The commercial banks accept deposits and also lend money to the people who require it for various purposes. Lending of funds to traders, businessmen and industrial enterprises is one of the important activities of commercial banks. The major part of the deposits received by banks is lent out, and a large part of their income is earned from interest on such lending. There is a considerable difference between the rate of interest which the commercial bank grants on deposits, and the rate they charge on loans and advances. It is this difference which constitutes the main source of bank earnings.
Meaning of Loans and Advances:
The term "loan" refers to the amount borrowed by one person from another.
The amount is in the nature of loan and refers to the sum paid to the borrower.
Thus, from the view point of borrower, it is 'borrowing' and from the view point of bank.it is lending'.
Loan may be regarded as 'credit. Granted where the money is disbursed and its recoveryis made on a later date.
It is a debt for the borrower. While granting loans, credit is given for a definite purposeand for a predetermined period. Interest is charged on the loan agreed rate and intervalsof payment.
'Advance' on the other hand, is a 'credit facility' granted by the bank. Banks grantadvances largely for short-term purposes.
Utility of Loans and Advances
1. Loans and advances can be arranged from banks in keeping with the flexibility in business operations. Traders may borrow money for day to day financial needs availing of the facility of cash credit, bank overdraft and discounting of bills. The amount raised as loan may be repaid within a short period to suit the convenience of the borrower. Thus business may be run efficiently with borrowed funds from banks for financing its
working capital requirements.
2. Loans and advances are utilized for making payment of current liabilities, wage and salaries of employees, and also the tax liability of business.
3. Loans and advances from banks are found to be 'economical' for traders and businessmen, because banks charge a reasonable rate of interest on such loans/advances.
Borrowing Rate and Lending Rate People make their funds available to the banks by depositing their ‘savings’ in various types of accounts. In other words, bank funds mainly consist of deposits from the public, though banks may also borrow money from other institutions and the Reserve Bank of India. Banks thus mobilizes funds through its deposits. On public deposits the banks pay interest at and the rate of interest varies according to the type of deposit. The borrowing rate refers to the rate of interest paid by a bank on its deposits. The rates which, the banks allow depend upon the nature of deposit account and the period for which the deposit is made with the bank. No interest is generally paid on current account deposits. The rate is relatively lower on savings account deposits.
Higher rates ranging from 6% to 12% perannum are paid on fixed deposit accounts according to the period of deposit. Banks also borrow from other institutions as well as from the Reserve Bank of India. When the Reserve Bank of India lends money to commercial banks, the rate of interest it charges for lending is known as ‘Bank Rate’ The rate at which commercial banks make funds available to people is known as ‘Lending - rate’. The lending rates also vary depending upon the nature of loans and advances. rates also vary according to the purpose in view. For example if the loan is sanctioned for the purpose of activities for the development of backward areas, the rate of interest is relatively lower as against loans and advances for commercial/business purposes. Similarly for smaller amounts of loan the rate of interest is higher as compared to larger amounts. Again lending rates for consumer durables, e.g. Loans for purchase of two-wheelers, cars, refrigerators, etc. are relatively higher than for commercial borrowings.