What is the principle of sound lending?

What is the principle of sound lending?

Every bank has to deal with risk while they lend their money to the lenders. Because they dealt such transactions through others\’ money. There are other bank operations. In which cash is needed to be ready with the bank. Because it is an obligation to return the money of customers to them, when they demand. So it is compulsory for the bank to handle bank funds by properly taking care of money.

So there are some principles on which banks have to lend cash to their borrowers. Such borrower money is concerned with the other person. Which needs to be arised to handle such money in a proper way. What is the principle of sound lending?

PRINCIPLES OF SOUND LENDING

IT is advisable for the bank that there are generally some principles for sound lending which must be followed by banks while they are granting advances loans to their customers.

Safety
Liquidity
Diversity
Stability
Profitability
Principal Purpose
Principal of social Responsibility

(1). Safety:- It is the most prestigious principle of lending. Which means that the borrower must be able to repay the loans and interest as per the required dealing without default. The repayment of the loan depends upon the security, goodwill of the borrower, his financial standing as well as his capacity to repay based on his salary and business. Because bank investment also involves risks.

So in most cases banks must keep the documents of property when it is to lend to the borrower. Which provides the security to the bank. And decreases the risk on the way of lending money by banks. However, safety of banks depends upon the technical feasibility and economic situation of the project for which loan is advanced.

(2). Liquidity:- It is also an important principle of bank lending. Liquidity plays important roles in the operations of the bank. Liquidity must be kept with the banks as always. Which will be able to meet the demands of customers during the time of withdrawal at any time by the depositors.

So in such cases banks must lend money to the borrower on those securities which are easily marketable and convertible into cash within a short period. So banks must choose securities which possess sufficient liquidity. Because the Bank always needs cash to meet the urgent requirements of its customers. There are some securities such as central, state and local government bounds which are easily saleable without affecting their market prices.

(3). Diversity:- Banks must not invest surplus money into one securities as particular securities. Rather it should invest in different types of security. As it must choose the different types of shares and debentures of different industries which are also situated in the different regions of the country. Because a rational diversification always minimises the risk of the portfolio investment of banks.

It also applied to advancing loans to various types of firms, industries, business and trades. By doing so, risks will be distributed among various trades and businesses in different parts of the nation. What is the principle of sound lending?

(4). Stability:- It is also an important principle of lending money or using money by banks. So banks must invest in those securities whose prices are generally stable in the market. So government bonds and debentures of companies carry fixed rates of interest. But banks may be required to liquidate a portion of them to meet its requirements of cash in case of a financial crisis. So investment of banks in debentures and bonds is more stable than in the shares of the company. What is the principle of sound lending?

(5). Profitability:- This principle represents that a bank must invest in those securities which ensures a fair and stable return on the funds invested. However, earning capacity of securities largely depends upon the interest rate and dividend rate as well as tax benefits. So it is the government securities as centre, state and local bodies which carry the exemption of their interest from taxes. The bank must invest in such securities rather than in the shares of new companies which also carry tax exemption.

(6). Principle Purpose:- It is the utmost main principle of lending. In which a banker must enquire about the purpose of loan before granting an advance. Such a process is productive in the way of granting advances which proves the capacity of the repayment of the borrower. What is the principle of sound lending?

During the enquiry it may be found that the productive purpose of the loan may raise the income for the investor. Then he can repay the loans promptly. If the purpose of investors is not productive then it will be difficult to repay loans to the bank. Then before granting such advances the bank can ignore such borrowers whose purpose is not very productive. What is the principle of sound lending?

(7). Principle of Social Responsibility:- While banks are dealing with the borrower, the banker must not emphasise the size of the borrower as well as his security that he is offering to the loan project. However, technically economic viability of the borrower must be considered before granting loans. Priority projects must be followed by the banks which can help to boost the national economy. However, other principles must not be avoided when banks have to obligate the social responsibility towards the society. By considering such responsibility, success of new ventures will be increased in the country. What is the principle of sound lending?

Conclusion:- From the above discussion we can conclude that every bank must go through the above principle while they are lending to their customers. Because through lending, the bank earns a major part of its income. So it\’s a primary task of the bank to lend. Thus, before lending every principle must be analysed appropriately. What is the principle of sound lending?

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