The term ‘loan’ refers to the amount borrowed by one person from another. The amount is in the nature of loan and refers to the sum paid to the borrower. The main method of lending by all the banks of the world is cash credit and about 70 per cent of the total bank credit is cash credit. Under this system, the banker fixes a limit for each customer, called cash credit limit, up to which the customer is allowed to take a loan against the security of tangible assets or guarantee. Loan is the amount borrowed from bank. The nature of borrowing is that the money is disbursed and recovery is made in instalments. While lending money by way of loan, credit is given for a definite purpose and for a pre-determined period. Cash credit is a flexible system of lending under which the borrower has the option to withdraw money as and when required. Under this arrangement the banker specifies a limit of credit for the customer, up to which the customer is allowed to withdraw. The cash credit limit is based on the need of the borrower and agreed with the bank. Against the cash credit limit, the borrower is allowed to withdraw money whenever he needs it, subject to the sanctioned limit. It is generally sanctioned for a period of one year and is secured by the security of some tangible assets or personal guarantee. If the account is running satisfactorily, the cash credit limit may be renewed by the bank at the end of the year. Interest is calculated and charged to the customer’s account. Cash credit is one of the types of bank lending against security in the form of pledge or hypothecation of goods. ‘Pledge’ means the bailment of goods as security for payment of a loan. Its primary purpose is to keep the pledged goods in the possession of the lender. Sometimes the bank also insists on either a promissory note from the borrower or personal security of borrower to ensure safety of amount withdrawn by the customer. It ensures recovery of the loan in case the borrower fails to pay the amount borrowed. In ‘hypothecation’, the goods remain in the possession of the borrower, who finds himself under the agreement to give the possession of the goods to the banker whenever the banker calls upon him to do so. Hypothecation is therefore a device for creating an encumbrance on property in circumstances in which transfer of possession is either inconvenient or impracticable. Other features of cash credit arrangement are as follows:
- Cash credit and some overdraft allow flexibility of borrowing, which depends upon the needs of the borrower
- Loans and advances are utilized for making payment of current liabilities, wage and salaries of employees, and also the tax liability of business.
- Under cash credit arrangement, a banker maintains sufficient cash balance to meet the demand of his customers. But the customer is charged interest only on the actual amount utilised by him. To neutralise the loss of interest on idle funds held by banks within the sanctioned credit limits, commitment charges may be levied by banks on unutilised limits.
- The Reserve Bank has advised banks to develop their own guidelines for ensuring credit discipline and levying commitment charges. Commitment charges are thus at the discretion of individual banks.
