JAIIB Paper 2 – Principles & Practices of Banking

Unit 3: Lending Operations of Banks – Key Topics & Study Guide

Unit 3 of JAIIB Paper 2 – Principles & Practices of Banking focuses on the lending operations of banks, covering loan types, credit appraisal, risk management, loan recovery, and regulatory aspects. Understanding these concepts is crucial for banking professionals to ensure effective lending and maintain asset quality.

Below is a detailed breakdown of the most important topics, frequently asked concepts, and expert study tips for Unit 3 – Lending Operations of Banks.

1. Principles of Lending

Lending is a core function of banking that must be carried out prudently. Key topics include:

• Basic Principles of Lending:
  • Safety – Ensuring the borrower’s ability to repay
  • Liquidity – Loans should not strain the bank’s liquidity
  • Profitability – Interest income should justify lending risk
  • Purpose of Loan – Must be productive and legally valid
  • Security – Collateral to reduce credit risk
  • Diversification of Risk – Avoiding overexposure to a single sector

2. Types of Loans & Advances

Banks offer different types of loans based on customer needs. Key categories include:

A. Fund-Based Loans

• Term Loans – Long-term financing for projects, home loans, infrastructure funding
• Working Capital Loans – Short-term financing for businesses (cash credit, overdraft)
• Retail Loans – Personal loans, housing loans, auto loans, education loans
• Corporate Loans – Large-scale financing for industries and businesses
• Priority Sector Lending (PSL) – Agriculture, MSME, education, housing, renewable energy

B. Non-Fund Based Loans

• Letter of Credit (LC) – Used in trade finance for guaranteeing payments
• Bank Guarantees – Assuring financial obligations for customers

3. Credit Appraisal & Loan Processing

Before sanctioning a loan, banks conduct a credit appraisal to assess the borrower’s financial health. Key areas include:

• Creditworthiness Assessment – Evaluating financial stability, repayment ability
• 5 Cs of Credit Appraisal:
  • Character – Borrower’s credit history
  • Capacity – Income and repayment ability
  • Capital – Net worth, equity contribution
  • Collateral – Security against loan default
  • Conditions – Market risks, external factors
• Loan Documentation – KYC, financial statements, property documents, collateral valuation
• Credit Rating & CIBIL Score – Role in determining loan eligibility

4. Risk Management in Lending

Risk assessment is essential to minimize loan defaults. Important areas include:

• Types of Lending Risks:
  • Credit Risk – Borrower’s inability to repay
  • Market Risk – Changes in interest rates affecting loan profitability
  • Operational Risk – Process failures, frauds, legal risks
  • Liquidity Risk – Mismatch in assets and liabilities
• Risk Mitigation Techniques:
  • Collateral & Guarantees – Reducing credit exposure
  • Diversification – Spreading loan exposure across industries
  • Loan Covenants – Imposing conditions on borrowers
  • Credit Risk Models – Probability of default (PD), Loss given default (LGD)

5. Loan Pricing & Interest Rate Mechanism

Banks determine loan pricing based on multiple factors. Key topics include:

• Factors Affecting Loan Pricing:
  • Cost of Funds – Interest rates on deposits
  • Risk Premium – Compensation for default risk
  • Market Conditions – Demand-supply, inflation, RBI policies
• Base Rate, MCLR & External Benchmark Rates – Determining lending rates
• Floating vs. Fixed Interest Rates – Differences, advantages, and disadvantages

6. Loan Recovery & NPA Management

Managing Non-Performing Assets (NPAs) is crucial for banking stability. Key topics include:

• NPA Classification – Standard, Sub-standard, Doubtful, Loss assets
• NPA Resolution Mechanisms:
  • SARFAESI Act, 2002 – Asset seizure, auction, legal proceedings
  • Debt Recovery Tribunals (DRTs) – Speedy resolution of loan disputes
  • Insolvency & Bankruptcy Code (IBC), 2016 – Corporate insolvency resolution process
  • One-Time Settlement (OTS) Schemes – Recovering dues through negotiated settlements
• Provisioning Norms for NPAs – RBI guidelines for maintaining reserves against bad loans

7. Loan Monitoring & Follow-Up

Monitoring loans post-disbursement ensures timely repayment and prevents defaults. Key areas include:

• Periodic Loan Reviews – Financial statement analysis, business performance checks
• Early Warning Signals of Default – Delay in EMI payments, decline in business revenue
• Loan Restructuring & Rehabilitation – For stressed accounts, corporate debt restructuring (CDR)

8. Priority Sector Lending (PSL) & Government Schemes

Banks must allocate a portion of lending to priority sectors as per RBI guidelines. Key areas include:

• RBI’s Priority Sector Lending (PSL) Norms – Minimum lending percentage requirements
• Major Government Loan Schemes:
  • MUDRA Loans – For micro-enterprises and MSMEs
  • PMEGP (Prime Minister’s Employment Generation Programme) – Entrepreneurial funding
  • Stand-Up India Scheme – Loans for SC/ST and women entrepreneurs
  • Kisan Credit Card (KCC) – Agricultural finance scheme

Expert Tips to Crack JAIIB Paper 2 Unit 3

• Focus on High-Weightage Topics – Credit appraisal, loan classification, NPA management
• Use IIBF Study Material – The official IIBF books provide comprehensive explanations
• Stay Updated on RBI Guidelines & NPA Policies – Follow recent banking circulars
• Revise Loan Documentation & Risk Models – Make short notes for quick recall
• Practice Case Studies & Mock Tests – Solve real-life banking scenarios for better understanding

Conclusion

Unit 3 of JAIIB Paper 2 – Principles & Practices of Banking provides an in-depth understanding of lending operations, loan types, credit appraisal, risk management, loan recovery, and regulatory aspects. Mastering these topics will enhance your banking knowledge and increase your chances of clearing the JAIIB exam on the first attempt.

For JAIIB study materials, mock tests, and expert guidance, visit iibfexaminations.com – your trusted platform for IIBF certification success!