The major business of banking company is to grant loans and advances to traders as well as commercial and industrial institutes. The most important use of banks money is lending. Yet, there are risks in lending. While lending loans or advances the banks usually keep such securities and assets as a supports so that lending may be safe and secured. Suppose, any particular state is hit by disasters but the bank shall get advantages from the lending to another states units. Thus, the effect on the entire business of banking is reduced. So the banks follow certain principles to minimize the risk. Following are the important areas to be taken care while lending:
4. Purpose of loan
5. Principle of diversification of risks
Normally the bank uses the money of depositors in granting loans and advances. Because of that while granting loans the banker should think about the safety of depositor’s money. The purpose behind the safety is to see the financial position of the borrower, whether he can pay the debt as well as interest easily.
It is a legal duty of a banker to pay the total deposited money to the depositor on demand. So the banker has to keep certain percent cash of the total deposits in hand. Moreover the bank grants loan. It is also for the addition of short term or productive capital. Such type of lending is recovered on demand.
Commercial banks are profit earning institutes; nationalized banks are also not an exception. They should have planning of deposits in a profitability way to pay more interest to the depositors and more salary to the employees. Before taking any decision the banker should make sure that it is profitable.
Purpose of loan
Banks never lend or advance for any type of purpose that will lead to loose of money. The banks grant loans and advances for the safety of its wealth, and assurance of recovery of loan and the bank lends only for productive purposes. Before giving a loan the bank has to make sure that whether the purpose for which the loan has given is productive or not.
Principle of diversification of risks
A bank should be very careful while lending loans because if the bank lends to a non credit worthy customer, it will affect the survival of the bank. To diversify the lending risk they should lend loans to customers from different sectors such as agriculture, housing, educational, etc. Concentrating on a particular set of customers will adversely affect the bank.