Principles of Lending

The basic principles of lending for minimizing

risk, maximizing profit and protecting depositors
funds to maintain the trust and faith of
customers.
 Principle of Safety and Security
Bank should lend their fund in such area where
there is least probabilities of default. For this
bank should have:
• Good CPG,
• Appropriate credit appraisal mechanism
• Past track records,
• Cashable securities
 Principle of Liquidity
• Match the maturity of credit with various
sources of funds such as deposit, borrowings
etc.
• Bank should not delay or default in making
payment to depositors or lenders to maintain
good faith.
• Bank must comply regulatory requirement like
CRR and SLR.
 Principle of Risk Diversification
• Various risks involved in lending business.
• Concentration risk should be monitored and
managed through credit diversification into
different sectors, industries, and borrowers.
 Principle of Profitability
• Banks are commercial organizations
• Profit making is their main objective.
• Profit is necessary for the bank’s sustainability
and growth.
• Need to pay adequate return to their
shareholders.
• Maximum possible return should be
considered while lending decision is made.
 Principle of Loan Purpose
• Disbursed loan should be utilized.
• If not, less chance of repayment.
• Lending should be within the boundaries of
CPG and legal framework.
• Bank need to be careful to prevent lending in
money laundering, terrorist activities,
conducting illegal business, etc.
 Types of Loan
1 Term Loan:
• It is specific purpose loan such as acquiring
machinery, constructing or renovating a building,
etc. (not for financing day-to-day operation)
• Value of the asset should exceed the loan
amount. 
• Maturity period should be lower than the life of
asset.  
• Generally, repaid on amortized basis
2 Overdraft :
An overdraft occurs:
• When customer writes a check on uncollected funds
Or
When there are insufficient funds in the account to
cover the withdrawal.
• Overdraft is unsecured and one day loan.
• In Nepal, it is extended on the prior permission of
bank.
• Normally, banks charge the higher rate of interest on
Overdraft.
3. Import Loan
Loan made available for importing goods.

4. Export Loan
Loan extended to produce exporting goods against
export L/C or other collateral and settled when
amount received from Importer

5. Trust Receipt Loan

• Loan created forcefully through import L/C
• Normal maturity period is 90 days to 365 days.
6 Working Capital Loan
• Credit extended to finance borrower’s
temporary or seasonal working capital needs.
• This is also known as Demand loan,
Hypothecation loan, short term loan, time
loan, cash credit etc.
• Revolving nature or fixed maturity period.
7 Residential Personal Home Loan : Loan
available to individual for construction residential
home up to Rs. 10 million.
8 Real Estate Loan: Loan extended to a firm, company
or institutions to develop land, construct commercial
complex, apartments, etc.
9 Margin Nature Loan : Credit extended against the
share or debenture of a company.
10 Hire Purchase Loan : Loan extended to purchase
vehicles or goods.
11 Deprived Sector Loan: Loan extended to deprived
sector 4%, 3.5% and 3% of 6 months prior total
loan and advance.
Deprived means low income and especially socially
backward women, tribal people, Dalit, blind, hearing
impaired and physically incapacitated persons,
marginalized and small farmers, craft-men, labor and
landless family.

12 Other Loan: Education loan, credit card, etc.

 Some Other types of loan
• Consortium Loan
(Reason: Loanable fund, Risk Div., SOL, Sectoral Limit etc.)
• Revolving Loan
• Line of credit
• Hypothecation credit
• Bridge gap loan
• Performing Loan
• Non-performing loan
 Collateral
a. Types of acceptable collateral
b. Criteria of collaterals
c. Valuation procedures:
• List of valuators
• Valuation by valuators
• Valuation by staffs
• Additional collaterals
• Monitoring of collaterals
• Insurance and other security for collateral
d. Mortgage procedures
 Classification of Loans
Entire loans and advances extended by a
licensed institution have to be classified as
Follows:
1. Performing Loan (Pass Loan):
• Loans not overdue or Overdue by 3 months;
• Loans against the collateral of gold and silver;
• Loans against collateral of FDR
• Loan against collateral of Govt. or NRB Bonds.
• Loans complying all regulations and own CPG
 Watch List
• Loan overdue by 1 to 3 months
• Temporarily extended working capital loan
• Having non-performing loan in other BFIs
• Having net loss since 2 years or having
negative net worth.
 Classification of Loans Contd…

2. Non-performing Loan: This class of loan is

subcategorized into following 4 groups:
a. Sub-standard Loan: Overdue by 3-6 months.
b. Doubtful Loans: Overdue by 6 to 12 months.
c. Loss Loans:
• Overdue by more than 1 year,
• Loans not secured by collateral,
• Debtor bankrupted or has been declared to be
bankrupt;
• debtor disappeared or not identified;
 Classification of Loans Contd…
• In case non-fund based facilities such as purchased
or discounted bills and L/C and guarantee which
have been converted into fund-based loan (forced
loan), are not recovered within ninety days from
the date of their conversion into loan;
• In case misuse of Loan;
• A case is pending at a count under the recovery
process;
• Providing loan to a debtor who has been enlisted
in the black-list of Credit Information Bureau Ltd;
 Classification of Loans Contd…
• The Project/business is not in a condition to
be operated or project or business is not in
operation
• The credit card loan is not written off within
90 days from the date of expiry of the
deadline;
• In case of expiry of the deadline of a trust-
receipt loan.
d. Restructured/Rescheduled Loans:
 Loan Loss Provision
Loan classification Minimum Provision

(a) Pass 1 percent

(b) Watch List 2 – 5 percent

(c) Sub-standard 25 percent

(d) Doubtful 50 percent
(e) Loss loan 100 percent
Steps in the Lending Process
1. Loan application
2. Interview by loan officer
3. Presentation of documents:
a. Citizenship certificate, collateral related
documents (for individual)
b. Registration certificate, Renewal
certificate, tax registration or PAN, and
citizenship of owner (for private firm)
 Documents
c. Registration certificate, Renewal certificate,
tax registration or PAN/VAT, Minute of partner
meeting for taking loan, Loan transaction
authorization letter, citizenship of partner, tax
renewal, audit report (for partnership firm)

d.Article f Association, Registration certificate,

Renewal certificate, tax registration or PAN/VAT,
Minute of BOD for taking loan and citizenship
of members, tax renewal, audit report loan
transaction authorization letter (for company)
 Documents
e. Detail of guarantor and his citizenship
f. Collateral documents (Ownership
certificate, land map, etc..)
g. Valuation report of collateral
h. Feasibility study report
i. Actual and Projected financial statement
j. CIC report
 Steps in the Lending Process contd..

4.Document verification & analysis

5. Site visit:
• Project (feasibility)
• Collateral (Valuation)

6. Credit analysis:
 6. Credit analysis
a. Credit worthiness of borrower (6 C)
1. Character—Specific Purpose For Loan and Serious
Intent to Repay Loan:
How can it be determined?
• Customer’s past payment record,
• Experience of other lender with this customer,
• Purpose of loan
• Customer’s track record in forecasting business or
personal income,
• Credit rating
• Presence of guarantor of the proposed loan
• Social status
 6. Credit analysis Contd…
2. Capacity—Customer Has Legal Authority to Sign
Binding Contract capacity.

How can it be determined?

• Identity of customer or guarantor
• Copies of social security cards, driving license,
Corporate charters, resolutions, partnership
agreement, other legal documents, Legal
structure
• History, nature of operation, products, principal
customers, suppliers etc.
 6. Credit analysis Contd…

3. Cash—Does the borrower have the ability to

generate enough cash to repay the loan
Cash flow = Net profit + Non cash expenses
Or
Cash flow = Sales revenue –Cost of goods sold
– selling, admin. & general expenses – tax paid
in cash + Non cash expenses
 6. Credit analysis Contd…

Sources of cash flow

1. Cash flow from operation
2. Cash flow from financing activities
3. Cash flow from investing activities

Normally, No.1. is the best way, but 2 and 3 are

riskier.
 6. Credit analysis Contd…
How can it be determined?

• The past earnings, dividends and sales record

for a business firm,
• Adequacy of past and projected cash flow
• Tools used to project cash flows and other
financial statements
 6. Credit analysis Contd…

• Availability of liquid reserves

• Turnover of payables, receivables and
inventory
• Capital structure and leverage
• Expense control
• Management quality
• Coverage ratios
 6. Credit analysis Contd…

• 4. Collateral—Does the Borrower Have Adequate quality

Assets or net worth to Support the Loan? Is not the asset
technologically obsolete?
How can it be determined?
• Ownership of asset
• Vulnerability of assets to obsolescence
• Liquidation value of assets
• Degree of specialization in assets
• Liens, encumbrances (burden), and restrictions against
property held,
 6. Credit analysis Contd…

• Leases and mortgages issued against property

and equipment,
• Insurance coverage
• Guarantees and warrantees issued to others
• Lenders relative position as creditor in placing
a claim against borrower’s assets
• Probable future financing needs
 6. Credit Analysis Contd…
5. Conditions—Must Look At the Industry and
Changing Economic Conditions to Assess
Ability to Repay
How can it be determined?
• Customer’s current position in industry and
expected market share
• Competitive climate for customer’s product
• Sensitivity of customer and industry to
business cycles and changes in technology
 5. Conditions…

• Labor market conditions in customer’s

industry or market area,
• Impact of inflation on customer’s balance
sheet and cash flow,
• Regulations, political and environmental
factors affecting the customer business.
 6. Credit Analysis Contd…

6. Control—Does loan meet written loan policy and

how would changing laws and regulations affect loan
How can it be determined?
• Applicable laws and regulations regarding the
character and quality of acceptable loans
• Adequate documentation
• Correctly prepared loan documents
• Consistency of loan request with lender’s written loan
policy
 6. Credit analysis Contd…

B. Financial Analysis:
• Financial analysis consists of analysis of past,
present & well justified projected Balance
sheet, Profit & loss account, Cash flow
statement, Ratio analysis etc.
• Key items to be analyzed: trends, market,
position, industry risk, industry status,
liquidity, inventory/receivable position
 10. Approval of loan

• Recommendation goes to the loan committee

for approval with memo.

• If the loan is approved, the loan officer check

on the property that is pledged as collateral in
order to ensure that the bank has immediate
access to the collateral if the loan agreement
is defaulted. This is often referred to as
perfecting the bank’s claim to collateral.