Bank Credit

Bank Credit Meaning

Bank credit is usually referred to as a loan given for business requirements or personal needs to its customers, with or without a guarantee or collateral, with an expectation of earning periodic interest on the loan amount. The principal amount is refunded at the end of loan tenure, which is duly agreed and mentioned in the loan covenant.

In today’s world, demands are continuously increasing, but means to fulfill those demands are limited; hence borrowing money will enable as the source to finance varied needs of a business, profession, and personal.

Bank credit is given to borrowers on the fulfillment of the necessary documentation required by the bank. Interest rates, terms of repayment are duly mentioned in the loan covenant. Documentation to bank includes financial statements, income tax returns, projected financial statements for three to five years, and changes based on the type of loan and from person to person.

Characteristics of Bank Credit

The following are characteristics of bank credit.

  1. Borrower: Person who borrows money.
  2. Lender: The person who lends money is usually the bank.
  3. Rate of Interest: Rate of interest can be fixed or floating rate of interest. The floating rate of interest is based on benchmark rates like LIBOR or MIBOR.
  4. Terms of Repayment: These are mentioned in the loan covenant and strictly adhered to avoid the prepayment penaltyThe Prepayment PenaltyThe prepayment clause states that if payment is made in advance before the due date, then terms and conditions of the mortgage are not adhered to by the borrower and would be liable to pay the penalty known as the prepayment penalty.read more.
  5. Mode of Loan: Normally given in cash but sometimes will be given in the form of raw material, fixed assetsFixed AssetsFixed assets are assets that are held for the long term and are not expected to be converted into cash in a short period of time. Plant and machinery, land and buildings, furniture, computers, copyright, and vehicles are all examples.read more.
Bank Credit

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#1 – Classification Based on Borrower

Let’s discuss classification based on the borrower.

#1 – Loan for Personal Purpose

Personal loans are given to meet the particular needs of an individual or the group of an individual. Personal loans are taken for the purchase of consumer goods, electronics, houses, vehicles, etc.

#2 – Loan for Business or Profession Purposes

These loans are offered for meeting the needs of the business. It can be a working capital loan, cash credit facility to meet short term liquidity crunch. Companies borrow money for major fixed asset expansion, diversification of business into different product portfolios, varied customer segments. The purpose of lending money will be different for different businesses based on circumstances, needs, environments in which the company operates.

#2 – Classification Based on Security

Let’s discuss classification based on security.

#1 – Secured Loan

Secured loans are secured against collateral, guarantee given to the Bank by the third party. Loans can be secured against property, plant and machinery and equipmentPlant And Machinery And EquipmentProperty plant and equipment (PP&E) refers to the fixed tangible assets used in business operations by the company for an extended period or many years. Such non-current assets are not purchased frequently, neither these are readily convertible into cash. read more, debtors, stock, fixed deposits, and any other asset which can be sold or liquidated by Bank in case of nonpayment of installment on the part of the borrower.

Bank will also lend money against the guarantee given by the third party on behalf of the borrower. In case of a guarantee, the guarantor will be liable to pay a balanced amount if the borrower fails to do so.

#2 – Unsecured Loan

Unsecured loans are neither secured against any asset, nor any guarantee is provided to the Bank. A borrower with a great history of the settlement of dues, good credit rating, sound financial records will generally get an unsecured loan. Unsecured loans are usually provided by small banks, ‘Patpedhis and relatives.

#3 – Classification Based on Duration

Let’s discuss classification based on the duration.

#1- Short Term Loans

These loans are given for a shorter duration, say one month to one year.

#2 – Long Term Loans

These loans are given for a longer duration, say three to five years or more than that. These loans are provided for the expansion of business, diversification of product portfolio or business, substantial investment in fixed assets, real estate where the cost to buy such assets or investments is so vast that repayment of the same within a year is not possible.

Purpose of Bank Credit

The following are the purpose of the loan.

Advantages

The different advantages related to bank credit are as follows.

Disadvantages

The different disadvantages related to bank credit are as follows.

  • A borrower may have to surrender ownership of an asset if installments are not paid in time.
  • Bank charges one-time processing fees that need to be paid upfront.
  • There is a pre-payment penalty if the borrower pays the loan in advance.
  • Companies should maintain the right debt-equity ratio. If there is a significant reliance on loans by the Companies, then in the event of crises, it will be difficult to pay interest.

Conclusion

Bank credit helps an organization to meet business needs; however, there should be the right mix of debt and equity components to have healthy financial statementsFinancial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more.

This has been a guide to what is bank credit and its meaning. Here we discuss the primary purpose of bank credit, its characteristics, and classification based on borrower, security, and duration. You can more about finance from the following articles –

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