Contract Lending is a classic form of bank lending. This term refers to lending provided by a bank or a credit institution, which can be used by the client in the amount necessary for him, not exceeding the amount established by the contract.
The main purpose of the loan is to provide the borrower with the opportunity to make payments in the absence of funds in the current or current account. Due to the loan issued, current assets of the client are created in the credit institution.
Features of Contract Account Loan
A contract account is provided by a credit institution simultaneously with the opening of a contract account. The account displays cash receipts, all payments and loans. Customer payment documents are paid at the expense of funds available on this account. The basis for opening a contract account is a contract drawn up with the client. The documents indicate the maximum amount of debt, loan terms, deadline for the presence of a debit balance in the account, interest rate, commission on the percentage of the loan and debit turnover. The amount of interest depends on the amount of loan used. Their calculation is carried out on the basis of the Central Bank rate taking into account the bank premium. The interest on the contract loan is the highest and accrued at the conclusion of the account.
Reliable and stable customers of a particular bank who have been working with it for a long time, a checking account is issued in the form of unsecured bank loans. But the bank at the same time has the right to require the client to fulfill certain conditions that act as collateral for the loan.
Collateral for small enterprises receiving a contractual loan includes securities, mortgages, collateral, third party guarantees and the client’s refusal from long-term claims due to his financial insolvency. To control the provision of credit repayment, the bank can resort to various methods, however, the main method is to compare the actual and planned balance of working capital. Another way is a quarterly comparison of the planned loan size and the contractual debt.
A contract loan is usually provided to reliable customers who have been cooperating with a banking organization for a long time and have a valid account. Operations should be carried out on it - for example, payment of payables or receivables. A contract account is attached to the account.
Credit Terms
Credit companies must meet two basic requirements:
- Own capital of the company should completely or 80% cover the need for financing.
- A loan may be issued without collateral, provided that the company meets the I credit rating.
When a bank requires a security deposit
A credit institution in certain cases may require a security deposit:
- The bank doubts the creditworthiness of the borrower.
- Credit rating below grade I.
- The tense economic situation in the economic sphere, industry or country.
- Low availability of credit resources due to instability in the credit market.
Credit rating
When applying for any types of bank loans, banks devote a lot of time to assessing the creditworthiness of a client. The assessment methodology may vary depending on the credit institution, however, the following are considered the main requirements:
- High rates, allowing to rank the borrower in the I class.
- Allowing you to create reserves the amount of net profit.
- Maintaining a market position for a long time.
- Good reputation and partnerships.
The contractual lending agreement includes the main provisions governing relations between a commercial bank and a client: methods of solvency control, forms of securing repayment of loans, interest rate mechanism, limiting or terminating lending subject to insufficient solvency and creditworthiness of the borrower, procedure for providing borrowed funds, maintaining accounts accounting and credit limit.
Differences in Contract Account Loan
A contract account is characterized by features that distinguish it from other types of short-term loans.
- The creditworthiness of the borrower is assessed once upon the first grant of a loan. Further financing does not require the client to provide documents.
- The maximum amount of loan funds for a contract account is not determined by the bank. The size of the loan depends on the assessment of the solvency of the borrower given by the credit institution. The Bank examines working capital, balances of customer finance and sources of financing. The limit of funds may correspond to the average value of previously issued loans.
- Lack of control over the solvency of the client and the need to have reserves for the provision of loans to the client increase the risk of lending to the bank.
- The loan must be repaid in the terms established by the contract, otherwise the bank has the right to set the interest rate scale in order to stimulate the borrower to repay the loan.
- Loan issued is not secured. This practice is most often found in the West when issuing short-term loans and borrowings. Russian credit organizations use the property of the borrower, guarantees of third parties, securities in view of high risks as collateral for the loan.
- Debt repayment occurs automatically from the funds in the client’s current account.
Differences between checking account and overdraft
Overdraft has the features that distinguish it from the contract:
- Both commercial banks and the Central Bank of the Russian Federation can act as a creditor.
- On the accounts of the borrower - settlement or correspondent - reflects all overdraft operations.
- A loan is provided by writing off funds on top of the account balance;
- The settlement and cash services agreement spells out the possibility of conducting overdraft lending operations, which eliminates the need to draw up an additional agreement.
- The loan limit is negotiated only subject to the issuance of loans with a high level of risk.
- The maximum overdraft period is 10-15 days. If the borrower violates this condition, the overdraft loan becomes ordinary and requires the preparation of a standard loan agreement.
- Compared to other short-term loans and borrowings, overdraft has a high interest rate. Loan payments represent a certain part of the debt, combined with the interest rate.
- Overdraft operations are reflected in the accounts of commercial banks with certain features.
Contractual loan in practice
A striking example of a checking loan is the work of an individual entrepreneur, paying for the goods he imports from his bank account. Expressed in cash equivalent, the entrepreneur’s income is credited to the same account. If it is necessary to provide an urgent prepayment and lack of financial resources, an entrepreneur can issue a contractor loan. This will allow you to make an advance payment and pay off the debt immediately after the appearance of funds in the account. This type of loan belongs to the category of short-term and unsecured collateral.
Bank Risks
Contract account - a type of short-term loan that carries certain risks for a banking institution. For this reason, it is provided only to reliable and reputable customers who are able to repay the loan.
When applying for a contract loan, the bank performs the following actions:
- Assesses the business reputation of the client.
- Keeps track of his debts to partners.
- It analyzes and evaluates the borrower's credit history in all the institutions with which he has ever worked.
- View the number of working capital and the balance sheet of the enterprise.
Based on this information, the bank determines the level of solvency and creditworthiness of the client.
Prospects for the development of a checking loan
Overdraft and contracted loan are very similar: credit cards are beneficial for the borrower, but only in the short term. Untimely repayment of a loan can lead to the fact that the rest of the debt begins to be taxed with high interest. The rates for a contractual loan, overdraft, and consumer lending vary: for a contractor, the indicator is higher, since such operations do not require collateral or collateral.
In the United States and European countries, a checking account is one of the most common types of loans. Many companies use bank debit accounts as loan accounts without drawing up additional agreements. Firms know which bank you can take out a loan because they are its regular customers. Contract account loan allows you to quickly pay off customers or suppliers.
Russian banks, in which you can take a loan, issue a contractor only after the assessment and verification of the borrower. However, the prospects for the development of this type of loan in the Russian Federation are possible only thanks to the main banks seeking to reach the world level.
Pros and Cons of a Contract Loan
Contract account lending is beneficial for both parties: the borrower can use credit funds in the absence of his own, and the bank saves credit resources. This type of lending is considered the most risky, which explains its drawback - a high interest rate for the use of such a loan.
Summary
Contractor lending is one of the most risky forms of lending. This explains the high fee for using the loan in comparison with other short-term loans.
Incomplete use of a credit line is a violation of the loan agreement. The contract line of credit, in simple words, is lending, combining the features of a loan and settlement accounts and characterized by the continuous issuance of loans to the client. The bank has the right to recover a commission from the client in compensation for lost profits.
The issuance of contractual loans by Russian banks has been temporarily suspended, since all the revenue of the organizations should be stored in their current account in accordance with current standards.