What precautions should be taken by a banker before advancing

What precautions should be taken by a banker before advancing

What precautions should be taken by a banker before advancing the loan or Investment?

No doubt the advancing of loan is also risk as well. If the loan is for a longer period then risk will be also greater. So before advancing the loan a banker should keep in view the following precautions :

1. Business Volume:

Character :
Character of the borrower depends upon honestly, family background, nature of employment, habits and the record of the past. So before advancing loan these things must

 be considered.

2. Ability To Repay :
Before advancing loan a banker must be satisfied with the sources of the repayment of the funds.

3. Check The Assets :
The banker should also check the property capital and borrower. This property can kept as a security of loan. In other words if the businessman financial condition is sound then it can be lended otherwise not.

4. Purpose Of Financing :-
Funds should be provided for genuine requirements of the customers. Bankers should not advance the loan gambling or smuggling.

5. Amount Of Loan :
The amount of loan must be according to the proportion of the customers own capital resources and it should be sufficient to meet the needs.

6. Period Of Loan :
It should be kept in view that funds may not be locked up for a long term. A major part of the loan should be payable on demand.

7. Expansion Of Credit :
A banker should not advance the loan to only one sector. It can be harmful. The bank should extend the loan various sectors of the economy. In this way there will be maximum safety for the banker.

8. National Interest :
Banker should also keep in view the national interest before advancing the loan. If loan advancing is not suitable for the speculation then he should not advance. So central bank credit policy must be followed.

9. Security :
Security is also demanded to ensure the payments on due date. So banker should take the security against the possibility of nonpayment.

10. Capability :
It is also necessary that a borrower should be capable to use the funds, wisely. Banker can examine the management ability of the businessman of checking the past and present record of the business.

11. Profit Margin Of The Business :
Banker should also keep in view the profit margin of business. If the demand and profit margin of the product is low, then loan may not be advanced.

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7 Factors Need Consideration before Sanctioning Banks Loans

Policy means action or procedure conforming to or considered with reference to prudence or expediency.

Bank lending policy refers to the policy and guidelines adopted by a bank in order to make its lending process systematic and methodical. Banks deal with other people’s money. They lend the money which they themselves borrow from the depositors.

Unless these.-deposits are prudently utilized banks are destined to incur losses. Banks cannot effort to either keep the deposits idle in the vaults or lend the deposits and not recollect. Hence, it is essential that a proper lending policy is in place.

Bank must carefully analyze following factors at the time and before sanctioning loans to the applicants:

1. Liquidity

The term ‘liquidity’ implies the ability to produce cash on demand. A bank mainly utilizes ‘ its deposits for the purpose of granting advances. These deposits are repayable on demand or on the expiry of a specified period.

To meet the demand of the depositors in time, banks should keep their funds in liquid state. Money locked up in long-term loans cannot be received back in time and so are less liquid. So a bank should confine its lending to short-term loans only.
2. Profitability

Like all other commercial institutions banks are run for profit. Even government owned ‘ banks are no exception to this.

Banks earn profit to pay interest to depositors, declare dividend to shareholders, meet establishment charges and other expenses, provide for reserve and for bad and doubtful debts, depreciation, maintenance and improvements of property owned by the bank and sufficient resources to meet contingent loss.

So profit is an essential consideration. A banker should employ his/her funds in such a way that they will bring him/her adequate return. However, a banker should never provide undue importance to profitability.
3. Safety and Security

The banker should ensure that the borrower has the ability and the willingness to repay the advances as par agreement. Closely allied to this point is that before granting a secured advance, he should carefully consider the margin of safety offered by the security and possibilities of fluctuations in value.

If it is an unsecured advance, its repayment depends on the creditworthiness of the borrower, and that of the guarantor. As such, the cardinal principles which the banker should consider in case of unsecured advances are character, capacity, and capital (popularly known as the 3 C’s) or reliability, responsibility, and resources (popularly known as the 3 R’s) of the borrower and the guarantor.
4. Purpose

The banker has to carefully examine the purpose for which the advance has been applied for. In case the advance is intended for productive purposes, it could be reasonably anticipated that cash flows arising for productive activities will result in prompt repayment. Of course, the banker has to be careful to monitor the exact purpose for which the advance is actually utilized.
5. Sources of Repayment

Before giving financial accommodation, a banker should consider the source from which repayment is promised. In some instances, debentures which are to be redeemed in few months’ time or a life insurance policy which is to mature in near future may be offered as security. Advances against such security give no trouble.

Sometimes customers may apply for loans for additional working capital for their business and undertake to repay out of the profits over a period. In such cases the rate at which the customer can reasonably hope to repay should be ascertained.
6. Diversification of Risk

The security consciousness of a banker and the integrity of the borrower are ‘ not adequate factors to keep the banker on safe side. What is also important is the diversification of risk. This means, the banker should not lend a major portion of his/her loan-able fund to any single borrower or to an industry or to one particular region. Otherwise, an adverse change in the economy may affect the entire business.

In such as a case repayment will be highly difficult and the survival of the bank becomes questionable. Therefore a bank should follow the wise policy of “do not put all the eggs in a single basket.” The bank must advance moderate sums to a large number of customers spread over a wide area and belonging to different industries.
7. Social Responsibility

While admitting that banks are essentially commercial ventures, a bank should not forget the fact that it is not enough that only people of means are given bank finance. Through productive effort bank finance should make people credit worthy, and turn them into people of means.

Technical competence of the borrower, operational flexibility, and economic viability of the project, rather than the security which the borrower can offer, should be considered in evaluating a loan proposal.

The identification of priority sectors for the purpose of extending bank credit should be considered as a positive development in the banking system, aimed at effectively discharging its responsibility towards society.

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Things for a Bank to Consider Before Lending Money to a Business

In business lending, banks weigh credit standing and other factors.
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When a bank receives a loan request from a small business, it considers a range of factors, some of which might not be apparent to the business owner. There is no single criterion for approval of a loan request. The bank will probably review its overall relationship with the company, including deposits, investments and other services. Credit analysts will review financial statements and obtain reports from outside credit agencies and other sources. If the resulting information is positive and meets the bank's credit standards, the bank will be inclined to approve the request.

Credit Rating

The bank will obtain a commercial credit report on the company from an agency such as Dun & Bradstreet. Agency reports include information on public filings, payment histories and credit scores. If any negative information, such as outstanding tax liens or past-due payments, appear on the reports, the bank officer might ask the company for an explanation. Sometimes these reports are not up to date, but they can still provide useful information to prospective lenders.
Financial Standing

The bank will normally require the company to provide its latest annual statement and, for comparison purposes, the statement for the previous year, plus an interim statement for the most recent month. These include a balance sheet (statement of assets, liabilities and net worth), an income statement (showing financial performance over a specified period) and a cash flow statement (giving cash inflows and outflows). Financial statement analysis can reveal a company's financial strengths and weaknesses and how easily the company can service -- make payments of principal and interest -- the proposed loan. The bank will usually require the annual statements to be prepared by a public accounting firm.
Available Collateral

In most cases, the bank will require collateral as security for the loan. Simply put, if the borrower defaults on the loan, the secured lender can be repaid by seizing the collateral and selling it. If the company is seeking a loan for the purpose of buying equipment for the business, it might be able to pledge title to the equipment as collateral for the loan. Not all assets are suitable for use as loan collateral. For example, highly specialized equipment might not be readily salable to another party in case of default on the loan. In such a case, the borrower would have to produce other assets that would be acceptable to the bank.
Management Guarantees

The bank will probably require personal guarantees from each owner of the company, assuming that it is a closely held business with only several owners. Usually, each owner completes a personal financial statement on a form provided by the bank. The standard procedure is for the bank to review the personal statements and then, when the loan is approved, have each owner execute a guarantee. In addition to providing additional security, the personal guarantees assure the bank that the owners will probably remain with the business while the loan is in force.
Bank Relationship

When a business customer applies for a loan, the bank normally reviews the company's overall relationship. Loan committees, the final approval authorities in most banks, will be impressed by a business customer that has been a depositor for several years before applying for credit. Also, if a company has been using fee-based services such as investments, that would also be a plus. Community bank executives might be pleased to learn about business customers being involved in civic affairs.
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5 Important Principles Followed by the Banks for Lending Money
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Banks follow the following principles of lending:
1. Liquidity:

Liquidity is an important principle of bank lending. Bank lend for short periods only because they lend public money which can be withdrawn at any time by depositors. They, therefore, advance loans on the security of such assets which are easily marketable and convertible into cash at a short notice.

Lending Money

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A bank chooses such securities in its investment portfolio which possess sufficient liquidity. It is essential because if the bank needs cash to meet the urgent requirements of its customers, it should be in a position to sell some of the securities at a very short notice without disturbing their market prices much. There are certain securities such as central, state and local government bonds which are easily saleable without affecting their market prices.
Liquidity

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The shares and debentures of large industrial concerns also fall in this category. But the shares and debentures of ordinary firms are not easily marketable without bringing down their market prices. So the banks should make investments in government securities and shares and debentures of reputed industrial houses.
2. Safety:

The safety of funds lent is another principle of lending. Safety means that the borrower should be able to repay the loan and interest in time at regular intervals without default. The repayment of the loan depends upon the nature of security, the character of the borrower, his capacity to repay and his financial standing.
Safety

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Like other investments, bank investments involve risk. But the degree of risk varies with the type of security. Securities of the central government are safer than those of the state governments and local bodies. And the securities of state government and local bodies are safer than those of the industrial concerns. This is because the resources of the central government are much higher than the state and local governments and of the latter higher than the industrial concerns.

In fact, the share and debentures of industrial concerns are tied to their earnings which may fluctuate with the business activity in the country. The bank should also take into consideration the debt repaying ability of the governments while investing in their securities. Political stability and peace and security are the prerequisites for this.

It is very safe to invest in the securities of a government having large tax revenue and high borrowing capacity. The same is the case with the securities of a rich municipality or local body and state government of a prosperous region. So in making investments the bank should choose securities, shares and debentures of such governments, local bodies and industrial concerns which satisfy the principle of safety.

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Thus from the bank’s viewpoint, the nature of security is the most important consideration while giving a loan. Even then, it has to take into consideration the creditworthiness of the borrower which is governed by his character, capacity to repay, and his financial standing. Above all, the safety of bank funds depends upon the technical feasibility and economic viability of the project for which the loan is advanced.
3. Diversity:

In choosing its investment portfolio, a commercial bank should follow the principle of diversity. It should not invest its surplus funds in a particular type of security but in different types of securities. It should choose the shares and debentures of different types of industries situated in different regions of the country. The same principle should be followed in the case of state governments and local bodies. Diversification aims at minimising risk of the investment portfolio of a bank.
Diversity

The principle of diversity also applies to the advancing of loans to varied types of firms, industries, businesses and trades. A bank should follow the maxim: “Do not keep all eggs in one basket.” It should spread it risks by giving loans to various trades and industries in different parts of the country.

4. Stability:

Another important principle of a bank’s investment policy should be to invest in those stocks and securities which possess a high degree of stability in their prices. The bank cannot afford any loss on the value of its securities. It should, therefore, invest it funds in the shares of reputed companies where the possibility of decline in their prices is remote.
4. Stability:

Government bonds and debentures of companies carry fixed rates of interest. Their value changes with changes in the market rate of interest. But the bank is forced to liquidate a portion of them to meet its requirements of cash in cash of financial crisis. Otherwise, they run to their full term of 10 years or more and changes in the market rate of interest do not affect them much. Thus bank investments in debentures and bonds are more stable than in the shares of companies.
5. Profitability:

This is the cardinal principle for making investment by a bank. It must earn sufficient profits. It should, therefore, invest in such securities which was sure a fair and stable return on the funds invested. The earning capacity of securities and shares depends upon the interest rate and the dividend rate and the tax benefits they carry.

It is largely the government securities of the centre, state and local bodies that largely carry the exemption of their interest from taxes. The bank should invest more in such securities rather than in the shares of new companies which also carry tax exemption. This is because shares of new companies are not safe investments.

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The primary function of the bank is to make short term commercial loans. As cash finance is a short term advance, therefore banks prefer to invest their funds in this loan which is self-liquidating. The bank however should take the following precautions in advancing cash finance. Before advancing loans against the good or documents of title of goods, the banker must thoroughly satisfy himself about the honesty, trustworthiness and experience of the borrower in the trade. In the words of John Paget provided the baker is dealing with honest and responsible persons documents of title to goods are convenient securities for advances. The banker must be familiar with the fluctuations of the prices in the commodities against which he is to advance loans or has advanced loans earlier. The up-to-date knowledge of the different markets enables the banker to regulate the margin for loans against produce goods.

The banker should advance loans against those commodities which are of seasonal nature and are readily saleable in the market. The banker must take every care in property storing the goods pledged with the bank. Deterioration and pilferage in the commodities reduces the security of the bank. In order to secure the loan the banker should take possession actual or constructive of the goods. He should also have a direct contract with the owner or the agent who is in possession of commodities.

There are many factors which may influence the granting of loans by most Bank Managers and a number of them are outlined below;

1. The type of Account The Customer operates: Although non-account owners get loans, loans are normally given to current account owners more than those who operate savings accounts.

2. The Amount Involved: If it is a large sum of loan, the Bank Manager will consider whether if such an amount is removed, it will not affect the financial standing of the bank.

3.The Past Financial Dealings of the Customer with the Bank: one with sound past financial dealings with a bank has a higher chance of getting a loan and vice versa.

4. The Purpose for which the loan will be used: financially yielding projects are considered more buy bank managers in order to make sure that the loan will be used for projects that will yield profit so that it will enable the borrower to repay the loan.

5.The Collateral Security Offered:These collateral securities which are fixed assets must be the things the bank can sell easily and more than the value of the loan given.

6. The Period of Repayment: The period of re-payment of such loan is very important because, the Bank would not want its loan to be tied down for a very long time in spite of the fact that it changes interest on the loan.

7. The Customers Referee: The referee must be one who is well known to the bank and who will guarantee that in case the borrower defaults or becomes insolvent, that he will repay the loan.

8. The Earning Power of The Customer: The person's earnings vis-a-vis the amount to be given out as loan are some of the determining factors in granting and issuing loans.

9. The Sources of Re-payment: The Bank Managers will also like to know the possible sources the customer intending to borrow loans has for repaying the loan.

10. The Present Government Policy on Bank Lending: A Customer may fulfill all the "Conditions" but if government policy on lending is credit squeeze, the Bank will not grant the Loan and vice versa.

Eze Ezenwa is an expert in providing financial solutions, he is the current owner of http://fynance.blogspot.com/

The Author of this article, gives any reader/viewer of this article the full right to re-print, this article, re-print should include Author's name and website(URL)

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    Create a credit policy. A formal credit policy will detail in writing exactly what your payment policies and expectations are. Putting a formal credit policy in writing shows customers that you’re serious about your business’ finances, and it gives you a legal leg to stand on should you ever have to sue a customer for nonpayment.

    Require customers to complete a credit application. The application should ask for key information about the customer’s background (for example, number of years in business, outstanding loans, and the name and branch of the customer’s bank) as well as the business’ structure (corporation, partnership, LLC, etc.), federal tax ID number, and at least three trade references you can contact.

    Check the customer’s trade references. Asking customers to list trade references does little good if you don’t follow through and call them. Ask them about the customer’s payment practices: Did it pay the full amounts due on time, every time? If not, try to determine if there were any extenuating circumstances you should consider in your credit evaluation.

    Run a credit check. This can be done for a small fee via your local credit bureau or one of the business financial-rating services, such as Dun & Bradstreet. It will tell you if there are any outstanding judgments against the customer and/or if the customer has a record of slow payment with anyone else.

    Request a personal guarantee from the business owner. If the customer’s company possesses minimal assets and/or assets that are hard to convert into cash, you can ask the owner to personally guarantee the credit. You can confirm that the owner possesses adequate personal assets to support the guarantee by requesting a personal financial statement and personal bank account information and by obtaining a personal credit report, for which you will need the owner’s permission (ask for this on the credit application).

    Take a security interest in your products. This will allow you to repossess the products you sold should the customer refuse to pay you according to the agreed-upon terms, rather than simply taking your place in line with other unsecured creditors. To do so, you’ll need to have your customer sign a security agreement and UCC financing statement, which you will then file with your secretary of state or county recorder.

    Set credit limits and payment terms. Based on all of the above, set a financial limit for each customer you deem to be creditworthy and decide how many days after delivery of your products full payment will be due to you. If your terms are net-30, for example, make it clear that receipt of payment is due to you no later than day 30. This isn’t the day the customer should put a check in the mail. Better still, set yourself up to receive payments electronically, so you can avoid the “check is in the mail” excuse.

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Apart from these factors stated above, lending officer is also guided by what is referred to as 4Cs of lending.

These are:

    i) Character

    ii) Capital

    iii) Capacity

    iv) Collateral

i. Character: The lender should be able to attest to the integrity of the borrower. Status enquiries on the borrower will help.

ii. Capital: No institution will lend more than the authorized capital of a company. The principle or partial contribution, where the promoters and the lender sponsor a project is advisable.

iii. Capacity: Law forbids lending to minors or incapacitated individuals such as lunatic or anyone whose sanity is in doubt. The Memorandum of Association of a company contain the object clause, loan given should be in line with operation of a company.

iv. Collateral: This is what the bank or lender fall back on to recoup its money should borrower defaults. This takes care of the unforeseen circumstances that can develop after granting the loan.

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1. Liquidity

The term ‘liquidity’ implies the ability to produce cash on demand. A bank mainly utilizes ‘ its deposits for the purpose of granting advances. These deposits are repayable on demand or on the expiry of a specified period.

To meet the demand of the depositors in time, banks should keep their funds in liquid state. Money locked up in long-term loans cannot be received back in time and so are less liquid. So a bank should confine its lending to short-term loans only.

2. Profitability

Like all other commercial institutions banks are run for profit. Even government owned ‘ banks are no exception to this.

Banks earn profit to pay interest to depositors, declare dividend to shareholders, meet establishment charges and other expenses, provide for reserve and for bad and doubtful debts, depreciation, maintenance and improvements of property owned by the bank and sufficient resources to meet contingent loss.

So profit is an essential consideration. A banker should employ his/her funds in such a way that they will bring him/her adequate return. However, a banker should never provide undue importance to profitability.

3. Safety and Security

The banker should ensure that the borrower has the ability and the willingness to repay the advances as par agreement. Closely allied to this point is that before granting a secured advance, he should carefully consider the margin of safety offered by the security and possibilities of fluctuations in value.

If it is an unsecured advance, its repayment depends on the creditworthiness of the borrower, and that of the guarantor. As such, the cardinal principles which the banker should consider in case of unsecured advances are character, capacity, and capital (popularly known as the 3 C’s) or reliability, responsibility, and resources (popularly known as the 3 R’s) of the borrower and the guarantor.

4. Purpose

The banker has to carefully examine the purpose for which the advance has been applied for. In case the advance is intended for productive purposes, it could be reasonably anticipated that cash flows arising for productive activities will result in prompt repayment. Of course, the banker has to be careful to monitor the exact purpose for which the advance is actually utilized.

5. Sources of Repayment

Before giving financial accommodation, a banker should consider the source from which repayment is promised. In some instances, debentures which are to be redeemed in few months’ time or a life insurance policy which is to mature in near future may be offered as security. Advances against such security give no trouble.

Sometimes customers may apply for loans for additional working capital for their business and undertake to repay out of the profits over a period. In such cases the rate at which the customer can reasonably hope to repay should be ascertained.

6. Diversification of Risk

The security consciousness of a banker and the integrity of the borrower are ‘ not adequate factors to keep the banker on safe side. What is also important is the diversification of risk. This means, the banker should not lend a major portion of his/her loan-able fund to any single borrower or to an industry or to one particular region. Otherwise, an adverse change in the economy may affect the entire business.

In such as a case repayment will be highly difficult and the survival of the bank becomes questionable. Therefore a bank should follow the wise policy of “do not put all the eggs in a single basket.” The bank must advance moderate sums to a large number of customers spread over a wide area and belonging to different industries.

7. Social Responsibility

While admitting that banks are essentially commercial ventures, a bank should not forget the fact that it is not enough that only people of means are given bank finance. Through productive effort bank finance should make people credit worthy, and turn them into people of means.

Technical competence of the borrower, operational flexibility, and economic viability of the project, rather than the security which the borrower can offer, should be considered in evaluating a loan proposal.

The identification of priority sectors for the purpose of extending bank credit should be considered as a positive development in the banking system, aimed at effectively discharging its responsibility towards society.

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What Lenders Look for Before Granting a Small Business Loan

By AllBusiness Editors | In: Financing & Credit

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Before lenders will grant a small business loan, they need to ensure that the loan will be repaid. Every loan is a risk but banks and brokers want to take as little risk as possible. They look for businesses that show promise and they award loans to businesspeople who have solid personal and business financials and are committed to the success of their businesses.

When deciding whether or not to issue you a loan, lenders may look at gross annual sales or revenues, checking account balances, profitability and the length of time you have been in business. If your business is relatively new, the lender may ask to see a business plan. Check out How Can You Increase Your Chances of Getting a Business Loan?

If you are just starting your business, include a business plan as part of your loan application. It should include monthly cash flow projections for the first 24 months (36 months for startups). Established businesses should show a schedule of current debts and loan balances, payment schedules, maturity and available collateral. Learn how to Clean Up Your Company’s Bad Credit Profile.

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A lender will review your personal credit history and FICO score, especially if your company does not have a track record of producing revenue. Among the personal credit information that may be considered are:

    personal credit card debt

    personal loans

    liquid assets

    real estate holdings

    tax returns

    personal financial statements

Lenders will consider your personal spending habits, including how you use credit cards and handle installment debt. Lenders look askance at individuals with substantial personal debt, as they are less likely to withstand a reduction in income during slow times.

Lenders pay close attention to balance sheets. Any uncertainty or discrepancy of their contents will raise a red flag. They will also expect a business summary that describes in detail: the nature of your business; how the funds from the loan will be used; and available working capital, with descriptions of how it will be allocated. It should also describe how you plan to differentiate your business from competitors.

While being prepared and organized can save time and possibly help your loan get approved, too much information may be more of a hindrance than a help. There is some information that lenders may want to see later on in the process, such as proof of insurance for collateralized items or lease documents. Have this information ready to submit if your lender requests it but don’t include it as part of your initial application. Overwhelming your loan officer with too much information may actually slow down the process.

This is the cardinal principle for making loan or investment by a bank. It must earn enough profits.