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After studying this chapter you will be able to understand: Basic lending principles, liquidity, asset management banking, liability management banking, profitability, profitability management. | Revise Lecture 17 Basic Lending Principles Basic Lending Principles According to section 6 of the Banking Regulation Act, 1949, banking means ‘accepting for the purpose of lending or investment of deposits of money from the public, repayable on demand or otherwise and withdrawable by cheque, draft, order or otherwise’. Basic Lending Principles Another major reason of the lending function is to add value to the bank. By lending the funds mobilized by it, a bank will be in a position to earn spreads to sustain profitability. Basic Lending Principles Profitability through lending will be obtained if the bank is in a position to take and manage credit risk that arises on account of the quality of the borrower and liquidity risk that may arise by borrowing short and lending long in order to attain greater spreads. Further, the spreads earned in this activity will also be exposed to risk arising from both interest and exchange rates. Basic Lending Principles Thus, while lending, the bank . | Revise Lecture 17 Basic Lending Principles Basic Lending Principles According to section 6 of the Banking Regulation Act, 1949, banking means ‘accepting for the purpose of lending or investment of deposits of money from the public, repayable on demand or otherwise and withdrawable by cheque, draft, order or otherwise’. Basic Lending Principles Another major reason of the lending function is to add value to the bank. By lending the funds mobilized by it, a bank will be in a position to earn spreads to sustain profitability. Basic Lending Principles Profitability through lending will be obtained if the bank is in a position to take and manage credit risk that arises on account of the quality of the borrower and liquidity risk that may arise by borrowing short and lending long in order to attain greater spreads. Further, the spreads earned in this activity will also be exposed to risk arising from both interest and exchange rates. Basic Lending Principles Thus, while lending, the bank should try to balance its spreads and the risk levels. Liquidity Basic Lending Principles Liquidity: Liquidity for a bank means the ability to meet its financial obligations. A bank lending finances invests in relatively illiquid assets, but it funds its loans with mostly short-term liabilities. A shortage of liquidity has often been a trigger for bank failures. Basic Lending Principles Liquidity: Holding assets in a highly liquid form tends to reduce the income from that asset (cash, for example, is the most liquid asset of all, but pays no interest). So banks try to reduce liquid assets as far as possible. However, a bank without sufficient liquidity to meet the demands of its depositors risks experiencing a bank run. Basic Lending Principles Liquidity: The result is that most banks now try to forecast their liquidity requirements and maintain emergency standby credit lines at other banks. Banking regulators also view liquidity as a major concern. Lecture 18 Asset management banking .
