LOANS & ADVANCES (CREDIT)
All loans are shown as’ asset’ in the balance sheet of the bank. Interest earned on loans is the major source of income for the banks. However, as the banks make all their loans from the money received as deposits from the public, they have to be very judicious in making loans and have to ensure timely recovery of loans.
FIXED RATE OF INTEREST
When the loan are sanctioned at a rate which will not change during the tenure of the loan.
FLUCTUATING /FLOATING RATE OF INTEREST
The interest rate which may increase or decrease in the coming times. In other words, it is opposite of fixed rate of interest.
TEASER RATE OF INTEREST
Interest rate that is low initially, but keeps on increasing gradually, as agreed to by the borrower. Usually it is applied to housing loans as they have a long term.
BASE RATE
It is the rate below which a bank is not allowed to charge interest on any loan. Every bank is free to decide its own base rate and RBI has no role in it. All banks have to declare their base rate publicly. In three exceptional cases banks are allowed to charge a rate lower than Base Rate:-
- Loan against Bank’s own deposits
- Loan to Bank’s own staff
- Loans under Differential Rate of Interest scheme
Concept of Base Rate was introduced w.e.f. 01.07.2010 on the recommendations of the Deepak Mohanty Committee.
SPREAD
Major source of income for banks is the interest earned on loans. Interest paid on deposits is their main expenditure. The difference between average rate of interest earned an average rate of interest earned an average rate of interest paid is known as ‘spread’. This is also referred to as ‘Net Interest Margin’ (NIM). If we talk in terms of difference between total interest earned and total interest paid, it is called ‘Net Interest Income (NII).
BRIDGE LOAN
Sanction of very large amount loans takes quite some time, may be several months. To meet fund requirements of the company during this interim period, banks normally sanction short term loan to the company, known as bridge loan.
SOFT LOAN
A loan sanctioned with comparatively long repayment period and low rate of interest. For example, a loan of $ one billion sanctioned by India to Bangladesh at 1.75% rate of interest.
EQUATED MONTHLY INSTALMENT (EMI)
It refers to monthly instalment fixed for repayment of any term loan, where instalment includes both, repayment of principal and interest.
BALLOON PAYMENT
The last instalment of a term loan paid to finally close the account. It may be larger or smaller than the regular EMI.
BULLET PAYMENT
Option to pay out the entire loan amount in one go, at the end of the specified loan term.
MORATORIUM PERIOD
It refers to the period, usually in the beginning of a term loan during which the borrower is exempted from the repayment of loan. For example, in a house loan, one year moratorium may be allowed to enable the borrower to complete the construction the house.
CHECK-OFF FACILITY
It is a system where the employer agrees to deduct the amount of EMI of the loan takne by its employees, from the salary of the employee and deposit it directly with the loan giving bank.
ESCROW ACCOUNT
A special account opened for a borrower to receive all his incomes and inward receipts. Later on, bank decides as to what amount has to be shared with the borrower and balance is appropriated towards repayment of bank dues and other statutory dues.
SUB-VENTION
It is a kind of subsidy announced by government on interest payable to banks by the borrowers. Unlike subsidy which is given in the beginning, the subvention portion of interest has to be recovered by the bank from the government. For example, at present, subvention of 3% is available on export loans, and rate of interest happens to be 7%, the bank will charge calculate interest @ 7%, but will charge only 4% to the borrower and recover 3% from the government. Further, subvention of 3% is available of farm loans up to Rs. 3 lacs if the loan is paid in time. A subvention of 1% is available housing loans of up to Rs. 15 lacs, provided the total cost of house does not exceed 25 lacs.
MARGIN MONEY (DOWN PAYMENT)
When a customer is sanctioned a loan, the bank does not given loan for the full value of the item to be purchased. The contribution that the customer is expected to make from his own resources is known as margin (Down payment).
FINANCIAL STATEMENTS
Various statements that record financial health and transactions of any business organization, such as balance sheet, profit and loss account, funds flow, cash flow statements. These are required assess the need of the customer for the loan and his repayment capacity.
DOCUMENTATION
Process of obtaining necessary agreements, documents for recording the terms and conditions of various loans, is called documentation. It is done in accordance of legal requirements to enable the bank to file a claim in the courts of law. If documentation is incomplete / defective, the bank’s claim will not be valid in the eyes of law. Most of the documents are valid for a period of 3 years only from the date of execution and thus they have to be renewed or revived before expiry of 3 years otherwise they become invalid or time barred / expired.
CREATING A CHARGE
It refers to the legal process of establishing banks interest in a security which is offered to the bank for securing a loan. It may be noted that even after creating a charge, ownership of assets charged remains with the borrower. Further, except in case of pledge, possession of the item also remains with the borrowers. Charges are of three main types as below:-
| CHARGE | UNDER THE ACT | ITEMS COVERED |
| MORTGAGE | Transfer of Property Act (TPA), 1882 | Land / Building of all types |
| PLEDGE (applicable only to items in possession of banks) | Indian Contract Act, 1872 | Stocks, Ornaments, Shares, NSC etc. |
| HYPOTHECATION | SARFAESI Act, 2002 | Stocks, Crops, Vehicles |
| ASSIGNMENT | TPA, 1882 | Life Ins. Policies |
PRIMARY / COLLATERAL SECURITY
Assets created by the amount of loan received from the banks are classified as ‘Primary Security’ and banks have the first charge on them. Any other asset taken as additional security by the bank is classified as ‘Collateral Security’.
REVERSE MORTGAGE
Objective: To address the financial needs of senior citizens owning self occupied property but not having any regular source of income.
It is a loan product where regular monthly payments are made to the senior citizen (borrower). Repayment of the loan is done usually after the death of the borrower and his spouse, from the sale proceeds of the property.
IRAC NORMS
INCOME RECOGNITION & ASSET CLASSIFICATION NORMS
In the bank’s balance sheet, all the loans are shown as assets as interest earned on them is the main source of income for the banks. Since banks lend money received from public as deposits, it is very essential for the bank to ensure timely recovery of loans and interest thereon. To ensure that banks do not show any laxity in this regard, RBI has formulated IRAC Norms.
Income recognition means that only that amount of interest which has actually been recovered from the borrower should be booked as interest income. It also means that if a borrower is not repaying the interest, banks are not allowed to book that interest as income. Thus, it results in loss of income to the banks.
ASSET CLASSIFICATION
It refers to classification of all the loan accounts into four health categories as prescribed by the RBI. These categories are as under:
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Standard Assets: Loan accounts which do not show any sign of irregularity and all the repayments, of instalments and interest are being received on time. Standard loan accounts which start showing signs of sickness are classified as ‘Special Mention Account’.
- Sub Standard Assets: Accounts where instalment / interest which is due but has not been paid for over 90 days, are classified in this category. This means that the said loan account has stopped performing and thus it is also termed as Non Performing Asset (NPA). Sub standard is the first stage of NPA account. A loan account can remain in this category for a maximum period of 12 months, after which it is classified as doubtful asset – second stage of NPA. Substandard accounts have good chances of recovery and may easily be converted into standard accounts after full due amount is recovered.
- Doubtful Asset: NPA accounts of age over 12 months and classified in this category. The account may continue to be in this category till its security values does not fall below 10% or whenever the bank auditors classify it into the next category of NPA – i.e. loss assets, whichever is earlier. Doubtful accounts have only fair chances of recovery.
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Loss Assets: This is the last stage of NPA accounts. Such loans accounts which have Nil chances of recovery or where security value has fallen below 10% are classified into this category. Chances of recovery are bleak in these accounts.
PROVISIONING
When an account becomes NPA, obviously bank’s funds get blocked to some extent, depending on category of NPA. To ensure that the bank funds are not blocked into NPA account, RBI has prescribed provision norms for NPA’s. As per this, depending on age of NPA, banks have to provide for a certain proportion of the loan amount classified as NPA. This amount has to be taken out from the profits of the bank and has to be parked in the Provision Account. Present rates of provisioning under:
Standard Accounts: 0.40% Sub Standard: 15%
Doubtful Assets: 25% to 100% Loss Assets: 100%
WRITE OFF
When 100% provisioning has been made in a bad account, banks close that loan account in their books, with a view to improve their balance sheet by showing lesser amount of NPAs. This is called ‘writing off’ the loan account. However, banks continue their efforts to recover the maximum possible written off amount.
ONE TIME SETTLEMENT (OTS)
When a loan account goes bad, banks may be compelled to initiate legal action against the borrower. However, there is still no guarantee that loan amount will be recovered fully, besides this process is time consuming and expensive too. OTS offers a middle way out for settlement of NPA’s. Banks negotiate with the borrower to recover maximum possible sum in one go, allowing some rebate in the amount due. Thus, an OTS deal is a win-win situation for both – borrower as well as banker.
OTS deal is based on Net Present Value (NPV) concept which simply states that a smaller amount available today is better than a bigger amount (uncertain) available at a future date.
LOK ADALAT
To give a formal shape to the OTS arrangements, Government of India has created the forum of Lok Adalats under the provision of Legal Services Authorities Act 1987. Once an OTS is finalized, both banker and the borrower appear before the Lok Adalat and present their settlement before the judge who after satisfying himself about the genuineness of the case, puts his official stamp on the agreement, making it a proper court verdict. Lok Adalat has the jurisdiction to handle cases up to Rs. 20 lacs.
DEBT RECOVERY TRIBUNAL (DRT)
With a view to strengthen the recovery efforts of the banks, particularly in the high value loan accounts, Government established DRTs – special courts exclusively for dealing with bank recovery cases, under the Recovery of Debts Due to Banks and Financial Institutions Act, 1993. A DRT is headed by a single judge; termed as Presiding Officer and can handle cases of Rs. 10 lacs and above. Proceedings of DRT cannot be challenged in any court except in DRAT.
DEBT RECOVERY APPELLATE TRIBUNAL (DRAT)
Whenever either party – bank or borrower is not satisfied with the decision of the DRT, they can file an appeal with the DRAT. Head of the DRAT is designated as chairperson.
SARFAESI ACT 2002
Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002
One of the major problem which banks faced in recovery cases was that of taking possession of the assets charged to them through mortgage / hypothecation. They had to obtain court permission which invariably took long time there by frustrating the bankers. As a result, bankers were not keen to make loans, particularly the big ones. To overcome this problem government, enacted the SARFAESI Act which empowered the bank officers themselves to take possession of the assets charged to them directly, without intervention of the court. This act proved extremely beneficial to the banks in improving their recovery efforts.
The act is applicable to recovery cases of above one lac and only to such cases where recovery has been less than 80% of total dues and is not applicable to agricultural land. Under this act, borrower is served a 60 days notice demanding the repayment of dues, failing which bank is authorized to take possession of the charged assets. After taking possession, if the borrower still fails to repay the dues, the bank can sell off the assets to realize its dues. The term ‘securitization’ refers to selling out of healthy loan accounts to a securitization company. Banks can also sell off their NPAs to Asset Reconstruction Companies – ARCs.
CONSORTIUM FINANCING
Under consortium financing, several banks (or financial institutions) get together to finance a single big borrower. The process is also known as ‘loan syndication’. The bank taking the lead or acting as coordinator is called consortium leader.
INTERNAL RATE OF RETURN (IRR)
It is the rate of return, a project is expected to generate. Generally speaking, the higher a project’s internal rate of return, the more desirable it is to undertake the project.
DEBT SERVICE COVERAGE RATIO (DSCR)
It is the ratio which is calculated to know the amount of cash available for repaying the loan liabilities of a unit, also known as debt servicing. It is a popular benchmark used in the measurement of an entity’s (person or corporation) ability to produce enough cash to cover its debt (including lease) payments. The higher this ratio is, the easier it is ti obtain a loan.
CREDIT DEPOSIT RATIO (CD Ratio)
It is the ratio showing proportion of total loans to the total deposits of a bank or a branch or a region. It indicates the level of deployment of funds by the bank. On average, it is around 60% to 70%, through it may go far below or above.
PRIORITY SECTOR (PS) LENDING
With a view to serve the interests of lower and middle segment of economic population, government has demarcated certain sectors of economy as ‘priority sector’ indicating that government expects banks to give priority to these sectors while making their financial lending plans.
All scheduled banks, including foreign banks, are required to make 40% of their total lending in these sectors. Total loans for this purpose are defined as Adjusted Net Bank Credit (ANBC). For foreign banks with less than 20 branches in India, the target is 32%.
PRIORITY SECTOR ADVANCES
| SR. NO. | ACTIVITY | TARGET |
| 1 | Agriculture & Allied Activities | 40% of Total Advances (ANBC): Share of agriculture not to be less than 18% |
| 2 | Micro, Small & Medium Enterprises | |
| 3 | Education (Loans upto Rs. 10 lacs for studies in India & Rs. 20 lacs for studies abroad) | |
| 4 | Housing (Loans upto Rs. 25 lacs for metros & Rs. 15 lacs at other places) | |
| 5 | Export credits | |
| 6 | Others – weaker sections* |
* Target for weaker section is 10% of, with in overall limit of 40%
Further, all public sector banks should allow 15% of total priority sector loans to the borrowers from the minority community. Government of India has recognized six religious communities as minority:-
(i) Muslims (ii) Sikhs (iii) Christians (iv) Parsis (v) Buddhist (vi) Jains
MSMED Act 2006
Micro, Small and Medium Enterprises Development Act 2006 defines 3 types of manufacturing and service sector units on the basis of original cost of investment made in plant and machinery in case of manufacturing units ( upto Rs. 10 Crore), and in equipment in service sector (upto Rs. 5 Crore). Loan to all such units are covered under priority sector. Units other than micro, small and medium are classified as ‘ Large units’ and are not covered under priority sector.
RIDF AND SEDF
Banks which fail to achieve their priority sector lending targets, have to subscribe to special purpose funds created for the purpose. Indian banks have to deposit the short fall amount in Rural Infrastructure Development Fund (RIDF) maintained by NABARD. Foreign banks have to deposit the amount in Small Enterprises Development Fund (SEDF), maintained by SIDBI.
CREDIT GUARANTEE FUND TRUST FOR MICRO AND SMALL ENTERPRISES (CGTMSE)
It is a government body set up to provide insurance covered to the banks which provide collateral / security free loans of upto Rs. 1 crore to the entrepreneurs in micro and small sector. The trust provides cover of upto 80% of amount in default, i.e. amount not repaid by the borrower.
KISSAN CREDIT CARD (KCC)
It’s a loan facility meant exclusively for farmers. Under KCC, a loan limit based on land holding of the farmer is allotted which can be operated through the KCC ATM card issued to the farmer.
SELF STUDY ZONE 