Krishna Niraula

Chartered Accountant

Lending Principles and its management

Q. What are the lending principles for a commercial bank? Explain in context with RBB.

Answer: Banks in Nepal are categorized into 4 categories, namely commercial banks, development banks,
finance companies and microfinance companies. The major objective of the banks and financial
institutions is to collect deposit distributed in mass public and utilize them to promote trade and
commerce through the process of lending. Commercial banks especially have huge capital funds
(minimum paid up capital Rs. 8 billion) and they invest the deposits in several sectors like production,
deprived sector, housing finance, personal overdraft, etc. In fact, commercial banks play a major role for
money supply, which is a sound indicator for economic progress.

Lending Principles:

Commercial banks like RBB should focus on several aspects before providing loans to customers. As
lending means to supply money with a trust that it becomes utilized and repaid properly, lending is the
major area a bank should focus upon. As lending involves giving money of depositors, several aspects are
to be considered upon. The lending principles for a bank like RBB are as follows:

1. Liquidity: Before providing loan, a bank should keep in mind of the adequate liquidity position so
that no liquidity crisis arises in the future after lending. NRB directive 13 states that CRR should
be maintained at 4% and SLR at 12%. Similarly, lending should be under the ceiling of 80% CCD
Ratio as per NRB Directive 5.
2. Diversity: Banks should diversify their funds into several sectors. Concentration in a single sector
and/or a single customer/group increases risk whereas diversification of loans into several areas
minimizes the risk level. NRB Directive 3 has provisions for sectoral credit as well as single obligor
limit. For instance, a bank can lend only to the extent of 25% of core capital to a single
customer/firm/company/related parties. Similarly, banks should adhere to the NRB directives for
diversified credit. For example, minimum investment in agriculture, tourism and hydropower
projects, etc.
3. Safety: Bank should study whether it is safe to invest in the sector of loan before loan sanctioning.
Bank should be assured that the investment in the related sector is safe and the loan amount gets
repaid in time.
4. Stability: It is always a wise decision to invest in a stable sector. For instance, banks should
promote the sectors where the investment gives a stable return.
5. Profitability: Banks are profitable organizations, so they should invest in the sectors where they
get maximum return. Commercial Banks should also keep in mind of the spread rate of 4.5% from
Ashadh 2076.
6. 6 C's for Credit Appraisal: Under this, bank should focus on 6 C's of customer before lending. The
6 C's are:
a. Character: Banks should assess the character of the customer, i.e. whether he is involved in
offence of moral turpitude or blacklisted or defaulter of any other bank, etc.
 Krishna Niraula
Chartered Accountant

b. Capacity: Here, banks should assess the repayment capacity of the borrower before
disbursing loan. Projected Cash Flow statement can be an effective tool of measurement of
the future cash flows to analyze whether it is safe for bank to invest in the loan.
c. Collateral: Banks should also keep adequate collateral from customer. The Loan to Value
Ratio should not exceed the provisions as mentioned in NRB Directive 3.
d. Condition: The condition of loan like repayment period, instalment, interest rate, etc. should
be properly managed before lending.
e. Capital: Bank should also assess the capital structure of the prospective borrower. By analysis
of the balance sheet, the debt equity ratio should be checked whether it is exceeding 2:1 or
not.
f. Confidence: It is an additional quality that a bank should see in a borrower. Confidence to
utilize the loan in desired sector and to repay the loan within due time frame is another trait
of borrower that a bank should see.

Apart from these, banks should also look on the following before lending:

 Financial Analysis: It includes ratio analysis, horizontal analysis, vertical analysis and trend
analysis which indicates the suitability and sustainability of the project.
 Important documents like Tax Certificate, identification documents like citizenship, name,
address, income source documents, etc.

RBB Context: RBB is one of the leading commercial banks of Nepal with more than 222 branches.
Having its credit exposure of more than Rs. 135 billion, the bank has provided lending service to
huge number of customers. Being its lower Cost of Fund, the lending rate is also lower as
compared to other commercial banks. Some of the practices in RBB for effective lending process
are as follows:

a. A separate Credit Department is established and it consists of effective staffs, who study the
loan proposal before disbursing loan.
b. Internal Audit Department is established to check the credit files management procedure of
Credit Department.
c. Planning Department provides proper feedback by studying the several sectors of loan.
d. Risk Management Department studies the credit risk associated with loan files and gives
proper feedback as to whether there is risk in specific lending or not.

Conclusion:

Lending is a crucial process in banking. A proper lending process and its management involves
sound planning for lending, direction & supervision to borrower, monitoring and controlling of
the utilization of the loans as per loan proposal, etc. Lending helps the scattered money in public
to be utilized in productive sector, which ultimately develops the country. However, there are
equal challenges in lending management. Some of the challenges are risk of the loan being bad,
misutilization of loan, using loan for illegal benefit and crimes like terrorist financing, anti-money
laundering, etc. NRB has several provisions in the NRB directives for addressing these issues. For
 Krishna Niraula
Chartered Accountant

example, NRB Directive 19 speaks about anti money laundering and there are several acts like
BAFIA, Anti Money Laundering Act, NRB Act, Companies Act, etc. which regulate banking sector.
If commercial bank like RBB adhere to the lending principles and follow NRB Directives, the
lending becomes effective and inclusive to almost all the sectors. And quality lending rather than
quantity lending gets priority.