Question

Discuss the different ways in which commercial banks extend loans to their customers.

Answer 1

The commercial banks can extend loans to their customers in different ways:

1. Cash credit loan: In the cash credit system, banks first estimate the worth of the borrower’s assets. Based on this calculation, the bank determines a credit limit for one borrower. The bank’s credit limit is the maximum amount the borrower can borrow. However, the borrower’s real credit utilization is determined by his or her withdrawal power. The borrower is only required to pay interest on the amount of credit withdrawn.
2. Overdraft: An overdraft facility offered by commercial banks to current account holders. Commercial banks offer this service, which allows consumers to withdraw funds from their accounts even when their balances are insufficient. The bank sets the maximum overdraft limit. The overdraft amount is subject to interest.
3. Discounting of bills: Commercial banks offer financial aid to the business community by discounting bills of exchange. A bill of exchange is a document that acknowledges the debtors’ monetary obligations in exchange for the products and services they receive. Banks purchase these bills produced by consumers after deducting interest from their face value.
4. Term loan: A loan with a set repayment period (typically monthly). Here level of maturity has been stated. The loan is typically used to fund business expansions, the purchase of machinery or equipment, building construction, and so on.