1. Lending
  2. Principles of loaning
  3. Purpose of the Loan
  4. Lending Works
  5. Principle of Diversification of Risks
  6. Cardinal Principles of lending


Lending also referred to as “financing” happens once somebody permits another person to borrow one thing. Money, property, or another quality is given by the investor to the receiver, with the expectation that the receiver can either come the quality or repay the investor. In different words, the investor offers a loan that creates a debt that the receiver should settle.

Principles of loaning

The business of loaning, which is the main business of the banks, carry bound inherent risks and the bank cannot take a quite calculated risk whenever it needs to lend. Hence, loaning activity needs to essentially adhere to bound principles. Loaning principles are often handily divided into 2 areas (i) activity and (ii) individual.

(i) Activity:

(a) Principle of Safety of Funds

(b) Principle of gain

(c) Principle of Liquidity

(d) Principle of Purpose

(e) Principle of Risk unfold

(f) Principle of Security

(ii) Individual:

(a) Method of loaning

(b) Five ‘C’s of the receiver = Character, Capacity, Capital, Collateral, Conditions Sources of data obtainable to assess the receiver

– Application

– Market reports

– Operation within the account

– Report from different Bankers

– Monetary statements, IT returns etc.

– Personal interview

– Unit scrutiny before sanction

(c) Security Appraisal

Primary & collateral security ought to be ‘MASTDAY’

M – Marketability

A – Simple to establish its title, value, amount, and quality.

S – Stability important

T – Interchangeability of title.

D – Sturdiness – not perishable.

A – Absence of contingent liability. I.e. the bank might not be got to pay extra money on the protection to create it marketable or perhaps to keep up it.

Y – Yield. The protection ought to give some ongoing financial gain to the borrower/ bank to hide interest & or partial compensation.

Purpose of the Loan

While loaning his funds, the banker enquires from the receiver the aim that he seeks the loan. Banks don’t grant loans for every and each purpose—they make sure the safety and liquidity of their funds by granting loans for productive functions solely, viz., for meeting the assets want of a commercial enterprise. Loans aren’t advanced for speculative and unproductive functions like social functions and ceremonies or for pleasure visits or for the compensation of a previous loan. Loans for cost for establishing a business square measure of semi-permanent nature and therefore the banks grant such term loans also. When the nationalization of major banks loans for initial expenditure to begin tiny trades, businesses, industries, etc., also are given by the banks.

Lending Works

Lending happens whenever an investor offers one thing to a receiver on credit. It is a broad term that encapsulates many various varieties of transactions. Common lenders embrace monetary establishments, like banks and credit unions that build a business model around loaning cash. The receiver pays a value for doing away with the loan within the type of interest. If the investor feels there is a higher risk of not being paid back by a receiver, like with a brand new start up business, they’re going to charge that receiver the next rate of interest. Lower-risk borrowers pay lower interest rates. Lenders don’t participate in your business within the same approach as shareholders, owners, or partners. In different words, an investor has no possession of your business. 

Principle of Diversification of Risks

This is conjointly a cardinal principle of sound loaning. A prudent banker forever tries to pick the receiver terribly rigorously and takes tangible assets as securities to safeguard his interests. Tangible assets are not any doubt valuable and also the banker feels safe whereas granting advances on the protection of such assets, nonetheless some risk is often concerned in that. Associate business or trade could face recessive conditions and also the value of the products and commodities could sharply fall. Natural calamities like floods and earthquakes, and political disturbances inbound elements of the country could ruin even a prosperous business.

Cardinal Principles of lending

A bank is an establishment that is primarily seen as a body that accepts financial deposits from its customers (general public), takes care of their cash, supplies them some helpful services like checkbooks to create payments, and lends cash to the different public (borrowers). Currently loaning cash to somebody comes with some inherent risks particularly once a bank uses its depositors’ cash to lend. To place it merely a bank’s major operation is to borrow cash from depositors and lend cash to totally different quiet borrowers. Since the first supply of funds for a bank is its depositors’ cash that square measure owed as and once demanded by the depositors, it’s extraordinarily vital for a bank to use caution whereas loaning cash to customers. Therefore, the banker ought to follow the cardinal principles of loaning whereas loaning cash and certify all the norms of sound monetary loaning square measure experienced. to place it merely banks build cash by loaning cash to borrowers, therefore it becomes important for banks to follow the cardinal principles of loaning.

About the Author

BankReed Admin

Banking Professional with 16 Years of Experience. The idea to start this Blogging Site is to Create Awareness about the Banking and Financial Services.

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