Types of Loans in India
There are various types of loans or advances, which can be divided on the basis of different sets of criteria. They have been discussed below:
Non-fund based lending versus fund based lending
In Non-fund based lending, bank does not make any funds outlay but only gives assurance. The “letter of credit” and “bank guarantees” fall into the category of non-funding loans. The non-funding loan can be converted to a fund-based advance if the client fails to fulfil the term of contract with the counterparty. In banking language, the non-funding advances are called Contingent Liability of the banks.
The Fund based lending is direct form of loans on which actual cash is given to the borrower by the bank. Such loan is backed by primary and / or a collateral security.
Secured Loans and Unsecured Loans
In the secured loans, the borrower has to pledge some assets (such as property) as collateral. Most common secured loan is Mortgage loan in which people mortgage their property or asset to get loans. Other example is Gold Loan, Car Loan, Housing loan etc.
In unsecured loans, the borrowers assets are not pledged as collateral. Examples of such loans are personal loans, education loans, credit cards etc. They are given out on the basis of credit worthiness of the borrowers.
We note here that the interest rates on unsecured loans is higher than the secured loans. This is mainly because the options for recourse for lender in case of unsecured loans are limited.
Term Loans versus Demand Loans
The commercial banks provide loans of both short term (short term credit), Medium and long term. Short term loans are those loans whose tenure is less than one year. Medium term tenure is between 1 to 3 years and long term is above 3 years. However, In case of agriculture loans, there are three types of loans viz. Short term (tenure <15 months), medium term (tenure 15 months to 5 years) and long terms (tenure > 5 years).
The demand loans are the loans which can be recalled by bank on demand at any time.
Personal loans versus commercial loans
If the debtor is an individual person (consumer) or a business; it is called personal loan or consumer loan. Common examples of personal loans are mortgage loans, car loans, credit cards, educational loan etc. The credit worthiness (or credit score) of the debtor is major criteria for banks to impart such loan facility. Commercial loans include commercial mortgages and corporate bonds. The credit rating of commercial organizations is one criterion for availing such loans.
Working Capital Finance versus Project finance
If the loan amount is used for operating purposes of the business, and its utilization results in the creation of the current assets; it is called Working Capital finance. To provide such loans, the lending banks carry out detailed analysis of the borrowers’ working capital requirements and then fix the credit limits. Normally, this loan is a secured loan and the working capital finance is primarily secured by the inventories and receivables of the business. The common examples of Working capital finance include Cash Credit Facility and Bill Discounting.
On the other hand, project finance mainly refers to extending the medium-term and long-term rupee and foreign currency loans to the manufacturing and infrastructure sectors. Various tools of project finance include Share capital, Term loan, Debenture capital etc.
Priority Sector Lending
The overall objective of priority sector lending program is to ensure that adequate institutional credit flows into some of the vulnerable sectors of the economy, which may not be attractive for the banks from the point of view of profitability. Details here
Banks grant a substantial amount of loans to the micro, small and medium enterprises (SMEs) as a part of Priority sector. Banks usually follow the cluster based approach while sanctioning such loans. This sector plays very important role in the economy and given its importance, RBI has taken several measures to increase flow of institutional credit to this segment. The Small Industries Development Bank of India (SIDBI) also facilitates the flow of credit to MSME sector at reasonable rates.
Rural and Agricultural Loans
Banks extend term loans to farmers for their agricultural inputs. Regional Rural Banks and Lead Bank Scheme have played important role in this.
The banks offer an array of various retail loan products such as home loans, automobile loans, personal loans (such as loans for marriage, medical expenses etc. ), credit cards, consumer loans (for TV sets, personal computers etc) and loans against time deposits and loans against shares. All of them come under the umbrella of retail loans. The target market for retails loans are the consumers in the middle and high income segment, salaried or self employed. Banks participate in the credit scoring programme to judge the credit worthiness of individuals. While granting such loans, banks use reports from agencies such as the Credit Information Bureau (India) Limited (CIBIL).