1. Revise Lecture 20

2. Loans and Advances

3. 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.

4. 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.

5. Loans and Advances Q: Some of the securities against which the banks lend are?

6. Loans and Advances 1.Commodities 2.Debts 3.Financial instruments 4.Real estate 5.Automobiles 6.Consumer durable goods 7.Documents of title

7. Loans and Advances Q: Classification of Loans are?

8. Loans and Advances Classification of Loans Bank loans can be classified as follows according to the activity being financed; 1.Priority sector lending 2.Commercial lending

9. 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.

10. 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.

11. 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.

12. Loans and Advances Classification of Loans Commercial lending: Today, many banks focus on commercial lending for improving their bottom lines. Fresh and innovative products are being launched to facilitate the corporate customer who forms the core of this business. There is big competition among banks to secure bigger share of this business.

13. 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

14. Loans and Advances Advances

15. 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.

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

17. Loans and Advances Bank grant short-term financial assistance by way of; 1.Cash credit 2.Overdraft 3.Discounting of bills

18. 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.

19. 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

20. 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

21. Lecture 21

22. Loans and Advances Overdraft

23. 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

24. 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.

25. 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.

26. Loans and Advances Discounting of Bills

27. 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 discount. The party gets the funds without waiting for the date of maturity of the bills. In case any bill is dishonoured on the due date, the bank can recover the amount from the customer.

28. Loans and Advances Lending Policies

29. 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.

30. Loans and Advances Lending Policies Hence the top management needs to set the standards. Standards relating to the exposure limits for individual / company/ industry, credit quality of the borrowers, lending rate, risk level, etc, enable decentralized decision making by the lending officers.

31. 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.

32. Loans and Advances Lending Policies Geographical Distribution There are various locations from where a bank conducts its operations. Of these locations, some may be weak credit demand areas with a considerably high deposit potential and vice versa.

33. 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.

34. Loans and Advances Evaluation of Loan proposals

35. 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.

36. 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;

37. 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

38. 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

39. 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

40. 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.