What is Credit Investment?
A bank acts as a bridge between those having surplus and those in shortage of funds or cash. It collects deposits from individuals and institutions through different deposit schemes. The cash collected through such schemes is given as a loan or credit to others after maintaining compulsory and needed reserves. Such cash given as loan is called credit investment or lending. Such credit investment is done in different sectors charging interest with collateral security. Such loan is provided for personal purposes, business, trade, construction, share investment, hydroelectricity, agriculture etc. In this way, such collected deposits are used for credit creation and capital formation.
Different Forms of Credit
Banks lend money to different parties for different purposes for different periods. They offer different loan schemes based on the feasibility of the sector or purpose for which the loan is being intended for. The collateral value, income status and credibility of the loan party are also considered while making these forms of loan. Notably, banks can provide credit or loans in the following forms :
- Cash Credit: This is the most common form of credit. Such credit is provided to clients charging interest and applicable charges bagged by collateral and income. Such credit is sanctioned after making a necessary valuation of collateral and stock. For such cash credit, the eligible borrowers have to submit all the personal, business, or trade and security-related documents of the approached bank. The bank evaluates all the aspects of the approaching borrower including credibility, paying capability, purposefulness etc. After this, a credit limit is sanctioned to the borrower. The borrower can withdraw the sanctioned limit fully or partially depending upon his/her need.
- Demand Loan: A demand loan is a form of loan which can be recalled on demand. It has no maturity assigned at the beginning. The entire amount of the loan is credited to the loan account of the borrower. Due to this, the entire amount of the loan becomes chargeable to interest. Security brokers and others whose credit need fluctuates day to day usually take this loan. Such loan is provided against the security of personal, financial assets, or goods.
- Overdraft: An overdraft is a special form of a loan. In overdraft, a party is allowed to withdraw an amount more than the actual amount in the current account as per agreement with the bank. It is provided against the security of financial assets like shares and debenture. It is a loan facility of temporary nature having a low-interest rate. It bears a low-interest rate because the risk involved and service cost of such credit facility is less and its recovery through financial assets is faster than physical assets as incase of cash credit loan.
Principles of Credit Investment
Credit investment is the key business of banks. It is done based onthe capability of banks to give as well as the capability of customers to take and repay. While making such credit investments,certain principles are followed by banks. Such principles are explained below:
- Principle of Liquidity:
Banks lend money with the help of deposits collected from others. Such deposits are to be paid back to them as and when they demand. That’s why banks follow the principle of liquidity while lending money to borrowers. The principle of liquidity means preference of investment in securities that are liquid and can be converted into cash to meet customers’ demand of deposit withdrawal. This means securities like government bonds and debentures or shares of highly reputed industries are preferred as security while lending. Hence, the principle of liquidity emphasizes lending against the security of liquid assets having prompt cash convertibility.
- Principle of Diversity:
Lending is a risky task. This means it is not good to invest all funds of business in one specific sector. That’s why banks should follow the principle of diversity while lending. This means different sectors and industries with different capital or profitability status located in different areas of the country should be considered while making lending decisions. With such the credit investment of the bank will be diversified and risk will be minimized.
- Principle of Purpose:
According to this principle, the purpose of lending should be clear, specified and scrutinized. Banks should lend only the purpose of the borrower is viable legally, socially and practically. Loan proposals for the short term and the productive sector should be highly encouraged and processed. Such proposals have better payback and liquidity sufficiency assurance for banks. Thus, lending should be purposeful enough for the bank and the borrowers of the loan.
- Principle of Safety:
With lending, the bank is taking a risk. To cover such risk, banks follow the principle of safety. The principle of safety means a guarantee of loan repayment and recovery of the loan. Thus, banks have to underline minutely the paying capacity, income condition and general character of the borrower. similarly, the collateral nature and value of collateral given to the bank are also considered to ensure safety if recovery is to be made incase of deferred loan. Thus, the principle of safety states that the loan disbursed is safe enough from the repayment and recovery perspective.
- Principle of Stability:
Another principle to be followed while lending is the principle of stability. While accepting security, banks must give priority to those assets whose prices are less volatile and highly stable. Stable price means less chance of a value of security going down and better assurance of immediate liquidity and long-term liquidation (for loan recovery).
- Principle of Profitability:
Credit investment is guided by the principle of profitability. The credit provided should have a rational level of earning through interest and charges. Further, the collateral of both physical and financial assets should have sufficient scope of growth, stability and profitability. No credit investment is done without it being viable in terms of profitability to ensure the overall profitability of the bank has high growth.
- Principle of National Interest:
Laon and advance of banks should follow the principle of national interest. A credit proposal might have good repayment assurance, excellent collateral and great growth potential. But it is against the national interest in social, legal, moral and geographical aspects. Such loan and advance proposals are not to be accepted by banks. On the other hand, those sectors or types of loans that are highly prioritized by the government or central bank should be welcomed and preferably invested by banks.
