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BANKING CONCEPTS
LOAN ACCOUNT
January 1, 2016
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LOAN ACCOUNT

Granting loans is a major income earning activity for the banks. Roughly, over two third of total income of the banks is by way of interest earned on loans. Banks are free to charge any rate of interest on loan accounts. Bank loans can be classified in two broad types – Demand Loans and Term Loans.

 

DEMAND LOANS

These accounts are also called as limit accounts as bank sanctions a limit to the borrower up to which he can draw the cheques. These accounts are operated like Current Accounts through cheques and allow for frequent withdrawals and deposits. These accounts are of two types: Cash Credit CC) and Over Draft (0D) account.

Cash Credit Account: These are most popular loan accounts, meant for the business community only. These limits are sanctioned against security of stocks and are meant for financing the day to day requirements of the business i.e. the working capital requirements. Also known as ‘Limit Accounts’, they cannot be sanctioned for more than 12 months & have to be renewed every year. As they are renewed every year, they are also known as ‘Evergreen Loan

Account

 

Over Draft Account: These are limited period temporary loan facilities sanctioned by banks, usually, against some securities. OD can be granted for both business as well as general purposes.

 

TERM LOANS

In these loan accounts, the sanctioned loan amount is disbursed in one or more installments and there after the borrower has to start the repayment in installments. In these accounts no cheque books are issued as frequent transactions are not allowed. Normally, banks charge interest at monthly intervals in these accounts. These are normally fixed duration accounts and are sanctioned for some specific purpose with the condition that funds should be used only for that purpose. Housing loans, Car Loans, Machinery Loans, Factory Loans etc., are some examples of term loans. These loans are the common source for funding of plant and machinery, construction of factory premises etc.

 

SPREAD

Major source of income for banks is the interest earned on loans. Interest paid on deposits is their main expenditure. The difference between average rate of interest earned an average rate of interest paid is known as ‘spread’. This is also referred to as ‘Net Interest Margin’ (NIM). If we talk in terms of difference between total interest earned and total interest paid, it is called ‘Net Interest

Income’ (NII).

 

STANDING INSTRUCTIONS

It is a facility offered by banks where they undertake to carry out the various transactions on behalf of their customers on recurring regular basis. For example, transferring school fee amount from customer’s account to school’s account on due dates, payment of loan installment on due dates, payment of insurance premium etc.

KYC NORMS

Banking operations are susceptible to the risks of money laundering and terrorist financing. In order to arrest money laundering, where banks are mostly used in the process, it is imperative that banks know their customers well. In order to check financing of terrorism, international body Financial Action Task Force (FATF), Paris introduced certain standard systems and procedures for proper document based identification of customers and verification of their address, known as know your customer (KYC) norms. In India, these norms have been introduced by RBI and their compliance is mandatory for opening all types of bank accounts. Suitable provisions have been enacted in the Prevention of Money Laundering Act 2002 for this purpose.

MONEY LAUNDERING

It is the process of disguising illegal sources of money so that it looks like it came from legal sources. It refers to money generated through illegal activities like drug trafficking, illegal sale of arms, ransoms realized in kidnappings, extortions, smuggling, etc. Thus, it is different from black money which is unaccounted money or the money on which tax has not been paid, but the source of earning is not illegal. Money laundering is one of the major means of funding of terrorism around the world. Adoption of KYC norms is one of the effective methods for checking the menace of money laundering. The process of Money Laundering involves three steps – placements, layering and integration. In India, government has framed Prevention of Money Laundering Act – (PMLA) 2002 to control money laundering. Instances of violations of PMLA in banking business are to be reported to FIU – IND (Financial Intelligence Unit – India) in Ministry of Finance, New Delhi. Banks are also required to report all cash transactions of above Rs 10 lac to AU-IND on monthly basis,

COUNTERFEIT CURRENCY: Refers to fake currency. Possession or use of counterfeit money is a legal offence. On detection of fake note by banker, it has to be cancelled and surrendered to nearest police station.

 

CAPITAL ADEQUACY NORMS

These norms refer to the minimum capital that has to be maintained by the banks all over the world. The norms have been formulated by Bank for International Settlements (BIS). This bank coordinates and regulates the banking business all over the world. Its headquarters are located at Basel, Switzerland and that is why their recommendations are popularly known as ‘Basel norms’. The bank has formed a committee by the name Basel Committee on Banking Supervision (BCBS) which prescribes various recommendations for banks. One of the major recommendations of BCBS is minimum capital requirement for banks. As per this, minimum capital of a bank cannot be less than 8 of its Risk Weighted Assets (RWA). Here assets refer to loans & investments. RBI has prescribed CAR at 9 for Indian Banks. This ratio is called Capital Adequacy Ratio (CAR). Another name for this ratio is Capital to Risk Weighted Assets Ratio (CRAR).

BASEL II RECOMMENDATIONS

Released in June 2004, these recommendations are known as 3 pillars of Basel.

1st Pillar – Minimum capital requirement- (80/0): It revises the

1988 Accord’s by aligning the minimum capital requirements more closely to each bank’s actual risk of economic loss.

2nd Pillar – Supervisory review process: Supervisors will evaluate the activities and risk profile of individual banks to determine whether those organisations should hold higher levels of capital and see whether there is any need for remedial actions.

3rd Pillar – Market discipline: It refers to certain mandatory disclosures that banks have to make to ensure the prudent management by enhancing the degree of transparency in banks’ public reporting to shareholders and customers.

BASEL III RECOMMENDATIONS

The Basel Committee issued the Basel III guidelines in December 2010. The Framework sets out higher and better-quality capital, better risk coverage, the introduction of a leverage ratio as a backup to the risk-based requirement, measures to promote the buildup of capital that can be drawn down in periods of stress. It recommends formation of Capital Conservation Buffer equivalent to 2.5 of risk weighted assets of the bank, over and above the prescribed minimum capital requirements. These norms shall be implemented w.eJ. 01.04.2013 to 31.3.2018, in a phased manner.