Lending Procedure 6. Lending and Credit Administration 8. Pricing of Loans D. Jessup, P. Luckett, D. International Edition. Uremadu, S. Uzoaga, W. Students are also expected to sign up for an email account for effective e— discussions. The course outline along with the complete lecture notes would be made available to the class and would be posted onto the internet. Students are expected to photocopy and or download and read the notes before each lecture for better understanding and effective participation during class discussion.
Uneven distribution of wealth in the society necessitated the need for banks to intermediate between the surplus and deficit units for economic growth and development. Lending is thus central and fundamental to the financial intermediation role of banks, making banks to granting different types of loans, with different periods of moratorium, rate of interest and repayment terms to their customers. The lending function of banks is equally ingrained in the need to generate maximum return for the shareholders and maximum liquidity for the depositors, as well as achieve their objectives.
A bank is a financial intermediary for the safeguarding, transferring, exchanging, or lending of money. When customers deposit their money with a bank, they are giving the bank permission to borrow the money. This borrowed money is what is used for the loans to the bank customers. The bank pays a smaller amount of interest to the customer who allowed them to borrow the money and charges a larger amount of interest to the customer they lent the money to.
The bank makes money from the difference in the interest. If too many depositors run to withdraw their money like in a time of depression, backup systems like a consortium of banks and the Central Bank and other systems intervenes to get money to the banks to meet their obligations to depositors and save the bank from collapsing. An effective lending therefore is one that maximized profit to shareholders and liquidly to depositors, as well as, ensure societal economic development. Bank Policies On Lending Commercial banks are business entities which are established for the purpose of carrying out banking operations with the aim of earning reasonable returns for the shareholders.
This implies that such organizations cannot be operated effectively and efficiently without internal laws, regulations and procedures for transacting banking business. Hence the need for operating policies by commercial banks cannot be overemphasized.
The bank policies are formulated with the intention of ensuring that the operations of the banks are established on sounding footing which conforms to the best practices of banking operations. This is because bank operations are basically embedded in financial intermediation; sourcing for funds from surplus areas and lending such funds to areas of needs. Bank policies affect the organizational structure and by extension also influence the employment of the personnel. Bank policies are also used to shape the bank personality and for shaping the desired course of action in terms of the operational direction of the banks.
The formulation of bank policies can be the responsibility of the board of directors. The policies can also be formulated by the chief executive officers and tabled before the board for consideration and approval before their implementation. In some instances, the policies can be formulated by committees constituted by the management for such purpose. The formulation of bank policies in unit banks with their operations being restricted to specific areas, such as the microfinance banks in the country, can be easily accomplished. For instance, a microfinance bank would have distinct operational policies given the peculiar socio-economic conditions as compared to the operational policies for a microfinance banks which engage in business in an area like Lagos.
These are also different from the operational policies of microfinance banks that are doing business in Bauchi. This is because of the fact that their operations spread over a large geographical areas. Therefore, the branch managers are expected to make some inputs into the overall corporate policies necessary for successful operations.
The operational policies of the banks, be they unit banks or branch banks, should be couched on the basis of flexibility due to the changing patterns of environmental conditions. Therefore, the need for the formulation and constant review of the bank policies becomes very relevant in the areas of sourcing for deposits from the public, investment of funds on marketable securities, hedging against risks in operations, managing credit risks, and above all lending or granting credits, loans and advances to customers.
Such principles of bank lending are as identified and discussed below. When a banker lends that the borrower is going to repay. If for example the borrower invest the money in unproductive and speculative venture or the borrower himself is dishonest the advance would be in jeopardy. Similarly if the borrower or suffer losses in his business due to incompetence the recovery would be difficult.
The bank ensures that the money advanced by him goes to the right type of borrower and is utilized in such a way that it will not only be safe at the time of lending but remain so throughout the period, and after serving a useful interest purpose in the trade or industry where it is employed to repaid with interest.
The borrower must be in position to repay within a reasonable time after demand for repayment is made and the source of repayment must be definite. This is because bulk of the bank deposits are repayable on demand or short notice and liquidity of the borrower can affect the ability of the bank to repay its depositors on demand in spite of the safety. They are usually granted with the intention of earning some income for the banks. This income can only be earned by the bank through the interest charges being made from the loans granted to customers.
The interest on loans from the banks to customers are normally established taking into consideration the prevailing market rate and the established bank rate by the apex bank in the economy, which is called the monetary policy rate. The loans being granted to customers are not normally concentrated in a particular type of sector but in different types of sectors, which will have to conform to the policy of sectorial distribution of loans as demanded by the apex bank.
The distribution of the loan portfolio is also imperative towards minimizing risks that are always inherent in lending of funds.
The CESEE Bank Lending Survey
The principle of diversity is also applicable to spreading loans to various industries, firms, businesses and trades. Hence, commercial banks do strive to spread of risks of investment in loan portfolio by giving out credits to various trades and industries. For instance, a customer who applies for a loan facility should have his project or business evaluated to determine the possibility of such ventures generating constant income with which to serve the loan and make repayment on regular basis.
Therefore, for a new project the technical feasibility and economic viability report will be evaluated to determine the nature of cash inflows in terms of stability of earnings, which will be used for repaying the loan and servicing it. The regularity of the earnings is very important and this will depend on the prudent management of the project.
In the case of existing business, the financial reports for a period of not less than five years on consecutive basis will be evaluated to determine the regularity and quantum of earnings. Such assessment is used to evaluate the stability of such earnings towards definite repayment of loan facility. It would be important if the purpose is short and the risk is small and the money be applied for the purpose intended.
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Such areas for policy formulation on bank lending are as identified and discussed below. In setting the magnitude of loan that can be approved by the officers in charge of credits, certain factors are usually taken into consideration. In terms of policy on loan limit for the officers, the factors taking into account may include the position of the officer, e. Furthermore, grading system can be used for setting the policies on loan limit such as portrayed by the Table 1. A grading or categorization system being used by any bank for setting loan limits on customers depends on choice.
In related terms, such categorization of loan limits can be also be used to set loan mandate for the officers of the bank when it comes to approval of loans for the customers. In the case of the branch manager, the usual policy on loan limit is for the bank to set the amount of funds that he or she can lend out to a customer. The limit is regarded as his or her authority in lending, and any loan request in excess of such lending authority will have to be communicated to the head office for advice.
The policies on granting of loans, their supervision, and recovery drive are normally established taking into consideration the relevant strategies used in the past and those ones being utilized by other banks. Bank policies on loan supervision are used to address responsibilities such as: a Teams to be constituted for checks and balances; b Superior officer s to be in charge of reports and evaluation, e.
There are other areas of responsibilities for the management of credit risks by various bank officials, which are not covered by above list. Therefore, the list is by no means exhaustive for the purpose of credit management of credit risks by the banks.
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Such policy should be used to specify the necessary actions to be initiated and taken by the bank officials to recover the amount of loan involved in the transaction. The necessary directives in managing difficult account involve the following considerations: a The use of committee for the recovery of the funds; b Discussion with the difficult customer by the bank officials; c Visit to the business premises of the customer for assessment; d The use of subtle pressure on the customer, e. In addition to the above, there are other areas for policy actions on difficult customers, which various banks can formulate to manage them.
More so, necessary responsibilities for the management of the difficult customers are formulated and assigned to various bank officials, which are not covered by above list. Therefore, the list is by no means exhaustive for the purpose of managing difficult customers by the banks.
The control of customer account is necessary because of the fact that a customer can be playing pranks on the repayment of loan and payment of interest on such funds. The above list is by no means is exhaustive, and therefore, it is left for individual banks to decide on the necessary considerations in this respect. In addition, there is every likelihood that such customers will use their accounts to demand for overdraft or loans in the course of their operations. There are areas on which policies can be established for such purpose.
Credit Extension By Banks Commercial banks operate business that is woven around financial intermediation activities. In fundamental terms, banks are institutions which evolve for the business of keeping, lending and exchanging of money. Therefore, banks are organizations whose principal operations are entrenched in accumulation of idle funds from the general public with the purpose of lending such funds to business entities and individuals as well as the government institutions. The position of the commercial banks is that of retail banking institutions that accept deposits from the public and in turn lend such funds to some members of the public.
Historically, the goldsmiths that pioneered the realm of banking business evolved the operations by accepting valuables such as bullions, money and ornaments for safekeeping. For the care of the valuables, the goldsmiths started charging some fees for the safekeeping of the money and the bullions.
In the process of the safekeeping of money, bullion and other valuables, the goldsmiths started lending the money to other people for fees. This serves as the precursor of the modern banking business operations. In conceptual terms, banks are institutions which evolve for the business of keeping, lending and exchanging of money. Hence, commercial banks as retail banks are institutions that accept deposits from the public and in turn advance loans by creating credit. The commercial banks, are the banks that perform all kinds of banking functions such as: a accepting deposits; b advancing loans; c credit creation; d financing foreign trade; e discounting bills of exchange; f agency functions; g keeping of valuables; h issue credit instruments; and i serve as underwriters for shares and debentures.
The commercial banks are known for granting short-term loans, in most cases, to customers. Nevertheless, in recent years, they have included medium—term and long term loans in their loan portfolios. In terms of ownership, commercial banks are joint stock banks in the sense that they are just like the joint stock companies whose ownership cuts across many strata of the society; and therefore the shareholders of each of such corporate banking entities run into millions. The situation may be different in advanced climes where there are some other forms of loans or credits which can be advanced to customers.
Advancing loans or credits out of the deposits constitutes one of the fundamental functions of the commercial banks.