After studying this chapter you will be able to understand: Basic lending principles, safety issues, diversification of risk, benefits of diversification, loans and advances, classification of loans, advances,. | Revise Lecture 19 Basic Lending Principles Basic Lending Principles Safety Issues Basic Lending Principles Safety Issues The persistent failures of banks to lend sensibly in Pakistan and in many other countries have brought the question of safety in lending to the fore; Why do banks persistently lend so imprudently and how should lending be done at minimum risk? Basic Lending Principles Safety Issues One essential problem is the human and managerial challenge of motivating employees of banks to cater to the interest of the owners (shareholders) of the bank. The history of banking is replete with episodes of employees favouring friends and relatives with loans. Basic Lending Principles Safety Issues In some countries, there are well-defined market rates for bribes for obtaining loans from banks. This problem is also present in Pakistan, though the record of Pakistan’s banking system in this aspect is much better than that of many other countries. Basic Lending Principles Safety Issues | Revise Lecture 19 Basic Lending Principles Basic Lending Principles Safety Issues Basic Lending Principles Safety Issues The persistent failures of banks to lend sensibly in Pakistan and in many other countries have brought the question of safety in lending to the fore; Why do banks persistently lend so imprudently and how should lending be done at minimum risk? Basic Lending Principles Safety Issues One essential problem is the human and managerial challenge of motivating employees of banks to cater to the interest of the owners (shareholders) of the bank. The history of banking is replete with episodes of employees favouring friends and relatives with loans. Basic Lending Principles Safety Issues In some countries, there are well-defined market rates for bribes for obtaining loans from banks. This problem is also present in Pakistan, though the record of Pakistan’s banking system in this aspect is much better than that of many other countries. Basic Lending Principles Safety Issues Another aspect of the problems of banks concerns prudent levels of leverage. A bank is a financial intermediary with fairly small equity capital, which borrows money from depositors and invest it into risky assets. This involves a high degree of leverage Basic Lending Principles Safety Issues Leverage, at the level of the bank, is dangerous regardless of the quality of credit analysis which has gone into each loan. High leverage generates high risk and high returns. If high returns are obtained, the bank takes the profits but it is protected from high losses by the government. Basic Lending Principles Safety Issues Regulators have tried many policy initiatives aimed at obtaining a banking system which has controlled leverage, high quality lending and thus, a reduced risk of failure. These include capital adequacy requirements based on clumsy measurement of risk, prohibition of lending against real estate, restrictions on lending against shares, rules governing collateral, etc. Basic .
