Loans, Advances and Credit Principles
This domain tests the principles of sound lending, the main forms of bank credit, security creation, and the classification and recovery of bad loans.
Credit principles
Banks balance safety, liquidity and profitability. The traditional 5 Cs are character, capacity, capital, collateral and conditions. Credit appraisal also uses CIBIL and other credit-bureau reports, cash-flow analysis and repayment capacity.
Forms of credit
Cash credit is a running account against stock or receivables. An overdraft is allowed on a current account. Demand loans are repayable on demand; term loans are repaid in instalments. Bill discounting advances against bills of exchange. Retail loans include home, auto, education and personal loans; MSME loans include MUDRA products.
Security
A pledge involves delivery of possession. Hypothecation creates a charge without possession. A mortgage is a charge on immovable property. A lien gives the bank the right to retain securities. A guarantee adds a surety’s liability.
NPA rules
A loan becomes a non-performing asset when interest or principal is overdue for more than 90 days. NPAs are classified as substandard, doubtful and loss. Recovery laws include SARFAESI, 2002 and the Insolvency and Bankruptcy Code, 2016.
Priority sector
Banks must lend 40% of adjusted net bank credit to priority sectors, including 18% to agriculture, 12% to weaker sections and 7.5% to micro enterprises.
Worked example
A term-loan instalment is due on 1 April and is unpaid. The account becomes an NPA on 1 July because 90 days have elapsed. If it remains an NPA for up to 12 months, it is substandard; beyond that it becomes doubtful.
Traps
Pledge requires possession; hypothecation does not. NPA is 90 days, not 180. SARFAESI does not cover agricultural land. Cash credit is a running facility, while a term loan is a lump-sum disbursal repaid on schedule.