Understanding Bank Loan Mechanisms: Why Banks Often Approve Loans That May Exceed Requirements

Banks, often perceived as entities that restrict lending, in reality, tend to be more flexible and willing to approve loans than many borrowers believe. Despite prevalent misconceptions, banks are not indiscriminately giving out loan amounts that surpass what borrowers require. This article explores the reasons behind this perception, focusing on the rigorous lending processes, the role of information asymmetry, and the necessity of collateral.

Lending Practices Based on Detailed Evaluations

When considering a loan application, banks perform extensive due diligence to ensure that the borrower can handle the financial obligation responsibly. This process includes a thorough review of the borrower's financial statements, business plans, and offered security. Banks aim to mitigate default risks by assessing the borrower's financial health and the viability of their projects.

The rigorous evaluation process involves multiple layers of approval, ensuring that only those who are truly deserving and capable of repaying the loan are granted credit. As a result, the transformation of accounts into Non-Performing Assets (NPAs)—where loans are not being repaid—is relatively rare. However, exceptions and isolated cases do exist.

Information Asymmetry and Poor Borrowers

One of the major challenges faced by banks when lending to poor borrowers is information asymmetry. This refers to the imbalance of information between the lender and the borrower. Since banks cannot accurately predict whether a borrower will repay the loan, they require collateral to secure the loan. Unfortunately, many poor individuals may not have suitable assets to serve as collateral, nor do they have reliable guarantors with stable incomes.

Without these assets to offer as security, banks may err on the side of caution and reject loan applications. This perceived reluctance to lend to poor individuals is often due to the underdevelopment of their credit history and the inability to provide sufficient guarantees or collateral. This situation highlights the importance of improving financial inclusion and access to credit for marginalized populations.

Loan Approval Process: A Closer Look

The real issue lies not in the availability of loans but in the stringent criteria and the advanced approval processes that banks follow. Personal loans, for instance, are scrutinized meticulously. These loans are unsecured, relying solely on the borrower's future income to repay the loan. For such loans, banks typically require a minimum of two to three years of employment history before processing the application.

Before granting the loan, banks conduct a thorough investigation into the borrower's creditworthiness. This includes checking the borrower's credit score, reviewing any previous loan or credit history, and requesting documents that verify their income and financial standing. Only after meeting these stringent requirements do banks approve the loan.

Secured Loans and Project Viability

Commercial and industrial loans, on the other hand, are secured by collateral and are issued based on the viability of the proposed project. Borrowers are required to present detailed project reports that outline the technical aspects, financial projections, and the expected business outcomes. Banks then conduct pre-sanction inspections to verify the project's feasibility and its alignment with the bank's lending criteria.

Only after a rigorous evaluation process where all aspects of the project are scrutinized, are banks willing to extend financial support. This process ensures that the loan is only granted to those who have a high probability of repaying the debt, thereby reducing the risk of default.

Conclusion

While it is true that banks take a cautious approach to lending, their stringent evaluation processes are designed to protect both the borrower and the lender. The issue of banks approving loans that exceed what is required often stems from the limitations in information and the necessity of collateral. By understanding these mechanisms, borrowers can better navigate the lending process and improve their chances of securing the necessary funding.

Future discussions should focus on how to bridge the gap in information asymmetry and increase access to credit for all segments of society, thereby fostering a more inclusive and sustainable financial ecosystem.