📚 JAIIB 2025 • PPB • Module B (Ch 1 of 20) • Unit 22

Principles of Lending, Borrowers & Credit

Cardinal lending principles: safety, liquidity, profitability, purpose, diversification. Borrowers: individual (ICA), proprietorship (unlimited liability), partnership (Sec 4, 18, 19), HUF (karta), company (MoA/AoA), LLP. Fund based: CC/OD, bill finance, term loan. Non-fund based: BG, LC. Working capital = day-to-day needs.

⏱ 17 min read🎯 High Exam Weightage🧠 5 Memory Tricks⚡ 8 Flash Cards

Banky Starts Lending! 💰

Welcome to Module B — the lending side of banking! This is where the real action happens. Understanding lending principles, borrower types, and credit facilities is the foundation of every credit officer’s career!

“Sir, a partnership firm wants a cash credit limit. What principles do I follow and what documents do I need?” 💰

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Section 1 of 9

Why Read This Chapter?

Lending is the primary revenue source for banks — getting it right = profitability, getting it wrong = NPAs

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What are the cardinal principles of lending?

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Every lending decision must satisfy 5 cardinal principles: (1) Safety — will I get my money back? (2) Liquidity — can I convert the security to cash quickly? (3) Profitability — does the return justify the risk? (4) Purpose — is the loan for a productive/legal purpose? (5) Diversification — am I spreading risk across sectors? Plus, know your borrower: individuals (ICA), partnerships (Partnership Act 1932), companies (Companies Act), HUF (karta manages), LLP (limited liability). Credit facilities: fund based (CC/OD, bills, term loans) and non-fund based (BG, LC).

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Exam Marks

3-4 questions — individual governed by ICA (not Partnership/LLP Act), public company shares = transferable (not negotiable), CC = fund based, working capital = day-to-day requirements, non-fund = both WC and capital. Very high weightage in Module B!

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Career Growth

Lending is the bread and butter of banking — mastering these principles = becoming a credit expert

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Real Life

Whether you take a home loan or business loan, understanding lending principles helps you negotiate better

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Section 2 of 9

How Will It Benefit You?

Real career advantages

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Give me a real scenario!

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💰 Scenario: A partnership firm (3 partners) applies for a CC limit of Rs 50 lakh for garment manufacturing. You evaluate: (1) Safety: Stock of garments as primary security ✅. (2) Liquidity: Garments are marketable ✅. (3) Profitability: Interest income covers risk ✅. (4) Purpose: Working capital for manufacturing ✅. (5) Diversification: Within sectoral exposure limits ✅. Documents: Partnership deed, Sec 4 (definition), check if registered (Sec 69 effects). All partners sign. Manager: ‘Principles satisfied — proceed to appraisal!’ 🌟

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Section 3 of 9

What Is This Chapter About?

30-second summary

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Quick version, sir!

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This chapter covers: Cardinal Principles: Safety, liquidity, profitability, purpose, diversification. Borrower Types: (1) Individual — governed by ICA (exam PYQ!). Minor cannot borrow. Illiterate: thumb impression + witnesses. Pardanashin woman: identity verification challenges. (2) Proprietorship — same as individual, ICA, unlimited liability. (3) Partnership — Sec 4 (definition), Sec 18 (implied authority), Sec 19 (partner = agent of firm). Not distinct from partners. Registration not mandatory but affects suit rights (Sec 69). Death of partner dissolves firm. (4) HUF — karta manages, Mitakshara/Dayabhag. Not created by contract. Male member = co-parcener. (5) Company — MoA (objects), AoA (rules). Public: shares transferable (exam PYQ!). Private: restricted transfer. Check borrowing powers in MoA. Board resolution. (6) LLP — limited liability + partnership flexibility. Small LLP: contribution ≤₹25L, turnover ≤₹40L. (7) Statutory corporations, trusts, cooperative societies. Credit Facilities: Fund based: CC/OD (running account, interest on utilised balance, Clayton rule), bill finance (discounting/purchase/collection), term loans (short/medium/long). Non-fund based: BG, LC, acceptance. Working capital = day-to-day needs (exam PYQ!). Operating cycle = inventory → production → sales → cash.

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Section 4 of 9

Key Definitions — Banky Asks, Mentor Explains

Every term explained like you’re 10

Critical Term

Cardinal Principles of Lending

Safety, Liquidity, Profitability, Purpose, Diversification — every loan must satisfy ALL five

5 principles

Banky’s Understanding: 5 Cardinal Principles: (1) Safety: Reasonable certainty of repayment. Assess character, capacity, capital, collateral. (2) Liquidity: Ability to convert security to cash. Marketability of assets. (3) Profitability: Return must justify risk. Interest + fees must cover cost of funds + risk premium. (4) Purpose: Must be productive and legal. Not for speculation/anti-social activity. (5) Diversification: Spread risk across borrowers, sectors, geographies. Avoid concentration risk.

🧒 Analogy: Like choosing where to invest your savings: Is it safe (safety)? Can I get my money back quickly (liquidity)? Will I earn enough (profitability)? Is the investment legitimate (purpose)? Am I not putting all eggs in one basket (diversification)?

Critical Term

Types of Borrowers

Individual (ICA), Proprietorship (unlimited), Partnership (Sec 4/18/19), HUF (karta), Company (MoA/AoA), LLP

7 types

Banky’s Understanding: Individual: Governed by ICA (exam PYQ! — not Partnership/LLP Act). Minor cannot contract. Illiterate: thumb impression. Pardanashin: extra care. Proprietorship: Same as individual, ICA, unlimited liability. Partnership: Partnership Act 1932. Sec 4 (definition). Sec 18 (implied authority). Sec 19 (partner = agent). Not distinct from partners. Registration optional but affects Sec 69. HUF: Karta manages. Mitakshara/Dayabhag. Not by contract. Company: MoA + AoA. Public: shares transferable (exam PYQ!). Private: restricted. Board resolution. LLP: Limited liability + partnership. Small LLP: ≤₹25L contribution, ≤₹40L turnover.

🧒 Analogy: Borrowers are like different vehicles on the road: individual = bicycle (simple), proprietorship = scooter (slightly bigger), partnership = car (shared), HUF = family van, company = bus (complex rules), LLP = hybrid car (best of both)!

Critical Term

Fund Based Credit Facilities

CC/OD (running account, interest on utilised), Bill Finance (discounting/purchase), Term Loans (short/medium/long)

3 main types

Banky’s Understanding: Cash Credit/Overdraft: Running account. Draw up to sanctioned limit. Interest on utilised balance only. Primary security: stock/receivables. Clayton’s rule: credit discharges earliest debit. Bill Finance: (a) Bill discounting (bank buys bill before maturity at discount). (b) Bills purchase (similar but for demand bills). (c) Advances against bills under collection. Term/Demand Loans: For capital assets. Short-term (<1 yr), medium-term (1-5 yr), long-term (>5 yr). Fixed repayment schedule. Higher credit risk than WC.

🧒 Analogy: CC = a revolving door (borrow, repay, borrow again). Bill finance = selling your invoice to the bank at a discount (get cash now). Term loan = EMI (fixed repayments over time, like a home loan)!

Critical Term

Non-Fund Based Facilities

Bank Guarantee (commitment to pay if customer defaults) and Letter of Credit (trade payment assurance)

2 main types

Banky’s Understanding: Non-fund based: Bank funds NOT directly lent. (1) Bank Guarantee: Bank commits to pay third party if customer defaults. Types: performance, financial, bid bond, deferred payment. (2) Letter of Credit: Bank assures seller of payment on behalf of buyer (trade finance). (3) Acceptance facility. Non-fund based can be for both WC and capital purposes (exam PYQ!). Risk: contingent liability — becomes fund-based if guarantee is invoked.

🧒 Analogy: BG = being a guarantor for your friend’s rent (you pay if they don’t). LC = being a trusted middleman in a deal (seller trusts you to ensure payment). Your money doesn’t leave your pocket unless something goes wrong!

Critical Term

Working Capital

Day-to-day requirements — raw materials, wages, expenses — operating cycle converts inventory to cash

Day-to-day needs

Banky’s Understanding: Working capital = funds for day-to-day requirements (exam PYQ! — not excess of CL over CA, not fixed-current assets). Includes: raw materials, wages, energy, fuel, statutory dues, selling/admin expenses. Operating cycle: Cash → raw materials → WIP → finished goods → receivables → cash. Gross WC = total current assets. Net WC = current assets – current liabilities. Adequacy of WC is crucial — too little = production stoppage, too much = idle funds.

🧒 Analogy: Working capital is like the fuel in your car’s tank — you need it to keep running daily. Too little fuel = car stops (production halt). Too much fuel in trunk = wasted money (excess WC). Operating cycle = the route from filling fuel to reaching destination!

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Section 5 of 9

Chapter Explained in Simple Stories

So easy even Banky’s nephew understands

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Sir, explain this like a story!

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Three bite-sized stories coming up — impossible to forget! 🚀

💰 Block 1: Lending Principles & Borrower Types

5 Cardinal Principles: Safety, Liquidity, Profitability, Purpose, Diversification.

Borrowers: Individual (ICA — exam PYQ!), Proprietorship (unlimited liability), Partnership (Sec 4/18/19, not distinct from partners), HUF (karta), Company (MoA/AoA, public shares = transferable — exam PYQ!), LLP (limited liability).

Minor cannot borrow. Illiterate = thumb impression + witnesses. Pardanashin = extra care.

Key Term

Individual = ICA

Individual borrowers are governed by the Indian Contract Act (ICA) — not the Partnership Act or LLP Act. This is a frequently tested distinction.

🧑‍💼 Banky: “5 principles (SLPPD), individual=ICA, public company shares=transferable, partnership Sec 4/18/19! 💰”

🏦 Block 2: Credit Facilities — Fund & Non-Fund

Fund based: CC/OD (running, interest on utilised, Clayton rule), Bill finance (discounting/purchase), Term loans (short/medium/long).

Non-fund based: BG (commitment to pay), LC (trade payment), Acceptance. For both WC and capital (exam PYQ!).

Working capital = day-to-day requirements (exam PYQ!). Operating cycle: cash→RM→WIP→FG→receivables→cash.

CC = fund based (exam PYQ!). Retail: vehicle, home, education, personal, consumer durables.

Key Term

WC = Day-to-Day

Working capital means requirements for day-to-day transactions — not excess of current liabilities over current assets, not fixed minus current assets. This is a guaranteed exam question!

🧑‍💼 Banky: “CC=fund based, BG/LC=non-fund, WC=day-to-day, non-fund=both WC+capital! 🏦”

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Section 6 of 9

Exam Angle — Every Testable Point

All facts, numbers, definitions JAIIB tests

✅ Must-Know Facts — Highest Probability

Individual borrowers governed by Indian Contract Act (not Partnership/LLP!) — exam PYQ!
Public company shares = transferable (not negotiable/sovereign) — exam PYQ!
Cash credit = fund based facility — exam PYQ!
Working capital = day-to-day requirements — exam PYQ!
Non-fund based = both working capital AND capital goods — exam PYQ!
Cardinal principles: safety, liquidity, profitability, purpose, diversification
Partnership: Sec 4 (definition), Sec 18 (implied authority), Sec 19 (partner = agent)
Partnership not distinct from partners | Registration not mandatory (but Sec 69 effects)
HUF: karta manages, not created by contract, co-parcener = male member by birth
Company: MoA (objects/powers), AoA (internal rules) | Check borrowing powers
LLP: limited liability + partnership flexibility | Small LLP: ≤₹25L contribution, ≤₹40L turnover
CC/OD: interest on utilised balance only | Clayton rule: credit discharges earliest debit
Term loans: short (<1yr), medium (1-5yr), long (>5yr) | Higher risk than WC
Bill finance: discounting (before maturity at discount), purchase (demand bills), collection
Death of partner dissolves firm | Insolvency: stop operations, pay receiver

📝 Previous Year Questions

Q: Individual borrowers governed by:

A: (c) Indian Contract Act ✅

Q: Public company shares are:

A: (b) Transferable ✅

Q: Cash credit is:

A: (a) Fund based facility ✅

Q: Working capital means:

A: (a) Day-to-day requirements ✅

Q: Non-fund based for:

A: (c) Both WC and capital ✅

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Section 7 of 9

Memory Tricks That STICK

Lock every fact permanently

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Too many facts! Help! 🤯

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These tricks will lock everything in forever! 🧲

🧠 Trick 1 — SLPPD Principles

5 cardinal

5 Lending Principles = SLPPD: Safety Liquidity Profitability Purpose Diversification

Every loan must satisfy all 5 cardinal principles. Remember SLPPD — Safety first, then Liquidity, Profitability, Purpose, and Diversification.

🧠 Trick 2 — Individual = ICA

Not Partnership Act!

INDIVIDUAL borrower = ICA! (Indian Contract Act!) Not Partnership Act! Not LLP Act! Not Companies Act!

Individual borrowers are governed by the Indian Contract Act. The exam gives Partnership Act, LLP Act as distractors.

🧠 Trick 3 — Fund vs Non-Fund

Key distinction

FUND based = bank money goes OUT (CC, OD, term loan, bills) NON-FUND = bank COMMITS only (BG, LC — money stays unless invoked!)

Fund based: bank actually lends money. Non-fund based: bank only commits to pay (money goes out only if guarantee is invoked).

🧠 Trick 4 — WC = Day-to-Day

Definition trap

Working Capital = DAY-TO-DAY needs! (RM + wages + expenses) NOT: CL excess over CA! NOT: Fixed minus Current!

Working capital means funds required for daily operations. The exam gives wrong definitions as options.

🧠 Trick 5 — Clayton Rule

CC account

CLAYTON’S RULE in CC: Credit FIRST discharges the EARLIEST debit! (First in, first out!)

In a cash credit account, when a credit comes in, it discharges the earliest outstanding debit first. Important for guarantor liability.

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Section 8 of 9

Visual Summary — Chapter Map

Entire chapter in one diagram

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Section 9 of 9

Flash Revision — Last-Minute Cards

Read these 10 minutes before exam

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EXAM IN 15 MINUTES! 😰

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8 cards — read twice, you’ll get every question right! 💪

5 Principles

Safety | Liquidity | Profitability | Purpose | Diversification

Every loan must satisfy ALL five

Individual

Governed by ICA (Indian Contract Act)

Minor cannot borrow | Illiterate = thumb impression

Partnership

Sec 4/18/19 | Not distinct from partners

Registration optional | Death = dissolution

Company

MoA (objects) + AoA (rules) | Board resolution

Public = transferable shares | Check borrowing powers

CC/OD

Fund based | Running account | Interest on utilised

Clayton rule: credit discharges earliest debit

Non-Fund

BG + LC | Bank commits, not lends

For BOTH WC and capital purposes

Working Capital

Day-to-day requirements | Operating cycle

Cash→RM→WIP→FG→Receivables→Cash

Term Loan

Short (<1yr) | Medium (1-5yr) | Long (>5yr)

For capital assets | Fixed repayment schedule

⚡ Chapter 22 Complete — Principles of Lending, Different Types of Borrowers, and Types of Credit Facilities

5 Principles: SLPPD — Safety, Liquidity, Profitability, Purpose, Diversification
Borrowers: Individual (ICA), Proprietorship, Partnership (Sec 4/18/19), HUF (karta), Company (MoA/AoA), LLP
Fund based: CC/OD (running, Clayton rule), Bill finance, Term loans | Non-fund: BG, LC (both WC+capital)
Working capital: day-to-day needs | Operating cycle | CC = fund based | Public shares = transferable

Banky says: “SLPPD principles, individual=ICA, CC=fund based, WC=day-to-day, non-fund=both!” 🎉💰

You now understand the foundations of lending — principles, borrowers, and credit types. This is the base for everything in Module B! 💪

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