bank pay between 6% and 7% on such deposits.  From the FY 2012-13, interest earned upto Rs 10,000 in a financial year  on Saving Bank accounts is exempted from tax. 

 

What are Recurring Deposit Accounts ?  Who use Recurring Deposit Accounts ? or RD accounts

 

 

These are popularly known as RD accounts and are special kind of Term Deposits and are suitable for people who do not have lump sum amount of savings, but are ready to save a small amount every month.    Normally, such deposits earn interest on the amount already deposited (through monthly installments) at the same rates as are applicable for Fixed Deposits / Term Deposits.   These are best if you wish to create a fund for your child's education or marriage of your daughter or buy a car without loans or save for the future.

 

Under these type of deposits, the person has to usually deposit a fixed amount of money every month (usually a minimum of Rs,100/- p.m.).   Any default in payment within the month attracts a small penalty.    However, some Banks besides offering a fixed installment RD, have also introduced a flexible / variable  RD. Under these flexible RDs the person is allowed to deposit even higher amount of installments, with an upper limit fixed for the same e.g. 10 times of the minimum amount agreed upon.

 

These accounts can be funded by giving Standing Instructions by which bank withdraws a fixed amount on a fixed date of the month from the saving bank of the customer (as per his mandate), and the same is credited to RD account.

 

 

Recurring Deposit accounts are normally allowed for maturities ranging from 6 months  to 120 months. A  Pass book is usually  issued  wherein  the person can get the entries for all the deposits made by him / her and the interest earned.   Banks also indicate the maturity value of the RD assuming that the monthly instalents will be paid regularly on due dates.    In case instalment is delayed, the interest payable in the account will be reduced and some nominal penalty charged for default in regular payments.  Premature withdrawal of accumulated amount permitted is usually allowed (however, penalty may be imposed for early withdrawals).    These accounts can be opened in single or joint names. Nomination facility is also available.

What are Fixed Deposit Accounts in India or Term Deposits

 

 

All Banks in India (including SBI, PNB, BoB, BoI, Canara Bank, ICICI Bank, Yes Bank etc.)  offer fixed deposits schemes with a wide range of tenures for periods from 7 days to 10 years.   These are also popularly known as FD accounts.   However, in some other countries these are known as "Term Deposits" or even called "Bond".    The term "fixed" in Fixed Deposits (FD) denotes the period of maturity or tenor. Therefore, the depositors  are supposed to continue such Fixed Deposits for the  length of time for which the depositor decides to keep the money with the bank.  However, in case of need,  the depositor can ask for closing (or breaking) the fixed deposit prematurely by paying paying a penalty (usually of 1%, but some banks either charge less or no penalty).   (Some  banks   introduced variable interest fixed deposits.  The rate of interest on such deposits  keeps on varying with the prevalent market rates i.e. it will go up if market interest rates goes and it will come down if the market rates fall.  However, such type of fixed deposits have not been popular till date).

 

 

The rate of interest for Fixed Deposits differs  from bank to bank (unlike earlier when the same were regulated by RBI and all banks used to have the same interest rate structure.   The present trends indicate that private sector and foreign banks offer higher rate of interest.  

 

The earlier trend that private sector and foreign banks offer higher rate of interest is no more valid these days.  However, now a days small banks are forced to offer higher rate of interest to attract more deposits.   Usually a bank FD is paid in lump sum on the date of maturity.  However, most of the banks have also facility to pay/ credit interest in saving account at the end of every quarter.  If one desires to get interest paid every month, then  the interest paid will  be at a marginal discounted rate.  In the changed computerized environment, now the Interest payable on Fixed Deposit can also be easily transferred on due dates to Savings Bank or Current Account of the customer.

 

 

Types of risk faced by banks

1)  Credit Risk - This is the risk of non recovery of loan or the risk of reduction in the value of asset.    The credit risk also includes the pre-payment risk resulting in loss of opportunity to the bank to earn higher interest interest income. Credit Risk also arises due  excess exposure to a single borrower, industry or a geographical area.     The element of country risk is also present which is the risk of losses being incurred due to adverse foreign exchange reserve situation or adverse political or economic situations in another country

(2)  Interest Rate Risk-This risk arises due to fluctuations in the interest rates.   It can result in reduction in the revenues of the bank due to fluctuations in the interestrates which are dynamic and which change differently for assets and liabilities.   With the deregulated era interest rates are market determined and banks have to fall in line with the market trends even though it may stifle their Net Interest margins

(3) Liquidity Risk-Liquidity is the ability to meet commitments as and when they are due and ability to undertake new transactions when they are profitable. Liquidity risk may emanate in any of the following situations-

            (a) net outflow of funds arising out of withdrawals/non renewal of                      deposits

            (b) non recovery of cash receipts from recovery of loans

            (c) conversion of contingent liabilities into fund based commitment                      and

            (d) increased availment of sanctioned limits

        

(4) Foreign Exchange Risk  -  Risk may arise on account of maintenance of positions in forex operations and it involves currency rate risk, transaction risks (profits/loss on transfer of earned profits due to time lag) and transportation risk (risks arising out of exchange restrictions)

 (5)   Regulatory Risks-   It is defined as the risk associated with the impact on profitability and financial position of a bank due to changes in the regulatory conditions, for example the introduction of asset classification norms have adversely affected the banks of NPAs and balance sheet bottom lines. 

(6)  Technology Risk -  This risk is associated with computers and the communication technology which is being increasingly introduced in the banks.  This entails the risk of obsolescence and  the risk of losing business to better technologically

(7)   Market Risk-This is the risk of losses in off and on balance sheet positions arising from movements in market prices.

(8)  Strategic Risk-This is the risk arising out of certain strategic decisions taken by the banks for sustaining themselves in the present day scenario  for example decision to open a subsidiary may run the risk of losses if the subsidiary does not do good business.

 The essential components of any risk management system are –

       (i)  Risk Identification-i.e the naming and defining of each type of risk associated with a transaction or type of product or service

       (ii)  Risk Measurement-i.e. the estimation of the size ,probability and timing of potential loss under various scenarios

       (iii)  Risk Control-i.e. the framing of policies and guidelines that define the risk limits not only at the individual level but also for particular transactions

In risk management exercise the top management has to lay down clear cut policy guidelines in quantifiable and precise terms - for different layers line personnel business parameters, limits etc. It is very important for the management to plant at the macro level what the organisations is  looking in for in any business proposition or venture and convert these expectations into micro level factors and requirements for field level functionaries only then they will be able to convert these expectations into reality. A very important assumption is made but normally omitted or over looked is provision of infra-structural support and conductive climate. Ultimately top management has a greater role to play in any risk management process