Banks do business with depositors’ funds.
The Banks have to honor their commitment to return the deposits whenever
demanded by the depositors. The primary source of funds for repayment is the
business itself; hence banks take considerable care to evaluate the
profitability and sustainability of the business financed by them. Despite all
care and due diligence some of the businesses could fail. The cause of failure
may be changes in the external environment or mismanagement. Banks have to
ensure that even if the business fails, their funds are recoverable by invoking
the “Security” offered by the
borrowers. Security is an asset like land, building and machinery, stocks (raw
materials / finished goods), receivables and other securities which are charged
to the bank. Charge is the legal right given by the borrower to the bank to
take possession of dispose of the security in the event of default. The types
of charges are:
Pledge
is
a charge where the borrower hands over possession of asset to the bank. For
example loans against gold jewellery, warehouse receipts, key loan etc. The
relationship between borrower and the bank is “Pledger” and “Pledgee”. Under
this, the ownership of the goods remains with the borrower but the possession
of the goods is in the hands of the bank. The bank enjoys Right of Sale in case
the loan is not repaid and the bank can sell the pledged goods after giving
adequate notice of sale to the borrower. It is the responsibility of the bank
to take as much care of the goods pledged as a man of ordinary prudence would
under similar circumstances. When the loan is fully paid, it is the
responsibility of the bank to handover the possession of the goods back to the
borrower.
Hypothecation – Normally banks lend funds to the borrowers to acquire raw material / assets to undertake their business activities and these assets continues to be in the possession of the borrower. It is as if the borrower holds the asset on behalf of the Bank. Hypothecation gives the Bank right to take possession and sell the asset, in case of default. However, bank need to initiate action either under SARFEASI or Court/DRT to take possession of the asset.
