Authors: Rajiv Fernando
ICMR (IBS Center for Management Research).
The Indian Banking Regulation Act, 1949 defines banking as "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". This essentially means that a bank performs two basic functions accepting deposits and lending/investing the same. Of course, there are many other functions that banks perform like providing safe deposit vaults, collection of cheques & bills, opening Letters of Credit, issuing guarantees, treasury operations etc.
The lending activity of a bank is particularly important to the economy as it caters to the credit requirements of business concerns for their expansion activities or working capital requirements. However, as any activity would entail risks, lending too has its fair share of inherent risks.
In the current environment where banking has become more or less a commodity business due to cutthroat competition, the challenge for any banker is to do a thorough credit assessment of the customer to ensure safety of loan; and more importantly this assessment has to be done fast to avoid losing the deal to the competitor. The downslide in case of a loan default is high. Any negligence on part of the assessing officer can lead to bad debts, which affect the asset quality and financial health of the bank.
Improper financial health of the bank erodes the trust of the depositors, which makes it vulnerable to a 'run' on its deposits. Dealing with non-performing loans also results in a huge waste of employee's time and energy in legal wrangling and recovery proceedings. In this article, we will focus on the lending function and how a proper assessment of the customer's creditworthiness at the ground level is important in the overall scheme of proactive credit risk management system of a bank.