As per the Reserve Bank of India, banks hold about 15% of their deposits as cash to arrange for daily withdrawals by depositors.
A major portion of the remaining deposits is used by banks to give loans to people. The depositors of a bank are allowed to withdraw their deposits on demand and are paid interest on their deposits. The borrowers taking loans repay it to the bank along with interest.
The interest charged on loans is more than the interest paid by the banks on deposits. The difference between the interest charged on loans and the interest paid on deposits is the bank’s income or profit.
The loan given by a bank is also referred to as credit.
A loan or credit is subject to certain conditions that the borrower must agree to. These conditions are called terms of credit and include:
- A specified rate of interest
- Security against the loan to recover the money if the borrower fails to repay it. This security is called collateral
- The assets accepted as collateral are land or property, vehicles, livestock, standing crops and bank deposits
- A borrower needs to submit certain documents like proofs of identity, residence, employment and income to avail a loan
- The lender reserves the right to sell the collateral in case of non-repayment to recover the loan amount.
A loan is usually given for a specific duration of time and needs to be completely repaid by a specified date. The borrower repays the loan in cash, by cheque or by card in instalments, or as a one-time repayment, as specified in the mode of repayment.
Collateral is the security provided by a borrower against a loan, and it can be sold in case of non-payment. Credit can bring about a positive or a negative change in a person’s life.