There are certain basic principles which every banker must follow while carrying out their lending and credit operations. Lending is one of the most important functions performed by the commercial banks and is major source of income of bank. But it carries certain inherent risks and banks cannot take more than calculated risk whenever it wants to lend.
Hence, lending activity has to necessarily adhere to certain principles. These principles revolve mainly around the concepts of safety, profitability and liquidity of advance.
Some of the important principles of lending are listed below :-
- STABILITY – Banks should invest only in those stocks and securities which possess a high degree of stability in their price. It should therefore invest the funds in the shares of reputed companies where the possibility of decline in their prices is remote. This is one of the most important principles of bank’s investment policy.
- LIQUIDITY – Liquidity is also an important principle of lending in banking. A banker must ensure that money will come back on demand or as per repayment schedule. The borrower must be able to repay the loan within a reasonable time after demand for repayment is made. Therefore, a bank puts only those securities in its investment portfolio which can offer it a sufficient amount of liquidity .
- PROFITABILITY – Banks accept deposits from public and lend it to make profit. It should therefore invest in such securities which will ensure a fair and stable return on the funds invested. Thus, profitability is referred as one of the cardinal principles of banking.
- SAFETY – Safety is the most important fundamental principle of lending. Banks deal with public money so safety of money from public is first priority of bank. Safety basically means that the borrower should be able to repay the loan and interest in time at regular intervals without default.
- DIVERSITY – A banker must follow principle of diversity while choosing its investment portfolio. Therefore, he must invest the funds over different shares and debentures of different industries rather than investing in particular type of security.
Thus, every bank must follow these basic principles while lending to mitigate the risks like loss and fraudulency etc. These principles of bank lending affect bank’s loan policies, credit operations to a great extent.