Page 119 - DCOM208_BANKING_THEORY_AND_PRACTICE

Banking Theory and Practice

Notes Self Assessment

Fill in the blanks:
17. Commercial banks in India demand ……………… security.
18. Short-term loans may take the form of cash credit and………………, demand loans, and
the purchase and discounting of bills.

7.8 Factors Influencing Loan Policy in a Bank

The important factors on which the loan policies of a bank depend are:

Capital Positions: The quantum of capital of the bank is certainly the most important
factor that influences its loan policy.
Capital provides the cushion (base) that absorbs the losses that may occur during
course of banking business.
Capital serves as a protective factor against losses for depositors and guaranteed
funds for the creditors.

A bank with a strong capital position can assume more credit risks than one with a
week capital position.
A bank with high capital can follow a liberal lending policy and provide different
types of loans, including long-term loans thus gets higher interest rates.
Profit Targets: Profit-making is one of the principal objectives of a commercial bank.
Banks may be in a position to emphasize the importance of income, while others
may lay stress on liquidity depending on policy, purpose, and managing capability.
The banks, which have set income as the principal goal of their lending policies,
would follow an aggressive lending policy and might make a larger amount of
term loans or customer loans. These loans are normally made at higher interest
rates because of the high amount of risk associated in them.
Banks should not take greater risks to merely accomplish the objective of
profitability.

Deposit Variability: Increase and decrease in deposits in the banks also determine their
lending capacity.
Banks that have experienced unstable deposits in past must follow a conservative
lending policy. They cannot afford to incur undue risks by extending their term
lending facilities.

Banks facing declining deposits should follow a similar policy.
Banks whose deposits have shown a rising trend in the past, and which expect the
rising trend to persist in future, can also be liberal in their loan policy.

State of Local and National Economy: The economic conditions that prevail in the region
served by the bank should be kept in mind while formulating the lending policy.

A bank operating in an area that is subject to seasonal and cyclical fluctuations
cannot afford to adopt a liberal lending policy because that would result into ill-
liquidity.

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