Banking Portfolio

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INSTITUTE OF MANAGEMENT SCIENCES

BANKINGPORTFOLIO

FINAL PROJECT

BANK LENDINGSBBA

PRESENTED TO :MIS SHEHLA SOHAIL

PRESENTED BY:

MUHAMMAD RAZA (081325)MUHAMMAD

AFROZE(081304)

JAWAD ANWAR (073361)MEHROZ HAIDER (081315)

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What is Lending?Lendingis to give away money to people for some specific

purpose for some particular period of time.

Bank lendingWhen lending process is carried on thorough banks is calledbank lending.

Cash and non cash lendingBoth cash and non-cash instruments are used by consumerand business to facilitate the

purchase of goods and services. Consumers hold aninventory of cash which is drawn down over time to makepurchases, businesses hold cash to make change for cashpurchases, and banks hold vault cash for re-supplying theseinventories either through ATMs or at branch offices. Thesecash holdings, part of which are the reserves required by thecentral bank, are not available for banks to make loans orpurchase securities since they are employed in the dailyliquidity payments (i.e. deposit withdrawals). In the loan

context, these cash holdings are an idle asset in thebanking system. In contrast, non-cashpayment instruments -debit and credit cards, cheques, directdebits, credit transfers- are a substitute method for makingpayments by consumers and businesses but the assets theydebit are not idle they are held as deposits and used bybanks to make loans or purchase securities. Other thingsbeing equal, as the share of payments shifts from cash tonon-cash instruments, loanable funds in the banking systemrises.

IntroductionBank lending is the transfer of fund from savor to borrower.Bank act as a financial intermediaries and help the depositmobilization from one sector to another. The sector that lend

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money to the bank for further lending is the sector which hassurplus money. The sector which get loans from the bank isone which has deficit in fund.

A banker or bank is a financial institution that as a paymentagent for customer and borrows and lend money.

Bank act as a payment agent by conducting currentaccounts for customers , payment cheques drawn bycustomer on the ban, and collecting cheques deposited to

the customer current account.Bank borrow money by accepting funds deposited on thecurrent account, accepted term deposit by issuing debtsecurities such as banknotes and bonds. Bank lends moneyby making advance to customer on account by makinginstallment loans and by investing in mark able debtsecurities and other form of lending.

Forms of lendingThe various forms of lending are given below.

Cash financing (cash credit)This is a common form of borrowing by commercial and

industrial concerns and is made available either againstpledge or hypothecation of goods, produced or merchandise.In case finance a borrowers is allowed to borrow money fromthe banker up to certain limit, either at once or as and whenrequired. The borrower refers to the form due to the facilityof paying markup service charges only on an amount he

utilized. If the borrower does not utilized the full limit, thebanker has to lose return on the un-utilized amount. In orderto offset this lose the banker may provide for the clause incash finance agreement according to which borrower has topay mark up charges on at least one half or one quarter ofthe amount of cash finance limit allowed to him even hedoes not utilize that amount.

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OverdraftWhen the borrower require temporary accommodations, his

banker allows with drawls on his account inn excess of thebalance which is borrowing customer credit and an overdraftoccur. this accommodation is generally allowed againstcollateral securities . when it is given collateral securities it iscalled secured overdraft. When the borrower customercannot offer any collateral security expect his personalsecurity the accodmandion is called clean overdraft.

The main difference between cash finance and overdraft liesin the fact that cash finance used for long term bycommercial and industrial concern on regular basis, whereasoverdraft is a temporary accommodation .

LoansWhen a customer borrows from a bankr a fixed amountrepayable euther in periodic installment or in lump sum at a

fixed future time , it is called a loan. When a banker

allowed loans to their customer against collateral securitiesthey are called secured loans and when no collateral securityis taken they are called clean loans.

The amount of loan is placed at the borrower disposal inlump sum for the period agreed upon and the borrowingcustomer has to pay interest on the entire amount. Thus the

borrower get a fixed amount of money for his use, while thebanker feel satisfied in lending money in fixed amount fordefinite short period against a satisfactory security.

Purchase and discounting of billsBanker in Pakistan purchase and discount bills of exchangeas a part of financing function. They also purchase out

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station cheques of reliable customer. then bill of exchangeare accompanied by document of title of good they arecalled documentary bills of exchange or clean bill ofexchange. If bill of exchange is payable on demand it is a

demand bill or usance bill. The banker purchased usance billof exchange from a reliable person it is called discountingbill.

Principles of lending1. Safety

Banker fund comprise mainly of money borrowed fromnumerous customer on various accounts, such as current

account, saving account, call deposit account, special noticeaccount and fixed deposit account. It indicates thatwhenever the money the banker holds is that of hiscustomer who have entrusted the banker with it onlybecause they have full confidence in the expert handling ofmoney by their banker. Therefore , the banker must be verycareful and ensure that his depositor money is advance tosafe hands where the risk of loss does not exist. Theelements of character, capacity and capital can help a

banker in arriving at a conclusion regarding the safety ofadvances allowed by him.

2. LiquidityLiquidity

Means the possibilities of recovering the advances inemergency because all th money borrowed by the customeris repayable in lump sum on demand. The borrower repaystheir loans and the funds thus released cab be use to allowfresh loans to the borrowers. The banker must ensure thatthe money he is lending is not blocked for undue long timeand that them on a short notice. In such a situation it is very

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important for a banker to study period in order to meet theshortfalls in the working capital. If the borrower asks for anadvance for the purchase of fixed assets

the banker should refuse because it shall not be possible forhim to repay when the banker wants his customer to repaythe amount. Hence the banker must adhere to theconsideration of the principles of liquidity very carefully.

3. DispersalThe dispersal of the amount of advances should be based sothat the large number of borrowing customer may benefit

from the banker fund. The banker must ensure that his fundsare not invested in specific sector like textile industry ,heavy engineering or agriculture etc. he must see that hisavailable funds he advances them to a wide range of sectorlike commerce industry, farming , agriculture, small businessand other financial concern in order of priorities.

4. RemunerationThe banker needs sufficient earning to meet the following

1 interest payable to the money deposited with him2 salaries and fringe benefit payable to the staff member3 overhead expense and depreciation and maintanece of thefixed assets of the bank4 an adequate sum to meet possible losses5 provision for a reverse fund unforeseen contingencies6payment of dividends to the shareholders7payments of dividends to the shareholder

A major portion of banker earning comes from interestcharged on the money borrowed by the customer. Thefixation of the rate of interest for the advances of

various classes depends on the type of security offered tohim and also on the duration for which the consider charging

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a lower rate of interest. Similarly the banker may consider alower rate of interest on an advance for a fixed period ascompared to that on a fluctuating overdraft.

5. SuitabilityIt mean that advances should be allowed not only to thecarefully selected and suitable borrowers but also in keepingwith the overall national development plans by theauthorities concerned. Before accommodating a borrowerthe banker should ensure that the lending is for a purpose inconformity with the current national credit policy laid downby the central bank of the country.

Since the banker mainly provide short term working capitalto commerce and industry, they should see that their lendingsolve the borrower financial problems. In doing so thebanker should not assume the role of a partner in thebusiness but should retain his primary status as acommercial lender only.Government have been exercising credit control throughcentral bank since the second world war. The central bankallocates priorities for giving or not giving advances in aparticular sector and regulates the minimum and maximumrate of interest to be charged.

TYPES OF LOANS

Loan types fall into four basic categories: construction,bridge (also known as interim), permanent and mezzanine.Lets look at each loan type and the role it plays in self-storage.

Construction Loans

The construction loan provides you the debt capital toacquire a plot of land and develop a storage facility on it.

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While all construction loans accomplish the same thing,theyre not all the same. In fact, every loan is unique.

The great majority of construction loans are provided bycommercial banks and thrifts. But in recent years, some ofthe Wall Street-based lenders and life-insurance companieshave entered the loan market, often combining constructionand permanent financing into a single transaction (usuallyfor larger deals). Shop alternatives, and pay attention todetail. Items that appear trivial or meaningless during the

loan process may prove to be important later in the project .

Bridge Loans

A bridge, or interim, loan is usually a floating-rate loanoffered for a short term, usually one to three years, with veryliberal prepayment terms. Bridge loans may require personalguarantees, but some are no recourse. The choice betweenbridge and permanent financing involves a careful analysis

of where your project stands now, and how successful youbelieve it will be in the future. Lets look at some scenarios inwhich bridge financing may be the smart choice

Permanent loans

Permanent loans are traditional fixed-rate mortgages, withterms as short as five years or as long as 30 years. Over thepast decade, the 10-year loan term has become the most

prevalent.

Permanent loans differ from bridge loans in two primaryareas. First, permanent loans generally have fixed interestratesand, thus, fixed monthly paymentsin effect for theentire loan term. second primary difference between bridgeand permanent loans: prepayment penalties. In most cases,

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a lenders willingness to provide a long-term, fixed-rate loanis contingent upon a guarantee that it will receive interestfor the entire loan term. To ensure this, lenders chargepenalties if a loan is paid before its maturity.

Charge on security

Charge on security means its a right of bank to sell outsecurity in case of non-repayment of loans. Charge can beoccur in two ways

Act of parties ( where there is consent of both parties)

Operation of law ( when you get order from law)

Fixed and floating charges

Definition:

A fixed and floating charge is a form of security interestusually taken by a lender from a company to securerepayment of a loan.

The company granting the charge is usually referred to asthe "Chargor" and the person in whose favor the charge isgranted is typically called the "Chargee".

This form of security is called "fixed and floating" becausethe chargee has:

an equitable charge over all the non-trading assets of

the chargor, e.g. real property, plant and equipment,intellectual property rights, book debts, insurancecontracts and other contracts; and

a floating charge over cash and stock-in-trade

MODES OF CREATING A CHARGE

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lien

mortgage

pledge

hypothecation

guarantees/ indemnity

1 LIEN

A lien is a legal claim or a "hold" on some type ofproperty, whether personal or real property, makingit collateral against monies or services owed to another

person or entity. A lien usually exists in situationslike second mortgages, loans against a vehicle title, ormoney loaned against any other substantial item ownedby a borrower. It may keep the borrower from selling theproperty, or at least keep him or her from transferring titleto the property. An ordinary creditor cannot sell thesecurity under lien to secure his amount that is aparticular lien. But banker lien is different from anordinary lien. Bankers lien is an implied pledge

and so the banker can sell the security to recover hisamount after giving notice to borrower. Bankers lien isalso called general lien.

2 MORTGAGE

A mortgage is defined as the transfer of interest in specificimmovable property for the purpose of securing payment ofmoney advanced or to be advanced or performance of anypromise which give rise to a pecuniary liability. mortgage,therefore creates a transfer of interest in an immovableproperty which is specific. The transferor is called the

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mortgagor and the transferee is mortgagee. Principle,interest, and other payments which are secured by themortgage are collectively called the mortgage debt. Thedeed executed to create mortgage is called mortgage deed.

Immovable property includes land, buildings, benefits toarise out of land and things attached to the earth orpermanently fastened to anything attached to earth.Building and machinery on the land cannot be mortgaged.Mortgaged property remains in the possession of themortgagor.

Types of mortgage1. equitable mortgage of immovable property by

depositing title deed with the bank

2. Registered mortgage by getting the mortgage deedregistered with the registration of titles.

EQUITABLE MORTGAGEEquitable mortgage of any immovable property may becreated by deposits of title deeds with the bank except incantonment areas.Equitable mortgage by deposits of title deeds ofimmovable properties may be created by those whothemselves avail of the finance against properties ownedby them and which stand in their name.Equitable mortgage by deposit the title deeds ofimmovable properties may be created by any of thefollowing three classes of persons

1. those who themselves avail of the finance againstproperties owned by them and which stand in theirname

2. those who avail of the finance, for the purpose of

their business, in the names of their firms orcompanies in which they happens to partners ordirectors, and deposit the title deeds of immovableproperties held by them in their names as collateralsecurities.

3. those who deposit their title deeds of propertiesbelonging to them and standing to their names, to


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secure the finance allowed to third parties on theirguarantee and recommendation.

DOCUMENTS REQUIRED Demand promissory note

Personal guarantee of the owner of theproperty

Finance agreement

Memorandum of deposits of title deeds

LEGAL MORTGAGE AND REGISTEREDMORTGAGE

Legal mortgage is created by registered instruments i.e. a

registered mortgage deed which should also contain aspecific/ special clause authorizing the bank to sell theproperty without going to court of law.

DOCUMENTS REQUIRED FOR LEGAL MORTGAGE ARE

1. Original title deed of the property being mortgage2. Extract from the property registrar3. Non encumbrance certificate4. No demand certificate from the income tax

authorities5. Valuation certificate6. Urban property tax clearance certificate

3 PLEDGE

The pledge is bailment of goods as security fir payments

of a debt or performance of promise by customer.Bailment is defined as the delivery of goods by one personto another person for some purpose. In the case of pledgebailer is called the pawner and bailee is called Pawnee.But in commercial parlance the pawner is known aspledgor and Pawnee is called as pledgee. The ownership


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of goods remain with the pledgor. Valid pledge requiresthat:

delivery of goods must take place

delivery must be made by one person to another

the purpose of delivery shall be to provide securityfor payment of debt or performance of promise

and the pledgee must return the goods or otherwisedispose them off as directed by pledgor after the

purpose is accomplished.

it is the responsibility of banker to hold the goodsunder pledge in its proper control, deliver the same tocustomer when the finance is repaid or effect sale ( incase of non adjustments of finance) after completion ofnecessary formalities, ensure that the goods are fullyensured andprotected from damage etc.

the banker has to be very careful in evaluating goods.

He has to satisfy himself about the marketability,quality, quantity as well as price of goods acceptedunder pledge.

The customer should possess clear title to goods whichshould be free from any encumbrance. There shouldnot be possibility in the steep fall in the price of goodsas a result of their storage fro long or short period oftime.

DELIVERY OF GOODS

Goods are delivered to the parties against deliveryorders, signed by two officers of the bank, one of themmust be the officer-in-charge, credit department.Before signing the delivery orders , the signature of the


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customers should be invariably verified on theapplication form and after having delivered the stocks itshould be ensured that the signature of the persontaking delivery of the goods is obtained on the back of

the delivery order.

GODOWN CHARGES

Godown charges are recovered from the parties inaccordance with the utility of space and/or workinvolved.

Documents required for pledge are:

1. Demand promissory note2. Letter of pledge3. Agreement4. Personal guarantee/collateral security.

4 HYPOTHECATION

When the property in the goods is charged as security forany finance but possession is left with the customer, thegoods are said to be hypothecated. The essencehypothecation is that possession of the same is not givento the bank. The security is charged by the way ofobtaining letter of hypothecation and in case of

incorporated companies, registration of charge with theregistrar of joint stock company. Therefore, finance thehypothecation being risky is granted after ensuring that

the security has all the attribibutes of good bankingsecurity.


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The customers has valid title to the goods or havesufficient interest entitling them to hypothecate thegoods.

The customer possesses adequate means to repay

the advance and enjoy a good reputation. The guarantors are trustworthy and possess good

means.

DOCUMENTS REQUIRED

1. Demand promissory notes2. Letter of hypothecation

3. Agreement\4. Personal guarantee/ collateral security.


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5 GUARANTEES AND INDEMNITY

GUARANTEEa contract of guarantee is a contract to perform toperform the promise or discharge the liability of a thirdperson in case of default

Indemnityis a contract by which one party promise to save theother from losses caused by him by the conduct ofpromisor himself as by the conduct of any other person.Its a direct engagement by two parties

Requirement for guarantee Guarantee must have to be in written form

It must be enforceable in the court of law

Guarantee of minor in not allowed

There must be a sound mind of person who is giving

guarantee

Company cannot authorized to give guarantee in

favor of its directors borrowings whereas directors

can give guarantee for its company

It should be signed by both creditors and customer.

Customer is called principle debtor


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Guarantee of woman cannot be given unless there is

given some security. ( she must visit head office, she

should be some solicitor, guarantee should be

stamped at prevailing paper.

RELEASE OF GUARANTEE

At the death of guaranter , the guaranty shouldstop immediately and should inform head officeand should act according to head office. Releasefrom guarantee is called discharge.

REVOKE OF GUARANTEE

Iif we see that guarantee is not suitable we can

eliminate the guarantee by giving suitable notice to

clients before revoking.

Guarantee also revoke when the payment is made by

principle debtor.

When guaranter himself pay loan

When there is some misrepresentation


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When there is some notice of guaranteer death or

insolvency.

When there is change in parties


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Suggestion while giving loans

The Banking sector in Pakistan continues to suffer from aloan problem portfolio, due to a variety of reasons whilethere is no guaranteed procedures for ensuring loans do notgo bad.

The important thing to remember is not to be overwhelmedby marketing or profit center reasons to book a loan but totake a balanced view when booking a loan, taking intoaccount the risk reward aspects. Generally we remainoptimistic during the upswing of the business cycle, but tend

to forget to see how the borrower will during the downturn,which is a shortsighted approach. Furthermore we tend toplace greater emphasis on financials, which are usuallyoutdated; this is further exacerbated by the fact that adescriptive approach is usually taken, rather than ananalytical approach, to the credit. Thus a forward lookingapproach should also be adopted, since the loan will berepaid primarily from future cash flows, not historicperformance; however both can be used as good repayment

indicators.

Having postulated above guidelines, following is a suggestedgeneral procedure for reviewing short term lendingproposals

Company Profile / Ownership:This should cover the legalstructure of company, i.e. is it public / private / listed. Iflisted then broker reports can be an additional source ofinformation besides share price.

When dealing with individual Group companies it is essentialgo review overall Group exposure to ensure that the GroupRisk is adequately analyzed and monitored, and Group limitsalso set.


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Proposed Transaction: Following keyitems should beaddressed:

Purpose of facility:This must be specific and general

terms should be avoided, such as "working capital facility." Aspecific need would be to "finance inventory" or"receivables" (or both). These two assets generallyconstitute the rationale for short-term borrowings.

Source of repayment:The cash cycle including paymentand selling terms must be reviewed, which impact cash flow.Normally there should be reliance on identifiable cash flowsfor the first way out to repay the loan rather than thesecurity itself. The

lending officer should understand the cash production cycleand its tenor, and should question how the Bank will be repaidif things do not work out as expected for the customer e.g. slowsales, increases in inventory costs, etc.

Financial Analysis

Days Inventory and Days Receivable are crucial indicators ofa Company's liquidity and show the need for an amount ofborrowed funds, which are repaid through the liquidation ofthese assets. Earnings are key to a company's success.

Therefore one should review long term earning power,consistency and trend of core earnings, earnings mix, anddividend policy.

Balance sheet figures are at a point of time - therefore it isessential to analyze realistically e.g. borrowings/inventorycan be reduced for balance sheet date


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purposes. Thus average figures are more reliable whereavailable. Figures can also be inflated for seasonal factorse.g. inventory build-up during the cotton-buying season,which should be recognized accordingly.

Risk Areas: The lending order should review all risks officerrelating to the lending point wise along with the mitigantsand justified why lending is warranted, i.e. can the risks becovered or are these acceptable risks. Each borrower willhave different risk profiles and therefore it is important toensure there are adequately understood and addressed

Checkings: Written checkings from other lenders should beobtained. Trade/market checkings can be obtained fromvarious sources e.g. suppliers, etc. Talking to suppliers andother market information can give updated input on thecompany's financial position, e.g. if company is delayingpayment to suppliers this could indicate liquidity problems.Also checks should be made from the market how thecompany's product is selling in the market or if it suffersfrom quality problems - these items are important since theyimpact sales and ultimately cash flow.

Loan Profitability: Again this is an important area whichhelps evaluate the risk / reward aspects of a transaction. It isimportant to earn an acceptable spread on a loan, andtherefore to arrange necessary funding, to compensate forthe credit risk. Apart from this the Bank should make anadequate return on the loan to help build the up net worthwhich is a cushion to absorb loan losses. The Bank shouldmaximize return on assets not only through spread incomebut other non funds income such as commissions, exchangeetc. which are generated from contingent risk and do notinvolve the use of Bank funds

There is no insurance against loan losses or problems, nor islending a rocket science. The lending officer must thereforeexercise common sense and follow basic lending rules whenanalyzing a credit. There is no short cut to this - after


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disbursement it is also essential to maintain contact with thecompany and remain abreast of its financial position. Alending officer must not only have requisite credit skills, butdevelop problem recognition abilities to enable him to take

necessary and timely action, as and when required.

The above is a basic guideline to reviewing short-termcredits and is not all exhaustive. It should thus be reviewed

on a case by case basis. Each borrower has differentcircumstances and should be reviewed as such.

However 3 'C' s of a credit are crucial and relevant to allborrowers / lending which must be kept in mind at alltimes

Character Capacity capital

If any one of these are missing in the equation then thelending officer must question the viability of the credit.

Personal character of borrower should be considered. He should be of good moralcharacter. (Should not be like hamesh khan)

There is no guarantee to ensure a loan does not run intoproblems; however if proper credit evaluation techniquesand monitoring are implemented then naturally the loan loss

probability / problems will be minimized, which should be theobjective of every lending officer.

Security: Full details should be provided, besides description ofsecurity as the alternative loan repayment source and itsrealizable value, where possible. It should be properly insured bya Bank approved Insurance Company and covered against


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various risks. Documentation must be precise, while securityevaluation should cover control, marketability and lendingmargin, to protect against price fluctuations. Frequentindependent verification of the security should take place.

Security is demanded to ensure the payment of loan with inthe due time. Following qualities are essential for goodsecurities.

Easy marketability

Stable price

Reasonable margin

Easily transferable

If the security taken is not saleable, then this should berecognized and the risk addressed e.g. if there is only a soleseller of the product, then there will be no other buyer for hisassets, in event of a forced sale. The Bank will thus be leftwith an unrealizable asset. Where receivables are taken assecurity, then quality / ageing should be reviewed, whichwould enable the Bank to assess the reliability of this assetas a loan repayment source.

Security of loans

Custody of securitySecurity may be in a shape of documents or property. It is

favorable for bank to take al securities under its owncustody


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joint propertyjoint property might be a source of loss in case of non-payment. So banks should avoid it. So in this case banksshould take the consent of all owners in writing form.

Disputed propertythe banks should not take disputed property as security ofloans. It means the right of ownership of security shouldbe confirm and clear.

Objectives of loan.Loan granted for the productive purposes are more usefulfor the banks as compared to non productive purposes

Amounts of loansinstead of giving away huge amount of loans to singleparty, banks should give away small number of loans tolarge number of people so that the possibility of loss andrisk could be avoided.

Insured securitymerchandise, vehicles and building should be insured ifthese are kept as security of certain loans


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