Security against Loan
Normally a banker does not lend money without adequate security. Security is meant to be an insurance against the money lended. The different types of securities which may be offered to a banker generally are as follows:
(i) Immovable properties
(ii) Movable properties
(c) Stock exchange securities
(d) Life insurance policies
(e) Fixed deposit receipts
(f) Book debts
(g) Supply bills
However, securities may also be classified as personal and tangible, as well as primary and collateral which are discussed below:
Personal and Tangible Security:
In all advances the bank has a right of action against borrower personally; Although the borrower’s personal liability is presumed, the banker by. way of abundant caution takes from him a demand promissory note, a bill of exchange or a bond, as the case may be. In certain cases, the bank requires, in addition, the guarantee of a respectable third party as personal security. Tangible security is something that can be realized from the sale or transfer. Shares, stocks, land, goods life policies are examples of tangible security, Where the debt is not fully realized from the sale of the tangible security, the bank has usually a right of action in law to recover the balance from the borrower’s other assets.
Primary and Collateral Security:
Primary security is that which is regarded as the main cover for an advance and is deposited by the borrower himself. The term collateral security is applied to security deposited by a third party to secure a customer’s borrowing. If, for example, A deposits shares belonging to him as security in his overdraft account, the shares will be considered as primary security. In case a third party, say B, deposits his shares as security in the overdraft account of A, to secure the bank’s advance made to A, such shares deposited by B will be considered as collateral security. This is the correct sense in which the term collateral security is ordinarily understood by bankers. There is an advantage in accepting collateral security from a third person. The banker may defer sale of the collateral security till he has exhausted all remedies for the recovery of the debit from the customer. In case the customer goes into insolvency, the banker can prove for the full amount of the debt against the assets of the debtor and after receiving his share of dividend from the estate, fall back on the collateral security for the deficiency, if any, if however, the banker has to realize it before claiming the balance from the debtor’s estate. In this case, therefore, if the dividend received from the official receiver in insolvency does not cover the balance due to the banker, he will have to suffer a loss. In the other case, the banker can recover the balance, if any, out of the sale proceeds of the collateral security.
Attributes of a good tangible security: There are certain qualities which a good tangible security should possess. Some of the important attributes are given below:
As security is obtained for the purpose of meeting an emergency in the event of default by the borrower, the main consideration which weighs with the banker is its ready marketability. Articles of necessity, primary commodities, seasonal goods, raw materials, textiles or other manufactured goods in general demand, afford good examples of marketable securities. Articles of luxury or valuables which appeal to only a small section of society have a limited market. For example, pearls and diamonds are not considered good security. A rich business magnate may have spent Tk.50 lacs on the construction of a palatial bungalow at an out-of-the-way hill station. The building may not be a good security at all, as in the event of a forced sales, there may be hardly, any purchaser at a reasonable price. Similarly, a building in the occupation of tenants would not be as marketable as a vacant building. Under the present tenancy laws, rents can hardly be increased and the tenants cannot be evicted except through a long-drawn-out legal process. The bank should be able to realize the security quickly and without undue formality, should the occasion demand. This is also the reason why banks prefer to advance against quoted and fully paid shares of good public limited companies and do not lend against unquoted shares, or shares of private limited companies.
b. Easy ascertainment of value: There are certain goods and commodities for which market quotations are easily available, such as shares which are dealt on the stock exchanges or commodities for which there are organized markets, for example, sugar, oilseeds, grains, etc. A reference to the commercial columns of any standard newspaper would enable the banker to obtain the day-to-day quotations prevailing in the markets for different types of securities or commodities.
There may be some articles which are rarely quoted to make be so highly specialized that it may not be possible to make an easy assessment of their value except by making a reference to an expert. It may not be possible to ascertain the exact value of certain articles such as paintings by old masters, buildings located in out-of-the-way places, highly specialized machines, etc.
c. Stability of value: It is not enough that the banker is able to ascertain the value of a particular security. He must also make sure that its value does not fluctuate violently over short periods. Due to the activities of speculators, commodities like pepper and yam are sometimes subject to such heavy variations in prices, that they are accepted as security only with a higher margin.
c. Storability: In the case of pledge, the security, if acceptable, should be capable of being stored in a godown or elsewhere so that it can be safely kept in the custody of the banker and it should be possible for him to supervise it. Securities such as timber floating on rivers, and iron ore near the mines present peculiar problems of storage and supervision. The same considerations apply to goods which cannot be stored except in air-conditioned godowns.
Films and certain chemicals are examples on the point. There may be goods and materials which cannot be stored except at considerable risk to other goods stored in the same godown. These also do not constitute a good security. A similar consideration applies to patent medicines which have an expiry date. Advances against such securities are made only to parties of undoubted means and reputation, generally with a fairly high margin, and after taking proper precautions.
A typical example is that of a bank financing Kolhapuri chappals manufactured by a firm for exports. The firm defaulted and the bank took the goods under pledge. It had to wait for a prolonged time before the decree could be obtained from the court in the usual manner. When the time came for sale of security, it was found that the chappals had become a pulp owing to atmospheric reaction with the chemicals.
e. Cost and labour of supervision: Other things being equal, the banker will prefer a security where very little supervision is involved. He will, for instance, prefer a reliable warehouse-keeper’s transferable receipt as security, to goods stored under his own lock and key. In the latter case, he will have to attend to a number of points e.g. proper conditions of storage, honesty of the godown keeper, custody of keys, display of bank’s name plate, periodical inspection, insurance, etc. For the same reasons, he would advance against Government securities or fully paid quoted shares, in preference to goods like kapas and cotton in godowns, which require consta.1t supervision and control.
f. Transportability: A security should be of such a nature that it can be moved from one place to another without much difficulty. For instance, if cloth bales of certain varieties are not easily marketable in one place and it is possible to find a ready market for them in another place, they can be railed to the other place where they can be easily disposed off. If, on the other hand, the security comprises heavy girders or machinery, it is not easy to transport them to some other place for sale as in the case of cloth bales.
g. Durability: A security should reasonably durable. Articles such as vegetables, fruits and mutton which are easily perishable unless stored under refrigeration, may not be suitable securities. Their cost may not justify the special storage arrangements. Gur, chillies, woollen cloth, etc., require special care in storage; otherwise they depreciate in quality. There are also a few types of grains and oilseeds which can last only for one or two seasons and have to be disposed off before they deteriorate by lapse of time. There are other commodities such as metals and iron and steel goods which do not deteriorate much in quality for many years. These aspects are also kept in view by a banker when making an advance against such goods.
h. Ascertainment of title: It should be possible for the banker to know that the time borrower’s title to the security is clear and undisputed. It has, therefore, to be verified if there are any other interests in the security such as prior charges or encumbrances thereon. It may be a case of house property in which a number of members of a joint Hindu family have interest, or a valuable piece of land over which there is a prior charge.
In such cases, complications may arise when a banker proceeds to realize the security. There is also one more reason why banks do not usually entertain mortgage loans. The solicitors have to verify the title of the borrower to the property. Even after that is done, litigation may arise because a certain point was inadvertently omitted or an enquiry was not made relating to the claims of one or more persons to the property.
i. Easy transfer of title: The transfer of title of a security should not be difficult if occasion demands it. In case of shares accompanied by relative transfer deeds, it is easy to get them transferred to the bank’s name. The shares can also be easily sold in the case of house property mortgaged to the bank, where an elaborate legal process will have to be gone through before its sale could be effected through a court of law.
j. Absence of contingent liability: A security which carries with it an onerous liability as in the case of partly paid shares, or immovable property where taxes are heavily in arrears, cannot be considered a suitable security. In the event of the need for sale of the security, the liabilities attached to it might either impair the changes of its sale or increase the burden of the debt at the time when possibly it is least desired.
k. Yield: In addition to all above qualities, if a security is a source of repayment of capital and interest either wholly or in part. For example, if the security consists of highly marketable shares on which substantial dividend is regularly received, the banker can take a mandate to collect the dividends and appropriate them in reduction from time to time of the indebtedness in the overdraft account. In actual practice, hardly any security possesses all the desirable attributes mentioned above and such defects as exist in the security are sometimes covered by taking a higher margin or insisting on other safeguards, say, a guarantee.
Margin: A bank does not meet cent per cent the requirements of a borrower. The borrower should have some stake in the business. In that case, he will devote more time and effort to make the business a success than may be in the case when he is dealing entirely with borrowed funds. Margin on securities is also maintained as a cushion against fluctuations in value of securities, a shortage which may not be discovered by inspection or shrinkage which may arise on account of the nature of the goods charged. Again, in case a borrower makes default in payment of the bank’s dues, the bank may have to takes steps to sell the security after giving an appropriate notice to him. In case of forced sale, the .security may not sell for its full value. To provide for such eventualities, the banker keeps a margin. The difference between the value of the securities and the amount up to which the borrower can draw is known as margin. The value of securities, less margin, is known as drawable limit or advance value.
A banker must keep adequate margin while granting loans because of the following reasons:
(a) The market value of the security is subject to fluctuations. In case of a fall in the value of the security, the interests of the bank are safe if there is an adequate margin.
(b) The security remains the same while advance against the borrower may go on increasing on account of non-payment of interest, charges etc.
Factors determining margin: The margin to be kept by a banker in respect of a particular security depends on several factors. Some of them are follows:
(i) Fluctuations in market prices: A banker will have to keep a larger margin in case of commodities whose prices are subject to greater fluctuations in comparison to the goods which have more or less a steady demand.
(ii) Financial soundness: In case of parties which are financially sound, a banker may keep a lower margin. Similarly in case of securities of goods companies a lower margin may do.
(iii) Central Bank’s control: In case of commodities which are subject to Central Bank’s selective credit control the banker has to keep margin in accordance with the directions of the Central Bank.
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