Retail Banking

FUND AND NON FUND BASED LOAN FACILITIES AND MODES OF CREATING CHARGE ON SECURITIES
DIFFERENT TYPES OF FUND BASED LOAN ACCOUNTS Banks sanction credit facilities to the borrower according to their use and requirement. According to use, the bank facilities can be Working capital limits for maintenance of current assets like Inventories of raw materials, work in process and finished goods, Debtors for credit sales, minimum liquidity cash holding, and Term loans for acquisition of fixed assets. It is essential for the banks that the nature of credit facilities to be sanctioned is the one which takes care of the requirement of the borrower.: OVERDRAFTS Purpose These are allowed by the banks to such customers who maintain accounts in the nature of current accounts with frequent operations. In this kind of account, a limit is fixed up to which the customer can overdraw his account. The overdrafts are generally granted against the security of bank deposits, life policies, documents of title, saving certificates, shares and debentures etc. Security At times the overdrafts are also allowed without any security which are of a very temporary nature and are called clean overdrafts. Interest On such accounts interest is charged on the amount drawn on day to day basis. Period It may be noted that the overdraft facility cannot be withdrawn suddenly and unilaterally by the bank and shall require prior intimation to the customer. CASH CREDIT ( HYPOTHECATION ) As per Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002, hypothecation has been defined as

a charge in or upon any movable property, existing or future, created by a borrower in favour of a secured creditor without delivery of possession of the movable property to such creditor, as security for financial assistance and includes floating charge and crystallization of such charge on movable property into fixed charge A cash credit account like an overdraft account, is a running account but with a fixed maximum drawing limit . But actual operative limit is computed monthly on the basis of value of the security e.g. stocks, debtors etc. A cash credit account is very convenient for the borrowers who enjoy the ownership as well as possession of stocks of raw materials, work in process and finished goods for their processing and sales and also enjoy credit against them based on loan documents like Hypothecations Agreement signed with the bank . Advantages a. The customer can deposit and withdraw money as per his convenience unlike a demand loan account, where money can be withdrawn only once. b. Being a running account, documents are obtained only once, unlike a demand loan where on adjustment of the account, fresh documents have to be taken if the loan is to raised again. c. Interest in the account is charged on the actual debit balance on day to day basis and is debited on a quarterly basis which becomes payable immediately. Banks are also entitled to charge commitment , charge say 1% for unutilized amount of cash credit limits. Securities Cash credit accounts may be against: a. Hypothecation of stocks of raw material, stock in process , finished goods or stores, spares etc. b. Hypothecation of book debts or receivables. c. Pledge of stocks of raw material or finished goods or documents of title to goods, bullion etc. These loans are sanctioned by the banks generally to those customer who are actually involved in some economic activity of a continuous basis, such as traders, manufacturers etc. Stock statement and margins

The borrowers are required to submit to the bank a statement of stocks and other securities charged to the bank on pre-fixed intervals, say fortnightly or monthly. The banks maintain margin on the security which differs from case to case depending upon the nature of security and other considerations. For a stipulated margin of 25% of total value of stocks/debtors etc is funded by the borrower and 75% of the value of such securities is allowed as operative limit up to which amount can be drawn in the cash credit account. Documents In order to secure themselves, the banks obtain cash credit agreement which create charge on the goods and other securities against which the loans are granted. Renewals Cash credit limits are sanctioned by the banks for a period of one year where after it can be extended for further period also on review. Precautions a. Firm is not enjoying similar facilities with other banks on the security of same goods. b. Borrower enjoys facilities from one bank has charge over such goods. c. Bank name board should be displayed where the securities are located stating that bank has charge over such goods. d. Recurring inspection should be conducted by the bank to see that the level of goods being maintained is same as the one declared by the borrower and as per his books. e. Borrower should submit a stock statement periodically, f. Such stocks should be insured for fire and other risks. If The borrower fails to return the advance against the hypothecation of goods, the bank can take possession of the goods with consent of the borrower and then charge of hypothecation becomes a charge of pledge. On becoming a pledge of goods , the bank gets all rights of a pledgee , can sell goods on giving a reasonable notice of sale to the borrower. Any short fall of recovery can still be claimed from borrower in the court. CASH CREDIT PLEDGE A cash credit pledge account is like a Cash credit hypothecation account. In such accounts, the legal rights are different as the possession of the securities remains with the bank while the ownership remains with the borrower. Delivery of goods pledged by the pledger to the pledge is essential for creating a pledge, which may be actual or constructive.

What is pledge U/s 172 of Indian Contracts Act. Pledge is bailment or delivery of goods as security for payment of a debt or performance of a promise. Who is pledger The owner of goods, the agent of the owner, the joint owner with the consent of other coowner and a person having limited interest in the goods (to the extent of his interest), can pledge the securities. Rights of pledgee The pledge has certain rights such as (which are not limited by law of Limitation): a. He may retain the goods until the payment of the debt or performance of the promise is fulfilled. b. To sell the goods by giving a due notice to the pledger in case the pledger fails to make the payment of the dept. c. Pledgee steps in the shoes of the pledger. d. To recover charges incurred for preservation of the goods pledged. Duties of the pledgee a. To return the goods (along with accretion to goods if any) once the money is paid back by the pledger. b. To take that much care of the goods, which he would have been taking, had the goods belonged to him. Bailment It may be noted that pledge is different from bailment. Bailment is delivery of goods by one person to another for some purpose while the purpose in pledge is performance of a specific promise or security for debt. The pledgee can sell the goods pledged after giving notice to the pledger while in bailment the goods can be retained or bailer can be sued for charges.

BILLS PURCHASE OR DISCOUNTING Depending upon the place where drawn, period for which drawn and their nature, the bills are classified as inland bills, foreign bills, demand bills, usance bills, clean bills or documentary bills. Advances against bills Banks allow advances by purchasing the demand documentary bills or discounting the usance documentary bills and negotiating the bills drawn under letters of credit, covering genuine sale of commodities (other than capital goods) in trade and movement thereof. Similarly banks allow advance against the security of bills under collection. The advances allowed by banks against the bills drawn on govt. departments are called Supply bills. Negotiable instruments The bills are negotiable instruments under NI Act and advance there against is of self liquidating nature, since the payment is received either on demand or after fixed time period. Security The advances against demand bills are considered to be relatively safe, since the document of title to goods remain with the bank till the payment is received. Not only this, the banks facing liquidity constraints can also approach RBI for allowing refinance against the bills discounted. The bills may be of varying types such as: a. Documentary bills are accompanied by documents of title to goods like Airway bill, Lorry/Goods receipt (GR), Railway Receipt(RR) , Bill of lading (B/L)for carriage of goods by sea. b. Demand bills are payable on demand or within 48 hours of presentation on the drawee. The document of title to goods is released on payment in respect of demand bills. c. Usance bills are payable after a fixed time from date of acceptance. The banks have to deliver document of title to goods in respect of usance bills immediately on acceptance .

The payment is made after the fixed tenure mention in the bill of exchange e.g., 60 or 90 or 120 or 180 days. d. Clean bills are those which are not accompanied by any documents . These may not arise out of genuine trade transactions and may be accommodation bills which are drawn by one trader to help another trader to procure finance without actual sale or purchase of goods between them . e. Accommodation bills Banks do not permit advance against accommodation bills. Accommodation bills can be detected by presence of characteristics such as i. ii. iii. iv. v. vi. these are clean bills drawn on associate or group concerns, addresses are common or in the form of care of, the line of activity of drawee is different, drawer presents another bill for discount on or around the date on which the previous bills fall due for payment, bills relate to items in which they do not deal, bills drawn by retail traders having no outstation business.

DEMAND LOANS Purpose Demand loans are the loans for a fixed amount (unlike cash credit) where no further debits (except for interest) are permitted once the initially fixed advance is availed. Demand loans are allowed for short term durations say, one year and are required to be repaid on falling due. Any amount deposited in the account is appropriated on a permanent basis without allowing it to be drawn again. Hence, whenever the borrower need fresh drawings, a fresh demand loan account shall be opened and fresh documents shall be obtained. Interest In demand loans also, the interest is charged on the amount outstanding on the close of each day and debited quarterly. The repayment in demand loan is normally as per the convenience of the borrower, which may be in lump sum (bullet payment) or by way of installment. Working capital Demand Loans

As per RBIs guidelines on loan system of delivery of bank credit, the bank sanction s working capital demand loans repayable over a period of one year by bifurcating the working capital limits into cash credit and demand loans. Such loans generally carry same rate of interest which is charged to cash credit advance. The security for such advances is also common security with cash credit accounts. TERM LOANs Purpose As the name suggests, these loans are given for fixed period of time with the provision that its repayment shall also come in regular pre-fixed periodical installments which may be equated or graduated. These loans are generally sanctioned for acquiring fixed assets by the persons engaged in business and trade or in manufacturing or servicing etc. Repayment The time period for which such loans are sanctioned varies from case to case depending upon the repayment capacity of the borrower concerned, which in turn depends upon the cash generation capacity of the financed activity or assets. Interest Interest on these accounts is charged on the daily products and is debited on a quarterly basis, except in case of agriculture related activities and small scale industrial activities, where the interest is debited, generally on half-yearly basis. Term loans are generally sanctioned for a period of more than 3 years and less than 10 years by the banks. Term loans up to 7 years repayment are called medium term loans and beyond that, long term loans. Margin The banks maintain margin on the security which differs from case to case depending upon the nature of security and other considerations. For an example, if the term loan is given fro purchase of fixed assets like Plant/ machinery/ equipment, a margin of say, 25% of the cost of these fixed assets will be provided by the borrower and the remaining 75% will be provided as a term loan by the bank.

WORKING CAPITAL TERM LOANS 7

Purpose Banks also sanction term loans meant to be utilised not for creation of fixed assets but for creation and maintenance of current assets to support the working capital requirements. Period These term loans are normally up to five years duration and they are like normal term loans. Repayment The repayment is fixed keeping in view the liquidity constraints and cash generation capacity of the borrower. Security These are secured by charge on the current assets along with working capital credit limits. TRUST RECEIPTS Purpose When goods pledged (charged) to a bank or goods covered under the bills purchased, are released before receiving payment, such facility is called trust receipt facility. This is usually resorted to in case of import credit facilities when the ship has arrived before the documents arrived at the bank , the goods are to be released on trust receipt to save demurrages . The customer pays later as per terms of the LC or as per terms of the Bill drawn by the exporter. Document In such cases, the borrower executes a trust receipt / bond / letter (to be stamped properly), agreeing to hold the goods and their sale proceeds in trust for the bank and return the unsold goods to the bank. The goods are not available to the official receiver in case of insolvency of the borrower. Nature of advance Advance against TRs is generally clean advances.

05 Non fund based limits

Bank Guarantees :
A guarantee, as distinguished from an indemnity, involves three parties. The provider of the guarantee viz. the surety, the person to whom it is provided viz the beneficiary of the guarantee or the Creditor and the person on whose behalf the guarantee is provided viz. the principal debtor. In the business of banking, a bankers position could be that of a beneficiary (Creditor) of a guarantee when he accepts a personal guarantee given by the borrowers in his favour or a surety when he (Banker) issue a bank guarantee on behalf of a customer to another entity. Bid Bond guarantee: is a financial guarantee given by the bank at the request of the applicant customer in favour of some company inviting bids and stipulating some minimum deposit towards tenders or contracts. In lieu of deposit, a bank guarantee for the equivalent amount is also accepted. The bank charges a commission of say 0.25% of the amount. The customer need not block his funds for tender money.

Performance guarantee : this is given for satisfactory performance of some contract by the customer of the bank. This is also a financial guarantee as the non performance is converted to monetary sum for which the performance guarantee is given. Deferred Payment Gurantees :
These are basically financial guarantees. These are given mostly when transactions of sale-purchase of capital goods are involved. For example, a machinery manufacturer may agree to sell a machinery on deferred payment terms to a buyer provided a banker issues a bank guarantee guaranteeing such payment. Usually in such transactions, a down payment of around 15% of the cost of machinery is made and the balance of 85% including interest thereon is agreed to be made payable in installments spread over a period of time.

Invocation of Guarantee and Payment of Claim :

In the event of default by the customer on whose behalf of the guarantee is given, the beneficiary will invoke the guarantee which in, other words, means that the beneficiary will demand payment of the sum undertaken by the guaranteeing banker. If a guarantee, be it financial or performance, is invoked, a banker has to make payment of it without any hesitation or demur subject, of course, to ensuring the following :a. That there is a letter from the beneficiary advising the banker of the default of the principal debtor (customer on whose behalf the guarantee has been issued) to perform the obligations undertaken by him in the contact which formed the basis for issuing bank guarantee. b. That the letter demands the payment of the sum undertaken in the guarantee. c. That the authority invoking the guarantee is the beneficiary, in his own right and capacity. d. That the guarantee has not expired or the invocation period given in the guarantee bond is not over yet Bank is not entitled to raise questions about default or cannot sit in judgment to decide whether default has taken place or not. Cannot refuse payment on the ground that the principal debtor has stalled payment of the guaranteed amount or has not authorise him to pay. Cannot delay payment on the ground that the principal debtor has promised settlement direct with the beneficiary or the principal debtor proposes to get a stay from the court of law etc.

A letter of Credit
is a mechanism which helps a trade transaction to be put through between a seller and a buyer. A Letter of Credit is an arrangement whereby a banker acting at the request of a customer, undertakes to pay a third party, by a given date according to agreed stipulations and against presentation of documents, the counter-value of the goods or services rendered or otherwise.

Charging of securities
Various modes of charging the securities. When a banker obtains a security for an advance given, it does not necessarily always mean transfer of ownership or possession of the security-property. It is possible to obtain security by having a charge on it. A charge is nothing but creation of a right to payment out of a property. It may therefore, be understood that obtention of security as cover for lending involves essentially a charge on the security. The type of charge that a banker would prefer depends on the nature of the property to be charged. There are various types of charges and methods of creating charge on securities. Hypothecation : Hypothecation is a charge which is preferred when the property to be taken as security is movable. In any property, be it movable or immovable, there are three primary rights associated with it. These are right of ownership, right of possession and right of enjoyment. When a charge is created on a property, it normally affects the owner with respect to any or all of these rights. But this charge of hypothecation does not, however, involve transfer of ownership or possession of or even interest in a property. It creates merely an equitable or notional charge on the property with a right to a banker to take possession of the property and sell the goods on default or a right to sue the owner to bring the property to sale and for realisation of the amount due. As per Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002, hypothecation has been defined as a charge in or upon any movable property, existing or future, created by a borrower in favour of a secured creditor without delivery of possession of the movable property to such creditor, as security for financial assistance and includes floating charge and crystallization of such charge on movable property into fixed charge Hypothecator The person who creates the charge of hypothecation is called hypothecator Hypothecatee the person in whose favour the charge is created is known as hypothecatee and the property which is hypothecated is denoted as hypothecated property. In an advance against hypothecation of goods, banker is the hypothecatee and the borrower is the hypothecator.

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It is suffice if we could understand it as a charge which extends to movable properties and it creates an equitable charge on goods. There is no transfer of ownership or possession of goods in a charge of hypothecation and both remain with the hypothecator i.e. the owner of the goods. The hypothecate, by virtue of the equitable charge on the goods, has a right to seize the goods on default from the hypothecator and sell the goods by auction. As the hypothecator holds the ownership and possession of the hypothecated goods, hypothecation can be considered as an extended pledge, with the hypothecator holding possession of the goods in trust for the hypothecatee. Pledge: Pledge is defined in Section 172 of the Indian Contract Act 1872 as a bailment of goods as security for repayment of a debt or performance of a promise. Section 148 of the Indian Contract Act 1872, defines bailment as delivery of goods by one person to another, as security for any some purpose, upon a contract that the goods, shall, when the purpose is accomplished, be returned or disposed off according to the instructions of the person delivering the goods. A pledge primarily involves delivery of goods by one person to another, i.e. it involves transfer of possession of goods by one person to another. Some-times, it could be even transfer of possession of document of title of goods (constructive delivery) and not necessarily always the transfer of possession of goods (physical delivery). The person who pledges the goods is called the pledgor and the person receiving the pledge of goods is called the pledgee. Mortgage : Mortgage is creation of a charge on an immovable property. Mortgage is not sale of property. In a sale, there is always a transfer of absolute ownership without conditions accompanied by transfer of possession and enjoyment of the property. But in a mortgage there is no transfer of absolute ownership. Nor is there transfer of possession in every case of mortgage. Mortgage is defined under Section 58 of Transfer of Property Act as transfer of an interest in a specific immovable property for the purpose of securing the money advanced or to be advanced or an existing or a future debt or for performance of an engagement which may give rise to a pecuniary liability. The person who is creating the charge of mortgage is called the mortgagee and the person in whose favour it is created is known as the mortgagee. The immovable property which is the subject of mortgage is referred to as mortgaged property. Lien : Lien is a right possessed by a person to detain or retain the goods or property belonging to another until he has received the dues or due remuneration for the services he has rendered in respect of them. This is defined under section 170 of the Indian Contract Act, 1872.

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