Friday, January 30, 2015

Lending Money - Cash Credit and Overdraft

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Lending money is one of the two major activities of any bank. Banks accept deposits from public for safe keeping and pay interest to them. They then lend this money to earn interest on this money. In a way, the banks act as intermediaries between the people who have the money to lend and those who need the money to carry out business transactions.

Spread The difference between the rate at which the interest is paid on deposits and is charged on loans, is called the “spread”.

Lending Activity – Commodities, Debts, Financial instruments, Real Estate, Automobiles, Consumer durable goods, Documents of title.

Apart from the above categories, the Banks also lend to people on the basis of their perceived personal worth. Such loans are called clean and the banks are understandably cagey about extending such loans. The credit card arms of the various banks, however, fill up this void.

a.    CASH CREDIT (CC) ACCOUNTThis account is the primary method in which banks lend money against the security of commodities and debt. It runs like a current account except that the money that can be withdrawn is not restricted to the amount deposited in the account. Instead, the account holder is permitted to withdraw a certain sum called “limit” or “credit facility” in excess of the amount deposited in the account.
Cash Credits are, in theory, payable on demand. These are, therefore, counter part of Demand Deposits of the banks.

b.    OVERDRAFT (OD)The word “overdraft” means the act of overdrawing from a bank account. In other words, the account holder withdraws more money from a bank account that has been deposited in it.

Now try to understand about the differences between these two -

The primary differences between cash credit and over draft is how they are secured and whether the money is lent out of a separate account.

Cash Credit (CC)
Over Draft (OD)
More commonly offered for businesses than individuals
Can be used for any purpose, individual or business
Security can be a tangible asset, such as stock, raw materials, or some other commodity
Allowed against a host of other securities including financial instruments, like shares, units of MFs, surrender value of LIC policy and debentures etc. Some ODs are even granted against the perceived “worth” of an individual, known as clean ODs.
Credit Limit
A certain percentage of the value of the commodities / debts pledged by the a/c holder
Acts more like a traditional loan. Money is lent as with a cash credit account, but a wider range of collateral can be used to secure the credit.

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