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What is the difference between loans and advances?

In general terms loans and advances are synonyms for fund based credit facilities. However, they are differentiated by the banks on the basis of the purpose of  a facility, tenure and repayment system and nature of prime security available to the credit facility etc.

In banking parlance, the word ‘Loan’ refer to sum paid to a borrower by the bank for the purpose of capital expenditure/capital investments such as purchase of land and building, Plant and machinery, furniture and fixture, office equipment, motor vehicles, purchase of Consumer Durables, crop loans, Clean Loans, Jewel Loan, Pensioners Loan, etc. Whereas ‘Advances’ refer to working capital finance extended by the bank to meet day to day requirements of the borrower. Cash Credit facility, packing credit (running account) facility; Bills finance facility etc., are some of the examples of advances.

Difference between tenure of Loans and advances:

The loans can be classified as demand loans and term loans based on nature of loan. Demand loans are mostly the secured loans repayable on demand. These loans are generally granted against securities like term deposits, NSC, LIC policies etc. The term loans are usually classified as short term, medium term and long term loans. The short-term loans (ex: crop loans) have tenure of one year; medium-term loans (Ex: retail loans) between one and three years. The maximum maturity for a long term loan including moratorium is normally 10 years and in exceptional cases 15 years (Ex: loans for infrastructure development, loans for acquiring Plant and machinery etc.). The home loans are considered for a term up to 30 years which depends upon the age of the borrower and borrower’s source of repayment.

Unlike loan account, there is no fixed tenure to close the advances accounts. As long as the enterprise is a going concern and the healthy turnover is shown in the account, Bank would annually review and renew the limits. However, bank has the right not to renew the limit and it can also recall the advance amount from the borrower if it has noticed irregularities in the account or non-adherence of sanction terms by the borrower.

Difference in repayment schedules:

The loan amount along with the interest shall be repaid by the borrower in one lump-sum (normally for demand loans) or in monthly, quarterly, half yearly installments over a period as fixed by the lender bank. The money once repaid in loan account cannot be withdrawn again from the same account; the borrower has to apply for a new loan if required.

Unlike a normal loan, there is no fixed repayment schedule for cash credit accounts. Similarly, Bills finance is short term and self- liquidating finance in nature and the drawing power is restored each time earlier bill is realized.  In fact, the borrower actually does not repay the principal amount borrowed under Cash Credit facility; only interest debited to the account is to be serviced. The borrower can remit the funds to the account as and when he has necessary funds and he is allowed to use the funds up to the available drawing power* at any number of time.

Charge against Security:

The prime security offered by the borrower in case of ‘loans’ will remain same and it cannot be changed till the loan is extinguished. In case of advances, the  securities offered by the borrower in the form of stocks and receivables to the banks are floating (changing) in nature i.e. subject to change in quantity and value rather than fixing on specific property in the ordinary course of the business of the borrower.

*Sanctioned Limit and Drawing Power (DP):

Sanctioned limit in a CC account means the maximum amount that can be withdrawn by the borrower from the account. The borrower cannot draw funds beyond the sanction limit irrespective of the value of the stock held. The drawing power denotes the permissible value of amount that can be drawn from the account. The drawing power of a CC account is calculated from value of the total stock held as per the latest periodic stock statement submitted by the borrower. The value of unpaid stock and obsolete stocks is deducted from total stock to arrive the net paid stock.  The net paid stock minus margin fixed in the sanction (say 25%) will be the drawing power. However drawing power cannot be more than sanctioned limit. In bills finance the sanctioned limit and drawing power are same.

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