General principles of secured advances
While granting advances on the basis of securities offered by customers, a banker should observe the following
(a) Adequacy of Margin:
The word ‘margin’ has special meaning and significance in the banking business. In banking terminology, ‘margin’ means the difference between the market value of the security and the amount of the advance granted against it. For example, if a banker sanctions an advance of ` 70 against the security of goods worth ` 100, the difference between the two (` 100 – ` 70 = `30) is called margin.
A banker always keeps an adequate margin because of the following reasons:
(i) The market value of the securities is liable to fluctuations in future with the result that the banker’s secured loans may turn into partly secured ones.
(ii) The liability of the borrower towards the banker increases gradually as interest accrues and other charges become payable by him. For example, if a loan of ` 100 is sanctioned by a banker today, the liability of the borrower at a future date, say, a year after, would be increased by the amount of interest accrued and other charges payable by him. Hence, a banker keeps adequate margin to cover not only the present debt but also the additions to the debt.
Factors Determining Margin:
The quantum of margin is not uniform in case of all commodities or in case of all customers. The following factors determine the margin:
(i) The amount of margin depends upon the likely fluctuations in the prices of the various commodities. For example, if a commodity enjoys steady demand and is an item of essential consumption, lower margin is fixed. But the prices of articles of luxury are likely to fluctuate widely. Hence, the banker should be very cautious in accepting the same and should require a very high margin.
(ii) In case of shares of industrial concerns the financial position and reputation of the issuing undertaking is also taken into account. Shares of sound industrial concerns are treated as good as Government securities and a lower margin is required.
(iii) Margins are fixed keeping in view the credit and reputation of the borrower concern, i.e. a lower margin may be fixed for the borrower having first class reputation against the security of the same commodity.
(iv) The margin, determined at the time of sanctioning an advance, may be raised or reduced subsequently according to the variation in the prices of the securities.
(v) In case of commodities which are subject to selective credit control of the Reserve Bank, margins are usually prescribed by the Reserve Bank from time to time. It is essential for the banks to keep such margins.
(b) Marketability of Securities: Advances are usually granted for short periods by the commercial banks because their deposit resources (except term deposits) are either repayable on demand or at short notice. If the customer defaults in making payment, the banker has to liquidate the security.
It is, therefore, essential that the security offered by a borrower may be disposed of without loss of time and money.
A banker should be very cautious in accepting assets which are not marketable. It is proverbially said “a banker lends his umbrella when the sky is clear and demands it back as soon as it rains”. This is true because in a wider sense he is the trustee of the people’s savings. He cannot act as a philanthropist in granting aid to the people who are likely to get ruined. Liquidity of the security is, therefore, a prime consideration.
(c) Documentation: Documentation means that necessary documents, e.g. agreement of pledge or mortgage, etc., are prepared and signed by the borrower at the time of securing a loan from the bank.
Though it is not necessary under the law to have such agreements in writing and mere deposit of goods or securities will be sufficient to constitute a charge over them, but it is highly desirable to get the documents signed by the borrower. These documents contain all the terms and conditions on which a loan is sanctioned by the banker and hence, any misunderstanding or dispute later on may easily be avoided.
(d) Realization of the Advance: If the borrower defaults in making payment on the specified date, the banker may realize his debt from the sale proceeds of the securities pledged to him. As noted in previous chapter, a pledgee may sell the securities by giving proper notice to the pledger of his intention to sell the securities. In case of loans repayable on demand a reasonable period is to be permitted by the banker for such repayment. This period may be a shorter one if there is urgency of selling the commodities immediately in view of the falling trend in their prices. If a banker is unable to recover his full dues from the security he shall file a suit for its recovery within the period of three years from the date of the sanction of the advance. In case of term loans repayable after a fixed period, the period of limitation (i.e. 3 years) shall be counted from the expiry of that fixed period.