LOANS AND ADVANCES:

After accepting deposits from the customer, a bank goes for lending or for
investment in different types of securities, such as government, company etc. For deposits received under savings account and fixed deposits, the bank has to pay an agreed interest rate. This, the bank has to pay only from its earnings. On the investments, the bank earns a good return. Similarly, when the bank lends, it earns a higher interest rate. From out of the return on investments and from the interest earned on loans, the bank will be able to
offer interest for the deposits, The difference between the interest offered on deposits, and the interest earned on lending will be the profit of the bank.

(a) Safety:

When a loan or investment is made, the banker will have to ensure that the
money advanced is returned by the borrower along with interest within the stipulated period. This is possible only when the borrower does not face any risk and strictly adheres to the terms and conditions of the loan. For this purpose, the banker will have to chose such type of borrowers who are prompt in repayment of the principal and interest amount.

(b) Liquidity:

An asset is said to be liquid when it can be converted into cash within a
short notice, with out loss. As the bank is investing or lending the depositors‘ money, it has to take more precaution while doing so. The depositor may demand his/her money at any time and the bank must be in a position to repay the same.

(c) Profitability:

When a bank is undertaking lending or investment, it has to earn a good
return. The bank has profit as its main business motive. So, while lending or investing the depositor‘s money, the bank must earn higher interest or higher return. if the bank is able to achieve this, it will be deploying its funds in such ventures which give a higher return.

(d) Shift ability:

As the bank is giving loan against the security, in case of bad debts, the
bank must be able to sell the security and realize the loan amount. In some cases, the bank will not sell the security, but will shift the same to the Central bank which will grant the commercial bank additional fund against the security. Mostly treasury bills can be shifted to Central bank and the commercial bank can raise additional funds.

(e) National Interest:

The bank must keep in mind national interest while lending or
investing depositor‘s money. When a country is facing unemployment, the bank must give more loans to employment oriented industries, so that the problem of unemployment can be reduced. Similarly, when a country is faced with food problem, more loans should be given for agriculture so that, food production can be increased.

(f) Safety Margin:

While granting loan against security, the bank will have to keep
sufficient safety margin. This means that a bank will land only unto 50 or 60% of the value of security as loan by keeping a safety margin of 4 or 50%. For example, when loan is given against a jewel whose market value is Rest. 10,000/-. the loan amount will be Rest. 6,000/- and the safety margin Rest. 4,000/- now even if the market value of the jewel fluctuates to Rest. 9,000/- or Rs.8,000/- still the banker will be able to realize the loan amount in case the borrower defaults.

(g) Diversification:

As the banker lends or invests, he cannot invest all his resources in a
single industry or with a single borrower. The banker should not keep all the eggs in the same basket. By choosing a single industry such as iron and steel or sugar, the banker is inviting more risks. It is likely that these industries may face depression and the banker will find it difficult to recover the loan or realize his investment.

THERE ARE TWO TYPES OF SECURITIES:

(i) Primary Security:

(ii) Collateral Security:

FORMS OF ADVANCES:

1. Loans:

In case of loan, the banker advances a lump sum for a certain period at an agreed rate of interest. The entire amount is paid on an occasion either in cash or by credit in his current account which he can draw at any time. The interest is charged for the full amount sanctioned whether he withdraws the money from his account or not. The loan may be repaid in installments or at the empery of a certain period. The loan may be made with or without security. A loan once repaid in full or in part cannot be withdrawn again by the
customer. In case a borrower wants further loan, he has to arrange for a fresh loan.

2. Cash Credit:

A cash credit is an arrangement by which the customer is allowed to borrow money up to a certain limit. This is a permanent arrangement and tube customer need not draw the sanctioned amount at once, but draw the amount as and when required. He can put back any surplus amount which he may find with him. Thus cash credit is an active and running account tow which deposits and withdrawals maybe effected frequently.

3. Over draft:

Over draft is an arrangement between a banker and his customer by which the
latter is allowed to withdraw over and above his credit balance in the current account unto an agreed limit. This is only a temporary accommodation usually granted against securities. The borrower is permitted to draw an repay any number of times, provided the total amount overdrawn does not exceed the agreed limit. The interest is charged only for the amount drawn and not for the whole amount sanctioned.

TEMPORARY OVERDRAFT:

Bank, Sometimes, grant unsecured overdraft for small amounts to customers
having current account with them. Such customers may be government employees with fixed income or traders. Temporary overdrafts are permitted only where reliable source of funds are available to a borrower for repayment.

3. Bills Discounted and Purchased:

Banks grant advances to their customers by discounting bill of exchange or promote. The amount, after deducting the interest from the amount of the instrument, is credited in the account of the customer. In this form of lending, the interest is received by the banker in advance. Discounting of bill constitutes a clean advance and banks rely on the credit worthiness of the parties to the bill.

SECURED AND UNSECURED ADVANCES:

Loans and advances may be made either on the personal security of the borrower or on the security of some tangible assets. The former is called unsecured or clean or personal advances and the latter is called secured advances. Unsecured Advances Section 5(i) (n) of the Banking Regulation Act defines unsecured loan as ―unsecured loan or advance means a loan or advance not so secured‖. The distinguishing feature of this type of loan, according to the definition is that no tangible security is offered to the bank.

The confidence is judged by three considerations, character, capacity and capital usually referred to as the three C‘s.

Character:

Character constitutes the best asset of a man. The word character implies personal qualities like honesty, responsibility, promptness, reputation and goodwill. A person who possesses most of the above qualities is considered as a man of character and bank can extent credit to him without any reservation.

Capacity:

The capacity of a borrower refers to his ability to manage the business. Success of the enterprise depends mainly on the initiative, interest, experience and managerial ability of the entrepreneur. So capacity is the next consideration in granting clean advances.

Capital:

In addition to the character and capacity of borrower, a banker looks into another aspect i.e., capital. A bank provides mainly the working capital requirements of the business. A borrower should have sufficient capital to conduct his business and adequate plant and machinery to carry out capital to production. In this respect banks may follow the formula evolved by Dr. C. B.Memoria.

a. Character + Capacity + Capital = Safe credit
b. Character + Capacity + Insufficient capital = Fair credit risk
c. Character + Capacity – Capital = Limited success
d. Character + Capacity -Impaired character= Doubtful credit risk
e. Character + Capacity – Character = Dangerous risk
f. Character + Capacity – Insufficient capital = Fair credit risk
g. Character + Capacity – Capacity = Inferior credit risk
h. Character + Capacity – Capacity = Fraudulent one
Modes of charging Security

The important methods of charging a security are the following:

1. Lien.
2. Pledge.
3. Mortgage.
4. Assignment.
5. Hypothecation.

LIEN:

Lien is the right of a creditor to retain the properties belonging to the debtor until the debt due to him is repaid. Lien gives a person only a right to retain the possession of the goods and not the power to sell them. A banker‘s lien is a general lien which tantamount to an implied pledge. It confers upon the banker the right to sell tee securities after serving reasonable notice to the borrower.

PLEDGE:

Section 172 of Indian Contract Act, 1872, defines a pledge as, the ―bailment of
goods as security for payment of a debt or performance of a promise.‖
Essentials of Pledge

(i) Delivery of goods: Delivery of goods is essential to complete a pledge.
The delivery may be physical delivery refers to physical transfer of goods from a pledge to the pledge.

(a) delivery of the key of the warehouse in which the goods are stored.
(b) Delivery of the document of title to goods like Bill of Lading, Railway        Receipt, Warehouse Warrant etc.
(c) Delivery of transferable warehouse warrant if the goods are kept in a public ware house.

(ii) Transfer of ownership: The ownership of goods remains with the pledge. The possession of the goods vests with pledge till the loan is repaid.

(iii) Right in case of failure to repay: If the pledge fails to repay within the stipulated time, pledge may,

(i) Sell the goods pledged after the pledge for the amount due,
(ii) File a suit against the pledge for the amount due,
(iii) File a suit for the sale of the goods pledged and the realization of money due to him.

MORTGAGE:

A Mortgage is a method of creating charge on immovable properties like land and building. Section 58 of the Transfer of Property Act, 1882, defines a mortgage as follows:
― A Mortgage is the transfer of an interest in specific immovable property for the purpose of securing the payment of money advanced or to be advanced by way of loan, an existing or future debt, or the performance of an engagement which may give rise to a pecuniary liability.‖

FORMS OF MORTGAGES:

Section 58 of the Transfer of Property Act enumerates six kinds of mortgages:
1. Simple mortgage.
2. Mortgage by conditional sale.
3. Usufructuary mortgage.
4. English mortgage.
5. Mortgage by deposit of title deeds.
6. Anomalous mortgage.

Simple Mortgage:

In a simple mortgage, the mortgager does not deliver the possession of the
mortgaged property. He binds himself personally to pay the mortgage money and agrees either expressly or impliedly, that in case of his failure to repay, the mortgagee shall have the right to cause the mortgaged property to be sold and apply the sale proceeds in payment of mortgage money.

Mortgage by Conditional Sale In this form of mortgager ostensibly sells the property to the mortgagee on the following conditions:

1. The sale shall become void on payment of the mortgage money.
2. The mortgagee will retransfer the property on payment of the mortgage money.
3. The sale shall become absolute if the mortgager fails to repay the amount on a certain date.

Usustructuary Mortgage:

Under this from of mortgage, the mortgager delivers possession of the property or binds himself to deliver possession of the property to the property to the mortgagee. The mortgagee is authorized to retain the possession until the debt is repaid. The mortgager reserves the right to recover the property when the money is repaid.

English Mortgage:

The English mortgage has the following characteristics:
1. The mortgager transfers the property absolutely to the mortgagee. The mortgagee, therefore, is entitle to take immediate possession of the property. The transfer is subject to the condition that the property shall be transferred on repayment of the loan.

2. The mortgager also binds himself to pay the mortgage money on a certain date.

Mortgage by Deposit of Title Deeds
When a debtor delivers to a creditor or his agent document of title to immovable property, with an intention to create a security there on, the transaction is called mortgage by deposit of title deeds.

Anomalous Mortgage:

In terms of this definition an anomalous mortgage is one which does not fall under any one of the above five terms of mortgages. Such a mortgage can be effected according to the terms and conditions of the mortgagor and the mortgagee.

Assignment:

Assignment means transfer of any existing or future right, property or debt by one person to another person. The person who assigns the property is called assignor and the person to whom it is transferred is called assignee. Usually assignments are made of actionable claims such as book debts, insurance claims etc., In banking business, a borrower may assign to the banker (i) the book debits, (ii) money due from government department, (iii) insurance Policies.

Assignment may be of two types:

1. Legal Assignment.
2. Equitable Assignment.

Hypothecation:

This is applicable to movable goods. The borrower is given loan for the purchase of goods or vehicles. Though the borrower is the owner of the security, the creditor has a charge on the security until the loan is repaid. If the borrower fails to pay, the creditor will cease the goods from the borrower. Thus, hypothecation provides a right for the creditor to take possession of the goods.

DIFFERENCE BETWEEN PLEDGE AND MORTGAGE:

Pledge Mortgage:

1. Applicable to movable goods only. 1. Applicable to immovable property.
2. Governed by Indian Contract Act. 2. Governed by Transfer of Property.
Act.
3. Possession of security with the
pledge or creditor. 3. There is no possession of property.
4. There is pledgor-Pledgee relationship.
5. There is mortgagor-mortgagee relationship.
6. As a bailee, the pledge has to take care of the security.
7. There is no such responsibility for the Mortgagee.
8. The pledge has a lien on the security.
9. There is no lien for the Mortgagee.
10. When there is a default, the pledge can sell the security and recover the
loan amount.
11. Under English mortgage, the ownership of property is transferred in
favour of mortgagee when there is default by the mortgagor.
12. A pledge can never take over the ownership of security pledged with him.
13. Mortgagee can take over the ownership of the property in case of
default.
14. There is transfer of possession of security from pledgor to pledge.
15. There is surrender of the right of sale by the mortgagor to the
mortgagee.
16. There is no need for registration of pledge agreement.
10. Mortgage deed has to be registered for making it a legal mortgage.

Difference between Lien and Hypothecation:

Lien Hypothecation:

1. It is a right exercised by the creditor on the debtor by retaining the security
owned by the debtor. The creditor is in possession of the security belonging to
the debtor.

2. Though the debtor is the owner, the creditor has a right to cease the goods,
from the debtor in case of default. The debtor is in the possession of the
security.

3. The creditor cannot use the goods which are in his possession and on
which lien is exercised.

4. The debtor is not only in possession but can also use the goods which are
hypothecated.

5. The creditor is a bailee and hence has to take care of the goods which are
in hi possession.

6. The creditor is not in possession but has a charge on the goods
hypothecated. The goods have to be taken care of by the debtor.

7. The creditor can not only retain the security, but can also sell the security a
pledge, after giving due notice to the debtor.

8. The creditor has to first obtain the goods from the debtor and then can
sell the goods, for the recovery of loan amount.

9. There is no notification on the goods which are under lien.

10. Hypothecated goods will be notified, by a board so that no other creditor can extend credit against the hypothecated goods.