Credit Preferences

The credit preference of a bank mainly depends upon the size of the bank and the state of the economy. Banks in developed countries have different trends and considerations while those in developing and underdeveloped countries have other preferences. Banks with high book sizes in a developed economy may extend credit and other services to the corporate sector for expansion, modernization, innovations, energy, Real Estate, and external credit. These may be categorized as wholesale banks. Banks with comparatively small book sizes may extend credit to Housing, agriculture, mortgage loans, and consumer financing. These may be categorized as retail banking.

Banks in developing and underdeveloped countries are by default small in size and cater to most development projects, international trade, small and medium enterprises, housing finance, and consumer loans. Credit card is a common feature of all types of banks. The mix of a credit portfolio is also different concerning the size of the bank and the economy and area in which the bank operates.

Commercial bank extends credit in different types and form for different purposes. Bank credit for the majority of customers is the primary source of available debt financing. Bank's good loans are the most profitable assets. Like any other investment, extending a loan to a business or individual involves taking a risk, and risk leads to earning a return. Bank's income comes from three sources i.e. Interest income, fee income, and investment income. Interest income is the largest chunk of total income which comes from loan interest. Banks also use loans to cross-sell other fee-generating services. The most prominent function of extending credit can assume a high risk in the form of loan defaults. Banks are not always on the good side of the economy and do not earn positive income over the period. Since banks, credit also fluctuates with seasonal and cyclic changes in the economy, during the recession and depressed economic cycle the economic activities are contracted, and chances of default increase. Banks' income is affected negatively. To address such a situation banks set aside an amount of profit as a reserve to meet the losses.

Banks' credit preference for various sectors of the economy varies with the size of a bank. With the exception, banks' loan-to-assets ratio generally increases with the bank size. The range is from 55% for banks with small book sizes and 65% for banks with bigger book sizes. Real estate loans represent the largest single loan category for all banks. Real estate loans for residential buildings for families mostly mortgages, contribute the largest amount. Commercial and industrial loans represent the second highest concentration of loans in books of the bank with big sizes but contribute less in other sectors. Agriculture loans make up a significant portion of the credit portfolio of small banks. Big bank contribution is negligible in this sector. Consumer expenditure financing represents less than 15%. Loans to other financial institutions, international finance, personal and wealth management, underwriting bonds, and syndications are common only with big banks in big and stable economies. Conversely during the economic boom banks make good money by extending credit to the sector of the economy where expectations of development are high.

In banks in underdeveloped countries and economies, the credit mix is different as these follow the policies of govt. Such economies concentrate on employment, the development of basic infrastructure, education, health, communication, and the development of small and medium-sized enterprises. The major portion of the credit portfolio of these banks contains commercial and trade-related financing. Financing imports of raw materials and machinery, housing finance, agriculture, and consumer expenditure are financed.