Question

Explain three of the badic principles of lending and what are the consequences of violating these principles?

Answer 1

Some of the key principles that guide lending decisions are:

Liquidity: Deposits by customers are liabilities for the bank. Customers can withdraw the money when and as needed. Banks therefore invest in liquid securities which can easily be converted to cash to fulfill customer withdrawals

Safety: Borrowers of funds should be able to repay back the fund. The borrowers should have a good credit profile. Defaults by customers can lead to insolvency of the bank as banks can no longer repay back their customers (depositors).

Diversity: Banks should not concentrate lending in a specific sector. They should diversify. Diversification helps in reducing risk.