PRINCIPLES OF CREDIT POLICY AND MEANING

Credit Policy Meaning :

Guidelines that spell out how to decide which customers are sold on open account, the exact payment terms, the limits set on outstanding balances and how to deal with delinquent accounts.

Though most consumers expect to pay cash or use of credit card when making a purchase, commercial customers typically want to be billed for any products and services they buy. You need to decide how much credit you’re willing to extend them and under what circumstances. There’s no one-size-fits-all credit policy your policy will be based on your particular business and cash-flow circumstances, industry standards, current economic conditions, and the degree of risk involved.

As you create your policy, consider the link between credit and sales. Easy credit terms can be an excellent way to boost sales, but they can also increase losses if customers default. A typical credit policy will address the following points.

Credit limits: You’ll establish dollar figures for the amount of credit you’re willing to extend and define the parameters or circumstances.

Credit terms: If you agree to bill a customer, you need to decide when the payment will be due. Your terms may also include early-payment discounts and late-payment penalties.

Deposits: You may require customers to pay a portion of the amount due in advance.

Credit Cards and Personal Checks: Your bank is a good resource for credit card merchant status and for setting policies regarding the acceptance of personal checks.

Customer Information: This section should outline what you want to know about a customer before making a credit decision. Typical points include years in business, length of time at present location, financial data, credit rating with other vendors and credit reporting agencies, information about the individual principals of the company, and how much they expect to purchase from you.

Documentation: This includes credit applications, sales agreements, contracts, purchase orders, bills of lading, delivery receipts, invoices, correspondence and so on.

Principles of Credit Policy :

Lending is most profitable business of a commercial bank, but at the some time it is highly risky. Loans always accompany credit risk arising out of borrowers default in repaying the money a banks should, therefore, manage loan business in a profitable and safe manner. He should take all precautions to minimise the risk associated with loan. In considering loan proposal the banker must keep in mind certain general principles of lending. The principles are discussed below.

Safety:

Safety of funds is the most important guiding principles of a banker. While lending out funds a banker should ensure that funds being lent out would remain. Safe otherwise the bank will not be in a position to repay his deposits and consequently it will lose public confidence which may subsequently, spell death knell of the bank itself. Safety of funds implies that the borrower would repay the principal sum and interest as per the terms and conditions provided in the loan agreement. A banker should always take a calculated risk. This is why a banker always insists upon collateral margins and guarantees in addition to personal promise of the borrower.

Liquidity:

Since majority of commercial bank liabilities are payable either on demand or after short notice the banker should ensure that loan would be liquid. Liquidity as already defined signifies the readiness with which the bank can convert its assets into cash with number or insignificant of loan will be liquid. If it has been given for a short period to finance same purchase of stock, raw materials etc.,

Diversification of Risks:

A banker should aware to the principle of diversification while lending out funds. Diversification implies dispersal of funds over a large number of borrowing firms situated in different regions of the country. Diversification is a means of minimising risk inherent in loans.

The most important form of diversification which a banker should attempt to achieve in the banker loan portfolio is maturity diversification. Under maturity diversification loan portfolio is staggered over different maturity periods. So that, a certain amount of loans mature at regular intervals which could be utilised to meet the depositors demands. If such funds are not needed the same can be lent but invested in securities that best fit into the bank’s loan and investment portfolio.

Profitability:

Equally important is the principles of profitability in bank advances. Like other commercial institutions banks must make sufficient income to pay interest to the depositors, establishment expenses to retain a portion of income for future and to pay dividends to owners. The difference between lending and borrowing rates constitutes gross profit of the bank and no banker ordinarily think of an advance without satisfying margin or profit.

Purpose:

Bankers should inquire into the purpose of the loan for which, it is taken. As a matter of fact safety and liquidity of loan depend on the purpose. If an advance is given for productive purpose say for financing purchase of inventories in all profitability – it will be rapid because grant of loan will a generate additional income sufficient to repay the loan. In the advance made for non-productive and speculative purpose is subject to greater credit risk because the purpose for which loan was sought would in no way improve repaying capacity of the borrower.