Before advancing loans and advances a bank should make sure that it wiil get the loan back in time. Since many borrowers default in repaying loans, borrowers need to deposit assets or give guarantee as a testimony of the assurance of repayment. This asset or guarantee is called the security of credit.

The Economist defines security as “something of value given to a lender by a borrower to support his or her intention to repay. In the case of a mortgage, the security is the property that the loan is being used to purchase”.

Oxford Dictionary of Finance and Banking defines security as “an asset or assets to which a lender can have recourse if the borrower defaults on any loan repayments”.

Hence security is what the borrower puts up to guarantee repayment of the loan. It may include tangible, intangible assets or even personal guarantee.

Kinds of Securities


  1. Personal Security: Personal security refers to the guarantee given by the borrower or by a third party in lead of pledging a tangible asset. Since advancing loan against personal guarantee is very risky banks rarely grant loan against such security unless the borrower has special and long relationship with the bank. The character, integrity, financial solvency, and social status are important factors that are looked into before sanction of loan against personal security.
  2. Non-personal Security: Non-personal security refers to movable and immovable tangible properties against which loans are granted. This type of security may include land, building, commodities etc. Non-personal security is safer than personal security. In case the borrower defaults a tangible property can be sold in the market to realize the unpaid amount. Non-personal security can be charged in the Conn of lien, pledge, mortgage, hypothecation, or assignment.
  3. Collateral Security: When the lender feels the security provided by the borrower is not sufficient or it may be difficult to recover the dues smoothly, the lender may ask for additional security to be provided by the borrower himself or by others on behalf of the borrower. In case of any default by the borrower, the collateral securities will come in hand to service and recover the loan.

Features of Good Security/ Canons of a Good Banking Security/ Conditions for Acceptable Securities

While accepting securities bankers need to consider certain factors. Otherwise the odds of getting the loan repaid will be very little and the security will not serve the intended purpose. These factors are considered to be the essentials of an acceptable security. In what follows we discuss this factors in detail.

In case of Non-personal Security


  • Acceptability: The asset accepted as security must be acceptable in the eyes of the law. Any asset considered illegal to own or possess will put the bank in difficulty at the time of disposing of. Moreover, the bank may face legal consequences for possession of illegal items.
  • Marketability: The security must have a ready market. The bank has not taken the asset to keep it in its possession for an indefinite period but rather to sell it in the market and realize the loan amount. Hence, no matter how valuable the asset may be it is of no use if it does not have a broad market.
  • Liquidity: Liquidity refers to how quickly an asset can be converted into cash or other assets with little or no diminution in value. Ideally a security should be liquid which will enable the banker to sell l he properly at a known price as soon as the default occurs.
  • Ownership: Before accepting a security the banker must ensure the ownership of the property. An asset which is not owned by the lender may render difficulty in getting the loan repaid. Moreover, if the title of the property is defective the lender may face problem.
  • Adequacy: The value of the security must be adequate to cover the full amount of the loan. Moreover, a reasonable margin over the (loan is to be maintained. The margin is the difference between the market value of the security offered and the loan granted.
  • Stability of Price: The price of the goods and commodities which are necessaries of life are relatively stable over a short period, though not necessarily over a long period. But wide variations in the prices of luxury goods take place due to changes in demand, fashions and tastes of the people. Bankers are generally reluctant to accept the commodities the prices of which are uncertain and fluctuate too widely and frequently.
  • Documentation: The banker should see that proper documents such as mortgage deed or the pledge agreement containing all terms and conditions of the mortgage or pledge are executed. This should be done in order to avoid all future disputes.
  • Non-encumbrance: A property or asset which has already been charged against a prior loan from some other lender should be avoided as a security. Because in that case the banker will have a secondary claim on that particular security.
  • Possession: Mere ownership of an asset without its possession may lead to unwanted circumstances for the banker. Unless the property being considered as a security is in the possession of the borrower (though he is the owner) that property should not be accepted as a security. If goods are taken as security the banker should take the possession before advancing the loan.
  • Quality: If a commodity has been used as a security it should be of good quality. A commodity which is perishable and may deteriorate in quality or quantity with passage of time should not be accepted as security.
  • Free from disabilities: A banker should disqualify securities crippled with certain disabilities like partly paid up shares, life insurance policy without surrender value and so on. He should see before accepting that the security is free from such disabilities.
  • Meld generating security: An asset which generates earnings during the period in which the loan is outstanding is a better security than those which do not and are preferred by the bankers.'
  • Easy store ability and low maintenance cost: A security should not create a headache or be a burden for the banker. It must be easy to store with low maintenance cost.

In case of Personal Security

  • Financial Ability: The banker must enquire into the financial condition of the guarantor. If the guarantor does not have the financial solvency to repay the loan in case the principal debtor defaults the existence of a guarantee will be futile.
  • Honesty: The ability of the guarantor to repay the loan is of use only if the guarantor also has the willingness and integrity. So in addition to the financial solvency of the surety his honesty is of immense importance in case of personal guarantee.
  • Social status: The social status of the borrower and that of the guarantor must be ensured before granting a loan. A person who holds esteemed kudos in the society is more likely to be conscious about fulfilling his promises.

Security of Credit

Creditworthiness is a measure of how deserving a loan applicant is to get a loan sanctioned in his favor. In other words, it is an assessment of the likelihood that a borrower will default on their debt obligations. It is based upon factors, such as their history of repayment and their credit score. Lending Institutions also consider the availability of assets and extent of liabilities to determine the probability of default.

The 7'Cs of Creditworthiness indicates the characteristic or features of creditworthiness.

Character

Responsibility, truthfulness, serious purpose, and serious intention to repay all monies owed make up what is called character. The loan officer must be convinced that the customer has a well-defined purpose for requesting credit and a serious intention to repay. The loan officer must determine if the purpose is consistent with the bank’s loan policy. Even with a good purpose, however, the loan officer must determine that the borrower has a responsible attitude toward using borrowed funds, is truthful in answering questions, and will make every effort to repay what is owed.

Capacity

The loan officer must be sure that the customer has the authority to request a loan and the legal standing to sign a binding loan agreement, this customer characteristic is known as the capacity to borrow money7For example, in most areas a minor cannot legally be held responsible for a credit agreement; thus, the lender would have great difficulty collecting on such a loan. Similarly, the loan officer must be sure that the representative from a corporation asking for credit has proper authority from the company’s board of directors to negotiate a loan and sign a credit agreement binding the company.

Cash

This feature of any loan application centers on the question: Does the borrower have the ability to generate enough cash - in the form of flow - to repay the loan? In an accounting sense, cash flow is defined as:

  • Cash flow = Net profits + Noncash expenses.
  • This is often called traditional cash flow and can be further broken down into: Cash flow = Sales revenues - Cost of goods sold - Selling, general, and administrative expenses- Taxes paid in cash + Noncash expenses.
The lender must determine if this volume of annual cash flow will be sufficient to comfortably cover repayment of the loan as well as deal with any unexpected expenses. Loan officers should look at five areas carefully when lending money to business firms or other institutions. These are:

  1. The level of and recent trends in sales revenue.
  2. The level of and recent changes in cost of goods sold.
  3. The level of and recent trends in selling, general, and administrative expenses.
  4. Any tax payments made in cash.
  5. The level of and recent trends in noncash expenses.

Capital

Capital represents the general financial position of the potential borrower’s firm with special emphasis on tangible net worth and profitability, which indicates ability to generate funds continuously over time. The net worth figure in the business enterprise is the key factor that governs the amount of credit that would be made available to the borrower.

Collateral

In assessing the collateral aspect of a loan request, the loan officer must ask, Does the borrower possess adequate net worth or own enough quality assets to provide adequate support for the loan. The loan officer is particularly sensitive to such features as the age, condition, and degree of specialization of the borrower’s assets. Technology plays an important role here as well. If the borrower’s assets are technologically obsolete, they will have limited value as collateral because of the difficulty of finding a buyer for those assets should the borrower’s income falter.

Conditions

The loan officer and credit analyst must be aware of recent trends in the borrower’s line of work or industry' and how changing economic conditions might affect the loan. A loan look very good on paper, only to have its value eroded by declining sales or income in a recession or by high interest rates occasioned by inflation.

Control

The last factor in assessing a borrower’s creditworthiness status is control. This factor centers on such questions as whether changes in law and regulation could adversely affect the borrower and whether the loan request meets the lender’s and the regulatory authorities’ standards for loan quality.

The 7'Cs of Creditworthiness

Credit risk refers to the risk that an issuer of debt securities or a borrower may default on his or her obligations or that the payment may not be made on a negotiable instrument. Credit risk grading is the process which helps the sanctioning authority to decide whether to lend or not to lend, what should be the lending price, what should be the extent of exposure, what should be the appropriate credit facility, what are the various facilities, what are the various risk mitigation tools to put a cap on the risk level. It provides detailed and formalized credit evaluation process for risk identification, measurement, monitoring and control, risk acceptance criteria, credit approval authority, maintenance procedures and guidelines for portfolio management.

CRG is an important tool for credit risk management as it helps the banks and financial institutions to understand various dimensions of risk involved in different credit transaction. It provides a better assessment of the quality of credit portfolio of a bank.

Components of credit risk grading

Financial risk: The uncertainty of future incomes due to the company’s financing. Financial risk management refers to the practices used by corporate finance managers and accountants to limit and control uncertainty in the firm’s total portfolio. Financial risk management aims to minimize the risk of loss from unexpected changes in the prices of currencies, interest rates, commodities, and equities.

Business/Industry risk: The risk related to the inability of the firm to hold its competitive position and maintain stability and growth in earnings. It is generally measured by the variability of the firm’s operating income over time.

Management Risk: The risks associated with ineffective destructive or under-performing management, which hurts shareholders and the company or fund being managed.
Security risk: Security risk mainly depends on the potential owners or other source. There is some Security risks are given below:

  1. Perishability,
  2. Enforceability/Legal structure, and
  3. Forced Sale Value.

Relationship risk: Relationship risk mainly based on supplier and customer relation to the entrepreneur.
If the entrepreneur can make a good relation to the customer or supplier he or she also get the loan at a lower rate.

HOW TO COMPUTE CREDIT RISK GRADING


  1. Identify all the Principal Risk Components.
  2. Allocate weight to Principal Risk Components.
  3. Establish the Key Parameters under each risk components.
  4. Assign weight to each of the key parameters.
  5. Add all the weight of the key parameters to have an overall score:
  6. Assign a grade based on the total weights. The grading method assumes simple weighted average addition of the risk criteria.

What is Credit Risk Grading (CRG)

Credit analysis is the process of evaluating an applicant’s loan request or a corporation’s debt issue in order to determine the likelihood that the borrower will live up to his/her obligations. In other words, credit analysis is the method by which one calculates the creditworthiness of an individual or organization.

Credit analysis involves a wide variety of financial analysis techniques, including ratio and trend analysis as well as the creation of projections and a detailed analysis of cash flows. Credit analysis also includes an examination of collateral and other sources of repayment as well as credit history and management ability. Analysts attempt to predict the probability that a borrower will default on its debts, and also the severity of losses in the event of default.
  1. Steps during the information collection stage

    Collecting information about the applicant: The first step in credit analysis is to collect information of the applicant regarding his/her past record of loan repayment, character, individual and organizational reputation, financial solvency, ability to utilize the load(if granted) etc. The bank may enquire into the transaction record of The applicant with the bank and other banks. The repayment history of loans previously granted may also reveal useful information in this regard.

    Collecting information about the business for which loan is required: The loan officer should know the purpose of the loan, the amount of the loan and if it is possible to implement the project by that amount. The banker should make sure the project is feasible. It is important that the project has a good potential and the applicant has a good plan to execute the project.
    Collecting information about the recovery process: The loan officer should collect information about the sources from which the borrower would repay the loan. Information in this purpose may include profitability of the project, payback period, sensitivity of the project cash flow to different economic factors etc.

    Collecting information about the security: Banks, most often than not, lend money against personal and non-personal securities. A bank would always prefer getting the loan repaid by the borrower to realizing the loan from the sale proceeds of the security. However, should the borrower default in repaying the loan the lender will have to fall back on the security. Hence, it is always advisable to know information like price stability,etc. about the security before advancing the loan.

    Collecting additional information if necessary: When the loan under consideration is for a large amount a bank may find it necessary to gather additional information like the overall business activities in the economy, probable political and economic condition of the country, efficiency and candidness of the management team, likely effect of local and international competition on the project etc.
  2. Steps during the information analysis stage

    Analyzing the accuracy of information: The information given in and along with the application are analyzed to judge their accuracy. In this regard the analyst would scrutinize the national identity card, driver’s license, trade license, partnership deed, corporate charters, resolutions, and other legal documents attached with the application.

    Analyzing the financial ability of the applicant: In this stage, the financial ability of the applicant is taken into consideration. The financial solvency of the applicant and his skill and capability are important factors in this regard. The analyst works out different financial ratios from the past and pro¬-forma income statements, balance sheets, cash flow statements, and other financial statements of the applicant and analyzes them to reach about a conclusion about the applicant’s financial ability.

    Analyzing the effectiveness of the project: One aspect of credit analysis is the analysis of quality, purpose, and future prospect of the project for which loan has been applied. The banker will be at ease to grant loans if the project is productive, expandable, and of course profitable. On the other hand, if the project is in a declining stage, is up against intense competition, or is confronted by adverse conditions the bank is likely to be reluctant to grant any loan.

    Analyzing the possibility of loan repayment:
    The analyst looks into what effect the proposed loan will have on increasing the liquidity and income of the applicant. The net cash flow is a good indicator of the ability of the applicant to repay the loan along with interest and other expenses within due time. An analyst may also interested to see the- interest burden and fixed charge burden of the applicant.
  3. Decision making stage

    Depending on the analysis the analyst identifies and measures the credit risk associated with a loan application and determines whether the level of risk inherent is acceptable or not. If the analyst is satisfied that the risk is acceptable and is convinced that the loan will be repaid, he/she prepares and submits a recommendation to the appropriate loan approval authority for sanctioning the loan.

Steps in Credit Analysis

Default essentially means a debtor has not paid a debt which he or she is required to have paid. In banking terms, default means failure to meet a contractual obligation, such as repayment of a loan by a borrower or payment of interest to bond holders. Default gives the note holder, or the holder of a mortgage bond, rights and recourse under the mortgage indenture to institute foreclosure proceedings or to accelerate the maturity date.

Problem loans and loan losses essentially reflect the default risk inherent in a borrower's willingness and ability to repay all obligations. Default culture is such a factor which is liable for creating problem loans. Here;


  1. The credit analysis may have been faulty because it was based on inadequate information or incomplete analytical procedures.
  2. Economic conditions may change adversely after the loan is granted so that the borrower cannot meet debt service requirements.
  3. A borrower may simply choose not to repay.

Events of default: Most loans contain a section listing events of default, specifying what actions or inactions by the borrower would represent a significant violation of the terms of the loan agreement and what actions the bank is legally authorized to take in order to secure the recovery of its funds. The events of default section also clarify who is responsible for collection costs, courts costs and attorney’s fees that may arise from litigation of the loan agreement.

In conclusion, we can say that borrower’s moral character, accountability and maintenance of transparency can ensured to avoid default culture.

What is Default Culture

Problem loans cause delinquency and loss to lending institution. Having identified which loans are problematic, the banker needs to do the following:

Create Policies and Procedures for Dealing with Problem Loan

A policy is set of decisions about how your company operates. Policies are written guidelines that help operation s. Procedures are written instructions that tell staff how to implement policies. Each lender must have its own policy for identifying problem loans and dealing with problem loans. These instructions are the procedures that will tell staff what to do to identify problem loans early. Sound policies and procedures protect lenders from loss.

Distinguish Between Can Pay versus Won't Pay

Tt is important to distinguish between borrowers who won’t pay, and those who can't pay. If borrowers can’t pay, bankers are wasting time and resources sending letters. If borrowers won't pay offering soft options is wastage of time, when in fact a more assertive approach would be more effective.

For borrowers who can't pay consider the following:
  • Find out whether they have relatives or children who can pay.
  • Be assertive in finding a source of repayment.
  • Be firm and unshakable - borrowers must feel it is not worth missing a repayment.
For borrowers who won’t pay consider the following:
  • Put in place procedures that protect you from these types of borrowers from the beginning of the loan process.
  • Get a list of assets up front so you have some collateral to fall back on if the borrower won’t pay.
  • Avoid lending to ‘won’t-payers’ if at all possible.
  • Do not get trapped in a cycle of sending letters with no intention of following up.
  • Take legal action earlier rather than later.
  • Make quick use of garnishee orders and emolument attachment orders.
  • Emolument Attachment Order: An emolument attachment order is a court order obtained by the lender / any creditor, which instructs an employer to make deductions from the borrower’s salary on a monthly basis until the debt has been settled.
  • Garnishee Order: A garnishee order allows the lender to attach money from the debtor’s bank account

Develop a Relationship with the Client Up-Front

It is worth taking the time at the beginning of the loan process to establish a good relationship with the borrower. This sets the tone for future relations. Lenders need to establish from the beginning that no late

Prompt and effective follow-up

As soon as a repayment is past due, some action needs to be taken. That action needs to be effective in securing the repayment. Procedures should not be devised that waste resources without securing payment. For example, sending a letter to a rural client, who cannot read, is not an effective procedure. It would be more effective to identify someone who lives nearby to visit the non-payer and secure payment.

Periodic stress testing of loans

Lenders should conduct Periodic stress testing of their loan portfolios to better understand the potential risks. The objective here is to identify those scenarios which, if they did actually occur, could result in severe losses and jeopardize the financial stability of the bank. Stress testing individual loans can serve as a valuable early-warning system to identify those customers most likely to experience financial stress under adverse economic conditions. Stress testing can give valuable insights into potential future losses; identify key areas of risk exposure within the portfolio.

Dealing with Problem Loans

Detecting Problem Loans is for loan officers and other credit professionals who need to understand the ways to minimize problem loans and to deal with them once they surface. The course is appropriate for junior to mid-level commercial lenders, credit review and credit policy officers, and junior workout officers.

Why is it Important to Identify Problem Loans/distressed loans Early?

Profitability

Problem loans must be identified early because they can affect profitability. Repayments with interest are the primary income source of lending institutions. If repayments are not made regularly, then ability to make a profit is severely affected.

Client Support

If the bank can identify a problem loan early it will be able to take steps to support a client to pay. For instance, banker may call them and offer them the option of paying part of the repayment immediately and part later.

Lending Institution Image

If the bank is slow to identify and follow' up on late repayments it sends a specific message to borrowers. The bank sends the message that it is ‘soft’, that it will not take immediate action, and that late payment or non-payment is a viable option for them. To work towards zero delinquency the bank must avoid this image at all costs".

What are the indications of problem Loans

If loan can be identified earlier as problem loans before it actually happens, regulating monitoring along with some other measures can prevent the loans from being problems loans. For identifying the “potential” problem loans, we have to know the symptoms of problem loan. The symptoms of problem loans can be classified in the following way:

Quantitative Indicators

  1. Preparation of irregular and delayed financial statements.
  2. Refusal of large insurance claim.
  3. Creating hindrances to the main source of income
  4. Diminishing deposit balance.
  5. Inability to pay the debt of creditors other than the bank.
  6. Non-repayment of the loan installments as repayment dates.
  7. Entering into big loan contracts frequently with institutions and persons other than the existing bank.
  8. Continuous decline in the market price of the shares of the borrowing company.
  9. Sudden rise or fall of large size deposit withdrawals.
  10. Excessive cash dividend payouts from reserve fund or even from capital.
  11. Al the end of the cycle, creditors are not completely paid out.
  12. Concentration changes from a major well-known customer to one of lesser stature.
  13. Loans are made to or from officers and affiliates.
  14. Unable to clean up bank debt, or cleanups are affected by rotating bank debt.
  15. Investment in fixed assets has become excessive.

Qualitative indicators

  1. Sudden death or accident of chief executive of the business
  2. Avoiding communication with the lending bank.
  3. The borrowing organization is not operating smoothly due to some conflicts among the executives and among the board members.
  4. Bitter relationship between borrower and lending bank.
  5. Occurrence of theft, fraud, robbery and/or hijacking in the organization of the borrowers.
  6. Conflicts among the heirs of the owners of the borrowing organization.
  7. Pretending in the manner that payables are paid.
  8. Financial reporting is frequently "down-tiered" due to changes in financial management.
  9. Delayed responses of financial transaction.
  10. Suppliers cut back terms or request cash on Delivery (COD)
  11. Distribution or production methods become obsolete.
  12. The company has grown dependent on trouble customers or industries.
  13. The board of directors is no longer active in making crucial business decisions.
  14. Lack of depth in managerial decision making.
  15. Financial control mechanisms are weak.
Qualitative indicators as well as quantitative indicators provide valuable information to the bank about the problem or make repeat requests of increasing or deferring the installment date. After getting this preliminary indication, banks may seek information regarding the above -mentioned qualitative and quantitative factor. Then, the bank can be certain about the problem loan.

Detecting Problem Loans

Inevitably, despite the safeguards most banks build into their lending program, some loans on a bank’s books will become problem loans. Usually this means the borrower has missed one or more promised payments or the collateral pledged behind a loan has declined significantly in value.

Problem loans lengthen the loan cycle and the bank misses opportunities to extend loans to many potential customers. Problem loans require close supervision and in some cases require legal actions. The bank faces liquidity crisis because planned cash flows have not come in as scheduled and this may create doubt in the depositors mind. Hence, it is essential to identify problem loans at the earliest and take necessary actions.

According to Professor A. R. Khan: “Problem loans refer to those which the borrowers do not return as and when required in spite of repeated reminder and are not able to show any acceptable reasons for such failure."

There are different opinions regarding whether or not a loan will be called problem loan if the borrower has proper reason for the default. Some opine that a loan cannot be called a distressed one if the borrower has both the ability and the willingness to repay the loan and will certainly repay as soon as the reason for default is pulled out, though the borrower has missed one or more promised payments. However, if the reason for default is not likely to be removed in the near future the loan will be called problem or distressed loan.

If the borrower has both the ability and the willingness to repay the loan it is called a good loan. Bank loans can be divided into two categories,
  1. Ideal Loan, and
  2. Problem Loan
These sections are described below;

Problem loan

The loans which cannot easily be recovered from borrowers are called Problem loans. When the loans can’t be repaid according to the terms of initial agreement or in an otherwise acceptable manner, it will be called problem loans.

In other words, problem loans refer to those which the borrowers do not return as & when required in spite of repeated reminders & are not able to show any acceptable reasons for such failure."

Ideal Loan

As all of the bank’s loans are not considered as ideal loan; in the same way, all of the bank’s loans are not treated as problem loans. There are borrowers who have both willingness and ability to repay the loan at the time of taking the loan. But with the passage of time both willingness and ability of repayment may be negative, which ultimately results in problem loans.

Let’s consider the following four scenarios:
Loan classification may be shown through the following ways:
  • Willingness to repay + Ability to repay= Ideal loan.
  • Unwillingness to repay + Ability to repay= problem loan.
  • Willingness to repay +inability to repay =problem loan.
  • Unwillingness to repay + Inability to repay= problem loan
The following figure depicts the above-mentioned scenarios:

Good Loans and Bad Loans


The willingness & ability of the borrowers to repay the loan may change over time after the loans are made to then. On the other hand, Bankers may also make mistakes in the process of lending.

Point of distinction Ideal Loan / Good loan Problem loan / Bad loan
Nature of the loan The loan installments are being paid regularly and in accordance with the repayment schedule as specified in the loan agreement One or more installments have been missed and no reasonable excuse has been shown.
Nature of borrower The borrower has both ability and willingness to repay The borrower has neither willingness nor ability to repay or has only ability or only willingness to repay
Loan supervision Minimum supervision suffices. Hence, supervision cost is low. Maximum supervision is necessary. Hence, supervision cost is high.
Credit analysis Results from a very good and efficient credit analysis Results from a poorly conducted credit analysis
Relation between banker and borrower Relationship of trust, mutual understanding, and cooperation Relationship of distrust and doubt often leading to civil case in the court
Effect on loan cycle Speeds up the loan cycle and enables the bank to extend credit to many potential customers. Slows down the loan cycle and the bank misses out opportunities to extend credit to many potential customers.
Effect on money supply Results in increased derivative demand deposit by way of multiple credit creation which in turn increases the money supply in the economy. Results in bad debts and shrinks the ability of the bank to lend credit and thereby decreases the money supply in the economy.
Effect on profit Low supervision cost and expanded creation of derivative demand deposit result in increased profit High maintenance cost coupled with bad debt losses results in decreased profit
Effect on liquidity The bank enjoys sound liquidity as it gets the cash flows as planned The bank faces a dearth of liquidity as cash flows do not come as planned


Ideal Loans are all banks darling. Bankers lending policy should proper in-order to detect problem loans.

Good Loans and Bad Loans

To conduct loan operations efficiently & successfully ,it is important to formulate a clear cut and comprehensive loan policy .Without an adequate loan policy .even the efficient loan officers very often fail to run the loan activities properly .The loan activities will be prone to error & mistake if the directions regarding the availability of loan able funds .the guidelines about the sectors for which loan to be made available .duration & maturity of loan besides nature of collaterals are clearly spelled out & prefixed .On the other hand loan officers may be .absent .ill .transferred, dismissed or retired ,in that case .written policy guidelines will facilitate the new officers replaced in such positions. Under these circumstances, if there is no specific loan policy .management will suffer a lot in taking many of the loan related decision or even remain confused.

Bank loan policy is the compilation of some wise decisions which help the loan officer in every steps of the loan process to execute his/her duty efficiently & properly.

According to Edward W. Reed, a bank scholar,”[A loan] policy establishes the direction & use of the funds of a bank that have derived from stockholders & depositors, and influences the decision or whether or not to lend”.

At last it can be said that ,the written loan policy is beneficial in case in order to handle loan activities of a bank in the situations stated .The absence .transfer or retirement or plight for better prospect of any employee may not create any complexity if the policy is properly spelled out & documented.

Steps of Bank Loan Policy
As bank loan policy is an important policy for the bank so ,the bank loan policy is a process which has been by the bank step by step .This steps has been shown below:
  1. Responsibility of Preparing Loan Policy

    Loan is the special aspect of the important policies taken by a bank .Board of directors has ultimate power & responsibility in this regard .Before that Joan officers prepare a draft loan policy .make necessary modification through several workshops & then submit it to the loan committee which is formed by the members of the board of directors .Loan committee restructures the loan policy in several meetings & submits it to the board of directors for approval .After necessary modifications & improvements ,the loan policy gets the final approval from the board of directors.
  2. Written or Unwritten Loan Policy

    Both written & unwritten loan policies are in different banks .Although written loan policy is preferable to the unwritten one .Because ,the written loan policy can overcome the situation arisen in the absence of experienced bank officers or in case of misunderstanding among the newly assigned loan officers .Written loan policy can be updated on the basis of experiences & the need of the hour.
  3. Whether Loan Policy Should be Rigid or Flexible

    Loan policy can be rigid or flexible .Flexible loan policy has some benefits as well as some problems. But as per the opinion of expert bankers & banking specialists, flexible loan policy has more benefits than problems .But as per the opinion of expert bankers & banking specialists ,flexible loan policy becomes popular due to its liberal stands for adjustment in case of changed situation & other unavoidable future contingencies.
  4. Elements of Successful Loan Policy

    Loan policy provides proper directions & guidelines to the officers in-charge of loan management, it helps the bankers to handle loan operations smoothly & effectively .The bankers find it quite easier to make credit decision when the policy covers all the areas of managing loan cases.

Steps of Bank Loan Policy

A lender of last resort is an institution which is willing to offer loans as a last resort. Such institution is usually a country's central bank. In this case, we talk of a wholesale lender m last resort. A central bank offers extension of credit to financial institutions experiencing financial difficultly which are unable to obtain necessary funds elsewhere.

The main task in front of the lender of last resort is to preserve the stability of the banking and financial system by protecting individuals’ deposited funds and preventing panic-ridden withdrawing from banks with temporary limited liquidity. For more than century and a half central banks have been trying to avoid great depressions by acting as lenders of last resort in times of financial crisis. At first, this act provides liquidity at a penalty rate. Subsequently through open market operations, it lowers interest rates on safe assets. Finally, this process involves direct market support.

Commercial banks usually resort to lender's help only in tunes of crisis because such actions indicate financial difficulties Loans may be granted not only to commercial banks but also to any other eligible financial institution, even private companies, which is considered highly risky.

Different institutions may act as a lender of last resort in different countries. For instance in the USA, the Federal Reserve serves as a lender of last resort. Us main purpose is to providing credit to financial institutions that are short of reserves, prevent their bankruptcy, and avoid negative impact on the economy As a lender of last resort, the Federal Reserve encourages member banks to borrow funds from the so called “discount window” The term refers to loans granted lo member banks. The banks may use these loans either to meet reserve requirements it to pay for large withdrawals In Bangladesh, the Bangladesh Bank serves as a lender of last resort.

In the United Kingdom, the central bank, the Bank of England functions as a lender of last resort. In New Zealand, this role is taken by the Reserve Bank of New Zealand, its central bank. On a global level, the International Monetary Fund also serves as an international monetary fund resort, taking such role because of the recent financial crisis.

Why Central Bank is the Lender of Last Resort