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smude solved assignment Q Discuss the principles of lending in detail.

Principles of sound lending:
a) Safety : As the bank lends the funds entrusted to it by its depositors, the first and foremost principle of lending is to ensure safety of funds lent. By safety is meant that the borrower is in a position to repay the loan, along with interest. Further, it is just not the capacity of the borrower to repay but also his willingness to repay. The former depends on his tangible assets and the success
of his business. The latter depends on the borrower’s character. 
b) Liquidity: The term liquidity refers to the extent of availability of funds with the banker for providing credit to borrowers. It is to be seen that money lent is not going to be locked up for a long time. The money should return to the bank as per the repayment schedule. This schedule that is drawn up by the banker has to adhere to the requirement that at any point of time the banker should possess adequate cash to meet the withdrawals of the depositors. It is to be kept in mind that various deposits have various maturities and some of it would also be payable on demand. A bank’s inability to meet the demand of its depositors can lead to a run on the bank which is a threat to its basic survival.
c) Profitability: All banks are profit-earning institutions. The ultimate objective of lending is to earn profits. Banks receive interest on loans and advances lent, and they pay interest to their depositors. This difference between the receipts and payments will be the bank’s gross profit. Banks further incur various expenses as any organisation does. After accounting for all such expenses and provisions, banks have to earn a reasonable amount as net profit so that dividends can be paid to its shareholders. The trust and confidence level of the customer and investor will be high with a bank that has a good track record of profits and dividend rates. Hence it is important that whatever the business the bank engages itself with, the business be profitable enough not just to cover its costs but to ensure generation of surplus funds or margin.
d) Purpose: While lending the funds, the banker enquires from the borrower the purpose for which he seeks the loan. Banks do not grant loans for each and every purpose. They ensure the safety and liquidity of their funds by granting loans only for productive purposes. The funds lent should be put to optimum use. Loans are not to be granted for speculative and unproductive purposes like hoarding stock or for anti-social activities, since apart from the morality of such activities, there are also inherent risks involved with regard to the repayment of such loans. Loans that are meant for personal expenditure like marriage cane be refused. In some cases, the banks grant loans for personal expenditure and for short/medium term like for education etc. Loans are now available for varied purposes these days. It is however the duty of the bank to keep in mind that the other principles of lending are adhered to, which in turn will automatically ensure that this principle is taken care of as well.
e) Security: The security offered against the loans may consist of a large variety of items. It may be a plot of land, building, flat, gold ornaments, insurance policies, term deposits etc. There may even be cases where there is no security at all. The banker must realise that is it only a cushion to fall back upon in case of need. The security and its adequacy alone should not form the sole consideration for judging the viability of a loan proposal. Nevertheless, the security if accepted must be adequate and readily marketable, easy to handle and free from encumbrances. It is the duty of the banker to check the nature of the security and assess whether it is adequate for the loan granted. Apart from the collateral, the banker has also to consider other factors such as capital of the borrower, his character and capacity. The evaluation of the borrower is an important activity of the banker and this topic is dealt with in detail in the forthcoming pages.
f) Risk management through diversification
A prudent banker always tries to select the borrower very carefully and takes tangible assets as security to safeguard his interests. While this is no doubt an adequate measure, there are other unforeseen contingencies against which the banker has to guard himself. Further if the bank lends large amounts to a single industry or borrower, then the default by that customer can affect the banking industry as a whole and will affect the basic survival of the industry. 

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