Lending, Credit & Interest Rates: Revision and Practice

How the five lessons connect#

The credit system can be understood as one sequence:

Borrower needs finance
↓
Bank appraises repayment capacity
↓
Loan structure and security are chosen
↓
Facility may be fund-based or non-fund-based
↓
Rate = benchmark + spread
↓
Credit history affects underwriting and pricing
↓
Loan is monitored through its life
↓
Repayment closes the exposure — or stress can lead to Module 07

The central principle is:

Good lending is not simply "giving money against collateral". It is the disciplined assessment, pricing, structuring, monitoring and recovery of credit risk.

Common Confusions#

1. Loan vs credit facility#

Loan is one type of credit.

Credit facility is broader and includes BG/LC.

2. Sanction vs disbursement#

Sanction = approval.

Disbursement = actual release/use of funds.

3. Security vs repayment capacity#

Collateral is secondary support.

Primary repayment should normally come from income/cash flow.

4. Primary security vs collateral security#

Primary security directly relates to financed asset/business.

Collateral is additional support.

5. Pledge vs hypothecation#

Pledge = possession/control with lender.

Hypothecation = possession with borrower.

6. Hypothecation vs mortgage#

Hypothecation = movable assets.

Mortgage = immovable property.

7. Lien vs mortgage#

Lien = right of retention.

Mortgage = security interest in immovable property.

8. Guarantee vs collateral#

Guarantee = third-party promise.

Collateral = asset/security.

9. Fund-based vs non-fund-based#

Fund-based = money deployed immediately.

Non-fund-based = contingent commitment initially.

10. Bank guarantee vs letter of credit#

BG mainly pays on default/non-performance.

LC is a documentary payment mechanism in trade.

11. Fixed vs floating rate#

Fixed stays fixed under contract.

Floating resets with benchmark.

12. Repo rate vs retail loan rate#

Repo is a policy benchmark.

Retail loan rate = benchmark + spread/other permitted pricing components.

13. MCLR vs EBLR#

MCLR is internal benchmark.

EBLR uses external benchmark.

14. Base Rate vs MCLR#

Base Rate is older framework.

MCLR applies to later applicable loan cohorts.

15. Benchmark vs spread#

Benchmark reflects external/internal reference rate.

Spread reflects borrower/product risk and cost.

16. Interest rate vs APR#

Interest rate is one component.

APR reflects broader annualised cost including applicable charges.

17. Penal charges vs penal interest#

Penal charge = fee for non-compliance.

Penal interest = extra interest rate; RBI's fair-lending framework moved away from this approach.

18. Credit score vs credit report#

Score = number.

Report = detailed history.

19. Credit score vs credit rating#

Credit score = borrower/consumer creditworthiness indicator.

Credit rating = issuer/instrument assessment.

20. No credit history vs bad credit#

No history = limited data.

Bad history = adverse repayment behaviour.

21. Write-off vs waiver#

Write-off = lender accounting action.

Waiver = debt legally forgiven/relieved under applicable arrangement.

They are not the same.

Important Exam Facts to Revise#

1. Deposits are liabilities; loans are assets for banks.
2. Credit appraisal focuses primarily on repayment capacity.
3. Collateral is normally the secondary source of repayment.
4. Sanction and disbursement are separate stages.
5. Margin is the borrower's contribution.
6. LTV = loan amount ÷ asset value × 100.
7. Cash credit is a working-capital facility.
8. Overdraft allows drawings beyond account balance up to sanctioned limit.
9. Drawing power depends on eligible security/current assets after margin.
10. Secured loan has specific security; unsecured loan does not.
11. Pledge involves possession/control of movable goods with lender.
12. Hypothecation creates charge on movable asset without delivery of possession.
13. Mortgage creates security interest in immovable property.
14. Section 58 of Transfer of Property Act defines mortgage.
15. Section 171 of Indian Contract Act recognises general lien of bankers.
16. CERSAI registers security interests under the applicable framework.
17. Fund-based facilities deploy bank funds.
18. Non-fund-based facilities create contingent obligations.
19. Bank guarantee and letter of credit are classic non-fund-based facilities.
20. Non-fund exposure can become funded on invocation/crystallisation.
21. Financial guarantee supports payment obligation.
22. Performance guarantee supports contractual performance.
23. Loan rate generally consists of benchmark + spread.
24. MCLR stands for Marginal Cost of Funds based Lending Rate.
25. MCLR became applicable to relevant new floating loans from 1 April 2016.
26. External-benchmark framework began for specified retail/MSE floating loans from 1 October 2019.
27. Medium-enterprise floating loans joined the external-benchmark framework from 1 April 2020.
28. Permitted external benchmarks include RBI repo and specified FBIL Treasury Bill yields.
29. External-benchmark loans reset at least once every three months.
30. KFS improves transparency of loan terms and cost.
31. APR reflects annualised all-in loan cost under the framework.
32. Penal charges should not be capitalised.
33. RBI's fair-lending framework distinguishes penal charges from penal interest.
34. Floating-rate EMI personal-loan borrowers receive specified reset options under RBI rules.
35. Property documents must be released promptly after full repayment under responsible-lending rules.
36. CIC stands for Credit Information Company.
37. India has four major RBI-registered CICs: CIBIL, Equifax, Experian, CRIF High Mark.
38. RBI does not prescribe each CIC's credit-scoring formula.
39. Credit information reporting moved to fortnightly updating from January 2025.
40. Individuals can obtain one free full credit report including score per calendar year from a CIC holding their data.
41. Credit score is one input, not an approval guarantee.
42. A "settled" status differs from a fully "closed" loan.
43. Multiple enquiries can affect underwriting perception.
44. High utilisation can indicate higher credit risk.
45. A guarantor can also carry credit risk exposure.

Module Recap#

Lending is the bank's process of transforming funding into earning assets while controlling credit risk.

A sound loan process involves:

• application;
• appraisal;
• sanction;
• documentation;
• security;
• disbursement;
• monitoring;
• repayment.

Banks distinguish:

• term loan;
• cash credit;
• overdraft;
• bill finance;
• fund-based;
• non-fund-based credit.

Security can take forms such as:

• pledge;
• hypothecation;
• mortgage;
• lien;
• assignment;
• guarantee.

Modern loan pricing uses:

• internal benchmarks such as MCLR; and
• external benchmarks such as RBI repo/T-Bill yields for specified categories.

Final loan pricing reflects:

benchmark + spread

Fair-lending rules require:

• transparency;
• KFS/APR;
• proper penal-charge treatment;
• borrower communication;
• responsible document release.

Credit Information Companies create shared credit histories.

Credit scores improve underwriting, but they are only one factor among many.

Glossary#

Advance - Broad banking term for credit extended by a bank.

APR - Annual Percentage Rate; annualised cost of credit including interest and applicable charges under RBI's framework.

Assignment - Transfer of a receivable/right/policy interest to the lender as security.

Bank Guarantee - Bank commitment to pay a beneficiary if its customer fails to meet the guaranteed obligation.

Benchmark - Reference rate used as the base for loan pricing.

BPLR - Benchmark Prime Lending Rate, an older internal benchmark system.

Base Rate - Internal bank lending benchmark used for applicable floating-rate loans sanctioned/renewed between July 2010 and March 2016.

Cash Credit - Running working-capital facility allowing drawings within sanctioned limit/drawing power.

CERSAI - Central Registry of Securitisation Asset Reconstruction and Security Interest of India.

CIC - Credit Information Company.

CIR - Credit Information Report.

Collateral - Asset/security supporting a credit exposure, often used to mean additional/secondary security.

Credit Appraisal - Lender's assessment of borrower, repayment capacity and proposal.

Credit Facility - Any sanctioned lending/credit arrangement, including funded and non-funded facilities.

Credit Risk - Risk that borrower/counterparty fails to meet financial obligations.

Credit Score - Numerical indicator of borrower creditworthiness based on credit information/model.

Disbursement - Actual release/utilisation of sanctioned credit.

Drawing Power - Amount available for drawing under a working-capital facility based on eligible security/current assets and margin.

EBLR - External Benchmark Lending Rate.

EMI - Equated Monthly Instalment.

Fixed-Rate Loan - Loan with rate fixed under the contractual structure.

Floating-Rate Loan - Loan whose interest rate changes with a benchmark.

Fund-Based Facility - Credit facility involving actual deployment of bank funds.

Guarantee - Promise by guarantor to fulfil obligation if principal debtor fails.

Haircut - Reduction applied to collateral value for risk purposes.

Hypothecation - Charge over movable property without delivery of possession to lender.

KFS - Key Facts Statement.

Letter of Credit (LC) - Documentary bank undertaking supporting trade payment.

Lien - Right to retain property/security until obligation is discharged.

Loan-to-Value (LTV) - Loan amount relative to value of financed/security asset.

Margin - Borrower's contribution or security cushion.

MCLR - Marginal Cost of Funds based Lending Rate.

Mortgage - Transfer of an interest in specific immovable property to secure debt.

Non-Fund-Based Facility - Contingent credit exposure without initial cash deployment, such as BG/LC.

Overdraft - Facility allowing customer to draw beyond account balance up to sanctioned limit.

Penal Charge - Charge levied for non-compliance with material loan terms under the fair-lending framework.

Pledge - Bailment of goods as security, involving delivery/control of possession.

Primary Security - Asset directly financed or directly associated with the loan purpose.

Repo-Linked Loan - Loan using RBI policy repo rate as its external benchmark.

Sanction - Approval of a credit facility on stated terms.

Security Interest - Legal right/interest over property securing debt.

Spread - Margin added over benchmark to determine loan rate.

Term Loan - Loan for a fixed amount/tenor with defined repayment.

Underwriting - Process of assessing, pricing and deciding credit risk.

VRR/VRRR - Liquidity tools studied in Module 04; relevant indirectly through benchmark/funding conditions.

Practice MCQs - Module 06#

Questions#

1. For a bank, a loan is generally classified as:#

A. Liability
B. Asset
C. Capital
D. Deposit

2. The primary expected source of loan repayment should normally be:#

A. Sale of collateral
B. Borrower's sustainable income/cash flow
C. Deposit insurance
D. Government guarantee

3. Which stage comes before disbursement?#

A. Sanction/documentation
B. NPA write-off
C. DICGC claim
D. Demonetisation

4. Margin means:#

A. Bank's profit only
B. Borrower's contribution to asset/project cost
C. Loan interest rate
D. Credit bureau fee

5. LTV is:#

A. Loan ÷ asset value
B. Asset value ÷ loan
C. Interest ÷ EMI
D. Deposit ÷ loan

6. Which is mainly a working-capital facility?#

A. Cash credit
B. Home term loan
C. FCNR(B) deposit
D. Bank guarantee only

7. Drawing power is most closely associated with:#

A. Cash credit
B. Savings account
C. DICGC
D. SLR

8. Which is a secured loan?#

A. Home loan backed by mortgage
B. Unsecured personal loan
C. Credit card without collateral
D. Clean overdraft

9. Pledge is mainly associated with:#

A. Delivery/control of movable goods
B. Immovable property only
C. No security
D. Taxation

10. Hypothecation means:#

A. Transfer of land ownership
B. Charge over movable property without delivery of possession
C. Deposit insurance
D. Fixed deposit renewal

11. Mortgage mainly relates to:#

A. Movable goods
B. Immovable property
C. Credit score
D. Bank guarantee

12. General lien of bankers is recognised in:#

A. Indian Contract Act
B. RBI Act only
C. FEMA only
D. SEBI Act

13. CERSAI is associated with:#

A. Currency printing
B. Security-interest registration
C. Mutual fund NAV
D. Monetary policy voting

14. Which is fund-based?#

A. Term loan
B. Bank guarantee
C. Letter of credit
D. Performance guarantee

15. Which is non-fund-based?#

A. Cash credit
B. Overdraft
C. Bank guarantee
D. Term loan

16. A non-fund-based facility can:#

A. Never create cash outflow
B. Become funded if invoked/crystallised
C. Never create credit risk
D. Avoid appraisal

17. A financial guarantee mainly supports:#

A. Payment obligation
B. Share price
C. Inflation
D. Currency printing

18. A performance guarantee mainly supports:#

A. Contractual performance
B. Deposit interest
C. Credit score
D. DICGC

19. An LC is primarily associated with:#

A. Trade finance
B. Fixed deposits
C. CRR
D. Insurance

20. In an LC, banks deal primarily in:#

A. Goods
B. Documents
C. Factory inspection
D. Tax returns

21. The modern loan-pricing formula can be expressed as:#

A. Benchmark + spread
B. Deposit + CRR
C. Score + DICGC
D. LTV + SLR

22. MCLR stands for:#

A. Marginal Cost of Funds based Lending Rate
B. Market Credit Lending Reserve
C. Minimum Cash Lending Ratio
D. Monetary Credit Liquidity Rate

23. MCLR was introduced for applicable new floating-rate loans from:#

A. 2010
B. 2016
C. 2019
D. 2025

24. External benchmark rules for specified floating-rate retail/MSE loans began from:#

A. 1 October 2019
B. 1 April 2016
C. 1 July 2010
D. 1 January 2000

25. Floating-rate loans to Medium Enterprises entered external benchmarking from:#

A. April 2020
B. April 2010
C. January 2025
D. July 2016

26. Which can be an RBI-permitted external benchmark?#

A. RBI policy repo rate
B. Any customer's savings rate
C. Gold price selected by bank privately
D. Random branch rate

27. External benchmark-linked rates must reset at least:#

A. Daily
B. Once in three months
C. Once in ten years
D. Never

28. Spread mainly reflects:#

A. Credit/product risk and lender cost
B. Only RBI ownership
C. DICGC cover
D. CRR

29. APR is useful because it captures:#

A. Only nominal interest
B. Broader annualised cost including applicable charges
C. Only processing fee
D. Only penal charge

30. KFS stands for:#

A. Key Facts Statement
B. Key Funding Standard
C. Known Financial Score
D. Key Forex Schedule

31. RBI's fair-lending framework requires penalty for loan-term non-compliance generally to be levied as:#

A. Penal charges
B. Additional penal interest capitalised monthly
C. Equity
D. CRR

32. Penal charges should:#

A. Be capitalised and earn interest
B. Not be capitalised
C. Be hidden
D. Be set by borrower

33. Floating-rate EMI personal-loan reset rules require borrower communication regarding:#

A. EMI/tenor impact and permitted options
B. Only bank profit
C. DICGC premium
D. Share prices

34. After full repayment/settlement of a personal secured loan, original property documents should be:#

A. Retained indefinitely
B. Released according to RBI responsible-lending timeline
C. Sent to SEBI
D. Destroyed

35. CIC stands for:#

A. Credit Information Company
B. Credit Insurance Corporation
C. Current Interest Council
D. Cash Information Centre

36. Which is an RBI-registered CIC?#

A. TransUnion CIBIL
B. NSE
C. IRDAI
D. DICGC

37. How many major RBI-registered CICs are commonly recognised?#

A. 2
B. 3
C. 4
D. 10

38. RBI prescribes the exact scoring formula for all CICs:#

A. True
B. False

39. Credit Information Report is:#

A. A detailed borrower credit-history report
B. Only a three-digit score
C. Tax return
D. Bank balance sheet

40. A credit score is:#

A. Guarantee of approval
B. Risk indicator used with other factors
C. Deposit-insurance limit
D. Repo rate

41. From January 2025, credit-information updating moved to:#

A. Annual
B. Quarterly
C. Fortnightly
D. Once in five years

42. An individual is entitled to a free full credit report from a CIC:#

A. Once per calendar year, subject to holding of data
B. Never
C. Only after default
D. Only through a bank manager

43. "Settled" loan status usually means:#

A. Fully repaid exactly as contracted
B. Lender accepted less than full contractual dues under settlement
C. No loan existed
D. Deposit insurance was paid

44. High credit-card utilisation can:#

A. Be a risk signal
B. Automatically improve score
C. Eliminate debt
D. Increase DICGC cover

45. Which sequence best represents lending?#

A. Appraisal → sanction → documentation → disbursement → monitoring → repayment
B. Repo → inflation → FD → DICGC
C. Deposit → coin → UPI → insurance
D. KYC → budget → SEBI → mortgage

Answers and Explanations#

1. B — Asset.
Loans are earning assets on a bank's balance sheet.

2. B — Borrower's sustainable income/cash flow.
Collateral is secondary protection.

3. A — Sanction/documentation.

4. B — Borrower's contribution.

5. A — Loan ÷ asset value.

6. A — Cash credit.

7. A — Cash credit.

8. A — Home loan backed by mortgage.

9. A — Delivery/control of movable goods.

10. B — Charge over movable property without possession transfer.

11. B — Immovable property.

12. A — Indian Contract Act.

13. B — Security-interest registration.

14. A — Term loan.

15. C — Bank guarantee.

16. B — Become funded on invocation/crystallisation.

17. A — Payment obligation.

18. A — Contractual performance.

19. A — Trade finance.

20. B — Documents.

21. A — Benchmark + spread.

22. A — Marginal Cost of Funds based Lending Rate.

23. B — 2016.

24. A — 1 October 2019.

25. A — April 2020.

26. A — RBI policy repo rate.

27. B — Once in three months.

28. A — Credit/product risk and lender cost.

29. B — Broader annualised cost including applicable charges.

30. A — Key Facts Statement.

31. A — Penal charges.

32. B — Not be capitalised.

33. A — EMI/tenor impact and permitted options.

34. B — Released according to RBI timeline.

35. A — Credit Information Company.

36. A — TransUnion CIBIL.

37. C — Four.

38. B — False.
Scoring models are proprietary.

39. A — Detailed borrower credit-history report.

40. B — Risk indicator used with other factors.

41. C — Fortnightly.

42. A — Once per calendar year from each CIC holding the person's data.

43. B — Lender accepted less than full contractual dues.

44. A — It can be a risk signal.

45. A — Appraisal → sanction → documentation → disbursement → monitoring → repayment.

Official Sources and Further Reading#

The module is based primarily on RBI and India Code materials. Loan pricing, fair-conduct and credit-reporting rules should be reviewed when RBI issues amendments.

Source 1 - RBI Master Direction: Interest Rate on Advances#

https://systemhealth.rbi.org.in/Scripts/BS_ViewMasDirections.aspx_id%3D10295.html

Used for:

• fixed/floating loan framework;
• Base Rate;
• MCLR;
• external benchmark;
• reset rules;
• benchmark + spread;
• exemptions.

Source 2 - RBI Handbook on Regulations at a Glance#

https://website.rbi.org.in/documents/d/rbi/handbookg27022025d0f3f53f5d3c4310a6bb2f8ac2175d3a

Used for:

• concise current regulatory summary;
• external benchmark applicability;
• MCLR;
• KFS;
• fair lending;
• responsible lending;
• guarantees and non-fund-based facilities.

Source 3 - RBI Master Circular - Guarantees and Co-acceptances#

https://www.rbi.org.in/Scripts/BS_CircularIndexDisplay.aspx?Id=12644

Used for:

• guarantee business;
• financial/performance guarantees;
• non-fund-based risk;
• letters of credit;
• co-acceptances.

Source 4 - RBI Fair Lending Practice - Penal Charges in Loan Accounts#

https://systemhealth.rbi.org.in/Scripts/NotificationUser.aspx_Id%3D12527%26Mode%3D0%281%29.html

Used for:

• penal charges;
• no capitalisation of penal charges;
• disclosure requirements.

Source 5 - RBI Reset of Floating Interest Rate on EMI-based Personal Loans#

https://www.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=12529

FAQ:

https://www.rbi.org.in/scripts/FAQView.aspx/FAQView.aspx/FAQView.aspx?Id=170

Used for:

• EMI/tenor reset;
• fixed-rate switch;
• prepayment option;
• borrower communication.

Source 6 - RBI Responsible Lending Conduct - Release of Property Documents#

https://systemhealth.rbi.org.in/Scripts/NotificationUser.aspx_Id%3D12535%26Mode%3D0.html

Used for:

• release of original documents;
• charge satisfaction;
• lender delay compensation framework.

Source 7 - RBI Credit Information Reporting / Reporting Frequency#

https://systemhealth.rbi.org.in/Scripts/FS_Notification.aspx_Id%3D12718%26fn%3D2755%26Mode%3D0.html

Used for:

• fortnightly reporting from January 2025;
• currentness of CIR data.

Source 8 - RBI Credit Information / Registered CICs#

https://www.rbi.org.in/Scripts/bs_viewmascirculardetails.aspx?id=9913

Used for:

• TransUnion CIBIL;
• Equifax;
• Experian;
• CRIF High Mark;
• use of CIR in lending.

Source 9 - RBI Financial Awareness Messages - Credit Scores#

https://www.rbi.org.in/commonman/images/FAME202426022024.pdf

Used for:

• definition of credit score;
• importance in lending;
• one free credit report;
• credit-report correction.

Source 10 - RBI Free Annual Credit Report#

https://rbi.org.in/commonperson/English/Scripts/Notification.aspx?Id=1884

Used for:

• one free full credit report including score per calendar year.

Source 11 - RBI RTI / Credit Score Methodology Clarification#

https://www.rbi.org.in/Scripts/bs_viewcontent.aspx?Id=624

Used for:

• RBI does not prescribe the proprietary scoring methodology used by CICs.

Source 12 - Indian Contract Act, 1872#

https://www.indiacode.nic.in/handle/123456789/12845

Used for:

• pledge;
• banker's lien.

Source 13 - Transfer of Property Act, 1882#

https://www.indiacode.nic.in/bitstream/123456789/14648/1/tpa.pdf

Used for:

• mortgage definition;
• types of mortgage.

Source 14 - SARFAESI Act, 2002#

https://www.indiacode.nic.in/bitstream/123456789/2006/1/A2002-54.pdf

Used for:

• hypothecation definition;
• security-interest framework.

Source policy for this module#

Use RBI and statutory sources for lending rules.

Do not treat:

• loan-comparison websites;
• bank advertisements;
• fintech marketing pages;
• coaching notes

as authoritative for regulatory facts.