Credit Operations and Management (COM)

Chapter-01: Introduction of Loans and Advances

IBB Banking Professional Academy

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Question: What do you mean by Credit? Types of Loans & Advances or Credit?
Or, What are different types of funded & Non-Funded credit?
Or, A lot of Questions may come from here

◆ Definition of Credit:

The word "credit" has many meanings in the financial world. In simple term, Credit is typically defined
as an agreement between a lender and a borrower. It also refers to a contractual agreement in which
a borrower receives a sum of money and commits to repaying the lender at a later date with agreed
interest.

Banks offer various types of credit to individuals, businesses, and governments to meet their financial
needs. The most common forms of credit provided by banks include:

◆ Different Types of Credit Facilities/Loans & Advances: Commercial banks make loans and advances
in different forms. All types of credit facilities can be broadly classified into following ways:

Based on Security
Secured Advance: The advance which is secured by primary or collateral security is called
Secured Advances. In the event of a loan default, the lender can take
possession of the asset and use it to cover the loan. e.g. Business loan,
housing loan, etc.
Unsecured Advances Unsecured advances don’t have assets either primary or collateral. These
are also called clean advances. Unsecured loans rely solely on the
borrower’s credit history and his income to qualify for the loan. e.g.- Credit
Card, Clean personal loan, Education loan (small), etc.
Based on Fund Outflow
Funded Credit Facility Funded Credit: Funded Credit is the credit facility that involves the direct
outflow of the Bank’s fund to the borrower.
1. Loans: A loan is a financial arrangement in which a lender provides a
borrower with a sum of money, and the borrower agrees to repay the
loan amount along with interest and any applicable fees over a specified
period. The loans are granted for:
• Short Term Loan: Usually short-term loans are repayable within
one year.
• Medium Term Loan: It is generally repayable between one and
three years.
• Long Term Loan: It is repayable in more than three years
2. Cash Credit (CC): Cash credit is the favorite mode of borrowing by
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business persons for meeting their working capital requirement. It is a

type of short-term loan or credit facility that provides businesses with
the flexibility to borrow up to limit and repay funds as needed.

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 • Cash Credit Pledge: This type of facility is provided against pledge
of goods, products, merchandise which remain in the godown
under the possession of the bank with effective control but
ownership remains with the borrower.
• Cash Credit Hypothecation: Cash Credit is sometimes allowed
against hypothecation of goods. In case of hypothecation both
ownership and possession remain with the borrower.

3. Overdraft: The overdraft is a kind of advance allowed on a current

account operated upon by cheques. The customer may be sanctioned
with a certain limit upon which he can overdraw. He/she can withdraw
from his current account more than his/her deposited amount (up to
certain limit) within a stipulated period.
4. Bill Purchase and Discount: Discounting and Purchasing of bill of
exchange is another way of investing bank’s fund. Bank allows advances
to the clients by purchasing or discounting export bills.
5. Retail Loan: Retail loans are those loans that are given by the banks to
meet personal needs, retail loans are smaller in size as compared to
corporate loans. Home loans, Vehicle loans, Education loans, personal
loans, Vacation purposes, medical purposes, etc. are categorized as
retail loans.
6. SME Credit: Small & Medium size enterprises are given various types of
loans including working capital financing.
7. Syndicated Loan: Syndicated Facility is offered by a group of lenders to
a single borrower when the loan amount is larger than the normal
range.

8. Bridge Loan: A bridge loan is a short-term loan that is used to provide

temporary financing until a more permanent form of financing can be
obtained. bridge loans are typically used to finance the purchase of
capital equipment, real estate, or other large expenses.

9. Composite Loans: Composite loans typically refer to a financing

arrangement that combines different types of loans into a single
package. This can involve various loan products, such as a combination
of fixed-rate and adjustable-rate mortgages.
Non-Fund Credit Facility Non-Funded Credit: Non-funded facilities are such facilities extended by
banks that do not involve out flow of funds from the bank when the
customer avails the facilities but may at a later date if the customer fails to
honor the commitment.
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1. Letter of Credit (LC): Letter of credit is an undertaking issued by a bank

on behalf of its customer for availing credit facility from the beneficiary.
A letter of credit is issued at the request of the client (the buyer)

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 guaranteeing the payment to the beneficiary (the seller) against
shipment of goods.

2. Bank Guarantee (Bid Bond): One kind of bank guarantee issued by the
bank on behalf of its clients (Mostly contractor). It serves as a guarantee
that the bidder will fulfill the terms of the bid if selected. For issuing bid
bond bank usually obtain cash margin and counter guarantee from the
clients

3. Bank Guarantee (Performance Bond): A bond or guarantee issued by a

bank on behalf of the client guaranteeing that the client will perform as
per the contractual agreement. Otherwise, the bank will compensate
the loss for the non-performance of the client.

4. Deferred /Payment Guarantee: A Deferred Payment Guarantee (DPG)

is a financial instrument issued by a bank or financial institution that
assures the seller that the payment for goods or services will be made
at a later date, as specified in the agreement. This type of guarantee is
often used in international trade.

5. Bank Guarantee (Custom and Excise Guarantee): This guarantee is

issued by the bank on behalf of their clients in favor of the custom
authority to make payment on account of their custom duties/excise
duties on imported goods or export of commodities on future date.

6. Derivative Products: In addition to the traditional non-fund facilities,

banks are now offering derivative products to their clients to enable
them to hedge their currency and interest rate risks.
Based on CL Reporting
Continuous Loan The loan accounts in which transactions may be made within certain limit
and have an expiry date for full adjustment will be treated as Continuous
Loan. Examples are: Cash Credit, Overdraft, etc.

Demand Loan The loans that become repayable on demand by the bank will be treated as
Demand Loan. If any contingent or any other liabilities are turned to forced
loan (i.e. without any prior approval as regular loan) those too will be
treated as Demand Loan. Such as:

• Forced Loan against Imported Merchandise,

• Payment against Document,
• Foreign Bill Purchased, and
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• Inland Bill Purchased, etc.

Fixed Term Loan The loans, which are repayable within a specific time period under a specific
repayment schedule, will be treated as Fixed Term Loan.

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 Short-term Agricultural Agricultural financing refers to the credit facilities allowed to the farmers
& Micro- Credit directly engaged in firming, fishing, forestry or livestock.

Export Credit or Finance

Pre-Shipment Finance Pre-Shipment Finance is granted before shipment of goods to procure raw
materials for paying manufacturing, packing charges, insurance premium,
and freight etc.
• Overdraft (OD)
• Back to Back L/C (Inland and Foreign)
• Export Cash Credit (ECC)
• Packing Credit (PC)-For preparing exporting goods.
• Export Development Fund (EDF)
Post-Shipment Finance: This type of facilities is given to the exporters after shipment of the goods
against export documents. Necessity for such credit arises as the exporter
cannot afford to wait for a long time for payment to local
manufacturers/suppliers. Export Bill Purchase (FBP/IBP), Bill Discounting.
Import Financing
Import Financing Facilities given to the importers:
• Letter of Credit (LC) (Sight/Deferred/UPAS)
• Loan Against Imported Merchandize (LIM)
• Loan Against Trust Receipt (LTR)
• Term Loan (TL) facility
• Payment against Documents (PAD)

Therefore, these are the credit facilities arranged by banks.

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Question: Explain the categories of relationship between banker and customer

Developing and managing quality relationships with the customers represents one of the essential
conditions for the growth and benefit of a bank. The relationship between a Bank and a customer depends
on the type of transaction.

The relationship between banks and customers is not only that of a debtor and creditor, they have other
relationships too.

1) Debtor and Creditor: When a customer opens an account with a bank and if the account has a
credit balance, then the relationship is that of debtor (banker / bank) and creditor (customer).
In case of loan / advance accounts, banker is the creditor, and the customer is the debtor because
the customer owes money to the banker. The banker can demand the repayment of loan /
advance on the due date, and the customer has to repay the debt.

2) Pledger and Pledgee: This happens when customer pledges (promises) certain assets or security
with the bank in order to get a loan. In this case, the customer becomes the Pledger, and the bank
becomes the Pledgee.
3) Licensor and Licensee: When the banker gives a safe deposit locker to the customer, the banker
will become the Licensor and the customer will become the Licensee.
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4) Bailor and Bailee: The relationship between banker and customer can be that of Bailor and Bailee.
• Bailment is a contract for delivering goods by one party to another to be held in trust for a
specific period and returned when the purpose is ended.

Sumon Ahammed. DAIBB, CECM, MBA (DU) Sazzad Hasan, AIBB, CECM, MBA (Fin) 5
 • Bailor is the party that delivers property to another.
• Bailee is the party to whom the property is delivered. So, when a customer gives a sealed box
to the bank for safe keeping, the customer became the bailor, and the bank became the
bailee.
5) Hypothecator and Hypothecatee: When the customer hypothecates (pledges) certain movable
or non-movable property or assets with the banker in order to get a loan, the customer became
the Hypothecator, and the Banker became the Hypothecatee.
6) Trustee and Beneficiary: A trustee holds property for the beneficiary, and the profit earned from
this property belongs to the beneficiary. If the customer deposits securities or valuables with the
banker for safe custody, banker becomes a trustee of his customer. The customer is the
beneficiary so the ownership remains with the customer.
7) Agent and Principal: The banker acts as an agent of the customer (principal) by providing the
following agency services:
• Buying and selling securities on his behalf,
• Collection of cheques, dividends, bills or promissory notes on his behalf, and acting
as a trustee, attorney, executor, correspondent or representative of a customer.
• Banker as an agent performs many other functions such as payment of insurance
premium, electricity and gas bills, handling tax problems, etc.

8) Advisor and Client: When a customer invests in securities, the banker acts as an advisor. The
advice can be given officially or unofficially. While giving advice the banker has to take maximum
care and caution. Here, the banker is an Advisor, and the customer is a Client.
So, these were some important banker-customer relationships.

Question: Mention different steps to follow for an informed credit decision. (Second
chapter/borrower selection process)

Before lending decision, it is most important to know all about the borrower, regulatory policy compliance
as well as profitability and safety of the credit. A banker should follow the following steps for an informed
credit decision:

1) Safety: A bank lends what it receives from the public as deposits. Safety depends upon – (i) the
security offered by the borrower, (ii) the repaying capacity and willingness of the debtor to repay
the loan with interest. It is also known as 5Cs of Credit (See the pic below).
2) Liquidity: Liquidity is the availability of Bank’s funds on short notice. It is not enough that the
money will come back, it is also necessary that it must come back on demand or in accordance
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with agreed terms of repayment.

3) Profitability: The main source of profit comes from the difference between the interest received
on loans and those paid on deposit. A bank must employ its funds in such a way that they will
bring adequate return for the bank.

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 4) Purpose: Before sanctioning loans, a banker should find out the purpose of loan. Loans for
undesirable activities such as speculation should be discouraged.
5) Good repayment history: If borrowers have good repayment record for long time, financing to
them is most likely to be good decision if other parameters comply.
6) Good Security: Security are of two types Personal/Intangible Security and Tangible Security
(Primary Security, Collateral Security). Security ensures loan repayment most of the time. Banks
should consider good quality, marketability of the security against the loan.
7) Avoid Loan Concentration: Diversification is a key risk management strategy in lending. Lenders
should avoid concentrating their loan portfolio on a single sector or industry.
8) Risk Diversification: Diversify the loan portfolio across different industries, sectors, and types of
loans. This helps spread risk and reduce the impact of adverse economic conditions on the overall
portfolio.
9) Loan Pricing: Interest rates play a pivotal role in lending transactions. Lenders must set interest
rates that are not only competitive but also reflective of the risk involved. The riskier the
borrower, the higher the interest rate is likely to be.
10) Transparency and Disclosure: Transparent communication is crucial in lending transactions.
Lenders are bound by sound lending principles to provide borrowers with clear and
comprehensive information about the terms and conditions of the loan.
11) Internal & Regulatory Compliance: The financial industry is heavily regulated to maintain stability
and protect both lenders and borrowers. Sound lending principles encompass strict adherence to
regulatory requirements and guidelines.
12) National benefit: Banking industry has significant role to play in the economic development of a
country. Before allowing credit, Banker must consider national & social interest of that particular
credit.
By adhering to these principles of sound lending, financial institutions can foster a culture of responsible
lending, protect the interests of both lenders and borrowers.

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Question: Mention qualities of a good borrower.

Success in selecting a right borrower that ensures smooth repayment of the financed amount and
ensuring profitability of a bank mostly depends on identifying a borrower having the following qualities:

Qualities of a Good Borrower:

1) Credit-worthiness: Creditworthiness is a critical aspect of being a good borrower, and it

encompasses several factors that lenders evaluate such as:

• Character: Credit History,

• Capacity: Capacity to Pay,
• Capital: Own Equity in Business
• Collateral: Value of Collateral
• Condition: Net Worth,
• Cash Flow: Stable Incomes
• Liquid Assets Etc.

2) Long term relationship: The quality borrower starts building relationship gradually with the
lender and earned trust and confidence.

3) Fund Management ability: This includes a solid understanding of one‘s cash flow, the ability to
live within your means, and the skill of keeping accurate and timely financial records.

4) Honesty & Integrity: If he borrows a certain sum of money, integrity means paying back the
agreed sum on time.

5) Proper fund utilization: A good borrower ensures that the funds borrowed are used properly and
for which they borrower the fund.

6) Clear Purpose: A good borrower practices purposeful spending, meaning they allocate their
financial resources in the suitable and best business purpose.

7) Borrow when required: The borrower only borrows when he needs it. He never convinced to
borrow at the request of lender whatever the terms and interest rate.

8) Good repayment record: Probably the best behavior to judge the borrower. But this is an issue
of post sanction and disbursement. This the best quality for future reference.

9) Debt Management Skill: Effective management of existing debt is crucial. Lenders evaluate the
types and amounts of outstanding debt to determine if the borrower can handle additional credit
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responsibly

10) Behave Responsibly: Responsible financial behavior, such as budgeting, saving, and managing
credit wisely, is essential. He/she does not use fund in most risky project.

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However, that these qualities may vary depending on the type of loan and the lender's specific criteria.

Question: What do you mean by Centralized and Decentralized Credit Operations? What are
advantages of centralized credit management over decentralized credit (Branch /RM)

◆ Centralized Credit Operations:

In a centralized credit operation, all credit-related decisions and functions are maintained by a single
department or location within an organization.

This central unit is responsible for assessing creditworthiness, approving or rejecting credit applications,
setting credit limits, and managing overall credit risk. All sorts of decision making is concentrated at the
headquarters or zonal hubs

◆ Decentralized Credit Operations:

In a decentralized credit operation, credit-related functions are distributed across various

departments or branches of an organization. Each unit may have its own credit decision-making
authority and may operate independently within particular guidelines.

◆ Advantages of centralized credit management over decentralized credit (Branch/RM):

1) Improving Customer Relationships - RMs can spend less time on administrative work and more
time developing new business, as well as strengthening existing relationships.

2) Efficiency and Time Savings: The centralization of credit operations can lead to efficiency gains
and time savings. RMs and branches may not need to spend significant time on credit analysis, as
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the centralized team takes on the responsibility.

3) Strong compliance of banking operations: Centralized credit operations ensure that credit
policies, procedures, and risk management practices are consistently applied across the
organization.

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 4) Better Communication: Clients have a central point of contact for all communication regarding
their loans. Customers can collect their required information from a single location.

5) Maintenance of internal discipline: When credit operations are managed by one central team, it
helps to keep everything organized and disciplined within the company.

6) Reducing Credit Risk: Separation of duties creates opportunity for unbiased risk management and
selection of borrowers.

7) Increase efficiency: Adopting a centralized lending process can dramatically increase efficiency
and productivity in the lending department. It allows employees to specialize in each of their areas
of the complete lending process and become extremely knowledgeable at their portion of the
work

8) Increasing Skills: The centralization allows for direct customer communication, specialized
training programs, knowledge sharing, and continuous professional development initiatives.

9) Better policy making: The centralized credit operations facilitate more strategic and informed
policy-making processes within the banks or financial institution.

10) Simplifying the Approval Process: With a centralized team handling credit assessment, there is a
consistent and efficient evaluation of credit applications. This reduces redundancy, minimizes
delays, and ensures that the approval process follows predetermined criteria.

11) Decrease employee errors: Another benefit of focusing employees on one skill is that the
likelihood of errors decreases. As experts in their area, they will be able to do their job more easily,
effectively, and at lower risk of making mistakes

12) Improving Technology Adoption: Centralized credit operations make it easier for a company to
use and benefit from new technologies. This is because when credit-related tasks are managed
by one central team, they can introduce and teach everyone in the company how to use advanced
tools and technologies.

13) Uniformity in Borrower Selections: Since the credit appraisal done from a single point by a team
there are batter options for unbiased selection of borrowers than many minds of RM at branch
level.

14) Developing Core Skills & Competencies: By designating a central Credit Management Division for
all loan management and administration, the HO will develop expertise in those duties in a shorter
amount of time.

15) Training Programs and Knowledge Sharing: Centralized credit operations can organize training
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programs and knowledge-sharing sessions that involve various teams within the organization.

While there are many lending processes which are able to serve the needs of a lending institutions,
centralized lending provides unmatched capabilities.

Sumon Ahammed. DAIBB, CECM, MBA (DU) Sazzad Hasan, AIBB, CECM, MBA (Fin) 10
 Short Notes

Question: Different types of Borrowers for a Bank Credit

◆ Different Types of Borrowers

Individuals: (Under retail Segments): Retail traders, Micro, Small and Medium Enterprises,
Farmers, Agricultural, Consumers, Home loan, Credit Card etc.
Proprietorship Firms.
Partnership Firms.
Private Limited Companies.
Public Limited Companies.
Large Corporates
Government Entities. (SOEs).

Question: What is Credit Planning? Mention Factors Influencing Credit Planning.

◆ Credit Planning:

Credit planning determines how credit should be approved in the future in order to achieve specific
credit objectives. A Credit planning involves the strategic management of a company's credit-related
activities to ensure effective use of financial resources and minimize credit risks.

It also involves decisions related to extending credit to customers, setting credit limits, and establishing
terms of payment.

◆ Factors Influencing Credit Planning:

➢ Objective of the bank.

➢ Government and regulatory priorities.
➢ Conditions of both Money Market and Capital Market.
➢ Performance scenario of the similar products in the market.
➢ Cost of Credit (Loan pricing).
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➢ Risk assessment from historical data

➢ Collaterals accepted by the bank.
➢ Tenure of the loan and repayment procedure.
➢ Geographical concentration.

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Question: Why Credit Planning is Important at Bank Level?

◆ Credit Planning at the Bank Level

Credit planning at bank level involves estimating total loanable fund that are likely to be available
within the given period and then allocating the same among various alternatives according to
guidelines issued by the central bank and priorities.

It is important for achieving the following objectives

 Maximization of profit;
 Diversification of credit portfolio;
 Ensuring the best alternative use of fund;
 Providing credit to right person at right time at right quantity;
 Compliance with regulatory limits and priority.

Question: What do you mean by Credit Policy? Write Features of a Good Credit Policy

◆ Credit Policy:

A credit policy is a set of guidelines and rules established by a financial institution to guide its lending
practices. This policy defines the criteria and standards that the bank should follow when evaluating
and approving credit applications from individuals, businesses, or other entities.

It helps to minimize credit risk for the safety of the depositor ‘s money and to ensure sustainable
earnings.

Features of a Good Credit Policy:

 Credit Approval / Sanction procedures
 Credit Application procedure
 Regular Policy Review and Update
 Credit Analysis Process
 Maintenance of Capital
 Credit terms & conditions
 Documentation guidelines
 Credit limits
 Monitoring and supervision of the Loans
 Loan pricing method
 Management of Non-Performing Loans
 Income assessment method
 Legal action
 Quality of securities
 Delegation of authority
 Regulatory compliances: Priority sector lending
 Approval authority
like CMSME, Agricultural credit, Large loan
 Maintenance of Liquidity and statutory reserves
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concentration, Single borrower exposures, ICRR,

CIB etc. (CRR, SLR)
 Target customers  Policy exception authority
 Priority sectors  Risk management guideline

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