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Types of Loans | Advances | Primary Functions of Commercial Banking

The commercial banks provide loans and advances in various forms like Overdraft, Cash Credit, Discounting of Bills etc. The commercial banks provide..
Types of Loans | Types of Advances | Primary Functions of Commercial Banking

In Previous articles, We had learned about banking In India and Commercial Banks and Types of Deposits. In this article we are going to continue to discuss Commercial banking and primary functions of Commercial banks. 

    Commercial Banks | Functions of Commercial Banks | Types of Loans and Advances |
    The commercial banks provide both demand and term loans mainly to businessmen and investors against personal security or goods of movable or immovable in nature.

    Primary Functions of Commercial Banks -Loans And Advances

    In this Article we are going to discuss kind of loans and advances offered by commercial banks.

    Types of Advances

    Advances given by bankers can be classified broadly into the following categories:

    Clean Advances

    Advances which are given on the personal security of the debtor, and for which no tangible or collateral security is taken. (this type of advance is given either when the amount of the advance is very small, or when the borrower is known to the Banker and the Banker has complete confidence in him .

    Secured Advance

    Advances which are covered by tangible or collateral security. Advances which are given against the personal security of the debtor but for which the Banker also holds in addition the guarantee of one or more sureties. This type of advance is often given by Banker to persons who are not known to them but whose surety is known to the Banker. 

    Bankers also often take the personal guarantee of the Directors of a company to whom they agree to advance a clean or unsecured loan.

    Overdraft

    This facility is given to holders of current accounts only. This is an arrangement with the bankers thereby the customer is allowed to draw money over and above the balance in his/her account. This facility of overdrawing his account is generally prearranged with the bank up to a certain limit. It is a short-term temporary fund facility from bank and the bank will charge interest over the amount overdrawn. This facility is generally available to business firms and companies.

    Cash Credit

    Cash credit is a form of working capital credit given to the business firms. Under this arrangement, the customer opens an account and the sanctioned amount is credited with that account. The customer can operate that account within the sanctioned limit as and when required. It is made against security of goods, personal security etc.

    On the basis of operation, the period of credit facility may be extended further. One advantage under this method is that bank charges interest only on the amount utilized and not on total amount sanctioned or credited to the account. Reserve Bank discourages this type of facility to business firms as it imposes an uncertainty on money supply. Hence this method of lending is slowly phased out from banks and replaced by loan accounts. Cash credit system is not in use in developed countries.

    Discounting of Bills

    Discounting of Bills may be another form of bank credit. The bank may purchase inland and foreign bills before these are due for payment by the drawer debtors, at discounted values, i.e., values a little lower than the face values.

    The Banker's discount is generally the interest on the full amount for the unexpired period of the bill. The banks reserve the right of debiting the accounts of the customers in case the bills are ultimately not paid, i.e., dishonored.

    The bill passes to the Banker after endorsement. Discounting of bills by banks provide immediate finance to sellers of goods. This helps them to carry on their business.

    Banks can discount only genuine commercial bills i.e., those drawn against sale of goods on Credit. Banks will not discount Accommodation Bills.

    Types of Loans

    It includes both demand and term loans, direct loans and advances given to all type of customers mainly to businessmen and investors against personal security or goods of movable or immovable in nature.

    The loan amount is paid in cash or by credit to customer account which the customer can draw at any time. The interest is charged for the full amount whether he withdraws the money from his account or not. Short-term loans are granted to meet the working capital requirements where as long-term loans are granted to meet capital expenditure.

    Housing Finance

    Nowadays the commercial banks are competing among themselves in providing housing finance facilities to their customers. It is mainly to increase the housing facilities in the country. State Bank of India, Indian Bank, Canara Bank, Punjab, National Bank, has formed housing subsidiaries to provide housing finance.

    The other banks are also providing housing finances to the public. Government of India also encourages banks to provide adequate housing finance. Borrowers of housing finance get tax exemption benefits on interest paid. Further housing finance up to Rs. 5 lakh is treated as priority sector advances for banks. The limit has been raised to Rs. 10 lakhs per borrower in cities.

    Educational Loan Scheme

    The Reserve Bank of India, from August, 1999 introduced a new Educational Loan Scheme for students of full time graduate/post-graduate professional courses in private professional colleges. Under the scheme all public sector banks have been directed to provide educational loan up to Rs. 15,000 for free seat and Rs. 50,000 for payment seat student at interest not more than 12 per cent per annum. This loan is on clean basis i.e., without calling for security. 

    This loan is available only for students whose annual family income does not exceed Rs. 1, 00,000. The loan has to be repaid together with interest within five years from the date of completion of the course. Studies in respect of the following subjects/are as covered under the scheme.
    • Medical and dental course.
    • Engineering course.
    • Chemical Technology.
    • Management courses like MBA.
    • Law studies.
    • Computer Science and Applications.

    This apart, some of the banks have other educational loan schemes against security etc., one can check up the details with the banks.

    Loans against Shares/Securities

    Commercial banks provide loans against the security of shares/debentures of reputed companies. Loans are usually given only up to 50% value (Market Value) of the shares subject to a maximum amount permissible as per RBI directives. Presently one can obtain a loan up to Rs.10 lakhs against the physical shares and up to Rs. 20 lakhs against dematerialized shares.

    Loans against Savings Certificates

    Banks are also providing loans up to certain value of savings certificates like National Savings Certificate, Fixed Deposit Receipt, Indira Vikas Patra, etc. The loan may be obtained for personal or business purposes.

    Consumer Loans and Advances

    One of the important areas for bank financing in recent years is towards purchase of consumer durables like TV sets, Washing Machines, Micro Oven, etc. Banks also provide liberal Car finance. These days banks are competing with one another to lend money for these purposes as default of payment is not high in these areas as the borrowers are usually salaried persons having regular income? Further, bank's interest rate is also higher. Hence, banks improve their profit through such profitable loans.

    Securitization of Loans

    Banks are recently trying to securities a part of their part of loan portfolio and sell it to another investor. Under this method, banks will convert their business loans into a security or a document and sell it to some Investment or Fund Manager for cash to enhance their liquidity position.

    It is a process of transferring credit risk from the banker to the buyer of securitized loans. It involves a cost to the banker but it helps the bank to ensure proper recovery of loan. Accordingly, securitization is the process of changing an illiquid asset into a liquid asset.

    Others Advances

    Commercial banks provide other types of advances such as venture capital advances, jewel loans, etc. 
    • Effective October 18, 1994 banks were free to determine their own prime lending rates (PLRs) for credit limit over Rs. 2 lakh.
    • The stipulation of minimum maturity period of term deposits was reduced from 30 days to 15 days, effective April 29, 1998.
    • The change in the Bank Rate was made effective from the close of business of respective dates of change except April 29, 1998.

    Credit Creation

    When a bank sanctions a loan to the customer, it does not give cash to him. But, a deposit account is opened in his name and the amount is credited to his account. He can withdraw the money whenever he needs. Thus, whenever a bank sanctions a loan it creates a deposit. In this way the bank increases the money supply of the economy. Such functions are known as credit creation.

    Prime Lending Rate (PLR)

    Previously interest on loan was also regulated by RBI. Currently, banks can determine the rate themselves. Each bank is, however required to fix a minimum rate known as Prime Lending Rate (PLR).

    Key Takeaways

    • The commercial banks provide loans and advances in various forms like Overdraft, Cash Credit, Discounting of Bills etc. 
    • The commercial banks provide both demand and term loans mainly to businessmen and investors against personal security or goods of movable or immovable in nature.
    • The commercial banks offers loans like Housing Finance, Educational Loan, Loans against Shares/Securities, Loans against Savings Certificates, Consumer Loans and Advances, Consumer Loans and Advances, Securitization of Loans.

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