Security- Concept & Types Characteristics of good Security
Proper Valuation of Security
- One of the most important functions of a bank is to employ its fund by way of Investments/loans and advances to its customers and a bank’s strength depends considerably on the quality of its Investments/loans and advances.
- Though the banks are now expected to lay greater emphasis on the purpose for which the customer needs Investments/loans and advances rather than security he can afford to give, security continues to be one of the most important factors which determines to a significant extent the banker’s willingness to invest/lend money. Most of the Investments/loans and advances granted by banks are secured against varied types of assets.
- Banks take/borrow money/fund/deposit from the people without security.
- Banks don’t usually invest/deploy money/fund/deposit to the people without security.
A security is an interest or a right in property given to the bank/FI/creditor/investor to convert it into cash in case the Investment customer/ debtor fails to meet the principal and profit/charge/ interest on Investment/ loan within the stipulated time. The bankers hold various kinds of securities as a cover of investment exposures/advances to their customers. The securities offered to the banks vary in qualities.
- Security is obtained as a line of last defense to fall back upon. It is meant to be an insurance against emergency.
Basically, there are two types of securities available to Banks to secure an Investment/ loan. They are-
- Primary security and
- Collateral security.
i) Primary Security:
It refers to the asset directly created out of Bank finance. For example, where a Bank finances the purchase of a home, the home is the primary security. In the same way, a car purchased with the help of a Bank Investment/loan, is the primary security for that loan. Further in the case of working capital Investment/loan, “stock and book debts” is considered as primary security and in case of trading, it is trading stock. Bank creates a charge against this primary security, to secure its Investment/loan. This charge gives the Bank the legal authority to dispose of the asset, and apply the proceeds there from to the Investment/loan amount in default.
ii) Collateral Security:
It refers to certain additional security obtained by the Bank to secure the Investment/loan. For example, a Bank has financed the purchase of rice for trading. This stock of rice would be the primary security for the Investment/loan. In addition, the Bank may obtain collateral security in the form of residential flat owned by the proprietor, as additional security. This will guard Bank’s interests in the event of the primary security not having sufficient value to liquidate the Investment/loan. Sometimes, on account of adverse market conditions, the value of the primary security gets eroded, exposing the Bank to a higher risk than it had originally dealt for.
Support (Guarantee): Additionally, Investment/ loan can also be secured with the help of personal security of other individual/company/ borrower himself. It happens through charging of guarantor’s Intangible assets (Goodwill), if above two securities fails to cover the exposures.
Margin: In case of non-funded business, i.e payment undertaking on behalf of the client [LC, BG etc.], the bank usually takes cash in full or part to mitigate the inherent risk; which is called margin.
Post Dated Cheque: Post dated cheque is also widely used as security for repayment of loan/investment.
- The ownership of the security, whatever it is movable or immovable, must be undisputed.
- The possession also be undisputed.
- It should be controllable as per norms of different method of charging the security.
- Problems in documentation
- The customer is able to influence legal process.
- Difficulty in evicting unlawful occupants.
- Easily encashable without/with minimum loss of value.
- Liquidation of security takes longer period.
- Security is highly specialized.
- The borrower has influence over potential buyers.
- Identification must be confirmed.
- The property must be un-encumbered.
- It must be covered to the exposures.
- Security is perishable.
- Security becomes obsolete.
- Product has been customized for customer (i.e. tailor made suit.)
- The property is emotionally related with the borrower.
PROPER VALUATION OF SECURITY (PHYSICAL AND FINANCIAL)
(i) Physical:
a) Land, Building & Heavy Machineries
b) Goods/Inventory Pledge with Bank
c) Gold/Gold Ornaments Pledge with Bank
Characteristics of good Security
Land, Building & Heavy Machineries:
- Ownership & Rigidity
- Factors influencing valuation
- Distressed Value is considered
- Revaluation
- Review
1) Ownership & Rigidity:
All Land, Building & Heavy Machineries items that are mortgaged/to be mortgaged must be backed by appropriate legal documentation of the owner of the property along with completion of documentation in favour of the bank before disbursement. Bankers should always be in a safer side or in rigidity with the market rate while valuing property or commodity. Valuation may be appreciated and depreciated depending on the changed circumstances.
2) Factors influencing valuation:
Valuation will be done based on the current market situation, economic condition, recent sales record of nearby/same nature of land and building, future prospect, nature of land and building, present construction status, connecting road, land development, disposability of the land etc.
3) Distressed Value is considered:
Value at which property is sold at lower price than that of open market due to difficulties of vendor. Banker must assess Distressed Value (DV) based on maximum of 80% of market value in case of urban/industrial area and 70% in case of rural/other areas.
4) Revaluation:
Revaluation may be done after 3(three) years from the date of 1st valuation. However revaluation may be done within 3 (three) years in case of infrastructural development activities undertaken by government/private in the locality or up gradation/development/new construction in the land/building.
C) Gold/Gold Ornaments Pledge with Bank:
Market value of gold or gold ornaments pledged with the bank.
(ii) Financial:
a) Financial Instrument issued by bank/NBFI under lien and Pledge
b) Government Bond/Savings Certificate under lien
c) Share
Characteristics of good Security
Financial Instrument issued by bank/NBFI under lien and Pledge:
- Value of Financial Securities will be considered as Face Value of the financial instrument or present encashment balance and principal deposit against other Scheme Deposit issued by own bank and other schedule bank/NBFI of the country or otherwise as per approval.
- In case of Instrument/Financial Obligation issued by other bank/NBFI authenticity of the Instrument/Financial Obligation, present balance, present en-cashable balance and marking LIEN on the Instrument/Financial Obligation must be done by the issuing authority of the instrument.
Financial Instrument issued by bank/NBFI under lien and Pledge:
3) Reconfirmation of authenticity of the instrument and marking LIEN and pledge by the issuing branch must be done from the office higher than the issuing office (preferably from Head Office) of that bank/NBFI.
Government Bond/Savings Certificate under lien:
100% of the value of government Bond/Savings Certificate
Share:
The average market value of last 06 months or current market price, whichever is lower of the shares traded in stock exchange.
(iii) Others:
Value of 100% of the guarantee amount given by the Government/ Bangladesh Bank.
- Cross Company Guarantee within a group can be accepted only where the issuer has authority as per their Memorandum and Articles of Association to issue such guarantee supported by Board Resolution.
- Guarantees taken from cross border correspondents should be within the rules prescribed in “Guidelines for Foreign Exchange Transaction” of Bangladesh Bank or directives issued by the competent authority time to time.
Contributor: Md. Towhid Hossain ,SVP, IRMD, HO, SIBL.
Characteristics of good Security