credit facilities provided by commercial banks

credit facilities provided by commercial banks. Banks can act as agent of lending by means of loan, overdraft and discounting bill of exchange. Commercial banks act as agent of lending through the following ways:

types of credit facilities provided by commercial banks

  1. commercial banks gives Loan: Through loan, money is lent out to customers at an agreed rate of interest for a specific period of time. In this case, the borrower’s current account will be credited by the amount of the loan.

2. At the same time, a loan account for the amount will be opened. The customer is required to have collateral security before he can be given loan. The customer will pay interest on the full amount he has borrowed.

Overdraft credit from commercial banks:

Overdraft is a method of credit facility in which a customer is allowed or permitted to draw a cheque more than the amount of money in his account.

For example, Mr. Fabian has 6 20,000 in his account and he was granted permission to withdraw 6 30,000. The 6 10,000 difference is the overdraft.

The customer pays interest on the overdraft. This type of credit facility can only be enjoyed by a current account holder.

Differences between loan and overdraft

 LoanOverdraft
1Collateral security is required Collateral security may not be required
2It attracts lower rate of interestIt attracts higher rate of interest
3The money is repayable at a fixed timeThere is gradual deduction from the customer’s account
4A separate account called loan accountNo separate account is opened

Factors for consideration before granting loan by commercial banks

  1. Purpose of the loan: The bank will want to know the purpose or reason why a customer will need loan.
  2. Ability to pay back the loan: The bank is also interested to know the: capability of the customer to repay I the loan at expiration
  3. Credibility of the customer: commercial bank will study the credibility of the customer to determine his credit worthiness.
  4. Source of income to repay the loan: When the loan is given out, the bank is interested in knowing 

The source(s) of income available to the customer to repay the loan, including the interest.

  • Financial position of customer’s account: The bank will also study and analyze the financial position of the customer’s account to ascertain whether loan can be given or not.

  • Total amount applied for as loan: The bank will consider the total amount of money applied for and match it with the bank’s ability to give out the loan and the customer’s ability to utilize the loan effectively and repay back at the agreed period of time.

Provision of collateral security: The bank will require from the customer collateral security to cover the amount of loan taken.

The essence of the collateral security is that in case the customer
defaults, the security can be converted to settle the loan taken.

Provision of referees or guarantors: Guarantors or referees may be required to provide a land or security for the loan.

Viability of the business: The bank studies the business critically to know whether the business or project is viable or not.

Period of repayment of loan: The bank is interested in knowing how long it will take the customer to repay back the loan given.

(3)        Discounting bill of exchange by commercial banks. Banks can provide credit facilities to customers by discounting bill of exchange. Creditors can be paid at once and the debtor is allowed a period of credit.

The bank will collect the debt when it is due for repayment. When a bank discounts a payment to the creditor whose debtor has promised to pay at some future date. Thus, the bank allows the creditor to be paid at once and it will collect the debt when it is due for payment.

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