In this article we will provide the information related Principles of lending in Banking. Lending is a fundamental aspect of banking , and financial institutions adhere to a set of general principles to evaluate and ensure the viability of advance proposals.

These principles are essential for maintaining the safety, liquidity, and profitability of the bank while fostering responsible lending practices. Let’s delve into these principles in detail.




The cornerstone of good lending is the principle of “safety first.” When a bank extends a loan, it must have confidence that the borrower will repay the amount. This involves a thorough assessment of various factors to gauge the safety of the loan.

For instance, if the borrower invests the funds in unproductive or speculative ventures, or if there are concerns about the borrower’s honesty, the safety of the loan is jeopardized.

Similarly, if the borrower’s business faces losses due to incompetence, recovering the loan may become challenging.


To ensure safety, the bank meticulously selects borrowers, scrutinizing their financial health, business acumen, and integrity.

The goal is to ensure that the money lent is directed to the right type of borrower, used judiciously, and repaid with interest.

This principle is critical not only at the time of lending but throughout the loan tenure, with a focus on serving a valuable purpose in the trade or industry.




While safety is paramount, the liquidity of the advance is equally crucial. It’s not just about the money coming back; it must return on demand or as per agreed repayment terms.

The borrower should be in a position to repay within a reasonable time after a demand for repayment is made.

Liquidity ensures that the borrower uses the funds for short-term requirements rather than locking them up in acquiring fixed assets or engaging in schemes with prolonged payback periods.


The bank’s emphasis on liquidity stems from the fact that a substantial portion of its deposits is repayable on demand or at short notice.

If the bank lends a significant portion of its funds to borrowers from whom repayment would be slow, it could impact the bank’s ability to meet demands promptly, despite the safety of the advances.




The purpose for which the loan is sought is a critical consideration. The loan should have a productive purpose to ensure not only safety but also a reliable source of repayment.

Banks discourage advances for hoarding stocks or speculative activities due to the inherent risks and anti-social nature of such transactions.


Banks carefully scrutinize the purpose for which the money is required, emphasizing short-term viability. Loans for productive and short-term purposes contribute to both safety and liquidity, aligning with the broader goals of responsible lending.

In the contemporary banking landscape, the purpose of the advance has assumed special significance.




Equally important is the principle of profitability in bank advances. Like any commercial institution, banks must generate profits to sustain their financial health. Various factors contribute to the profitability of a loan.

Firstly, banks need to pay interest on the deposits they receive. They also incur expenses on establishment, rent, stationery, and more.

Additionally, provisions must be made for the depreciation of fixed assets and potential bad or doubtful debts.


After meeting these expenditures, a reasonable profit must be generated to contribute to reserves or pay dividends to shareholders.

Banks consider all these factors when deciding on lending rates. While a specific transaction may not appear profitable in isolation, ancillary businesses associated with the borrower, such as deposits from the borrower’s other concerns or involvement in foreign exchange business, may enhance overall profitability.


It’s important to note that lending rates are influenced by the Bank Rate, inter-bank competition, and directives from federal or central banks (e.g., Reserve Bank of India, RBI).

Rates may also vary based on the borrower’s creditworthiness, nature of security, mode of charge, and form and type of advance, whether it’s a cash credit, pre-shipment finance, or a consumer loan.




The practice of banks lending against security is grounded in the principle of mitigating risks. Security serves as insurance or a cushion to fall back on in case of emergencies.

The bank conducts a thorough examination of all aspects of an advance before granting it, providing for unexpected changes in circumstances that may affect the safety and liquidity of the advance.


While security is a crucial consideration, it’s essential to understand that an advance is not granted solely based on security.

A good banker assesses an advance proposal on its merits, considering safety, purpose, and the borrower’s character, capacity, and capital.

Beyond serving as a safety valve for unexpected emergencies, the provision of security also makes it challenging for the borrower to secure advances from other sources against the same security.




Diversification of advances is another important principle of good lending. Every advance carries an element of risk, no matter how secure it may seem.

Successful banking involves taking calculated risks, and a prudent banker aims to spread these risks over a large number of borrowers, industries, areas, and different types of securities.


The rationale behind spreading risks is to avoid concentrated exposure to specific sectors or assets. For instance, if a bank lends a substantial amount against a single type of security, it faces significant risk if the value of that security sharply depreciates.

By diversifying the portfolio across various borrowers and industries, a bank can mitigate the impact of downturns in specific sectors, ensuring greater stability in its lending activities.




Even if an advance adheres to all the aforementioned principles, it may still not be suitable for various reasons.

An advance may run counter to national interest, and regulatory bodies, such as federal or central banks (e.g., Reserve Bank of India, RBI), may issue directives prohibiting specific types of advances.

Factors beyond financial metrics, such as law and order situations at the borrower’s business location, may also impact the suitability of an advance.


In the evolving landscape of banking, factors like the purpose of the advance, its viability, and alignment with national interest are assuming greater importance than security.

This shift is particularly notable in advances to sectors such as agriculture, small industries, and export-oriented industries.




L.C. Mather aptly describes an ideal advance as one granted to a reliable customer for an approved purpose.

The borrower’s experience and the assurance that the money will be used advantageously are crucial considerations.

Repayment within a reasonable period, facilitated by trading receipts or known maturities, further characterizes an ideal advance.



The principles of good lending form the bedrock of responsible banking practices. Financial institutions must balance the imperative of safety with the need for liquidity and profitability.

The purpose of the advance, the suitability of the borrower, and considerations beyond financial metrics are integral to making lending decisions that align with the best interests of the bank, its customers, and the broader economy.

Through a judicious application of these principles, banks can navigate the complexities of lending, contributing to their own stability and the economic well-being of the communities they serve.

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