INTRODUCTION TO BANKING

Till 1949. there was no separate law for banking

companies in India. To safeguard the interests of
depositors against frequent

bank failures, the Banking companies Act was

enacted in 1949 (now as Banking regulation Act
1949) Banking regulation Act, 1949 was passed to
regulate the working of the banks in India. Before the
enactment of the Act, banks were governed by the
corporate laws.

DEFINITION OF BANKING

A banking company is defined as company

which transact the business of banking in India. The
Banking Requlation Act defines business of banking
by stating the essential function of a banker.

According to sea 5(b) of the act, banking mans.

“the acceptance for the purpose of lending or
investment of deposits of money from the public
repayable on demand. Order or otherwise and
windrawal by cheque draft, order or otherwise,’’

This definition states that a banking company

must perform both of the essential function viz.

(a) Accepting of deposits and

(b) Lending or investing the same and
secondly the banker accepts deposit of
 money from public and not of anything
else.

LOANS AND ADVANCES

Lending of funds to the constituents, mainly traders

business and industrial enterprises, constitutes the
main business of a banking company.

The major portion of a bank) s. fund is employed by

way of loans and advances, which is the most
profitable employment of its funds. The major part of
the bank’s income in earned from interest and
discount on the so lent. The business of lending is not
free from certain inherent risks. So while lending his
funds, a banker follows a very cautious policy &
conducts his business on the basis of the well-known
principles of sound lending in order to minimize the
risks.

IMPORTANCE OF ADVANCES IN

BANKING BUSINESSS

Of, all the function of a modern bank, lending is for

the most important. A study of the balance sheets as
on 31st march of the public sector banks viz. State
Bank of India and its subsidiaries and the
Nationalized banks reveals that about 80% of their
revenue comes from interest’ and ‘discounted’ that
bills purchased and interest on investment Advances
comprise a very large bank’s structure. The strength
of a bank is thus primarily judged by the soundness
of advance. A wise and prudent policy in regard to
advance is considered an important factor inspiring
confidence in the depositors and prospective
customers of bank.

BANK ADVANCES ASSIST

ECONOMIC DEVELOPMENT

Advance not only plays an important part in gross

earnings of banks. But also promote the economic
development of the country. All types of business
activity including trade, industry and agriculture
move to depend on bank finance in one form of the
other Banks by channelizing accumulated saving of
the nation into productive uses help both the
depositors and the borrowers. Banks assist in
creating more avenues of employment and thus help
raising the standard of living of the people.

PRINCIPLES OF SOUND LENDING

There are few general principles of good lending

which every banker follows while appraising an
advance proposal. These are seated in the following
paragraph.

1. Safety
“Safety first” is the most important principle of
good lending. When a banker lends, he must
feel certain that the advance is safe: the money
will definitely come back. The banker ensures
that the money advanced by him goes to the
 right types of borrower and is utilized in such on
way that it will not only be safe at the time of
lending but will remain so throughout and after
servicing a useful purpose in the trade or
industry, where it is employs is repaid with
interest.
2. Liquidity
Banks are essentially intermediates for short
term funds. Therefore they lend funds for short
term funds. Therefore they lend funds for short
periods and mainly for working capital purposes.
The Loan are therefore, largely payable on
demand. The banker must ensure that the
borrower is able to reply 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. Thus, the banker regards
liquidity as important as safety of fund and
grant loans on the security of assets.
3. Profitability
Commercial banks are profit earning institution.
They must empty 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 rates of interest charges by
banks primarily depend on the directions issued
by the Reserve Banks. The rates may also differ
depending on the borrower’s credit, natures of,
security, mode of charge, and form and type of
advance, whether its cash credit, loan,
reshipment finance or a consumer loan etc.
 4. Purpose of the loan
While lending his fund, the banker enquiries of
the borrower the purposes for which he seeks
the loan. The purpose should be productive so
that the money not only remains safe but also
proud a definite source of repayment. It should
be short-termed so that it ensures liquidity.
Loans are not advanced for speculative and
unproductive purpose. Loans for capital
expenditure for establishing business are of long
term nature and the banks grant such term
loans also.

5. DIVERSIFICATION OF RISKS:

This is also a cardinal principal of sound lending.

A prudent banker always tries to select the borrower
very carefully and takes tangible assets as security to
safeguard his interests and the banker feels safe
while granting advance on the security of such
assets. An element of always present in every
advance. To safeguard his interest against inforseen
contingencies, the bankers follow this principle and
diversifies the risk involved in landing.

FORMS OF ADVANCES

INTRODUCTION

Advance by commercial banks are made in different

forms such as loans, cash credits, overdrafts, bills
purchased, bills discounted etc. These are generally
short term advance. Commercial banks finance
working capital requirements of their customers.
Advances may be granted against tangible security
in special deserving cases on an unsecured/clean
basis.

1. LOANS
Under the loan system, credit is given for a
define purpose and for a predetermined period.
Normally, these loans are repayable in
installments. Funds are required for single non-
repetitive transactions and are withdrawn only
once. If the borrow needs funds again or wants
renewal of an existing loan. Banker is at liberty
to grant or refuse such a request depending
upon his own cash resources and the credit
policy of the central bank.

ADVANTAGES OF LOAN SYSTEM

1. Financial discipline or the borrower: At the time

of repayment of the loan or its installments is
fixed in advance, this system ensures as greater
degree of self-discipline on the borrow as
compared to the cash credit system.
2. Periodic review of loan account : Whenever any
loan is granted or its renewal is sanctioned the
banker gets an opportunity of automatically
reviewing the loan account. Unsatisfactory loan
accounts may be discontinued at the discretion
of the banker.
3. Profitability : The system is comparatively
simple interest accrues to the bank on the
entire amount lent to a customer.
4. Loan documentation is more comprehensive as
compared to cash credit system.

TYPES OF LOANS :
Loans are granted for short, medium or long
period short term loans are usually granted to
meet the working capital needed of the
borrowers. Medium term loans repayable over a
period, ranging from 1year to 5 years, are
granted for the purchase of durable goods like
tractors and vehicles, equipments for
professional and other tools and machinery etc.
Long term loans, generally called ‘term loan’,
are extended by banks and other term lending
institution for meeting the requirements of
capital investment in industry to agriculture.
When a loan is granted, both for buying
equipment and for working capital purpose,
specially in case of small borrowers, it is called a
composite loan, Banks also provide on a limited
scale ‘consumption loans to meet the medical
and educational expenses and expenses
relating to marriage and other religious
ceremonies eta.

1. CASH CREDIT :
A cash credit is essentially a drawing account
against credit granted by the bank and is
operated in the same current account in which
an overdraft limit has been sanctioned. The
principal advantage of a cash credit account to
a borrower are, unlike the party borrowing on a
fixed loan basis, he may operate the accounts
 within the stipulated limit as and when required,
and can save interest by reducing the debit
balance. Wherever he is in a position to do so
the borrow can also provide alternative
securities from time to time in conformity with
the terms of the advance and according to his
own requirement. Cash credits are against
personal security. If there is good turnover both
in the account and in the goods, and there are
no adverse factors, a cash credit limit is allowed
to continue for year together.

ADVANCE OF CASH CREDIT SYSTEM

1. Flexibility : The borrowers need not keep

surplus idle funds with themselves, they can re-
cycle the funds quite efficiently and can
minimize interest charges by depositing all cash
accruals in the bank account and thus keeping
in the drawls at the minimum required level.
The system thus ensured lesser cost of funds to
the borrows and better turnover of funds for the
banks.
2. Operative Convenience : Banks have to
maintain one account for all the transaction of a
customers. The repetitive documentation can be
avoided.

WEAKNESSES OF THE SYSTEM

1. Fixation of credit limits: The cash credit

limits are prescribed once in a year. Hence it
 gives rise to the practice of fixing large limits
that is required for most part of the year. The
borrowers mistiness the unutilized gap in times
of credit restraint.
2. Banks inability to verify the end-use of the
funds : Under this system, the stress is on the
security aspect. Hence there is no conscious
effort on the part of the banks to verify the end-
use of funds. Funds are diverted without
banker’s knowledge, to unapproved purpose.
3. Lack of proper Management of Funds :
Under this system the level of advance in a
bank is determined not by how much the banker
can lend at a particular time but by the
borrower’s decision to borrows at that time. The
system, therefore does not encourage proper
management of funs by banks.

1. OVERDRAFTS

When a current account holder is permitted by the

banker to draw more than what stands to his credit
such an advance is called an overdraft. An
overdraft is a fluctuating account where in the
balance sometimes may be in credit or debit. The
banker may take some collateral security or may
grant such advance on the personal security of the
borrower. The customer is permitted to withdraw
the amount as and when it is feasible for him.
Interest is change on the exact amount overdraw
by the customer and for the period of its actual
utilization.
 Generally an overdraft facility is giving by a
bank on the basis of a written application and the
promissory note send by customer in such cases
and express contract come into existence. In some
cases, in the absence of an express contracted to
grant overdraft, such a agreement can be inferred.
From the course a business. For example, if an
account holder, even without any express grant of
an overdraft facility, overdraws on his account and
his cheque is duly honored by bank, the
transaction amount to a lone.

Bank should therefore obtained a letter and a

promissory note in cooperating the terms and
condition of the facilities including the rate of
interest changeable in respect of the overdraft
facility. This is to be complied with even when the
overdraft facility might be temporary in nature.

2. TEMPORARY OVERDRAFTS

Bank sometime grant unsecured overdrafts for

small amounts to customers, having current
accounts with them. The account holders may be
salaried officials or persons engaged in trade or
industry. Such overdrawings require strict control.
Except for isolated drawings which are promptly
repaid and are not likely to be resorted to gain,
Sanction is necessary in all other cases. It may be
permitted with safely, only where there is an
apparently reliable source of funds available to a
borrower for e.g. Government officials.
Such drawings should be allowed merely asa
means of supplementing the monthly income of a
customer , the amount being dissipated in meeting
his ordinary monthly . The adjustment of such
occasional overdrafts depends also on the
continuity of the service of the employee
concerned.

An uninterrupted temporary overdraft

facility allowed by a bank extending over a period
of time. Say a few years, though without execution
of documents, is tantamount to a contract
between the customer and the bank. A contract is
implied from the conduct of the parties. The bank
cannot therefore unilaterally the facility without
giving the account holder notice in this regard.

3. Clean Advances :

Traditionally, clean (unsecured) advances were

grated for short periods after taking into
consideration for the net liquid resources of the
borrowers. Since there was no security to fall back
upon, be carefully assessed before such facilities
were allowed . Clean advances are generally
spread over a number of parties and are
sometimes required only such parties were
considered eligible as would at short notice be
expected to adjust the account. Credit capital and
capacity had therefore to be reinforced by suitable
guarantees, be carefully assessed before such
facilities were allowed . Clean advances are
generally spread over a number of parties and are
some times required to be reinforced by suitable
guarantees.

The extent of free resources of the borrower

have to be examined and reasons for his not
furnishing any security are considered . In case of
borrower insolvency , his other unsecured
creditors would rank pori passes with the bank.
While making clean advances to a limited
company , search should be made in advance to
ascertain, if there are any charges on the
company’s assets.

4. Term Loans :
Since sometimes , bankers have started lending
large amounts for fairly long periods to
industries and agriculture on the security of
fixed assets on term loan basis. Such loans are
repayable by installments over a number of
years ranging from 3 to 10 and sometimes
more.