Principles of Sound Lending (Explained with Examples)

When a bank gives a loan, it must follow some important principles to make sure the loan is safe, profitable, and good for the economy. These are called the Principles of Sound Lending.

1. Liquidity

Meaning:
The bank should give loans in such a way that the money can be recovered easily when needed.

Example:
A bank prefers giving short-term loans to businesses for buying raw materials because these are repaid quickly. This helps the bank maintain liquidity.

2. Safety

Meaning:
The bank must ensure that the borrower is able to repay the loan. The money should be safe.

Example:
A bank checks the borrower’s income, business performance, CIB report, and past loan history before giving a loan.

3. Profitability

Meaning:
Banks must earn enough profit from loans (interest and service charges) to cover costs and earn income.

Example:
A bank charges interest on personal loans or home loans. This interest is the bank’s profit.

4. Purpose

Meaning:
The bank should know why the customer needs the loan and whether the purpose is genuine and productive.

Example:
Loan for buying a flat, expanding a business, purchasing machinery, or education loan.
But if the purpose is unclear, the bank may reject the loan.

5. Diversification

Meaning:
Banks should avoid giving too many loans to one customer, one sector, or one area.
This reduces risk.

Example:
A bank gives loans to industries, agriculture, SMEs, housing, education, etc.—not only to one type of business.

6. Security

Meaning:
Banks take collateral (land, building, deposit, gold, etc.) to reduce the risk of loss if the borrower fails to repay.

Example:
For a home loan, the bank takes the flat or land as mortgage.
For a car loan, the car is hypothecated.

7. Control

Meaning:
The bank must monitor how the loan is used and ensure repayment through proper control systems.

Example:
The bank checks business performance, stock reports, repayment behavior, etc., during the loan period.

8. National Interest

Meaning:
Loans should support the country’s economic goals—like employment, industry growth, export development, and poverty reduction.

Example:
Loans to SME entrepreneurs, women entrepreneurs, agriculture financing, green energy projects, or export-oriented industries.

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