Question

Explain the types of Bank credit.

Answer 1

Meaning: -
Banks are an integral part of the economy and provide short term to long term loans. Banks also provide a wide range of services in an economy. They not only promote saving habit within the economy but also use these savings to disburse loans to companies, firms, and individuals for business resulting in capital formation.

Types of bank credits:

There are number of bank credit products in the market. However, the major types of bank credits which provide both short term and long term funding are as follows: 

1. Overdraft :-
It is a credit facility provided by banks on current accounts. The banks allow their current account holders to withdraw money up to the credit limit in excess of the balance in the account. The credit limit is approved by the bank depending on customer relationship, the credit risk of the customer, etc. no security is needed by the bank. The overdraft needs to be repaid before the due date fixed by the bank. The Internet is payable only on the overdraft amount. 

2. Cash Credit: - 
There is not much of a difference between overdraft and cash credit. The cash credit also works in a similar manner as an overdraft where the bank sanctions a credit limit on the current account. The account holder can withdraw the amount of credit limit sanctioned in excess of his account balance. However, the only difference here is that the cash credit is provided on the basis of some security pledged or hypothecated (some form of security is given to the bank) with the bank. Interest is charged only on the cash credit used and for the period of use. 

3. Term Loans: -
Banks provide term loans for business purposes. The term loans are given for a specific period of time. The loan is sanctioned after evaluating the credit risk of the customer. The amount is repaid in installments over the term loan. Interest is payable on reducing balance method i.e. on the principal amount being unpaid.