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SCERT Class 12 Banking Chapter 7 Employment Of Funds
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Employment Of Funds
Chapter: 7
Answer Questions
Q.1. Write the full form of CRR.
Ans :- The full form of C.R.R. is Cash Reserve Ratio.
Q.2. Write the full form of SLR.
Ans :- The full form of S.L.R. is Statutory Liquidity Ratio.
B. Short answer questions : Type-I
Q.1. State the meaning of liquidity.
Ans :- Meaning of liquidity :- The term ‘liquidity’ has special significance in banking business. The banker must safeguard his position by meaning sufficient cash with himself or with other banks or in the form of assets i.e., liquid assets. The term liquid assets refers to the assets which can be readily converted into cash with out any loss. These assets include.
(i) Cash in had and balance with other banks
(ii) Money at call and short notice and
(iii) Investment in government and semi government securities.
According to R.S. Sayers, ‘Liquidity’ is word, “that the banker used to describe his ability to satisfy demand for cash in exchange for deposits.
Q.2. What do you mean by Hypothecation ?
Ans :- An important method of creating charge over movable assets is the hypothecation of goods. In case of hypothecation, possession of goods is not given to the bank. The goods remain at the disposal and in the godowns of the borrower. The bank is given access to goods wherever it so desires.
M.L. Tanan States “A transaction intended to be a security over chattels (Movable goods), in which there are no word of transfer and there the possession remains with the borrower, will therefore amount to an equitable charge which is generally known as hypothecation.”
Q.3. What is the meaning of cash credit ?
Ans :- Meaning of Cash Credit :- A cash credit is an arrangement by which a banker allows his customer to borrow money up to a certain limit, cash credit arrangements are usually made against the security of commodities hypothecated or pledged with the bank.
From the above it is clear that under an arrangement the banker agrees to lend certain amount which is the limit of cash credit. The limit is determined by considering the requirements of the borrower. The agreement may extend to one year. The agreement is supported by the security of tangible assets or by a guarantee.
Q.4. Give the meaning of Cash Reserve Ratio.
Ans :- Banks are required to maintain a percentage of their deposits as cash, meaning that if your deposit Rs. 100 in your Bank, than bank can’t use the entire Rs. 100 for lending or investment purpose. They have to maintain a portion of the deposit as cash and can use only the remaining amount for lending/investment. This minimum percentage which is determined by the central bank is known as cash Reserve Ratio.
Q.5. What is Overdraft ?
Ans :- When a current account holder is permitted by the banker to draw more than what stands to his credit such an advance is called as overdraft. The banker may grant such advance on the personal security of the borrower.
Generally, on overdraft facility is given by a bank on the basis of a written application and a promissory note signed by the customer. Banks obtain a letter and a promissory note incorporating the terms and conditions of the facility including the rate of interest chargeable in respect of the overdraft facility.
Q.6. Explain Pledge.
Ans :- Incase of pledge, the goods are placed in custody of the bank with its on the godown where they are stored. The borrower has no right to deal with them.
Q.7. What is money at call and short notice ?
Ans :- The money at call and short notice is a type of loan. These loans represent mainly the loans given by one bank to another for a short period. Call loans are repayable at any time the banker recalls them while short notice advances are payable within a short notice of say 24 hours. Demand loans for a short period are payable of a notice of maximum usually a week. The State Bank of India is the main lender in the call money market.
Q.8. What do you mean by statutory liquidity ratio ?
Ans :- Banks in India has to maintain statutory liquidity ration under section 24 of BR Act, 1949.
Accordingly every scheduled commercial bank has to maintain in India in cash, gold or unencumbered approved securities at least 25% of its time and demand liabilities. The R.B.I. has the power to vary this ratio upto a maximum of 40% percent. Thus, the R.B.I. may compel the banks to maintain larger portion of their liabilities in liquid form.
The SLR has been applied by the RBI very frequently as a tool to regulate bank credit. By 1991 the SLR was raised to 88.5% in September, 1990. The CRR plays the role of primary reserve requirement but the SLR enables RBI to impose secondary and supplementary reserve requirements on the banks to curb credit creating capacity of banks.
Q.9. What do you mean by Letter of Credit ?
Ans :- A letter of credit may be defined as on open letter of request, whereby one person (usually a merchant or a banker) requesting so other person or persons to advance money or give credit to a third person, named there and promises that he will pay the same to the person advancing the same or accept bills drawn upon himself for the like amount.
Thus, the sole objective of a letter of credit is to enable credit to be extended to one person on the promise of the other (usually a banker) to act as pay-master to the person extending the credits. Hence, the banks gear the machinery of commerce specially in case of international trade by acting as an useful like between. Buyer and seller.
By issuing or establishing a letter of credit, a banker requests another party to grant a specified amount to a third party and the issuing banker himself binds to pay the money paid under the letter of credit.
C. Short Answer Questions : Type-II
Q.10. Mention any three differences between Loan and Hypothecation.
Ans :- The three differences between Loan and Hypothecation as follows :
Under loan system the banker sanctions a specified lumpsum amount to a customer for a specified period at a certain rate of interest.
A separate loan account is opened in the name of the customer and the customer draw the amount at any time. The loan can be repaid in instalment or in full at the expiry of the period. But, hypothecation is a mode of creating an equitable charge against a property, for payment of a debts which continue to be in a possession of the debtor. Hypothecation is otherwise called mortgage of movable property. This method of charge has been evolve in banking practice. It is an extended idea of pledge only.
Q.11. Mention any three differences between Cash credit and Loan.
Ans :- The three differences between Cash credit and Loan are as follows :
(i) In loan system the banker sanction a specified lumpsum amount to a customer.
But in cash credit a customer is permitted to borrow money against security.
(ii) In loan system a separate account is opened in the name of the customer.
But in cash credit the borrower can withdraw money from his account as and when need.
(iii) The loan can be repaid in the from of instalment is or in full at the expiry of the period.
In cash credit system the customer can deposit any surplus funds into this account and borrow again.
Q.12. Mention any three differences between Cash credit and Hypothecation.
Ans :- The three differences between Cash credit and Hypothecation are as follows :
(i) Cash credit is on arrangement by which a banker allows his customer to borrow a certain limit of amount. But Hypothecation is a mode of creating on equitable charge against a property.
(ii) Cash credit method is very popular in India. But Hypothecation method is also known as mortgage of movable property.
(iii) Cash credit method is used by traders, agriculturist, industrialist to meeting their working capital. But, manufacturing concern can not pledge their raw materials. Hypothecation is on extended India of pledge only.
● Write short notes on :
Q.13. Loan.
Ans :- Loan : A loan is a kind of advance mode with or without security. It is given for a fixed period at an agreed rote of interest. Repayments may be made in instalments or at the expiry of a certain period. The customer has to pay interest on the total amounts advanced whether he withdraws the money from his account (credited with the loan) or not. A loan once repaid in full or in part cannot be drawn again by the borrower unless the banker sanctions a fresh loan.
Loan may be a term loan or a demand loan. Term loans payment is spread over a long period. It includes a medium term loan (repayable within 3 to 5 years) and a long term loan (repayable after 5 years).
Q.14. Cash Credit.
Ans :- Cash Credit :- A cash credit is an arrangement by which a banker allows his customer to borrow money up to a certain limit. Cash credit arrangements are usually made against the security of commodities hypothecated or pledged with bank.
From the above it is a clear that under an arrangement the banker agrees to lend certain amount which is the limit of cash credit. The limit is determined by considering the requirements of the borrower. The agreement may extend to one year. The agreement is supported by the security of tangible assets or by a guarantee. This is the most favourite mode of borrowing by the commercial and industrial concerns in India. About two-thirds of total bank lending takes the form of cash credit. It is advantageous for the borrower that he need not borrow the whole amount within the limit of Cash Credit as and when required.
He can also put back any surplus amount in his hand for the time being, thus the account remained running or current. Usually the borrower is charged interest on the actual amount utilised by him and for the period of actual utilisation only. But there may be commitment charges are imposed on the unutilised portion of cash credit as directed by the RBI from time to time.
Q.15. Overdraft.
Ans :- Overdraft :- When an current account holder is permitted by the banker to draw more than what stands to his credit, such an advance is called an overdraft. The banker may grant such advance on the personal security of the borrower. The customer is permitted to withdraw the amount as and when he needs it and to repay it by means of deposit in his account as and when it is feasible for him.
Generally, on overdraft facility is given by a bank on the basis of a written application and a Promissory note signed by the customer. Banks obtain a letter and a promissory note incorporating the terms and conditions of the facility including the rate of interest chargeable in respect of the overdraft facility. This is to be complied with even when the overdraft facility might be temporary in nature.
Q.16. Letter of Credit.
Ans :- Letter of Credit :- A letter of credit may be defined as an open letter of request, where by one person (usually a merchant or a banker) requesting so other person or persons to advance money or give credit to a third person, named there in and promises that he will pay the same to the person advancing the same or accept bills drawn upon himself for the like amount.
Thus, the sole objective of a letter of credit is to enable credit to be extended to one person on the promise of the other (usually a banker) to act as pay master to the person extending the credits. Hence, the banks gear the machinery of commerce specially in case of international trade, by acting as an useful like between buyer and seller.
Q.17. Mortgage.
Ans :- Mortgage :- A loan to finance the purchase of real estate, usually with specified payment periods and internal rate. The borrower (mortgagor) gives the lender (mortgage) a lien on the property as collateral for the loan.
Q.18. Hypothecation.
Ans :- Hypothecation :- An important method of creating charge over movable assets is the Hypothecation of goods. In case of Hypothecation possession of goods is not given to the bank. The goods remain at the disposal and in the godowns of the borrower. The bank is given access to goods wherever it so desires.
M.L. Tanan States “A transaction intended to be security over chattels (Movable goods) in which there are no words of transfer and there the possession remains with the borrower, will there fore amount to an equitable charge which is generally, known as hypothecation.”
It is clear that incase of hypothecation possession and ownership of goods remain with the debtor. But the agreement contains a provision to handover the possession of the goods to the lender (creditor) when demanded by the creditor. The borrower furnishes periodical return of stock with him to the bank. Such an advance is granted by the bank only to a person in whose integrity it has full confidence. Hypothecation is useful in those cases where it is almost impossible to give possession of goods to lender. For instance, if money is borrowed on the charge of goods in the show room, raw material goods in process, stock of goods, or on the security of motor car, truck, buses which are to be used by the customer (borrower) for the purposes of his business, their possession or ownership can not be given to the banker, because without these business can not be conducted. In such cases hypothecation is the only choice.
Q.19. Discounting of Bill.
Ans :- Discounting of Bill :- The bank also give advances to their customers by discounting their bills. The net amount after deducting the amount of discount is credited to the account of the customer. The banks may discount the bills with or without any security from the debtor in addition to the personal security of one or more persons already liable on the bill.
Q.20. Pledge.
Ans :- Pledge :- Incase of pledge the goods are placed in custody of the bank with its on the godown where they are stored. The borrower has no right to deal with them.
Q.21. SLR.
Ans :- SLR :- Banks in India has to maintain statutory liquidity ratio under section 24 of BR Act, 1949. Accordingly every scheduled Commercial bank has to maintain in India in cash, gold or unencumbered approved securities at least 25% of its time and demand liabilities. The RBI has the power to vary this ratio upto a maximum of 40% percent. Thus, the R.B.I may compel the banks to maintain larger portion of their liabilities in liquid from.
The SLR has been applied by the RBI very frequently as a tool to regulate bank credit. By 1991 the SLR was raised to 38.5% in September 1990. The CRR plays the role of primary reserve requirement but the SLR enables RBI to impose secondary and supplementary reserve requirements on the banks to curb credit creating Capacity of banks.
Q.22. CRR.
Ans :- CRR :- Banks are required to maintain a percentage of their deposits as each, meaning that if your deposit Rs. 100 in your Bank, than bank can’t use the entire Rs. 100 for lending or investment purpose. They have to maintain a portion of the deposit as cash and can use only the remaining amount for lending/investment. This minimum percentage which is determined by the central bank is known as Cash Reserve Ratio.
Q.23. Semi Government Securities.
Ans :- Semi Government Securities :- Semi-government securities include the Port Trust, Improvement Trust and Municipal Bonds and Debentures. It also includes debentures on bonds issued by the corporations established under a special Act of Parliament or Legislative Assembly. In times of need, these securities may be liquidated without any difficulty. However, the yield is comparatively low verification of title is not difficult and the supervision is also easy as securities remain in banks custody. The prices of these securities do not fluctuate widely.
Q.24. Government Securities.
Ans :- Government Securities :- The term “government securities” includes gilt-edged securities issued by central government as well as state government form time to time to raise loans. They are known as gilt-edged securities because they are safe and easily reliable. Government Securities are one of the best securities for advances by the banker. These are safest of all the stock exchange securities. They may be of three types :
(a) Stocks :- In case of stocks, a stock certificate is issued to its owner which indicates that his name has been registered with the public debt office as the proprietor of the amount of loan specified in the stock certificate.
(b) Bearer bonds :- As the name indicates these bonds certify that their bearer is entitled to a certain sum of money in respect of a government loan. These bonds are payable to the bearer and their mere possession is sufficient to constitute ownership.
(c) Promissory Notes :- They are most popular among government securities. In their case the president of India (for central Government loans) or the Governor (for State Government loans) Promises to pay on the specified date the specified sum of money to the holder of the promissory note.
Q.25. Bearer Bond.
Ans :- Bearer Bond :- As the name indicates these bonds certify that their bearer is entitled to a certain sum of money in respect of a government loan. These bonds are payable to the bearer and their mere possession is sufficient to constitute ownership.
Q.26. Stocks.
Ans :- Stocks :- In case of stocks, a stock certificate is issued to its owner which indicates that his name has been registered with the public Debt office as the proprietor of the amount of loan specified in the stock certificate. The transfer of such a stock will be effective only when the name of the transferee has been registered with the Public Debt Office and a new certificate has been issued in his name. A prescribed form will have to be filled in for this purpose.
Q.27. Gilt-Edged Securities.
Ans :- Gilt-Edged Securities :- Gilt-Edged Securities issued by Central government as well as State government from time to time, to raise loans. They are known as gilt-edged securities because they are safe and easily reliable. They include government and semi government securities. There are three hypes of securities :
→ Promissory Notes
→ Bearer Bonds
→ Stocks.
D. Long answer questions : Type-I
Q.28. Explain briefly about the cash balance and statutory liquidity ratio of a commercial bank ?
Ans :- Cash balance :- The most liquid assets of a bank is the cash held by itself or with the Reserve Bank of India, State Bank of India or other banks in current accounts. The demand of the customers is immediately met by the bank with the cash balances with itself or the balances which are within its immediate command. The determination of the adequate size of cash balances is an important task faced by a banker.
The following factors determine the quantum of cash balances maintained by a banker :
(a) Growth of banking habit :- Banking habits implies dependence of the people on banks for keeping their liquid resources. If people are habituated to make and receive payments through Cheques, actual payments in cash by the banks will be necessitated in a few cases only and the banker need not keep more of cash balances. But where people are not habituated to use cheque facility and prefer to receive and pay cash, banks will have to keep comparatively heavy cash balance with it.
(b) Conditions of the locality :- The conditions of locality where the bank is serving also affect the cash balance to be kept by the bank. A bank will have to keep a larger cash balance with it in case locality is inhabited by business community who have numerous and rapid business transactions in comparison to a locality inhabited by agriculturists.
(c) Existence of Bankers clearing Houses :- In a city where clearing house facility is available, bankers may maintain lower cash balances in comparison to a city where this facility is not available. This is because the existence of the clearing house enables the bank to settle its accounts with other banks simply by paying or receiving the difference of the cheques drawn in its favour or against it. A majority of clearing houses in our country are managed by the state Bank of India and its subsidiaries.
(d) Nature and Number of Accounts :- The nature of deposit, i.e., savings, current or fixed and the number of accounts also affected the quantum of cash balances to be kept by the bank. In case of fixed deposit account holders, the bank has not to maintain much cash balance with it. But in case of current deposit holders, it will have to keep a larger cash balance. In case a banker has got a small number of big deposit holders it will have to, keep a large cash balance.
(e) Nature of Advance :- A bank which has used a large portion of is surplus funds in discounting good bills can manage with a lower cash balance in comparison to a banker who invests its funds in other forms of loans. This is because such bills can be rediscounted easily with the Reserve Bank.
Statutory liquidity ratio :- Banks in India has to maintain statutory liquidity ratio under section 24 of BR Act, 1949. Accordingly every scheduled commercial bank has to maintain in India in Cash, gold or unencumbered approved securities at least 25% of its time and demand liabilities. The RBI has the power to vary this ration upto a maximum of 40% percent. Thus the RBI may compel the banks to maintain larger portion of their liabilities in liquid from.
The SLR has been applied by the RBI very frequently as a tool to regulate bank credit. By 1991 the SLR was raised to 38.5% in September, 1990. The CRR plays the role of primary reserve requirement but the SLR enables RBI to impose secondary and supplementary reserve requirements on the banks to curb credit creating capacity of banks.
Since approved securities are mainly Government and semi Government and other gilt-edged securities, or increase in SLR implies a transfer of banking funds to Government and reduction of credit to private sector. It also implies the profitability and working of banks apart from paucity funds for private sector. The Narasimham committee recommended reduction of SLR to minimum level on phase manner.
It is pointed out that on November, 1972 the SLR was fixed at 30%. It was raised on 32% in 1973 and to 33% in 1974. From 1st December, 1978 the SLR was effective at 34%, it was increased to 35% on October 1981, to 35.5 on July 28, 1984, SLR was as high as 38.5% with effect from 22nd September, 1990 while implementing financial sector reform measures the RBI gradually but steadily reduced SLR. It was fixed at minimum level of 25% from 25th October 1997.
Q.29. Explain the Significance of liquidity.
Ans :- Liquidity determines the banks ability to pay the depositor’s money on demand. If the bank fails to pay them their money because of inadequacy of liquid resources, the public will lose its confidence on the bank and ultimately will result into its failure.
The banking Regulation Act, 1949 also recognizes the importance of liquidity and under its section 24, it requires every banking company in India to maintain such liquid assets of an amount less than 25% of the agreement of its time and demand liabilities.
The banks along with liquidity is also greatly concerned about its profitability. The success of a bank is not on the availability of more and more funds but on employment of funds in a manner in which it maintains a stable balance between liquidity and profitability. For attaining these two objectives it has, first to keep sufficient cash at its disposal so as to meet the demand for money by the depositors, and secondly, to provide reasonable share of profit to the shareholders of the bank.
Q.30. What factors determine the quantum of cash balance ?
Ans :- The following factors determine the quantum of cash balances maintained by a banker :
(a) Growth of banking habit :- Banking habits implies dependence of the people on banks for keeping their liquid resources. If people are habituated to make and receive payments through cheques, actual payments in cash by the banks will be necessitated in a few cases only and the banker need not keep more of cash balances.
(b) Conditions of the locality :- The conditions of locality where the bank is serving also affect the cash balance to be kept by the bank. A bank will have to keep a larger cash balance with it in case locality is inhabited by business community who have numerous and rapid business transactions in comparison to a locality inhabited by agriculturists.
(c) Existence of Banker’s Clearing House :- In a city where clearing house facility is available, bankers may maintain lower cash balances in comparison to a city where this facility is not available. This is because the existence of a clearing house enables the bank to settle its accounts with other banks simply by paying or receiving the difference of the cheques drawn in its favour or against it.
(d) Nature and Number of Accounts :- The nature of deposit i.e. savings, current are fixed and the number of accounts also affect the quantum of cash balances to be kept by the bank. In case of fixed deposit account holders, the bank has not to maintain much cash balance with it. But in case of current deposit holders it will have to kept a larger cash balance. In case a banker has got a small number of big deposit holders it will have to keep a larger cash balance.
(e) Nature of Advance :- A bank which has used a large portion of its surplus funds in discounting good bills can manage with a lower cash balance in comparison to a banker who invests its funds in other forms of loans.
Q.31. What is discounting of bill ? State its importance.
Ans :- Advances against bills are of self-liquidating nature as they are paid at sight or on the due date, while lending against bills, banks pay the amount of the bill to the customer after deducting the ‘interest’ due to the bank, known as discount of bill.
Following are the importance of discounting of bill :-
(i) Certainty of payment :- The banker is almost certain of getting the payment of bills on our date. This is because the drawee in order to maintain his credit will sec that the amount will be paid on maturity. Incase the drawee refuses to honour the bill the banker can get the payment from the customer for whom he has discounted the bills.
(ii) Safety of funds :- The funds of the banker are safe because of double security. The drawee is liable to pay the bill in the event of his inability to meet the bill, the banker can recover all expenses from the customer. In the event of dishonour of the bill. The bank debits the account of the customer with the amount, under intimation to him.
(iii) Employment of funds for a definite period :- Since the bills are drawn for a definite period the banker by making a judicious selection of bills can invest his surplus funds for the period he considers appreciate.
(iv) Refinance facility :- The banker can obtain refinance facility from the approved financial institutions of the country in respect of bills discounted and purchased by him. Thus, bills discounted are as good as liquid assets.
(v) No fluctuation in price :- There is no fluctuation in the value of bills where as other securities such as goods or property are affected by fluctuation in the market price. However, sometimes a bill may be rediscounted at a higher rate than the rate at which it might have been discounted but such fluctuation are marginal.
(vi) Higher Yield :- The discounting of bills gives a higher rate of return than loans and cash credits even when the rate of interest in uniform. This is because in case of discounting the bills, the bank charges interest known as discount right at the time of discounting the bill by deducting the amount from the nature of the bill.
Q.32. Discuss the principles followed by the commercial banks in granting loans and advances.
Ans :- Loans and advances :- The major portion of the bank fund is employed by way of loans and advances to traders, business and industrial enterprises and others. The Major part of the bank income is earned by way of interest on the funds so lend.
The loans and advances granted may be either secured or unsecured. As per section 5(a) of the Banking Regulation Act, 1949, a secured loan or advances and unsecured loans or advances mean a loan or advance not so secured.
Loans and advances granted by Indian Banks generally take the following three forms :
(a) Cash Credit :- Cash credit is the main method of lending by banks in India. It is an arrangement by which a banker allows his customer to borrow money upto a certain limit against the security of tangible assets or guarantee.
The cash credit account is an active and running account to which deposits and withdrawals may be affected frequently. Here, the borrower is charged interest on the actual amount utilised by him for the period of actual utilisation only.
(b) Overdrafts :- It is an arrangement in relation to a persons current account and under the arrangement the customer can overdraw at an agreed limit withdrawals or deposit can be made any number of times provided the total amount overdrawn does not at any time exceed the agreed limit. Interest is charged on daily debit balance. Securities normally accepted against on overdraft are shares, government promissory notes, fixed deposit receipts and life insurance policies.
(c) Loans :- It is a kind of investment with or without cash, where the entire amount is paid to the borrower in the lumpsum either in cash or by way of transfer to his current account. It is given for a fixed period and agreed rate of interest. Repayment can be made in instalment or at the expiry of the certain period. The customer has to pay interest on the total amount advanced whether he withdraws the money from his account credited with the loan or not. But loan once repaid in full or in part cannot be drawn again by the borrower unless the banker demands a fresh loan.
Q.33. Discuss the principles of sound lending to be followed by the commercial banks.
Ans :- The main principles of sound lending followed by banks are :
(i) Safety (ii) Liquidity (iii) Profitability (iv) Purpose of loan (v) Diversification of risk (vi) Security of loan, (vii) Basis of credit & Nature of Borrowers.
(i) Safety :- The first and foremost principle of lending is to ensure safety of the money lent out because the banker employs the fund which is really entrusted to him by the customer. Safety depends mainly on the borrowers capacity and willingness to repay the loan and interest in time.
(ii) Liquidity :- Liquidity of loan indicates the State for quick realisation of loan. Banker receive deposits for short time usually repayable on demand. So he lends for short term realisable on short notice. Bank provides working capital to business enterprises. Liquidity largely depends or the nature of the borrower assets pledged to the banker. Goods and goods in process are marketable commodities. Loan granted on the pledge of such tangible assets can be easily repaid on their sale. But fixed assets like plant, building as security of loan can not be regarded as good security from the point of view of liquidity.
(iii) Profitability :- Commercial banks are profit seeking institutions. The difference between his borrowing and lending rates constitutes his gross profit. No banker ordinarily will think of an advance without a satisfactory margin of return. The rate of interest charged will depend on the borrower and his project. These is no hard and fast rule that can be laid down about the margin between borrowing and lending rate of bank. In some cases margin may be 2 or 3 percent. To earn more profit a prudent banker will not sacrifice the principle of safety and liquidity.
(iv) Purpose of Loan :- Banker does not grant loan for each and every purpose Loans are generally granted for productive purpose. Even then a banker will not sacrifice safety and liquidity principles. Before granting a loan, a banker appraise the project for which loan is sought for loan is not granted for nonproductive or speculative purposes of course RBI’s directive under section 21 of BR Act guides loan policy.
(v) Diversification of Risk :- The principal of diversification is based on the famous Maxim “do not keep all the eggs in one basket”. As there is risk in every advances bank should spread the risk by lending a large number of borrowers instead of giving the advance to few, by making large advances. Advances should not be concentrated in few big firms or few industries rather should be spread amongst a number, of firms indifferent industries and different cities.
(vi) Security of Loan :- Different types of security may be offered for loan. It may vary from a piece of land to a commercial paper of bullion. Loan may even be granted on the personal security or on a promissory note of the debtor. The security is only a cushion to fall back upon the case of need. Security for banker’s loan should be adequate readily marketable and easy to handle and after all free from encumbrance. Security like goods, semi finished goods raw-material etc. Are preferable than land, building, plant etc.
(vii) Basis of Credit and Nature of borrowers :- Timely repayment of advance and its interest mainly depend on the nature of the borrower. In fact credit worthiness of the borrower surpasses all other qualities. The safety of a loan largely depends on the honesty, integrity and tangible assets of the borrower. A creditworthy man deserves some credit. The credit worthiness of a borrower is Judged by considering 3Cs or 3Rs. These are character, capacity and capitals or Reliability, Responsibility and resources. These are considered as the basis of credit.
E. Long answer questions : Type-II
Q.34. Discuss the loans and advances granted by Commercial Banks.
Ans :- The major portion of the bank fund is employed by way of loans and advances to traders, business and industrial enterprises and others. The major part of the bank income is earned by way of interest on the funds so lent.
The loans and advances granted may be either secured or unsecured. As per section 5(a) of the Banking Regulation Act, 1949, a secured loans or advances and unsecured loans or advances, mean a loan or advance not so secured.”
Loans and advances granted by Indian banks generally take the following three forms :
(a) Cash Credit :- Cash credit is the main method of lending by banks in India. It is an arrangement by which a banker allows his customer to borrow money upto a certain limit against the security of tangible assets or guarantee.
The cash credit account is an active and running account to which deposits and withdrawals may be affected frequently. Here, the borrower is charged interest on the actual amount utilised by him for the period of actual utilisation only.
(b) Overdrafts :- It is an arrangement in relation to a person’s current account and under the arrangement the customer can overdraw at an agreed limit withdrawals or deposits can be made any number of times provided the total amount overdrawn does not at any time exceed the agreed limit. Interest is charged on daily debit balance. Securities normally accepted against on overdraft are shares, government promissory notes, fixed deposit receipts and life insurance policies.
(c) Loans :- It is a kind of investment with or without cash, where the entire amount is paid to the borrower in the lumpsum either in cash or by way of transfer to his current account. It is given for a fixed period and agreed mate of interest. Repayment can be made in instalment or at the expiry of the certain period. The customer has to pay interest on the total amount advanced whether he withdraws the money from his account credited with the loan or not. But loan once repaid in full or in part cannot be drawn again by the borrower unless the banker demands a fresh loan.
Q.35. Write briefly the sound principles of investment.
Ans :- Banking business essentially involves lending. In fact, the deposits are accepted for lending or investment. Since the major portion of bankers resources consists of public deposits a banker has to be extra careful in selecting the borrowers. He, therefore, follows a very cautious policy while lending funds and conducts his business on the basis of well-known principles of sound lending :
(i) Safety :- Whenever a bank lends money, he most carefully consider the chances of it being repaid by the borrower along with interest. The repayment of the loan depends upon the borrowers (a) Capacity to pay (b) Willingness to pay.
(ii) Liquidity :- Liquidity here means that the amount advanced should be returned fairly quickly A banker has to remember that the bulk of his funds are short term funds received as deposit form the public, and this being so, it is prudent to confide himself to short-term advances. Liquidity sometimes depend upon the types of securities received against the advance. It is not enough if the advances are safe. They should be liquid for return flow of funds from the borrowers more or less on demand or immediately after the purpose for which money is borrowed.
(iii) Profitability :- Banks including the nationalised ones run commercial institutions, with a profit motive. Interest on deposits is governed by the RBI directives. The rate of interest to be charged from the customers depends upon the purpose for the advance and the degree of risk involved in lending to them.
(iv) Diversification of risk :- The principle of diversification is based on the famous Maxim ” do not keep all the eggs in one basket”. As there is risk in every advances, bank should spread the risk by lending a large number of borrowers instead of giving the advances to the few, by making large advances. Advances should not be concentrated in few big firms or few, by making large advances. Advances should not be concentrated in few big firms or few industries rather should be spread amongst a number of firms in different industries and different cities.
(v) Purpose of loan :- This is a fact of the principle of safety Banks do not grant loans for each corollary and every purpose. For the safety of funds, it is necessary that funds be lent for productive purpose only. Particularly after nationalisation, the purpose of loan has become make significant in the consideration of proposal of the proposed is in with the policy.
Q.36. Explain the term ‘Cash Reserve’ and ‘Cash Credit’.
Ans :- Cash Reserve : In finance, cash reserves primarily refers to two things. One is a type of short term highly liquid instrument that earns a low rate of return (perhaps 3%) annually such as investment company fidelity mutual funds called fidelity cash Reserves. This is where same individuals keep money it not they want to have quick access to the other type of cash reserves refers to the money a company or individual keeps on kind to meet its short term and emergency funding needs.
Cash Credit :- A cash credit is an arrangement by which a banker allows his customer to borrow money up to a certain limit. Cash credit arrangements are usually made against the security of commodities hypothecated or pledge with bank.
From the above it is clear that under on arrangement the banker agrees to lend certain amount which is the limit of cash credit. The limit is determined by considering the requirements of the borrower. The agreement may extend to one year. The agreement is supported by the security of tangible assets or by a guarantee. This is the most favourite mode of borrowing by the commercial and industrial concerns in India. About two thirds of voted bank lending takes the form of Cash Credit. It is advantageous for the borrower that he need not borrow the whole amount within the limit of Cash Credit as and when required. He can also put back any surplus amount in his hand for the time being, those the account remained running or current. Usually the borrower is charged interest on the actual amount utilised by him and for the period of actual utilisation only. But there may be commitment charges are imposed on the unutilised portion of cash credit as directed by the RBI from time to time.
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Class 12 Banking Chapter 7 Employment Of Funds Question answer to each chapter is provided in the list so that you can easily browse through different chapters HS 2nd Year Banking Chapter 7 Employment Of Funds Notes and select needs one.
SCERT Class 12 Banking Chapter 7 Employment Of Funds
Also, you can read the SCERT book online in these sections Solutions by Expert Teachers as per SCERT (CBSE) Book guidelines. These solutions are part of SCERT All Subject Solutions. Here we have given Class 12 Banking Chapter 7 Employment Of Funds Solutions for All Subjects, You can practice these here.
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