A secured advance is not really secured, unless the security deposited satisfies certain requirements. There must be critical appraisal of security. Let’s discuss about attributes of good security. There are two angles to appraisal of the security. One is the legal angle regarding the validity and enforces ability of the security. The second angle is the economic one, involving consideration of marketability, valuation and other economic considerations. |

Legal Aspects

Ascertainment of title: It should be possible for the banker to know that the 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 poor charges or encumbrances thereon. The solicitors have to verify the title of the borrower to the property. Even after that is done, litigation’s may arise because a certain point was inadvertently omitted or an inquiry was not made relating to the claims of one or more persons to the property.

Validity of title: The banker cannot enforce the security unless he obtains a valid title form the borrower. If there is any defect in the title of the borrower, the banker can obtain only a defective title. The rule is that no one can convey a better title than what he has. So, the banker will not be in a position to sell the security if he himself about the title of the borrower. The legal interest must be properly conveyed to the banker by executing the appropriate instrument.

Economic aspects :

Marketability: The security taken must be readily sale-able with the minimum of expenses and without this essential attribute of ready reliability, the security is worthless. The banker should prefer essential goods, industrial raw materials and other manufactured goods having ready marketability for the purpose of collateral.

Easy ascertainment of value: The security must be capable of being valued with ease. There are certain securities for which the market is continuous and active and, therefore, the banker does not find it difficult to value the security. 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 or highly specialized machines or buildings located in out-of-the way places, which are not easy to make assessment of their value except by making reference to an expert.

Stability of price: The value of security must be fairly stable. Banker must also make sure that value of the security does not fluctuate violently over short periods. Where such heavy variation in prices of security is apprehended, banker may accept such security only with a higher margin.

Easy storability: Where goods are pledged, the banker must keep them under his custody when it is possible for him to supervise. Some goods are easily storable and do not require special storage facilities and they satisfy the condition of easy storability. Certain types of securities such as iron ores near the mines and timber floating on rivers pose peculiar problems for storage and supervision and also require huge space necessitating higher storage cost. The same considerations apply to goods which cannot be stored except in air-conditioned godsons. Some goods are risky to store, such as inflammable articles.

Durability: A security should be reasonably durable. Perishable commodities like vegetable, fruits, fish as securities. Some of the commodities like chilies, woolen garments etc. require special care in storage; otherwise they depreciate in quality and value. There are a few types of grains and oil seeds which can be stored for 3 to 4 months only. There are other commodities such as metal and iron and steel goods which do not deteriorate much in quality for many years. Bankers should prefer such securities which are reasonably durable.

Transport ability: 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 sent to the other place where they can be easily disposed off. Therefore, securities which are easily transportable at less cost are preferable to bulky materials like heavy machinery which are difficult and expensive to transport.

Cost consideration: Certain securities are very costly to keep. For example, if an advance is given by obtaining a pledge of the goods, the banker has to maintain godowns, appoint store keepers, insure the goods etc. Instead of advancing against goods, it may be preferable to advance against reliable warehouse-keeper transferable receipt as security.

Absence of contingent liability: a security which carries with it an onerous liability as in the case of partly paid it an onerous liability as in the case of partly paid shares where unpaid amount on the share money has to be paid to the company, when calls are made, cannot be considered a suitable security. Therefore, a banker should prefer fully-paid shares to partly-paid shares as security because it is free from such disabilities.

Yield: A security which provides a steady income is most welcome to the banker, since such income enhances the value of the security and also facilitates the repayment of capital and interest; for example securities like gilt-edged securities and highly marketable shares on which substantial dividend is regularly received. In case of these securities the banker can obtain a mandate from the borrower to collect interest or dividend, which can be appropriated in reduction of the loan account.

Liquidity:Liquidity describes the degree to which an asset or security can be quickly bought or sold in the market without affecting the asset’s price.

Market liquidity refers to the extent to which a market, such as a country’s stock market or a city’s real estate market, allows assets to be bought and sold at stable prices. Cash is the most liquid asset, while real estate, fine art and collectibles are all relatively illiquid. In 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.