1.

Financial Credit: Meaning & Objectives

Meaning: Financial credit refers to the borrowing of money by individuals, businesses, or

governments from financial institutions like banks or lenders, with a promise to repay in the
future.

Objectives:

• To support business growth (e.g., A company taking a loan to expand operations).

• To help individuals meet financial needs (e.g., A person taking a home loan).

• To improve economic activity by making funds available for investments.

Example:
Imagine you want to start a business but don’t have enough money. You go to a bank and
take a loan to buy equipment. This loan is financial credit.

2. Credit Risk

Meaning: Credit risk is the chance that a borrower may not repay the loan, leading to losses
for the lender.

Example:
A bank lends money to a startup. If the startup fails, it may not repay the loan, causing a loss
for the bank.

How to reduce credit risk?

• Checking the borrower’s credit history.

• Asking for collateral (property, gold, etc.).

• Setting loan limits.

3. Credit Analysis

Meaning: Credit analysis is the process of assessing a borrower’s ability to repay a loan.

Example:
Before giving a car loan, a bank checks the borrower’s salary, past loans, and repayment
history to ensure they can pay the EMI.

4. Seven C’s of Credit

These are factors used to evaluate a borrower’s creditworthiness:

 1. Character – Borrower’s reputation and trustworthiness.

o Example: A person with a good credit history is considered more trustworthy.

2. Capacity – Ability to repay the loan.

o Example: A bank checks income to see if EMI payments are possible.

3. Capital – Borrower’s own investment in the project.

o Example: A business owner who invests their own money shows

commitment.

4. Collateral – Assets pledged as security.

o Example: A home loan requires the house itself as collateral.

5. Conditions – Economic and industry conditions affecting the borrower.

o Example: A bank may hesitate to lend to a tourism business during a

recession.

6. Credit Score – Numerical rating of creditworthiness.

o Example: A score above 750 improves loan approval chances.

7. Covenants – Loan terms agreed upon by the borrower.

o Example: A bank may require regular financial reports from a business.

5. Credit Analysis Process

This involves:

1. Collecting information (financial statements, credit reports).

2. Assessing repayment ability (income, expenses, existing loans).

3. Evaluating risks (economic conditions, business risks).

4. Decision making (approve, reject, or modify the loan).

Example:
A bank reviews a company’s financial statements before approving a business loan.
6. Credit Process

Steps involved in granting credit:

1. Loan application – Borrower submits details.

2. Credit evaluation – Lender checks credit history and financial position.

3. Loan approval – Bank sanctions the loan if criteria are met.

4. Loan disbursement – Funds are given to the borrower.

5. Loan monitoring – Regular tracking of repayments.

Example:
A person applies for a personal loan, the bank checks documents, approves, and transfers
money.

7. Documentation

Documents required for loan processing:

• KYC Documents – ID proof, address proof.

• Financial Documents – Salary slips, bank statements.

• Collateral Documents – Property papers (if secured loan).

Example:
For a car loan, a person submits Aadhaar, salary slips, and bank statements.

8. Loan Pricing and Profitability Analysis

• Loan Pricing: Deciding the interest rate on a loan.

• Profitability Analysis: Checking if the interest earned covers bank expenses and risk.

Example:
A bank charges 10% interest on a home loan to cover risks and make profits.

9. Regulations

Rules set by central banks (like RBI in India) for fair lending practices.

Example:
RBI directs banks to follow strict KYC norms to prevent fraud.
10. Types of Credit Facilities

A. Cash Credit (CC)

A revolving loan where businesses can withdraw money up to a limit.

Example: A company gets ₹10 lakh CC limit and can use funds as needed.

B. Overdraft (OD)

Allows a customer to withdraw more money than they have in their account.
Example: A person with ₹50,000 in their account can withdraw ₹80,000 using an OD facility.

C. Demand Loan

A short-term loan payable on demand by the lender.

Example: A bank gives ₹5 lakh as a demand loan to a business, which must repay whenever
the bank asks.

D. Bill Finance

Financing against trade bills.

• Drawee Bill Scheme: Loan given against bills payable by customers.

o Example: A wholesaler gets a loan using unpaid bills from retailers.

• Bill Discounting: Selling a bill before maturity for immediate cash at a discount.

o Example: A supplier sells a ₹1 lakh bill to the bank for ₹95,000 before
maturity.

11. Cash Delivery

Methods through which loan funds are disbursed.

Types of Facilities:

• Term Loan – Given as a lump sum.

• Working Capital Loan – Used for daily business expenses.

Modes of Delivery:

1. Cheque Issuance – Loan amount given via cheque.

2. Bank Transfer – Direct credit to the borrower’s account.

3. Cash Payment – Rare, but sometimes used for small loans. Example:
A business loan of ₹10 lakh is credited directly to the borrower’s bank account.
1. Sole Banking Arrangement

This means a borrower (business or individual) takes a loan from only one bank.

Example:
A startup needs ₹50 lakh for expansion. It takes the loan from only one bank, say HDFC
Bank, instead of multiple banks.

Pros:

• Easy to manage.

• Single-point communication.

• No confusion between banks.

Cons:

• Higher risk for the bank.

• Limited loan amount, as one bank might not give a huge loan.

2. Multiple Banking Arrangement

In this system, a borrower takes loans from multiple banks separately but manages them
independently.

Example:
A business needs ₹10 crore for expansion. It takes:

• ₹5 crore from SBI

• ₹3 crore from ICICI Bank

• ₹2 crore from Axis Bank

Each bank operates separately, and the borrower has to repay each loan as per the terms of
that specific bank.

Pros:

• Access to a higher loan amount.

• Reduces dependency on a single bank.

 Cons:

• Managing multiple loans can be difficult.

• Higher documentation and compliance required.

3. Consortium Lending

A group of banks jointly provides a loan to a borrower under one agreement.

Example:
A large manufacturing company needs ₹500 crore for expansion. Five banks come together
and decide:

• SBI gives ₹200 crore

• ICICI Bank gives ₹150 crore

• HDFC Bank gives ₹100 crore

• Axis Bank gives ₹50 crore

All banks work together, but one lead bank manages the loan.

Pros:

• Reduces risk for individual banks.

• Single agreement, easier for the borrower.

Cons:

• Banks must cooperate, which can delay decisions.

• If one bank has issues, the whole consortium can be affected.

4. Syndication

Similar to consortium lending, but in syndicated loans, an investment bank (or a financial
institution) arranges the loan from multiple lenders.

Example:
A company wants a $1 billion loan for an international project. A financial institution like JP
Morgan or Goldman Sachs acts as the loan arranger and collects funds from different banks
worldwide.
 Pros:

• Allows huge funding.

• Borrowers don’t have to negotiate separately with each bank.

Cons:

• Can be complex and costly.

5. Credit Thrust

This refers to areas where banks focus more while lending, based on government policies
and economic needs.

Example:

• The government may encourage loans to small businesses (MSMEs) or renewable

energy projects.

• Banks may prioritize agriculture loans over luxury real estate loans.

6. Credit Priorities

This means which sectors should get priority for loans as per government or economic
needs.

Example:

• Priority sectors: Agriculture, Small Businesses, Education Loans, Housing for the
Poor.

• Non-priority sectors: Luxury Hotels, High-end Real Estate, Casinos.

Banks must allocate a percentage of their loans to priority sectors.

7. Credit Acquisitions

This refers to how banks get new borrowers for loans.

Methods:

• Offering attractive interest rates.

• Marketing to businesses and individuals.

• Providing pre-approved loans.

Example:

• A bank offers pre-approved home loans to existing customers with good credit
history.

8. Statutory & Regulatory Restrictions on Advances

Laws and rules set by the Reserve Bank of India (RBI) or other regulators that banks must
follow when giving loans.

Key Restrictions:

• Banks cannot lend more than a set percentage of their total capital to one borrower.

• Loans to related parties (e.g., directors of the bank) are restricted.

• Banks must maintain a minimum percentage of loans for priority sectors.

Example:

• RBI may say that 40% of total loans should go to agriculture and small businesses.

• Banks cannot give more than 15% of their capital to a single large company.
9. Credit Appraisal

This means checking whether the borrower is capable of repaying the loan before
approving it.

A. Validation of Proposal

The bank verifies if the loan request is genuine and reasonable.

Example:
If a small shop owner applies for a ₹5 crore loan, the bank may reject it if it finds the request
unrealistic.

B. Dimensions of Credit Appraisals

Banks check several factors before approving a loan:

1. Financial Position – Does the borrower have a stable income or profits?

2. Business Viability – Is the borrower’s business likely to succeed?

3. Loan Purpose – Is the loan being used for a genuine reason?

Example:
A company applying for a ₹1 crore loan to buy new machinery will be more likely approved
than someone asking for a personal luxury loan.

C. Structuring of Loan Documents

Once a loan is approved, banks prepare legal documents stating:

• Loan amount.

• Interest rate.

• Repayment schedule.

• Collateral details.

Example:
If a company takes a ₹10 crore loan, the agreement will clearly mention how it must repay in
monthly installments over 5 years.
10. Credit Risk

This is the risk that the borrower will not repay the loan.

Example:
A person loses their job and stops paying home loan EMIs. The bank faces a credit risk.

11. Credit Risk Rating

A score given to a borrower based on their ability to repay.

Example:

• A person with a high CIBIL score (750+) is low risk and will get a loan easily.

• A person with a poor credit score (500) is high risk and may be denied a loan.

12. Creditworthiness of Borrower

This refers to how reliable the borrower is in repaying loans.

Example:

• High Creditworthiness: A government employee with a steady salary.

• Low Creditworthiness: A startup business with no proven track record.

13. Purpose of Loan

Banks analyze why the loan is needed.

Example:

• A loan for education is seen as positive.

• A loan for gambling or speculation will be rejected.

14. Source of Repayment

How the borrower plans to pay back the loan.

Example:

• A salaried person will repay through monthly salary.

• A business will repay from profits or revenue.

15. Cash Flow

This refers to the movement of money into and out of the borrower’s business or account.

Example:
A retail shop owner who earns ₹10 lakh monthly can easily repay a ₹1 lakh EMI.

16. Collateral

An asset given as security in case the borrower fails to repay the loan.

Example:

• Home Loan: The house itself is collateral.

• Business Loan: Machinery, land, or inventory can be used as collateral.

Final Summary

• Banks lend money in different ways: Sole, Multiple, Consortium, and Syndication.

• Credit priorities focus on important sectors like MSMEs and agriculture.

• Banks check creditworthiness, risk, and repayment sources before approving loans.

• Collateral ensures safety for the bank in case of non-repayment.