S. MuraliFCMA, ACS, CAIIB, LL.B., MFM, M.Com., Ph. D.

Adjunct Professor, ICFAI Business School,Director, Enhance Your Competence

andFormerly Assistant Vice President and ING Vysya Bank, Bengaluru.

K.R. Subbakrishna M.A., CAIIB, LL.B., B.Sc.

Adjunct Professor, ICFAI Business School (Retired),Director, Enhance Your Competence,

andFormerly Associate Vice President, ING Vysya Bank, Bengaluru.

Bank CreditManagement

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First Edition : 2008Second Revised Edition : 2012

Reprint : 2013, 2015, 2017Reprint : 2018

Third Revised Edition : 2019

Published by : Mrs. Meena Pandey for Himalaya Publishing House Pvt. Ltd.,Ramdoot, Dr. Bhalerao Marg, Girgaon, Mumbai - 400 004Phone: 022-23860170/23863863; Fax: 022-23877178E-mail: himpub@vsnl.com; Website: www.himpub.com

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Phone: 033-32449649; Mobile: 07439040301DTP by : Krunali/SnehaPrinted at : M/s. Aditya Offset Process (I) Pvt. Ltd., Hyderabad. On behalf of HPH.

Credit administration has been evolving and now more than a century old. InEurope, it is more than three centuries. Banks in India followed their own principles andpractices until globalization in economic front including financial sector reforms wereinitiated in 1990s.

In 1988, the Committee for International Banking Supervision, Basel (Switzerland)evolved risk-weighted approach and capital adequacy known as Basel II. In 1998, Basel IIwas recommended. The main aspects of Basel II are: (i) more risk-sensitive, (ii) developrisk measurement and risk management techniques and (iii) align regulatory capital toeconomic capital. Risk management has assumed high degree of importance. Of the threetypes of risks, namely credit, market and operational, emphasis is on Credit risk.Deregulation and globalization of financial services together with growing sophisticationof financial services make banking and risk profiles more complex. Banks in India have toimplement Basel II not later than 31.03.2009. All these developments and the fact creditportfolio both on and off-balance sheet constitutes substantial composition, there isabsolute need for bankers to understand the revised processes and systems that aredifferent from traditional or pre-liberalisation approach to credit function.

The book on “Bank Credit Management” encompasses all the developments withadequate lucidity the credit management in banks. It has captured the latest developmentsincluding Recovery Management as well as Micro Credit. I have no doubt that the bookwill be a useful guide to bankers and students of banking.

I congratulate Sarvashri S. Murali and K.R. Subbakrishna for their pioneering work.

Banking is dynamic throughout the world. It is necessary that those involved keepthemselves abreast of the developments and stay updated.

M.S. Sundara Rajan

Chairman and Managing Director,Indian Bank.

Foreword

We are glad to note that this book has completed one decade since its first edition.We take this opportunity to thank all the readers of the book for their support andfeedback.

After the release of Second Edition in the year 2012, lots of changes have taken placein the banking sector, and in particular, credit management area. Hence, we have broughtout the following changes in this edition to capture the major changes:

» Chapter 4 – Policy Rates and RBI Guidelines (CRR Maintenance, MonetaryPolicy Committee)

» Chapter 5 – Prudential Norms (Basel III Guidelines, Prompt Corrective Action)

» Chapter 7 – Types of Borrowers (Guidelines regarding Charge Creation PostCompanies Act, 2013)

» Chapter 13 – Priority Sector Lending (Latest Norms)

» Chapter 19 – Recovery Management (Insolvency and Bankruptcy Code 2016)

» Chapter 20 – Micro Finance and Financial Inclusion (Jan-Dhan Yojana andMUDRA Scheme)

We thank Mr. G.N. Venkataraman, Practicing Cost and Management Accountant,and a Qualified Insolvency Professional, for his inputs on the Insolvency and BankruptcyCode and Mr. D. Murugesan for reviewing the Chapter on Foreign Exchange. We, onceagain, thank all those who have contributed a few chapters and provided inputs for ourearlier editions.

We are grateful to our publishers M/s Himalaya Publishing House Pvt. Ltd. for theefforts taken in popularising this book and bringing out this edition.

We hope this revised third edition will also be received by our readers with sameenthusiasm as hitherto.

We welcome suggestions from the readers which we would address in our nextedition.

Bengaluru S. Murali[ibsmurali@gmail.com]

K.R. Subbakrishna[kr.subbakrishna@gmail.com]

Preface to Third Revised Edition

Banks deal with public funds as they accept deposits from those who have surplusand lend them to the needy in the form of Advances. Depositors have to be paid interest.To meet the interest cost and the overheads (expenditure), a bank has to earn income inthe form of interest on money lent and fee for other services rendered. Banks cannot justkeep the money received as idle deposits. The same has to be lent to such persons who arein a position to service the loans on time. If there is any laxity in the selection ofborrowers or at the time of disbursement of the loan or follow-up of the money advanced,the probability of the account becoming Non-Performing is greater. Hence, ‘CreditManagement’ gains vital importance in the functioning of any bank.

Not many books are available exclusively covering Credit Management in Banks.This book contains in detail the various steps in Credit Management – right fromprospecting a client to the proposal sanction, monitoring and follow-up of advance. It alsohas a chapter on the Recovery Measures – Legal and Non-legal in the event of an accountturning NPA despite all efforts taken by the bank. Risk Management has been gaining lotof importance since the last couple of years and more so with the implementation of BaselII norms. A chapter is dedicated to Risk Management. ‘Microfinance’ is fast catching up asa means of effective lending for the rural mass and also enabling banks to achieve theirPriority Sector targets. An exclusive chapter deals on this topic.

The book has been written in a very simple language and we have tried to share our over25 years’ experience in the banking industry by our specific comments/suggestions at relevantplaces.

We are sure this book would be of great help to students who are doing their MBA,M.Com., BBM and other similar courses and also those who would be entering the CreditDepartment of the Bank for the first time.

We thank Mr. S. Sridhar, Competence Development Facilitator of ING Vysya BankCDC for having contributed the Chapter on ‘Credit Policy in Banks’ and Mr. P.S.Kulkarni, Management Consultant and formerly AGM, Canara Bank and Chairman,Chitradurga Grameena Bank for contributing the chapter on “Microfinance”.

We also thank our parents, other family members and friends who have directly orindirectly helped us in bringing out this book.

We will be failing in our duty if we do not thank our publishers M/s. HimalayaPublishing House Pvt. Ltd. for having brought out this book in such a nice form.

We welcome suggestions for improving the contents of this book which we wouldaddress in our future editions.

Bengaluru S. Murali[Smurali77@yahoo.com]

K.R. Subbakrishna[kr.subbakrishna@gmail.com]

Preface to First Edition

Contents

1. Overview of Lending Activity 1 – 8– Primary and Secondary Functions of a Bank

– Directed Lending and Normal Lending

– Wholesale and Retail Banking

– Requirements for Effective Lending

2. Principles and Objectives of Credit Management 9 – 28– Objectives of Credit Management

– Qualities of a Good Borrower

– 6 Cs of Credit

– Credit Information Companies

– Cardinal Principles of Bank Lending

– An “Ideal Advance”

– Stages in a “Credit Cycle”

– Client/Customer Acceptance Criteria

– Modes of Credit Disbursement

– Checklist for SSI Entrepreneurs

– Checklist for Branch Managers

– Fair Practices Code

3. Credit Policy in Banks 29 – 40– Meaning of Credit Policy of a Bank

– Four Types of Credit Culture

– Objectives of a Sound Credit Policy

– Regulatory Requirements under Credit Policy

– Credit Policy as a Risk Management Tool

– Case Study

4. Policy Rates and RBI Guidelines 41 – 52– Cash Reserve Ratio (CRR)

– Methodology for Maintenance of CRR

– Statutory Liquidity Ratio (SLR)

– Approved Securities for SLR

– Penalty for Non-maintenance of CRR/SLR by Banks

– Bank Rate, Repo and Reverse Repo

– Prime Lending Rate and Base Rate

– Monetary Policy Committee

– Case Study

5A. Prudential Norms on Capital Adequacy andCredit Risk Management 53 – 82

– Basel I, Narasimham Committee and Basel II CommitteeRecommendations

– Approaches Proposed by Basel II Committee for Computing Credit Risk

– Tier-1, Tier-2 and Tier-3 Capitals

– Meaning of Risk-weighted Assets

– Mode of Computing the Capital Adequacy Ratio of a Bank

– Various Risks Faced by the Banks

5B. Basel III Capital Regulations 83 – 101– Salient Features of Basel III Capital Regulations

– Composition of Regulatory Capital – Relevance and Need for Risk Rating

– Credit Risk Mitigation

– Calculation of Capital Requirement

5C. Prompt Corrective Action 102 – 105– What is Prompt Corrective Action (PCA)?

– Trigger for PCA

– Different Capital Measures

– Risk Thresholds

– Benefits of PCA

– Mandatory and Discretionary Actions by RBI

6. Income Recognition, Asset Classification (IRAC) andProvisioning Norms 106 – 121

– Income Recognition and Asset Classification norms

– Meaning of Standard Asset, Sub-standard, Doubtful and Loss Assetsand Special Mention Accounts

– Norms for Treating an Advance as Non-performing

– Provisioning Norms for Various Class of Assets

– RBI Guidelines on Apportionment of Recoveries

– Concept of ENPA

– Case Studies

7. Types of Borrowers 122 – 142– Various Types of Borrowers

– Special Features of Each Type of Borrower

– Salient Points to be Noted While Dealing with Minors

– Limited Company as a Borrower – Formalities for Creation of Charge

– MCA21 – E-filing of Returns of Limited Companies

– Hindu Undivided Family as a Borrower – Precautions to be Taken

8. Analysis of Financial Statements 143 – 179– Meaning of Financial Statements

– Directors’ Responsibility Statement

– Users’ Information Needs

– Qualitative Characteristics of Financial Statements

– Quantitative Tools of Financial Statement Analysis

– Comparative Financial Statement Analysis

– Common Size Financial Statement Analysis

– Ratio Analysis

– Funds Flow Analysis

– Cash Flow Analysis

– Limitations of Financial Statement Analysis

– Creative Accounting/Window Dressing

9. Credit Evaluation — Working Capital Finance 180 – 198– Meaning of Working Capital

– Kinds of Working Capital

– Operating Cycle

– Factors Affecting the Level of Working Capital

– Assessment of Working Capital

- Methods of Assessment of Working Capital

– Tools of Financial Statement Analysis

– Case Studies

10. Credit Evaluation of Term Loans 199 – 232– Meaning of Term Loan

– Deferred Payment Guarantee

– Factors to be Considered While Considering a Term Loan Proposal

– Technical, Economic and Financial Feasibility of a Project

– Use of Break-even Analysis, Sensitivity Analysis, Leverage, InterestCoverage and Debt Service Coverage Ratios

– Case Study

11. Dynamics of Foreign Exchange 233 – 246– Foreign Trade Policy in India

– Foreign Exchange Rates

– Pre-Shipment and Post-shipment Credit

– Meaning and Types of Letter of Credit

– Common Documents Used in International Trade

– EEFC: Exchange Earners Foreign Currency Accounts

– External Commercial Borrowing (ECB)

12. Types of Credit Facilities 247 – 258– Types of Facilities

– Overdraft, Cash Credit, Bills Facility and Term Loans

– Drawing Power and Drawing Limit

– Fund-based and Non-fund-based Facilities

– Bank Guarantee (BG)

– Format of BG

– Case Study on BG

– Letter of Credit (LC)

13. Priority Sector Lending 259 – 267– Understand the Background before Introduction of Priority Sector

– Meaning of Priority Sector

– Activities Classified as Priority Sector

– Targets under Priority Sector

– Other RBI Guidelines Regarding Priority Sector

14. Corporate Funding 268 – 288– Consortium Lending, Syndication and Lending by Multiple Banks

– Use of Leasing as a Mode of Financing

– Factoring and its Nuances

15. Infrastructure Lending 289 – 297– Meaning of Infrastructure

– Importance of Infrastructure

– Meaning of Public Private Partnership (PPP)

– Various Models of PPP

– Key Issues in Bank Financing

16. Supply Chain and Channel Financing 298 – 310– Meaning of Channel Financing

– Differences between Channel Financing and Conventional Financing

– Benefits of Channel Financing

– Supply Chain Concepts

– Financial Supply Chain

– Benefits of Supply Chain Financing

– Differences between Supply Chain Financing and Channel Financing

17. Documentation 311 – 344– Meaning and Importance

– Evidence

– Steps Involved in Documentation

– Procedure for Execution of Documents

– Attestation

– Registration of Documents

– Time Barred Documents

– Renewal of Documents

– Documents Normally Obtained from Borrower (Constitution-wise)

– Types of Charges

Hypothecation, Pledge, Lien, Assignment

– Different Types of Mortgages

– Do’s and Don’ts of Documentation

– Caselets on Documentation

18. Monitoring and Follow-up 345 – 367– Meaning

– Importance of Monitoring

– Pre-disbursement and Post-disbursement Care

– Off-site and On-site Monitoring

– QIS Returns

– Unit Inspection

– Early Warning Signals

– Unfair Practices Normally Adopted by Borrowers

19. Recovery Management 368 – 390– Legal and Non-legal Recovery Measures

– Debt Recovery Tribunal (DRT)

– Asset Securitisation and Asset Reconstruction

– SARFAESI Act – Provisions Applicable to Bank Recoveries

– Notices to be Issued to Borrowers under SARFAESI Act Insolvencyand Bankruptcy Code 2016

20. Micro Finance and Financial Inclusion 391 – 414– Financial Problems Faced by Rural People in India

– Meaning of Micro Finance

– Origin and Growth of Micro Finance in India and Abroad

– Self-help Groups and their Formation

– Role of NABARD in Micro Finance

– Assessment of Micro Finance Lending Proposal

– Grading of MFIs and NGOs

– Meaning and Significance of Financial Inclusion

– Financial Inclusion Models Followed by Banks

– MUDRA Loans

21. Effective Funds Management through E-banking 415 – 420

22. Comprehensive Case Study 421 – 426

Chapter

1Learning Objectives

After going through this chapter,you will learn:

1. Primary and SecondaryFunctions of a Bank

2. Difference between DirectedLending and Normal Lending

3. Meaning of Wholesale andRetail Banking

4. Requirements for EffectiveLending Activity in a Bank

Overview ofLending Activity

2 Chapter - 1 Bank Credit Management

PRIMARY

Accepting Deposits

Cross Selling

Collection ofCheques/Bills Remittances

Issuance ofBGs/LCs/DPG

Lending or Investment

Safe Deposit Vault

Safe Custody

Functions of a Bank

SECONDARY

Banks are institutions which mobilize savings from the publicand channelize the same to the various sectors of the economy.Banks have been in existence in India since Vedic times. Sec.5(b) of the Banking Regulation Act, 1949 defines ‘Banking’as:

“ACCEPTING, FOR THE PURPOSE OF LENDING OR INVESTMENT, OF DEPOSITS OFMONEY FROM THE PUBLIC, REPAYABLE ON DEMAND OR OTHERWISE ANDWITHDRAWABLE BY CHEQUE, DRAFT, ORDER OR OTHERWISE”.

Thus, Banks cannot just accept deposits and sit quite. For the deposits mobilized, they are requiredto pay interest. In addition, the Bank has to meet various expenses in running the business likeestablishment expenses, rent, lighting and other overheads. For taking care of the interest payment ondeposits and meeting overheads, the Bank has to effectively deploy the funds mobilized. The deposits canbe deployed in two ways as defined under the Banking Regulation Act, viz., lend as loans and advancesto the needy persons at a rate of interest which is normally more than what the bank pays for its depositcustomers or investment in some interest-yielding securities. (Note: The difference in the rate of interestthat a Bank charges on the amount lent and the rate it pays to the depositors is technically called‘Spread’). It is important to note at this stage, the fact that from the ‘Spread’ Bank has to not only meetall its overheads and interest on deposits but also provide for ‘Non-performing Loans’ or ‘Non-performingAssets’ (NPAs).

Primary and Secondary Functions of a Bank

The activities that a banker performs in tune with the definition given in the Banking Regulation Act istermed as ‘Primary Functions’, viz., accepting of deposits and lending of money (loans and advances). Theincome that a Bank derives from the primary function is normally called as ‘Interest’.

INTRODUCTION

3Chapter - 1Overview of Lending Activity

The modern day banker does render a host of services which are not forming part of the primary functionsdetailed above. These are known as ‘Secondary’ or ‘Ancillary’ functions. Some of the ancillary functions that abank performs are:

Collection of Cheques and Bills of Exchange.

Undertaking remittance facilities for the customers – Issuance of Demand Drafts or effectingtransfer of funds via TT, RTGS or NEFT (Telegraphic Transfer, Real Time Gross Settlement orNational Electronic Funds Transfer).

Provision of Safe Deposit Lockers to customers to enable them to keep their belongings in asafe and secure place.

Safe Custody of articles, securities, Will and other important documents. Here, a sealed box orclosed cover is handed over to the banker by customers with a request to return him wheneverhe demands. The box/cover would be kept in the Safe Vault of the Bank and will be under dualcustody and control of the Bank.

Non-fund facilities – Issuance of Bank Guarantees, Letters of Credit or Co-acceptance of Billsof Exchange (popularly called Deferred Payment Guarantee).

Selling of Third Party products – Cross Selling – Insurance and Mutual Fund products,Government Securities, etc. In fact, this function of bank is gaining vital importance becauseof its ability to generate income without any further investment and need to provide anyadditional capital or risk capital.

The income that a Bank earns by performing ancillary functions is technically called ‘Fee-basedincome’ or ‘CEB income’ (Commission, Exchange and Brokerage). All the banks areconcentrating more and more on increasing the share of fee-based income as the bank does nottake much risk in doing this business.

Banks cannot exist without performing the vital function, viz.,lending. This is just like a human being cannot sit idle withoutmoving out of the house, even though he has all the facilities tospend his time. Though banker can earn income by investing insecurities, the returns would comparatively be low and fraughtwith more risks.

In India, the lending can be categorized into:

Retail Lending and Wholesale Lending

Directed Lending and Normal Lending

BUSINESS OFLENDING

4 Chapter - 1 Bank Credit Management

Retail and Wholesale Lending

Retail lending refers to the lending by banks to non-corporate borrowers, i.e., individuals and smalland medium businessmen. The ticket size of these advances would be small but the number of accountswould be high. The advantages of retail lending are:

The yield is normally high.

The risk for the bank is diversified.

Advancing to a greater number of customers and helping them in increasing their standard ofliving.

The level of NPA is generally very low.

Ease of processing the loan proposals.

Wholesale lending is financing of corporate customers and institutional finance. Here, the size ofadvance is large and the number of borrowers is relatively small. The products under this sector are quitecomplicated and customized/structured to meet the specific needs of the client. Main advantages ofwholesale lending are:

The follow-up is easier since the number of customers is small.

Cost of maintenance is low.

Since the ticket-size is big, personalized attention can be given to customers by attaching aRelationship Manager for a group of accounts.

Though wholesale lending has above advantages, it suffers from serious deficiencies like:

The risk for the bank is very high.

The yields are low.

The borrowers are highly demanding and in this era of competitive banking, many a time banksare lending to this sector much below the cost of funds and not taking care of the prudentprinciples of lending.

Encourages concentration of wealth in the hands of a few.

Lending

Size of Advance Regulated Lending

Retail Lending Wholesale Lending Normal LendingDirected Lending

5Chapter - 1Overview of Lending Activity

Directed and Normal Lending

This type of classification of lending is very peculiar to developing countries. The banks arecommercial organizations and they would normally lend only to activities which are safe and yield goodreturns. Due to various economic factors, the developing countries would like the banks to lend to sectorswhich are important for social upliftment as well as economic growth or for generating foreign exchange.

In India, the central bank of the country, Reserve Bank of India, issues directives to commercialbanks in the area of lending. The sectors which were once-neglected but important for the developmentof the Indian economy are designated as ‘Priority Sectors’. Banks are required to lend 40% of the NetBank Credit to these sectors. Here, the yield is comparatively low and the default risk is high. Lendingto these priority sectors and other areas on the basis of the directives of RBI or other governmentdepartments is termed as ‘Directed Lending’. (Discussed in detail under the Chapter 4 on RegulatoryFramework).

Loans and advances of banks other than directed lending is termed as ‘Normal Lending’. Here,banks have liberty in selection of the industries, sectors to be financed, etc.

Requirements for Lending

Just as any trader requires commodities in his stores for effecting sales, a banker requires funds forlending.

Sources of Funds

The primary source of funds for any business is owner’s capital. For banks too, the share capitalforms a source of fund. Unlike other industries, in banks this source constitutes a very smallportion. Before the Basel I norms, this constituted a very miniscule portion of the bank’sresources (1-2%). Now, banks are required to maintain at least 9% of their risk-weightedassets as capital. Post-implementation of Basel I norms, we do find that on an average, bankshave a capital of 10-11%.

The main sources of funds for a banker comes from the deposits it mobilizes from the public.From the point of view of cost of deposits, it would be better if CASA (Current and SavingsAccounts) constitute a sizable portion of the deposits. Almost all banks are focusing in the areaof improving the share of CASA.

One other source is the ‘Reserves’ and ‘Undistributed Profits’.

The next source of fund could be ‘Borrowings’. In view of the huge cost involved, this constitutesa small portion of a Bank’s Balance Sheet (Less than 5% of the total funds).

Good Systems and Procedures: The bank should have good systems and procedures in place.Updated manual of instructions giving details about various aspects of lending would be handy for freshrecruits as well as those who work in the credit department first time.

Credit Policy: Every bank should have its own credit policy which should be in tune with thecredit policy of RBI, statutory requirements of the government, credit appetite of the bank and itsexposures to various sectors.

6 Chapter - 1 Bank Credit Management

Delegation of Powers: The bank should have an approved ‘Delegation of Powers’ document fromthe Board. This should clearly give the details of the sanctioning/approval powers of various authoritiesat the Branch and Administrative Offices.

Trained Manpower: Lending is both a science and an art. It is science insofar as there are variousrules and procedures that have to be strictly adhered to before granting an advance. It is an art becausethe dealing officials are in constant touch with customers and have to be very tactful while transactingthe business. The credit officials cannot go by rule-book always. They should be very considerate to thefinancial problems a businessman has and suggest solutions within the broad framework of credit policyand guidelines of the bank. It is said that the banker is one who can nurture a successful entrepreneur bysupporting him at the times of need. To quote in a lighter vein:

‘Banker should not be the one who lends umbrella when it is shining and takes away when it is raining’.

If one wants to be a friendly and helpful banker, the officials should have right attitude. Hence, inaddition to imparting training in the areas of skills for building proposals, the dealing officers should betrained in ‘attitude’ and other soft skill areas.

What is Credit Creation?

As already seen, banks accept deposits and lend a portion of it as credit or advances. As per normalunderstanding, if a banker accepts deposits of say, ` 1 lakh, he should be able to lend up to a maximumof ` 1 lakh as credit. Since, he has to keep a certain portion of it to take care of the demands of depositors,his lending capacity is restricted by that amount. If, we take into account, that by past experience, thebanker is able to judge that about 20% of the amount collected as deposits would be required to meetthe daily requirements, the maximum lendable resources would be ` 80,000 (` 1,00,000 – 20,000).

Though, in the above cited illustration, the banker can lend upto a maximum of ` 80,000, in reality,he can lend much more. Think that the banker lent ` 80,000 and this money was paid to the supplier ofgoods to the borrower and the supplier deposits the cheque into another bank. The second banker, afterkeeping 20% cushion, i.e., ` 16,000, lends ` 64,000 to his customer who issues cheques to his supplier.This third customer deposits with his banker ` 64,000 and his banker lends ` 51,200 after keeping thecushion of ` 12,800 (20%) and the process is continued, the amount of credit that a bank can lend wouldbe 5 times the original deposit of ` 1 lakh, i.e., ` 5 lakh. This is found by using the following formula:

Maximum credit creation = 1/cushion% * Original Deposit = 1/0.20 * 1,00,000 = ` 5 lakh.

Are there any factors that restrict the amount of credit creation by banks?

YES. The capacity of credit creation depends on:

The amount of cash required for day-to-day operations.

Maintenance of Cash Reserve Ratio as per statutory requirements (In India, at present it is 6%of NDTL). (Monetary policy of the central bank of the country).

Investment in Statutory Liquidity Ratio (at present it is 24% of NDTL).

* NDTL - Net Demand and Time Liabilities.

7Chapter - 1Overview of Lending Activity

Level of banking culture among the people – Higher the level, lower the cash requirement andgreater the power of credit creation

Non-continuance of Chain of Credit Creation, i.e., if the banks do not extend credit up to themaximum potential (80% of the amount of deposits in our illustration) and/or any of theparties in the chain not depositing the entire amount in a bank and wishes to hold as PhysicalCash.

Flow Chart of a Credit Creation Cycle

Customer A deposits

` 1 lakh with Bank A

Bank A lends ` 80,000/-

to Customer M

Customer M issues cheques

to his Supplier N

Supplier N deposits the cheque

of ` 80,000/- with his Bank B

Bank B lends to Customer O

` 64,000/-

Customer O issues cheques

to his Supplier P

Supplier P deposits the cheque

of ` 64,000/- in Bank C

Bank C gives loan of

` 51,200/- to Customer Q

And so on …. and if process is continued

Total Credit Creation would be ` 5 lakh

8 Chapter - 1 Bank Credit Management

Summary

Bank is accepting f or the purpose of

lending or investment of deposits of money

from the public, repayable on demand orotherwise.

Primary function of a banker is accepting of

deposits and lending of funds/investment inprofitable securities.

In addition to primary function, a bankeroffers several other services called Ancillary

Services or Secondary functions. Some of

them are remittance facilities, Safe Depositlockers, collection of cheques, cross selling

of insurance, mutual fund products, etc.

Income from primary function is ‘Interest”and that from subsidiary services “Fee-based

income” – Commission, Exchange and

Brokerage.

Lending activity of a bank can be eitherDirected Lending or Normal Lending.

Directed Lending is as per some directions

of the Government or Central Bank of thecountry. Another classification is “Wholesale”

and “Retail” lending depending on whether

it is for Corporates or Non-corporates.

For activity of lending, a bank requires funds

(main source being deposits), good systemsand procedures in place, delegation of powers

explicitly stated, trained manpower, etc.

Review Questions

1 . How is banking defined under Banking Regulation Act, 1949?

2. What are the main functions of a Bank?

3. What are the subsidiary functions of a Bank?

4. What is Directed Lending and Normal Lending?

5. Distinguish between Wholesale Lending and Retail Lending.

6. What are the sources of funds available to a Bank for lending?

7. Other than funds what other things are needed for the activity of lending?

W W W