In order to protect the interest of all the stakeholders, banks need to adopt six basic principles viz., Safety, Liquidity, Profitability, Purpose, Risk Diversification and Security
Safety means that the borrower should be able to repay the loan and interest in time at regular intervals without default. Banks are trustee of public money. Bank‘s deposits are always payable on demand. Bank has to maintain trust of depositor forever. It is just not the capacity of the borrower to repay but also his willingness to repay. The former depends on his tangible assets and the success of his business. The latter depends on the borrower‘s character
The term liquidity refers to the extent of availability of funds with the banker for providing credit to borrowers. It is to be seen that money lent is not going to be locked up for a long time. The money should return to the bank as per the repayment schedule. This schedule that is drawn up by the banker has to adhere to the requirement that at any point of time the banker should possess liquidity to meet the withdrawals of the depositors. The concept of liquidity entails the banker to look for easy sale and absence of risk of loss on sale of asset, which has been taken as collateral.
Banks are not charitable institutions. All banks are profit-earning institutions. The ultimate objective of lending is to earn profits. Banks receive interest on loans and advances lent, and they pay interest to their depositors. This difference between the receipts and payments will be the bank‘s gross profit. Banks have to earn reasonable amount as net profit so that dividends can be paid to its shareholders.
The purpose should be productive so that the money not only remain safe but also provides a definite source of repayment. Loans may be required for productive purposes, trading purposes, agriculture, transport, self-employment etc. If a loan is required for a non-productive or speculative purpose, the banker should be very much cautious in entertaining such proposals. It is very difficult to ensure that the loan has been utilized for the purpose for which it was sanctioned. Banker should take follow-up measures to ensure end use of fund exactly for the same purpose for which it is borrowed.
A prudent banker always tries to select the borrower very carefully and takes tangible assets as security to safeguard his interests. While this is no doubt an adequate measure, there are other unforeseen contingencies against which the banker has to guard himself. If the bank lends large amounts to a single industry or borrower, then the default by that customer can affect the banking industry as a whole and will affect the basic survival of the industry. Banks have to lend to a large number of industries and borrowers so that the risk gets diversified.
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