What principles observed by the banks while advancing different kinds of loans?

As we know that bank borrow to lend, after keeping the portion bank of total deposits so cash reserve the balance amount is either invested advance to the needy persons so businessman to earn profit. For this purpose bank advances his cash balance by using different methods. We also know that bank deeds with the other people’s money. So any banker before making advances will have to consider many factors for the people investment and safe return of the principle amount along with the profit expected. The principles are as under:

1.                 Principle of safety:

It is the basic principle for the use of bank funds, there should be full security and safety of the return of money advanced. For this purpose bank ask for different kinds of generate the loan, and security for cover risk for advances. In case of lose of amount of advances is covered by selling the securities for the loan.

2.                 Principle of liquidity:

It is in the interest in liquid form, convertible easy into cash as an when desired by the bank, so bank invest money in the short term advances and avoid any long term financing like land, building and machinery etc.

3.                 Diversification of loan/spread of risk:

At the time of advancing loan, bank should satisfy himself about the purpose and use for which loan is advance. For non productive or illegal business, no advance should be granted because they are unfruitful and risky.

An element of risk is present in every advance. It is therefore advised that the           loan should be spread over.

                                                        i.            Large number of borrowers.

                                                      ii.            Over large number of industries.

                                                    iii.            Over a large number of areas.

Diversification of advances thus minimizes the risk of defect of loan.

4.                 Management of cash reserve:

A bank has to keep a certain minimum percentage of its deposits in ready cash to met its liability towards deposits there is, however no limit on the maximum reserve to be kept by it. The bank, therefore through its experience must keep an effective amount to meet the liability of the depositors.

5.                 National interest:

The loan should be advance keeping in view the national interest of the country. If the central bank direct that advances to be given to small scale industrial so agriculture, the instrument should be followed in the national interest.