Introduction

Personal loans are un-secured lending not backed by any collateral. But some time to mitigate the risk, bank can ask for guarantee from the third party.
Following sub- products falls under this major category of bank asset product –

Personal loans
Revolving credit / Credit Card
Overdraft
Buy Now Pay Later (BNPL)
Short/Medium Personal Term loan

Revolving Credit / Credit Card (RC, CC)

Under this facility, a credit line or limit is provided to the customer. Unlike loan where the entire loan amount is disbursed to the customer and interest rate is charged on the loan amount, the limit can be utilized by the customer as and when required and hence interest is charged only for the amount utilized.

Utilization of the limit can be made in multiple ways viz., Transaction over POS, Online payments via merchant sites, cheque drawing, over ATMs etc.

Repayment of the facility is by way of paying

Minimum Amount Due (MAD)
Billed Outstanding
Current Outstanding

This facility is subject to review and renewal for further period , normally every year.

Overdraft (OD)

This facility is extended by the lending institution as a drawing limit in the operating account viz., Current Account where the customer is allowed to draw over and above their credit balance in their account.

Utilization of the limit can be done in all allowed modes of Current Account. Interest is charged on daily basis for the amount that is overdrawn.

Overdraft facility is also subject to review and renewal, normally every year

Buy Now Pay Later (BNPL)

This loan is provided to those customer segments who wish to purchase household articles. This facility helps the lending institutions to augment their client base which are coming under lower and middle class segment and help expanding their business.

The lending institution enters in to agreement with business firms who has good amount of customer base for their product. Facility is extended to the buyer clients at low interest rates. This facility also helps increasing business volume and expanding their network for the partner entity.

Under this model both customer on-boarding and facility / Loan disbursement is taken care by well defined technology platforms.

This facility is repayable by borrowers over a pre-defined period viz., 6, 12 or 18 months. Repayment is by means of EMIs or by means of standing instruction to collect the EMI from the borrowers account through Debit mandate (ENACH)

Though there are sub products under personal loan category, we deal with personal term loan in this article. This type of loan is sanctioned to customers to meet variety of personal needs repayable over a specified period time in Equated Monthly Instalments (EMIs).

You may also like: Rise of BNPL – How BNPL is the Next Big Thing for the Finance Future

Personal Term Loan

Evolution of Personal Loans

The personal loans, traditionally, were accessible only for the fixed income group of people, especially salaried. The purpose of loan was limited to financing of household articles viz., Radio, Television, Refrigerator, Bi-Cycles, Household articles. Over the period, the spectrum has widened and it has been offered to all class of people right from the Salaried, Professionals, Business people for varied purpose including payment of credit card dues of other banks, top-up loans, marriage loans, loans for home renovation, Travel loan, medical loan etc.

Earlier the financing institutions were reluctant to entertain personal loans due to high-risk and personal loan applications were limited to a small segment of people, who are well known to the lending institution and that too for very limited purpose. Now the situation turned in such a way, that all lending institutions offer pre-approved loans basis the credit score to all categories of customer as stated above.

With the advancement of technology, processing time of the application has been reduced considerably, due to online application processing, digital documentation. Besides, many Fintech companies are in the market to lend personal loan. Thus, the time to avail personal loan at a competitive rate, becomes very fast. In fact, the facility is now available at the touch of a button over websites, mobile apps.

Product Feature

Fixed repayment over specific tenor repayable in EMIs
Flexibility to repay in bulk / top-up
Simple product sanctioned based mostly on personal income and credit score (CIBIL Score).
Quantum of loan mostly not exceeding 5 lacs
Unsecured loan

Type of Customer

Salaried
Professionals
Small Business / Retailers

Product Risk Profile

Since the product is unsecured in nature, there are high possibility for default
Due to high-risk nature, the interest rate for the product will be higher than the secured loans
This product portfolio requires more stringent capital adequacy and provisioning norms in case of defaults as per Basel requirements

Security / Terms of Loan

The personal loans are totally un-secured
Due to inherent risk involved in the repayment of personal loans, lending institutions prefer to provide this to those clients who are with good take-home income, repayment track record and good credit score (CIBIL Score)
To mitigate risk, lending institution may ask for third party guarantee / pledge of deposit.
Lending institution may stipulate pre-condition
1. Salary account with lending institution
2. Standing instruction to recover EMI from the salary account
3. When borrower leave their employer, undertaking from the borrower to recover outstanding from the final settlement from the employer

Sales Channel

These products are offered to clients by lending institutions via

Branch
Online
Direct Selling Agents
Contact Centres
Business Partners

Risk Cover / Mitigation

Additional personal guarantee from third party
Mandating payroll account opening with the lending institution
Post dated cheque to cover default and to initiate suit against the borrower
To reduce the risk of default due to death / accident, the lending institution may offer (by cross selling) insurance products to cover the above risk.

Eligibility Criteria

The quantum of loan that is sanctioned is based on various factors as below:

Income – take home pay.
Credit Score

Note: Apart from above, there may be other criteria as specified by the lending institution as per their loan policy

Refer below links

https://cloudbankin.com/blog/loan-origination/decoding-the-key-parameters-in-indian-credit-bureau-reports/

https://cloudbankin.com/loan-origination/why-is-bank-statement-analysis-important-in-los/

Personal Loan Underwriting Policies

Documentation

Following are the documents that are obtained by the lending institution:

Demand Promissory Note (DPN)
Loan Repayment Schedule / Instalment Payment Agreement (Loan Agreement)
Post Dated cheque / Debit Mandate (ENACH)
Third party Guarantee letter
Agreement with employer to pay the salary to customer account.

Revenue Model

Risk adjusted Interest rate on loan, processing fee and charges
Periodical review of Interest rate, fee and charges
Special rates during campaign to promote loan product.

Repayment (collection of dues)

The collection of EMI/Outstanding balance can be carried out by the lending institution in one or more of the following:

Debit to account with them
Debit mandate (ENACH) by means of standing instruction by borrower
Post dated cheque
On / Off line transfer by borrower via on-line banking of lending institution or from other bank accounts
Direct remittance to the loan account by cash across/cheque the counter

Repayment Types

The borrower can repay / opt for anyone of the below methods of repaying the personal loan:

Equated Monthly Instalment (EMI) – The most popular method of payment majorly used by lending institutions/borrowers. Under this method, the principal and interest on the principle are calculated in such a way that they are payable in equal instalments for the agreed tenor of the loan
1. Fixed EMI – Where the monthly instalment amount remains the same.
2. Floating EMI – Also known as Variable Repayment Method, the instalment amount that is to be paid will vary basis the market conditions viz., change in the interest rate
3. Fixed Cum Variable – Under this methods, financial institutions offer fixed EMI for a period say for example 3 to 5 years and then switch to floating rate of interest.

In all the above methods, the appropriation towards interest will be more and less for the principal at the beginning. However, the appropriation towards principal will be more than that of interest

Step-Up or Staggered Payment – Under this method, the initial instalment amount will be less and will be higher after sometime. This method is opted by borrowers when they are not able to pay more now and expect their income to grow in the future.
Step-Down Payment – This is opposite to Step-Up method where the instalment amount will be high during initial periods and will be lesser later. This type is preferred by those who expect reduction in their earnings viz., the people who are on the verge of retirement.
Bullet Payment – Under this method, the borrower agrees to make payment to the loan account in bulk over an agreed period viz., every quarter or half-year. This method is offered mostly by business people, professionals who used to get a lump sum amount and would prefer to reduce the cost of loan

Growth of Personal Loans in India

Refer RBI Bulletin on “Dynamics of Credit Growth in the Retail Segment:
Risk and Stability Concerns”

Reserve Bank of India – RBI Bulletin

Accounting

Chart of account:

Personal Loan Account: Asset: To Book and control loan outstanding
Overdue personal loan account: asset: To Book and control loan overdue outstanding
Commission on Personal loan: P&L: to book commission / charges earning on personal loan
Interest on Personal loan: P&L : to book interest earned on personal loan

Event: Journal Postings

Loan Disbursement

1. Dr Personal loan account
2. Cr Borrowers SB account or RTGS settlement a/c

Loan Collection

1. Dr: Customer A/c / Pool Account (Other bank Transfers/Collections)
2. Cr: Personal Loan (Asset)

Loan Overdue

- Overdue Loan (Transfer of Asset):
  1. Dr: Overdue Loan (Asset)
  2. Cr: Personal Loan (Asset)

Collection of Overdue Loan

1. Dr: Customer Account / Pool Account (Other bank Transfers/Collections)
2. Cr: Overdue Loan (Asset)

Loan Re-scheduling

1. Dr: Personal Loan (Asset)
2. Cr: Overdue Loan (Asset)

Interest Accrual

1. Dr: Interest Receivable
2. Cr: Interest Income (P&L)

Interest Recovery

1. Dr: Customer Account / Pool Account (Other bank Transfers/Collections)
2. Cr: Interest Receivable

Product Life Cycle Stages

Onboarding activities

Lead generation by Existing and New to bank customers via any of the channel
Submission of relevant documents
Application validation/screening for completeness and correctness of data

Underwriting activities

Underwriting – Check for Credit Score, Credit Bureau check and decide on either approve or reject the application

Disbursement activities

Documentation execution
Onboarding and account set up for NTB clients and account set up for ETB clients
Setting up of standing instruction / direct mandate (ENACH) collection from other banks
Amount disbursement as per instruction

Loan monitoring activities

Instalment / Amortization scheduling
Notification of instalment due to clients
Overdue follow up with clients
Recovery proceedings
Client queries, requests, complaints handling

Parties involved

DSA, Third party sales agencies
Applicant / Customer
Processing office
Credit approver
Recovery / collection agent
Monitoring authorities

Cloudbankin application

Application which supports personal term loan product

Glossary

Sl No	Term	Definition
1	EMI	Equated monthly instalments
2	RC	Revolving credit
3	CC	Credit Card
4	POS	Point of sale
5	ATM	Automated Teller Machine
6	NTB	New To Bank
7	ETB	Existing To Bank
8	DSA	Direct Selling Agent

04 Aug

A Comprehensive Guide to Personal Loan