1. The Principles & Control of Lending

2. The Principles & Control of Lending
Modern banking is believed to have started in England and it grew out of the custom of goldsmiths who took in their customers’ gold and silver for safe keeping. They then discovered that they could lend such precious metals out, keeping just a certain customer proportion as reserves. This was possible because not all the customers would come in for collection for their assets at the same time. This is how lending came into existence

3. The Principles & Control of Lending
Lending is a major function of banks and is the main source of income to every banking institution. However, most of the banks in the course of lending incur bad debt or non-performing assets which lead to losses affecting the bank’s profitability. This is attributable to noncompliance with lending principles and practices from banking officials

4. Principles of Lending
It is a fundamental precept of banking everywhere that advances are made to customers in reliance on his promise to repay, rather than the security held by the banker. Although all lending involves some degree of risks, it is necessary for any bank to develop sound and safe lending policies and new lending techniques in order to keep the risk to a minimum. As such, the banks are required to follow certain principles of sound lending.

5. Principles of Lending Safety Liquidity Profitability
The Purpose of the Loan
The Principle of Diversification of Risks

6. Safety
As the bank lends the funds entrusted to it by the depositors, the first and foremost principle of lending is to ensure the safety of the funds lent. By safety is meant that the borrower is in a position to repay the loan, along with interest, according to the terms of the loan contract. The repayment of the loan depends upon the borrower’s:
(a) capacity to pay, and
(b) willingness to pay.

7. Safety
The former depends upon his tangible assets and the success of his business; if he is successful in his efforts, he earns profits and can repay the loan promptly. Otherwise, the loan is recovered out of the sale proceeds of his tangible assets. The willingness to pay depends upon the honesty and character of the borrower. The banker should, therefore, taken utmost care in ensuring that the enterprise or business for which a loan is sought is a sound one and the borrower is capable of carrying it out successfully. He should be a person of integrity, good character and reputation. In addition to the above, the banker generally relies on the security of tangible assets owned by the borrower to ensure the safety of his funds

8. Liquidity
Banks are essentially intermediaries for short term funds. Therefore, they lend funds for short periods and mainly for working capital purposes. The loans are, therefore, largely payable on demand. The banker must ensure that the borrower is able to repay the loan on demand or within a short period. This depends upon the nature of assets owned by the borrower and pledged to the banker.

9. Liquidity
. For example, goods and commodities are easily marketable while fixed assets like land and buildings and specialized types of plants and equipments can be liquidated after a time interval. Thus, the banker regards liquidity as important as safety of the funds and grants loans on the security of assets which are easily marketable without much loss.

10. Profitability
Commercial banks are profit-earning institutions; the nationalized banks are no exception to this. They must employ their funds profitably so as to earn sufficient income out of which to pay interest to the depositors, salaries to the staff and to meet various other establishment expenses and distribute dividends to the shareholders (the Government in case of nationalized banks). The rates of interest charged by banks were in the past primarily dependant on the directives issued by the Reserve Bank. Now banks are free to determine their own rates of interest on advances of above.

11. Profitability
The variations in the rates of interest charged from different customers depend upon the degree of risk involved in lending to them. A customer with high reputation is charged the lower rate of interest as compared to an ordinary customer. The sound principle of lending is not to sacrifice safety or liquidity for the sake of higher profitability. That is to say that the banks should not grant advances to unsound parties with doubtful repaying capacity, even if they are ready to pay a very high rate of interest. Such advances ultimately prove to be irrecoverable to the detriment of the interests of the bank and its depositors.

12. The Purpose of the Loan
While lending his funds, the banker enquires from the borrower the purpose for which he seeks the loan. Banks do not grant loans for each and every purpose—they ensure the safety and liquidity of their funds by granting loans for productive purposes only, viz., for meeting working capital needs of a business enterprise. Loans are not advanced for speculative and unproductive purposes like social functions and ceremonies or for pleasure trips or for the repayment of a prior loan.

13. The Purpose of the Loan
Loans for capital expenditure for establishing business are of long-term nature and the banks grant such term loans also. After the nationalization of major banks loans for initial expenditure to start small trades, businesses, industries, etc., are also given by the banks.

14. The Principle of Diversification of Risks
This is also a cardinal principle of sound lending. A prudent banker always tries to select the borrower very carefully and takes tangible assets as securities to safeguard his interests. Tangible assets are no doubt valuable and the banker feels safe while granting advances on the security of such assets, yet some risk is always involved therein. An industry or trade may face depression conditions and the price of the goods and commodities may sharply fall. Natural calamities like floods and earthquakes, and political disturbances in certain parts of the country may ruin even a prosperous business.

15. The Principle of Diversification of Risks
To safeguard his interest against such unforeseen contingencies, the banker follows the principle of diversification of risks based on the famous maxim "do not keep all the eggs in one basket." It means that the banker should not grant advances to a few big firms only or to concentrate them in a few industries or in a few cities or regions of the country only. The advances, on the other hand, should be over a reasonably wide area, distributed amongst a good number of customers belonging to different trades and industries. The banker, thus, diversifies the risk involved in lending. If a big customer meets misfortune, or certain trades or industries are affected adversely, the overall position of the bank will not be in jeopardy.

16. Lending Models
A lending model describes the various structures of policies and procedures for granting financial assistance that ought to be followed before loans are granted to customers. Lending models tend to be very specific in terms of what they will consider and how deals can be structured. They are also rather inflexible so as to maintain a certain amount of integrity in the lending policies that have been established in the first place (Brent, 2010). According to Korwa and Richard (2008), banks attach considerable importance to screening loans through stringent lending principles requirement for the following reasons: to screen out borrowers that is likely to default; to add an incentive for the borrower to repay the loan; to offset the cost to the lender of a loan default; and, to reduce the lending risk.

17. The CAMPARI Model
One of the oldest models used by banks to evaluate lending propositions is the CAMPARI. This model looks at a range of aspects associated with lending which covers not just the finance that is being sought but the people who are seeking it. The model provides the banker with a tried and trusted model for credit analysis (Philip, 2003). It assesses the borrower on the basis of character, ability to pay, margin of profit, purpose of the loan, amount being requested, the terms of repayment and the insurance in case of default.

18. The Credit Scoring Model
A credit score is a numerical expression based on a statistical analysis of a person's credit files, to represent the creditworthiness of that person. A credit score is primarily based on credit report information typically sourced from credit bureaus ( Credit scoring models are developed by analyzing statistics and picking out characteristics that are believed to relate to creditworthiness. Credit Reporting Agencies (CRA) use different scoring models for different purposes. Auto financing, for example, could employ a different model than instalment loans.

19. The Credit Scoring Model
Lenders, such as banks and credit card companies, use credit scores to evaluate the loan application in addition to the potential risk posed by lending money to the applicant. This goes a long way to mitigate losses that may arise from non-payment of the loan Lenders thus use credit scores to determine who qualifies for a loan, at what interest rate, and what credit limits

20. The 5 C’s Model
This is a model used by lenders to determine the credit worthiness of potential borrowers and it is based solely on the information declared by the applicant to the bank. The system weighs five characteristics of the borrower in an attempt to gauge the chance of default. The 5 c’s model emphasizes on the character, capacity, capital, collateral and conditions of the applicant who requires the financial assistance. The concept if correctly applied seeks to evaluate the key criteria of repayment ability, by analyzing the stream of cash flows, the character of financial discipline, the financial health of the borrower and other qualitative factors

21. CCC PARTS It is a lending model that is based on the evaluation of
Character - who are you lending to
Capability - just how good are they at what they do
Capital - what is the customer stake: the bank is not the entrepreneur and the customer needs to put in a fair share (it seems to me that this is often the sticking point where the customer thinks they have a right for others to take the risk when they can take the profit).

22. CCC PARTS
Purpose - is it legal and does it fit within the criteria we wish to support
Amount - reasonable/too much or even is it enough. How does it relate to customer input?
Repayment - how, where from and over how long
Security - is it necessary and what is available/offered. Again a sticking point for many
Terms - what rate/fees etc are appropriate.