A loan is one of the most profitable instrument of a bank since it helps the bank to increase its earnings and make profits. The efficient management of loans and advances assumes a greater significance as it is also the largest asset for any bank. However, with the tightening of financial regulations and credit norms, increased competition, and the emergence of newer forms of risk, it becomes imperative that the credit functions of the financial establishments are further strengthened. RBI has been continuously working with commercial banks to help them evolve relevant guidelines to meet the demand of a rising market as well as control credit risks.
Classification of loans
Classification of Loans can be done into two types:
- On the basis of activity
- On the basis of purpose
Classification of loans on the basis of activity
- Priority Sector Lending
- Commercial Lending
Priority Sector Lending
Priority Sector lending or Directed credit is one of the types of lending which the Government of India through the RBI has allowed the banks to offer.
The RBI allows the banks to offer loans to certain sectors who, the Central Bank thinks, will not be able to pay the interest at the commercial rates or will not have access to the organized lending market. Small scale industry, small businesses, agricultural activities, and exports fall under this sector. It is also called directed credit. Financing of these priority sectors are done at concessional rates.
Through this, the banks influence the economic development of the country, by subsidizing the business efforts of small businesses and help them flourish.
Commercial Lending
Commercial Lending is the mainstay of Indian Banking.
In the beginning, it was the priority lending that had kept the banks afloat. However, with the evolving economic landscape and rise of income and the widening of the Indian middle class, commercial lending has become the main focus.
Commercial loans are for both short term and long term. They can be further divided into Corporate Loan and Retail Loan based on the type of customer.
Classification of Loans Based on the type of customer
Corporate Loan
These types of loans are provided to corporate houses, proprietorships, partnerships, and HUFs engaged in any legal business activity, with the objective of earning profit.
The loans are disbursed on the basis of:
- The balance Sheet’s strength
- The Cash Cycle
- Products offered by the banks
Balance Sheet’s strength
Balance sheets are audited and the banks try to analyze the profitability of the said entity. This is done to check the ability of the entity to fully utilize the loan as well as be able to pay it back.
Customers who are interested in availing loans need to furnish the balance sheets of their companies along with their application of a request for the loan. The overall line of credit is segmented into various facilities. Each facility has its own limits within the line of credit, though it is dependent on the needs of the customer.
The borrower will then proceed to complete the formalities and complete filling the other documents, as deemed necessary by the bank. The security or title to the security has to be surrendered to the bank and suitable accounts opened. Thereafter, after the formalities are completed the borrower can operate this account within the line of credit.
The cash cycle
A cash cycle is the time taken by the company to convert cash into goods and then sell the goods to earn cash or if provided on credit, retrieve the debt.
The products offered by banks
Banks are awash with financial offerings and the business community is spoilt for choices. The loans are also modeled to cater to the needs of the customer.
Retail Loans
Retail loans are meant for small traders and businesses. It is given to them on strength of their earnings keeping an eye on their returning capacity.
Classification of Loans-Purpose wise
Personal loans
These are also called consumer loans. They vary from medical loans, education loans, loans to buy a refrigerator, vacations, etc. These are personal loans, as in loans meant for individuals as opposed to corporate loans. They are also taken to consolidate debts and the amount is amortized over a fixed time period and a combination of principal and interest is paid. Such loans are either unsecured or secured by the purchase of an asset or consigned by a guarantor.
Unsecured loans are those which are offered based on the credit history of the borrower and his ability to repay the loan. Repayment is ideally done through fixed amount installments over a fixed period of time. They are also called consumer loans.
Loans for purchase of Automobiles and consumer durables
Banks provide a large number of loans to individuals for the purchase of durables and automobiles. The amount of loan is usually dependent on the repayment capacity of the borrower.
The loan provided is equated into Monthly Instalments also called EMI. It is calculated taking into consideration the maximum limit afforded by the customer. The banks look into the following to decide whether the borrower must be given a load or not –
- Latest salary certificate from the employer
- The previous year’s income tax returns
While taking the loan, it is important for the borrower to be aware of the following points:
- To check whether the interest is payable on the entire loan or just the outstanding amount
- Check all the details
- Look out for hidden charges
- The documents need to be read carefully and every clause and statement understood clearly.
Auto Loans: It is a personal loan to buy a car. Most banks offer car loans. It is one of the fastest-selling banking product in the market now. Banks sanction up to 85% of the ex-showroom price. A processing fee is also charged along with some paperwork.
Loan against shares: This is a kind of a liquid guarantee.
Home loan: This is a personal loan for buying a house. This is also one of the fastest-selling banking products as well as one of the most profitable ones.
Education Loans: With the rising cost of education, banks saw an opportunity to finance education for the students who wish to pursue higher education. This also made higher education affordable. This also led to a larger group of individuals attaining skills and join the job market.
Despite scholarships, the number of students were far greater than the available seats. The boom in the banking sector led to the glut in money and hence education became a sector of focus. With this move, the banks were able to create more demand in the education domain as well as become the driver for economic growth.
Both Nationalised as well as private banks offer a variety of schemes which cater to a larger number of students. Most banks start attracting students who clear the national level competitive exams.
The education loans are provided to cover the following:
- The college fee along with the hostel fee
- Expenses related to books, uniform, instruments, etc
- Laboratory fee
- Expenses related to buying a laptop for those pursuing engineering-related courses
- Travel and lodging expenses
- Caution deposit and the refundable deposit
- Costs borne out of any other activity essential to the completion of the course