Principles followed by banks for lending money

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Principles followed by banks for lending money

When you're looking for a loan, your bank is usually the first place you turn. Knowing the principles of bank lending can help you get your finances and credit in better shape — which means you should stand a better chance of being accepted when you apply.

So why are these principles so important? First, when you approach your bank for a loan, you're borrowing public money. Money that's been deposited by other people as well as businesses and charities. 

It's the bank's responsibility to make sensible decisions about the way money is loaned. It's the main reason why they rely on sound lending principles to make sure they safeguard the cash and assets in their possession. 

Because it pays to know the lending principles behind a bank's decision when you're thinking about a loan, we've put together this article. It's worth remembering that banks may offer different terms when you're looking to borrow. Still, the underlying principles of sound lending remain the same.

5 principles of bank lending

Liquidity

Liquidity is one of the essential principles of bank lending, along with the principle of safety. 

Liquidity means that your bank is ready and able to convert its assets into cash with a small, or no, loss if there's a sudden shortfall.

Every bank makes loans with public money. It's the same money that is deposited by customers and can be paid out at any time. Before a bank makes a loan, they need to be in a position to cover any withdrawals that the public might make during the same period. 

That's why banks tend to lend over the short term and why they expect you to make repayments on time and to a set schedule. And why your own cash flow history can be important when applying for a loan.

Safety

Safety is equally as crucial as liquidity when it comes to the principles of sound lending. That's because any loans the bank makes are with public funds, so its first priority is to look after the money.

In reality, this means that your loan will come with terms and conditions attached relating to repayments and missed payments. Safety concerns also connect to your character, financial health and ability to repay. Your bank also needs to know that you're using your loan for the agreed purpose. 

Loan security is always uppermost when a bank loans money. That's why your creditworthiness will affect the result of your application and could impact your credit rating. 

At Salad Money, we assess your ability to repay by using Open Banking, which doesn't affect your credit score. 

Diversity

The phrase "don't put all your eggs in one basket" is a perfect illustration of the principle of diversity. Banks are big believers in spreading the risk whenever they make loans to their customers. Lending to different trades, businesses and industries is the way banks spread and minimise the risk.

By lending to a wide range of different borrowers and making some high-risk loans and investments, banks can offer varying interest rates to their customers. Looking after your credit score and being in good financial health means you could be considered as low risk and benefit from a preferential rate. 

Profitability

Banks work by accepting your money and then lending it out to make a profit. Therefore, rents, depreciation of assets, bad loans and other expenditures all need to be balanced against a bank's income. In turn, that means that every loan has to be worth it for the bank. 

Your bank needs to remain competitive and sustain its profitability. Your lender will make sure that extending credit is also profitable. If you're assumed to be a bad risk, you may find that your bank charges you a higher interest rate, so they don't lose out.

Purpose

Your bank won't lend to you without knowing what the loan is for, which is why they won't loan for speculative or illegal purposes. Knowing what the loan is for also impacts its riskiness and determines the interest rate you'll pay. 

Banks prefer to loan for productive purposes because they have a better chance of getting the loan repaid. However, if you work in the public sector you could use a small personal loan from Salad Money for anything from getting back on your feet after Covid to that dream holiday.

A new way of lending with Salad Money

Before you borrow any money, it pays to look after your financial health and take care of your credit score. You’ll have a greater chance of being accepted for a loan and be in a better position to take on debt.

At Salad Money, we do things differently. By using Open Banking, we can assess your ability to repay without affecting your credit score. That's because we believe that every worker should have access to fair, ethical and affordable loans. 

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