LONG-TERM AND SHORT-TERM LOANS


LONG-TERM AND SHORT-TERM LOANS

Commercial banks grant loans for different periods-long, short and medium term for different purposes.
Short-term loans
Short term loans are granted by banks to meet the working capital needs of business. The working capital needs refer to financial needs for such purposes as, purchase of raw materials, payment of wages, electricity bill, taxes etc. Such loans are granted by banks to its borrowers to be repaid within a short period of time not exceeding 15 months.
Short term loans are normally granted against the security of tangible assets like goods in stock, shares, debentures, etc. The rate of interest charged on short term loans ranges from 12% to 18% p.a.
Term Loans
Medium and long term loans are generally known as ‘term loans’. These loans are granted for more than 15 months. In case of medium term loan, the period ranges from 15 months to less than 5 years. Medium term loans are generally granted for heavy repairs, expansion of existing units, modernisation/renovation etc. Such loans are sanctioned against the security of immovable assets. The normal rate of interest ranges between 12% to 18% depending upon the period, purpose, nature and amount of the loan. Though banks may grant long term loans, they avoid granting loan for more than 5 years.



NATURE AND SECURITY OF LOANS
To ensure the safety of funds lent, the first and most important factor considered by a bank is the capacity of borrowers to repay the amount of loan, The bank therefore, relies primarily on the character, capacity and financial soundness of the borrower. But the bank can hardly afford to take any risk in this regard and hence it also has the security of tangible assets owned by the borrower. In case the borrower fails to repay the loan, the bank can recover the amount by attaching the assets.
It can sell the assets offered as security and realize the amount. Thus from the view point of security of loans, we can devide the loans into two categories: (a) secured, and (b) unsecured. Unsecured loans are those loans which are not covered by the security of tangible assets. Such loans are granted to firms/institutions against the personal security of the owner, manager or director. On the other hand, Secured loans are those which are granted against the security of tangible assets, like stock in trade and immovable property. Thus, while granting loan against the security of some assets, a charge is created over the assets of the borrower in favour of the bank. This enables the bank to recover the dues from the customer out of the sale proceeds of the assets in case the borrower fails to repay the loan.
There are various types of securities which may be offered against loans granted, but all of those are not acceptable to the banks. The types of securities generally accepted by the bank are the following: l Tangible assets such as plant and machinery, motor-van, etc.
l Documents of title to goods, like Railway Receipt (R/R), Bills of exchange, etc. l Financial Securities (Shares and Debentures) l Life-Insurance Policy l Real estates (Land, building, etc). l Fixed Deposit Receipt (FDR) l Gold ornaments, Jewellery etc.

Comments

Post a Comment

Popular posts from this blog

Fundamental and Particular Risks

Image
Fundamental and Particular Risks The distinction between fundamental and partiCUlar risks is based on the concept of hazard defined by Kulp. Particular risks involve losses that arise out of individual events and are felt by individuals rather than a group. Fundamental risks involve losses that affect a large segment of the population. The later are caused for the most part by economic, social, climatic, health and/or political phenomena. Examples are wars, earthquakes, health diseases, economic recessions leading to unemployment.   Fundamental risks may be static or dynamic.Systematic and Unsystematic Risks This is a basic principle in financial management: risk can be eliminated through diversification. Diversification reduces risks if all the outcomes of risky events do not produce the same result or do not arise all at the same time. The convention in finance is to interpret risk in the spirit of Willet and Knight. A risky outcome is one that can assure a number of values. It i...
Read more

The Risk Management Process

Image
The Risk Management Process Hamrd (or Risk) Identification One of the most critical functions of risk man agement  is probably the identification process. A failure to recognize the existence of one or more potential events can result in financial disaster. The importance of being able to anticipate the existence of the problem before it materializes is recognized by everyone but unfortunately there is no scientific method or systemic approach to the identification process. In the extreme case, the very existence of the risk may be unknown. In the past, exposure identification has largely been exercised in terms of those exposures that are insurable and in terms of the company past experience. The most difficult part of the identification process is that it requires that the manager be clairvoyant and continually asks "what if" questions. Williams and Heins (1989) define risk identification as "the process by which a business systematically and continuously identifies pr...
Read more

The Objective of Risk Management

Image
The Objective of Risk Management According to asset pricing models in Finance, the risks specific to a firm are diversifiable and therefore irrelevant except as it affects  the firm's systematic risk. However, corporations are majors purchasers of insurance and financial futures and forward contracts, sign long-term purchase and sales contracts, and engage in a variety of activities to avoid or reduce risks. One explanation of this behavior is that asset pricing models are concerned only with the effect of risk on market discount rates and for the most part ignore its effect on expected cashflows. Property losses are often not the only losses that occur when property is damaged or destroyed. Until that property is replaced or restored to its initial condition, the business may suffer a reduction in its net income either because revenues are decreased or because expenses are increased or both. Any action taken by a firm that decreases risks, improves its prospects for survival and...
Read more