Loan against stock exchange securities

Loan against stock exchange securities

The following are the drawbacks of advancing money against stock- exchange securities :

(i) Liability to pay in case of partly-up shares. In case partly paid shares have been transferred in the banker’s name and the company makes a call, the banker will have to make payment of such a call.

(ii) Company’s lien: The articles of the companies generally provide that the company will have a right of lien on its shares for any call due on them or any money due by the shareholder to the company. However, his right of lien will not be available to the company against such debts which the company might have contracted after receipt of notice of pledge from the bank. But in case the bank fails to give notice or there are already large debts outstanding against the debtor in favour of the company, the banker’s interests will be adversely affected.

(iii) Forgery:The bank may suffer loss on account of forgery committed by the borrower, e.g.. the transferor’s signatures may have been forged or the original as well as duplicate copy of the same certificate might have been pledged with different bankers by the borrower. In case the shares have been registered in the name of the bank on the basis of forged signatures of the transferor, the banker is liable to the company for any loss suffered by it. This liability continues even in cases where the banker (the transferee) has subsequently sold shares.

(iv) Fluctuations in prices: The bank may have to suffer loss in case there are violent fluctuations in the value of the securities and it has not kept adequate margin.

Precautions to be taken

The drawbacks listed above are mainly in respect of corporate securities. The bank can protect its interest if takes the following precautions :

1. Selection of the securities: The task of the selection of corporate securities is profaned by the Head Office of the bank. A list of such securities is prepared and sent to every branch of the bank. The bank should not grant loan on a corporate security which is not included in the list unless the consent of the Head Office is obtained. While selecting such securities for inclusion in the list, the following factors are considered :

(a) Nature of company’s business: The type of business activity, its importance in the national economy, its future prospects and the company’s position in that industry, etc., are factors which should be examined. In case they are all favourable, the compat1y’s security can be rated high.

(b) Company’s management: In case the company is being managed by persons of proven competence, integrity and honesty, the banker can take it as a plus point for inclusion of the security in its list.

(c) Past-working results. The past performance of the company in tenns of production, sales, profits, dividends, etc., can be suitable basis for performance of the company in future. The various accounting ratios based on previous income statements and balance sheets will help the bank in ascertaining the financial position of the company.

(d) Market trends in values of the shares of the company. The ends invalue of the shares of the company are indicators of the value of company’s shares in future. The bank can also judge about the stability in the values of the company’s shares on the basis of such trends.

2. Valuation of securities: ll1e valuation of corporate securities dealt on stock exchange can be done on the basis of daily stock exchange quotations.

However, the bank should also calculate the break-up value’ of the shares. While valuing these securities in case they are quoted cum-dividend or com- interest, the amount of dividend or interest included in the price should be subtracted.

  1. 3. Creation or charge: The banker should finally get the securities charged in its favour. Such charge can be created in either of the two ways :

(i) By giving a legal title

(ii) By creating an equitable title.

 

Legal Title. In case of legal title the securities transferred by the borrower to the bank in its name. l1le name of the banks or its nominee replaces the name of the borrower in the company’s records. The borrower usually does not prefer a legal mortgage on account of following reasons:

(i) The transfer and retransfer of securities involve costs in terms of stamp duty which has to be borne by him.

(ii) The reputation of the borrower is lowered because the fact of charging the security becomes public.

(iii) The borrower is deprived of voting and other rights attached to the securities for the period they stand in the name of the bank. In case the borrower was holding directorship of a company on the basis of these shares, he may lose that also.

Equitable. In case of an equitable charge the borrower transfers the equitable title to the securities in favour of the bank by depositing the securities with it. The securities continue to stand in the borrower’s name in company’s records. The equitable charge may be created by any of the following methods :

(i) By mere deposit of securities: Mere deposit of securities with the banker with the intention of creating a charge in favour of the bank is riot very , popular with the banks on account of likely complications that may arise in , the absence of any written document.

(i) By memorandum of deposit: The bank may obtain from the borrower a memorandum stating that :

(a) the securities mentioned therein have been deposited by the borrower as security for the loan obtained from the bank.

(b) the bank will be entitled to sell the securities in the event of failure of the borrower to make repayment as per terms of agreement.

(c) the banker will be entitled to debit the borrower’s account with any, amount that it might have to pay towards payment of call on securities (in the event of their being partly paid-up),

The memorandum duly signed by the borrower will be handed over by him to the bank together with the securities.

(iii) By blank transfer: The customer may be required to deposit with the bank together with blank transfer forms duly signed by him. In case of blank transfer the name of the transferee is not filled in the form. The advantage of such a transfer is that the bank may at any time fill its own name or that of any I other person to whom it has sold the securities for recovering the loan. The bank or such other person can get legal title to the securities by sending the transfer form duly filled in together with securities to the company for registration.

(iv) By power of attorney: The bank may get executed from their customers in respect of securities deposited, special powers of attorney either in its own favour or in favour of its nominees. The power of attorney will empower the bank or its no1ninees to deal in the securities so deposited on behalf of the customers. The power of attorney will protect the banker from all possible risks. The second and third methods of creating equitable charge are more popular with the banks.

 

Risks in case or equitable charge

(i) Existence of prior equitable title: An equitable charge becomes defective by a prior equitable charge or a subsequent legal charge.

(ii) Company’s right of lien: In case the articles give the company right of lien on its shares, it will have an adverse effect on banker’s right of equitable charge.

(iii) Absence of information to the bank : Since the borrower continues to be the registered holder of shares, he gets every information regarding issue of bonus shares, company’s meetings, issue of right shares etc. The borrower may get bonus shares and may sell them directly. Thus, the banker’s security is reduced. Precautions to be taken by the banker in case of an equitable charge

I. The banker should generally accept only such shares under equitable charge which are in the borrower’s name. In case shares in the name of the person other than the borrower are accepted, the banker should get a blank transfer form duly signed by the registered holder in the presence of a bank’s official. In addition to that the banker should obtain a certificate signed by the registered holder declaring that he had authorized the borrower to pledge his shares with the bank.

  1. The bank should give a notice to the company intimating about its charge over the company’s shares. This will help the bank in three ways:

(a) the company will let the bank know about any prior charge ;

(b) the bank will have priority over any subsequent advance which the company might make to the borrower ;

(c) this will prevent the company from issuing a duplicate share certificate to the borrower .

3. In no case the bank should part with the possession of the shares or debenture certificates. This is necessary to protect the banker against any legal charge which the borrower may create against such securities.

4. The banker should accept the securities in good faith. In other words, are should be no reasonable cause to arouse banker’s suspicion about the title of the borrower to the securities.

5. The bank should obtain in the Memorandum the power of selling the securities in case the need arises.

6. The banker should also obtain from the borrower a mandate addressed to the company directing it to pay dividends to the bank in respect of the shares over which it has an equitable charge.

7. The limit for sanction of advances against shares by a bank to an individual has been fixed-at Tk.10 lac.

The banks generally accept equitable charge on securities when each the following conditions is satisfied:

i. The customer is of high integrity.

ii. The advance is not of a high amount.

iii. The advance is for a temporary period.

iv. The constituents of the shares deposited change frequently.

 

Documents

  1. Application for credit
  2. Accepted copy of sanction letter
  3. D. P. note
  4. Letter of arrangement.
  5. Share certificate alongwith TF. 117 duly filled in, signed & verified.
  6. Letter of lien signed by the borrower.
  7. Confirmation letter of registration of lien.
  8. Letter of continuity.
  9. Memorandum of deposit of securities.
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