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 as loans and advances on the basis of the purpose of a facility, tenure and repayment system, and nature of prime security available to the credit facility, etc.

The word ‘Loan’ refers to the sum paid to a borrower by the bank for the purpose of capital expenditure/capital investments such as the 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.

Advances are issued by banks to address short-term financial needs; they are repaid within one year. ‘Advances’ refer to working capital finance extended by the bank to meet day to day requirements of the borrower. The overdraft facility, drawing against uncleared effects, cash Credit facility, packing credit (running account) facilities; Bills finance facilities, credit card facilities, cheques purchase,  etc., are some examples of advances.

Difference between tenure of Loans and advances:

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

Unlike loan accounts, there is no fixed tenure to close the advances accounts. As long as the enterprise is a going concern and a healthy turnover is shown in the account, Bank would annually review and renew the limits. However, the 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 to sanction terms by the borrower.

The 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, or half-yearly installments over a period as fixed by the lender bank. The money once repaid in the 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, Bill finance is short-term and self-liquidating finance in nature, and the drawing power is restored each time an earlier bill is realized.  In fact, the borrower actually does not repay the principal amount borrowed under the 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 the necessary funds and he is allowed to use the funds up to the available drawing power* at any number of times.

Charge against Security:

The prime security offered by the borrower in case of ‘loans’ will remain the same and it cannot be changed till the loan is extinguished. In the 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 the specific property in the ordinary course of the business of the borrower.

*Sanctioned Limit and Drawing Power (DP):

A 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 sanctioned limit irrespective of the value of the stock held. The drawing power denotes the permissible value of the amount that can be drawn from the account. The drawing power of a CC account is calculated from the 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 the total stock to arrive at the net paid stock.  The net paid stock minus the margin fixed in the sanction (say 25%) will be the drawing power. However, drawing power cannot be more than a sanctioned limit. In bills finance, the sanctioned limit and drawing power are the same.

Originally posted on October 7, 2015, edited and reposted on 16.01.2023

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