Banking Awareness : Loans and Advances

Loans

Loans refer to money lent to a borrower for short-term, long-term or for unspecified period (working capital facility which is renewed every year). Loan carries a specific rate of interest as agreed between the lender and the borrower and the terms of the agreement. A loan may be for general purpose (say working capital) or specific purpose (equipment loan, export packing credit, car loan etc)

Advances

Advances are also a type of credit facility provided by bank. The basic difference is that whereas the loans may be granted for longer period, advances are generally granted for a shorter time. Advances are granted to meet the day to day requirements of the business. The interest rate varies from bank to bank. Interest is charged only on the amount withdrawn.

Types of Advances

Cash Credit

Cash credit is an arrangement whereby the bank allows the borrower to draw amount upto a specified limit. The amount is credited to the account of the customer.

Overdraft

Overdraft is also a credit facility granted by bank. A customer who has a current account with the bank is allowed to withdraw more than the amount of credit balance in his account.

Discounting of Bills

        If the drawer of the bill does not want to wait till the due date of the bill and is in need of money, he may sell his bill to a bank at a certain rate of discount. The bill will be endorsed by the drawer with a signed and dated order to pay the bank. The bank will become the holder and the owner of the bill. After getting the bill, the bank will pay cash to the drawer equal to the face value less interest or discount at an agreed rate for the number of days it has to run. This process is known as discounting of a bill of exchange.