Banks or financial institutions which are in the business of lending have to be very careful while lending the funds to borrowers because in case of loans you can ask from borrower anything whether its documents, history post-dated checks of installment amount and so on but once loan is disbursed the borrower has upper hand as lender is dependent on borrower for timely repayment of debt and that is the reason why if lender has followed certain principles of lending than lender do not need to worry about repayments as chances of default are less when lending is done following principals of lending. Given below are some of the sound lending principals –
Lending Principals
Security of Loan
The first and foremost principle of sound lending is that the amount of loan which the lender is giving to the borrower should have proper security in the form of mortgage or lien on the property of the borrower so that in the event of any default by the borrower lender can liquidate that security and get the dues back. In simple words, if the bank has given a loan of $100000 and fair value of the security is $60000 then the bank should avoid giving such loans even though the market value of the security is $150000.
Profitability Aspect
Another principle of lending is that banks or borrowers should keep in mind the profitability aspect because if the borrower is taking a risk for meager profit than it is a bad move. Hence for example, if the bank is giving a loan at 9 percent when the cost of funds to the bank is 8 percent than for 1 percent bank is taking too much risk. In simple profit margin should be high enough so that banks or lenders can undertake the risk associated with giving loans to the borrower.
Liquidity of Borrower
Liquidity position of the borrower should be comfortable implying that he or she should have liquid assets like cash, stock, marketable securities instead of non-liquid assets like land, building, machineries as many times borrowers have assets but due to liquidity problem, they default on their loans which can create big problems for banks or financial institutions as they have to categorize such loans as bad loans even though borrower can repay the loan.
Reason for Loan
Another principle is to know the reason for which the loan is taken because if the reason is genuine than chances are loan amount will be utilized properly. Hence for example if an individual who is in the construction business is taking a loan for opening garment or grocery shop is not a valid reason, however, if the same person is taking loan for purchase of land to build apartments is a good reason for which he or she can be given loan by the lender.
History of Borrower
History never forgets anyone and same applies to borrowers because a good borrower is one who seldom defaults on the loan or credit cards and since there are various credit rating agencies, credit bureaus who have data of many borrowers and if borrower has defaulted on any loan then it gets reflected in the data of these agencies which can save banks or lenders from giving loan to those borrowers who have bad credit history.
Personality of Borrower
Personality plays a big role when it comes to repayment of a loan by the borrower as sometimes borrower personality is such that even when he or she can arrange for funds they deliberately delay the repayment or worse willingly defaulting on their loans. The personality of the borrower can be determined only when the lender meets the borrower 2 or 3 times and that is the reason why a lender should not give the loan on a first meeting with the borrower rather lender should meet borrower 2 or 3 times before sanctioning the loan amount to the borrower.
As one can see from the above that lending is not an easy task and banks or financial institutions should be careful and follow the above principals of lending if they want to ensure that they receive repayment from the borrower on time without much trouble.