Banks tend to safeguard their advances by taking different kinds of securities. The main purpose of taking security is to fall back on it in case the loan is defaulted. Banks take movable properties, immovable properties or a debt as security for loan. The method of creating charge over properties depend upon the nature of property and nature of charge. For example, when a bank gives loan against the security of gold ornaments, it takes the possession of the ornaments whereas when it advances against the security of a vehicle or a house property, the bank does not take physical possession.
Types of Charges
Bank charge over properties confines itself to one or more of the following five types of charges.
They are further explained below:
It is a mode of providing security to a bank for an advance. It is transfer of a right of property or a debt. The transferor is called assignor and the transferee is called assignee.
Borrowers generally assign the actionable claims to the banker as security for an advance. In banking practice, a borrower may assign the book debt, money due from government department and life insurance policies as security for an advance.
As regard to the mode of assignment, no particular form or words is necessary for effecting an assignment, if the intention is clear from the language used. An assignment can be absolute or by the way of security.
An assignment may be legal or equitable assignment. A legal assignment is the absolute transfer of an actionable claim, must be in writing and signed by the assignor. The assignor informs his debtor, also in writing, intimating the assignee’s name and address. The assignee also serves a notice on the debtor and seeks his confirmation of balance assigned. If the formality is not fulfilled, the assignment is called an equitable assignment. Banks generally go in for legal assignment and insist for obtaining an acknowledgement of assignment from the debtor.
Lien is the right of the banker to retain possession of the goods and securities owned by the debtor until the debt due from the latter is paid. For example, while giving loan against shares banks obtain letter of consent from borrower to the concerned company for the lien over shares in favor of lender and accretion (dividend, bonus shares, right shares). The bank’s lien is an implied pledge. A banker acquires the right to sell the goods which came into its possession in the ordinary course of banking business, in case the debt is not paid.
However, when a customer inadvertently leaves a packet containing certain share certificates, life insurance policies, fixed deposit receipts of other banks, etc. while leaving the bank premises, the bank will have no right of lien over those securities because those were not given to the bank in the normal course of banking business.
Hypothecation differs form mortgage in two respects. Firstly mortgage relates to immovable property whereas hypothecation relates to movable property. Secondly, in a mortgage, there is transfer of interest in the property to the creditor but in hypothecation there is only an obligation to repay money and no transfer of interest. In a mortgage registered with land revenue office (LRO), charge over both fixed and current assets are created.
Hypothecation charge extends to all the goods and moveable properties with the borrower as per the agreement of hypothecation and operations in these accounts are permitted on the basis of stock statement, submitted by the borrower periodically usually every month. Hypothecation can, however, be created as a fixed charge over a particular machinery/vehicle etc.
The term ‘Hypothecation’ means a charge in or upon any moveable property, existing or future, created by a borrower in favor of a secured creditor, without delivery of possession of the movable property to such creditor, as a security for financial assistance and includes floating charges and crystallization of such charge in to fixed charge on movable property. Hypothecation agreements obtained by BFIs generally have a clause under which hypothecation can be converted into a pledge at a later date.
This form of charge is ideal from the point of view of the borrower as he is always in control of goods offered as security to the bank. In case of default by the borrower, the bank can take possession of goods and convert it to pledge.
In the pledge, the ownership of goods remain with the borrower whereas physical control over these goods will be exercised by the bank. Goods may be delivered by the debtor (the pledger also known as pawnor ) to the creditor (pledgee also known as pawnee ). Pledge can be created only in case of existing goods which are in the possession of the pawnor himself. There can be no pledge of future goods or goods which the pawnor is likely to get into his possession subsequently. Since delivery is involved, goods must be specific and identified.
The borrower has a right to get the goods returned to him after payment of debt created here against. The delivery of goods must be with an intention of the parties to create security for the debt or performance of a promise.
In case of default by the borrower, the BFIs can sell the goods after giving a reasonable notice of sale as required. Notice must clearly indicate the intention of the pledgee to sell the security and is compulsory before the sale can be affected. If the bank realises more than its due by such sale, the excess realised will have to be returned to the borrower. However, if there is any shortfall, the BFI can proceed against the borrower in a court of law for the recovery of the balance.
This mode of charge can be considered an ideal one for the bank as it has full control over the security and can even realise it without any legal process merely by serving a notice on the borrower. The borrower, however, is put to great disadvantage as he loses control over the goods and may involve operational difficulties. Generally, the raw material or finished goods or stock in trade etc not immediately required by the borrower can be offered to the bank for pledge.
Mortgage is a transfer of an interest in a specific immovable property for the purpose of securing an existing or future debt. The person transferring the interest is known as mortgagor and the person to whom the interest is transferred is known as mortgagee.
Immovable property will include land, things attached to the earth or permanently fastened to anything attached to the earth. Immovable property does not include standing timber, growing crops or grass. Attached to the earth means:
a. rooted in the earth, as in case of trees and shrubs
b. imbedded in the earth, as in case of walls or buildings
c. attached to what is so imbedded for the permanent enjoyment of that to which it is attached.
Immovable property include land, buildings, rights to ways, lights etc. and things attached to the earth or permanently fastened to anything which is attached to the earth but not standing timber, growing grass or crops.
A point in case can arise in respect of machinery. Machinery which is not permanently attached to the earth and can be shifted to other place will not be considered as immovable property. But if machinery is permanently attached to the earth, in a manner that it cannot be removed from there, it will be considered as immovable property.