Lending money to the public
Lending money is one of the two major activities of any Bank.
Banks accept deposit from public for safe-keeping and pay interest to them. They then lend
this money to earn interest on this money. In a way, the Banks act as intermediaries
between the people who have the money to lend and those who have the need for money to
carry out business transactions. The difference between the rate at which the interest is
paid on deposits and is charged on loans, is called the "spread".
Banks lend money in various forms and they lend for
practically every activity. Let us first look at the lending activity from the point of
view of security. Loans are given against or in exchange of the ownership (physical or
constructive) of various type of tangible items. Some of the securities against which the
Banks lend are :
Consumer durable goods
Documents of title
Apart from the above categories, the Banks also lend to people
on the basis of their perceived personal worth. Such loans are called clean and the Banks
are understandably cagey about extending such loans. The credit card arms of the various
Banks, however, fill up this void.
Cash credit Account
This account is the primary method in which Banks lend money against the security
of commodities and debt. It runs like a current account except that the money that can be
withdrawn from this account is not restricted to the amount deposited in the account.
Instead, the account holder is permitted to withdraw a certain sum called
"limit" or "credit facility" in excess of the amount deposited in the
Cash Credits are, in theory, payable on demand. These are, therefore, counter part of
demand deposits of the Bank.
OverdraftThe word overdraft means the act of overdrawing from a Bank account. In other
words, the account holder withdraws more money from a Bank Account than has been deposited
How does this account then differ from a Cash Credit Account?
The difference is very subtle and relates to the operation of the account. In the case of
Cash Credit, a proper limit is sanctioned which normally is a certain percentage of the
value of the commodities/debts pledged by the account holder with the Bank. Overdraft, on
the other hand, is allowed against a host of other securities including financial
instruments like shares, units of mutual funds, surrender value of LIC policy and
debentures etc. Some overdrafts are even granted against the perceived "worth"
of an individual. Such overdrafts are called clean overdrafts.
Bill discounting is a major activity with some of the smaller Banks. Under this type of
lending, Bank takes the bill drawn by borrower on his(borrower's) customer and pay him
immediately deducting some amount as discount/commission. The Bank then presents the Bill
to the borrower's customer on the due date of the Bill and collect the total amount. If
the bill is delayed, the borrower or his customer pay the Bank a pre-determined interest
depending upon the terms of transaction.
Term Loans are the counter parts of Fixed Deposits in the Bank. Banks lend money in
this mode when the repayment is sought to be made in fixed, pre-determined installments.
This type of loan is normally given to the borrowers for acquiring long term assets i.e.
assets which will benefit the borrower over a long period (exceeding at least one year).
Purchases of plant and machinery, constructing building for factory, setting up new
projects fall in this category. Financing for purchase of automobiles, consumer durables,
real estate and creation of infra structure also falls in this category.
Classification of loans
Another way to classify the loans is through the activity being financed. Viewed from this
angle, bank loans are bifurcated into :