SECURITIES FOR BANK CREDIT

Types of Security for Bank Credit

Before advancing loans and advances a bank should make sure that it will get the
loan back in time.

Since many borrowers default in repaying loans, borrowers need to deposit assets
or give a guarantee as a testimony of the assurance of repayment.

This asset or guarantee is called the security of credit.

Types of Securities for Bank Credit

i) Personal Security

Personal security refers to the guarantee given by the borrower or by a third party
in the lead of pledging a tangible asset.

Since advancing loan against personal guarantee is very risky banks rarely grant a
loan against such security unless the borrower has a special and long relationship
with the bank.

The character, integrity, financial solvency, and social status are important factors
that are looked into before sanctioning of loan against personal security.

ii) Non-personal Security

Non-personal security refers to movable and immovable tangible properties against

which loans are granted. This type of security may include land, building,
commodities etc.

Non-personal security is safer than personal security.

In case the borrower defaults a tangible property can be sold in the market to
realize the unpaid amount.

Non-personal security can be charged in the Conn of lien, pledge, mortgage,

hypothecation, or assignment.

iii) Collateral Security

When the lender feels the security provided by the borrower is not sufficient or it
may be difficult to recover the dues smoothly, the lender may ask for additional
security to be provided by the borrower himself or by others on behalf of the
borrower.

In case of any default by the borrower, the collateral securities will come in hand
to service and recover the loan.

Types of Security for Bank Credit In the case of Non-personal Security

Acceptability

Asset accepted as security must be acceptable in the eyes of the law. Any asset
considered illegal to own or possess will put the bank in difficulty at the time of
disposing of.

Moreover, the bank may face legal consequences for possession of illegal items.

Marketability

The security must have a ready market. The bank has not taken the asset to keep it
in its possession for an indefinite period but rather to sell it in the market and
realize the loan amount.

Hence, no matter how valuable the asset maybe it is of no use if it does not have a
broad market.

Liquidity

Liquidity refers to how quickly an asset can be converted into cash or other assets
with little or no diminution in value.

Ideally, a security should be liquid which will enable the banker to sell l he
properly at a known price as soon as the default occurs.

Ownership

Before accepting a security the banker must ensure the ownership of the property.
An asset which is not owned by the lender may render difficulty in getting the loan
repaid.
Moreover, if the title of the property is defective the lender may face the problem.

Adequacy

The value of the security must be adequate to cover the full amount of the loan.
Moreover, a reasonable margin over the (loan is to be maintained.

The margin is the difference between the market value of the security offered and
the loan granted.

Stability of Price

The price of the goods and commodities which are necessaries of life are relatively
stable over a short period, though not necessarily over a long period.

But wide variations in the prices of luxury goods take place due to changes in
demand, fashions, and tastes of the people.

Bankers are generally reluctant to accept the commodities the prices of which are
uncertain and fluctuate too widely and frequently.

Documentation

The banker should see that proper documents such as a mortgage deed or the
pledge agreement containing all terms and conditions of the mortgage or pledge
are executed. This should be done in order to avoid all future disputes.

Non-encumbrance

A property or asset which has already been charged against a prior loan from some
other lender should be avoided as a security.

Because in that case, the banker will have a secondary claim on that particular
security.

Possession

Mere ownership of an asset without its possession may lead to unwanted

circumstances for the banker.

Unless the property is considered as a security is in the possession of the borrower

(though he is the owner) that property should not be accepted as a security.
If goods are taken as security the banker should take the possession before
advancing the loan.

Quality

If a commodity has been used as a security it should be of good quality. A

commodity which is perishable and may deteriorate in quality or quantity with the
passage of time should not be accepted as security.

Free from disabilities

A banker should disqualify securities crippled with certain disabilities like partly
paid up shares, life insurance policy without surrender value and so on. He should
see before accepting that the security is free from such disabilities.

Meld generating security

An asset which generates earnings during the period in which the loan is
outstanding is a better security than those which do not and are preferred by the
bankers.’

Easy store ability and low maintenance cost

A security should not create a headache or be a burden for the banker. It must be
easy to store with low maintenance cost.

Types of Security for Bank Credit In case of Personal Security

Financial Ability

The banker must inquire into the financial condition of the guarantor.

If the guarantor does not have the financial solvency to repay the loan in case the
principal debtor defaults the existence of a guarantee will be futile.

Honesty

The ability of the guarantor to repay the loan is of use only if the guarantor also has
the willingness and integrity.

So in addition to the financial solvency of the surety, his honesty is of immense

importance in case of personal guarantee.
Social status

The social status of the borrower and that of the guarantor must be ensured before
granting a loan.

A person who holds esteemed kudos in the society is more likely to be conscious
about fulfilling his promises

Factors Need Consideration before Sanctioning Banks Loans

Commercial Bank will carefully analyze and consider 7 factors before sanctioning
loans to its customers.

i) Liquidity.

ii) Profitability

iii) Safety and Security.

iv) Purpose.

v) Sources of Repayment.

vi) Diversification of Risk.

vii) Social Responsibility.

1. Liquidity

The term ‘liquidity’ implies the ability to produce cash on demand. A bank mainly
utilizes ‘ its deposits for the purpose of granting advances.

These deposits are repayable on demand or on the expiry of a specified period. To

meet the demand of the depositors in time, banks should keep their funds in the
liquid state.

2. Profitability

Like all other commercial institutions, banks are run for profit. Even government-
owned ‘ banks are no exception to this.
Banks earn profit to pay interest to depositors, declare a dividend to shareholders,
meet establishment charges and other expenses, provide for reserve and for bad
and doubtful debts, depreciation, maintenance and improvements of property
owned by the bank and sufficient resources to meet contingent loss.

3. Safety and Security

The banker should ensure that the borrower has the ability and the willingness to
repay the advances as par agreement.

Closely allied to this point is that before granting a secured advance, he should
carefully consider the margin of safety offered by the security and possibilities of
fluctuations in value.

4. Purpose

The banker has to carefully examine the purpose for which the advance has been
applied for.

In case the advance is intended for productive purposes, it could be reasonably

anticipated that cash flows arising for productive activities will result in prompt
repayment.

5. Sources of Repayment

Before giving financial accommodation, a banker should consider the source from
which repayment is promised. In some instances, debentures which are to be
redeemed in a few months’ time or a life insurance policy which is to mature in
near future may be offered as security.

6. Diversification of Risk

The security consciousness of a banker and the integrity of the borrower are ‘ not
adequate factors to keep the banker on the safe side.

What is also important is the diversification of risk.

This means the banker should not lend a major portion of his/her loan-able fund to
any single borrower or to an industry or to one particular region.

7. Social Responsibility
While admitting that banks are essentially commercial ventures, a bank should not
forget the fact that it is not enough that only people of means are given bank
finance.

Types of Bank Charges

Charge mean where in a transaction for value both parties evidence an intention
that property existing or further shall be made available as security for payment of
a debt and that the creditors shall have a present right to have it made available,
there is a charge, even though the present legal right which is contemplated can
only be enforced at some future date, and though the creditor gets no legal rights of
property, either absolute or special or any legal right to possession but only gets the
right to have the security made available by an order of the court.

i) Fixed charge

A charge is said to be fixed if it is made specifically to cover definite and

ascertained assets of a permanent nature or assets capable of being ascertained and
defined e.g., charge on land and building or heavy machinery.

It precludes the company from dealing with the property charged without the
consent of the charge-holder.

ii) Floating charge

It is a charge on property which is constantly changing e.g., stock.

The company can deal with such property in the normal course of its business until
it becomes fixed on the happening of an event. Thus, it is a charge on the assets of
the company in general.

Types of Bank Credits

Bank Credit is the aggregated amount financial institutions (i.e., bank) are willing
and able to offer a loan or advance to an individual or organization.

Bank credit can be classified into many sections on the various basis.

By Purpose of the Credit

i) Real estate loans are secured by real property – land, buildings, and other
structures – and include short-term loans for construction and land development
and longer-term loans to finance the purchase of farmland, homes, apartments,
commercial structures, and foreign properties.

ii) Financial institution loans include credit to banks, insurance companies,

finance companies, and other financial institutions.

iii) Agricultural loans are extended to farms and ranches to assist in planting and
harvesting crops and supporting the feeding and care of livestock.

iv) Commercial and industrial loans are granted to businesses to cover purchasing

inventories, paying taxes, and meeting payrolls.

v) Loans to individuals include credit to finance the purchase of automobiles,

mobile homes, appliances, and other retail goods, to repair and modernize homes,
and to cover the cost of medical care and other personal expenses, and are either
extended directly to individuals or indirectly through retail dealers.

vi) Miscellaneous loans include all loans not listed above, including securities’
loans.

vii) Lease financing receivables, where the lender buys equipment or vehicles and
leases them to its customers.

By Duration of the Credit

Depending on the duration for which loans are given loans can be classified into
three categories:

Short-term credits are scheduled to be repaid within one year. Businesses take

short-term loans to meet working capital needs. Short-term loans are usually given
against inventory and accounts receivable. These loans can also be unsecured, such
as a line of credit, revolving credit.

Mid-term credits are repaid over a period ranging from one year to five years.
Banks customarily grant such loans against immovable properties. Interest rates on
mid-term loans are higher than on short-term loans.
Long-term credits are the loans whose repayment period extends beyond five
years. Long-term loans are used for constructing plants and factories, construction
of a house, purchase of land, equipment, and machinery. Immovable properties are
used as securities for such loans.

By Nature of the Credit

Funded credits or non-documentary credits are given out of the bank’s funds to

individuals and organizations through current accounts or loan accounts. Financed
credits include loan, cash credit, and bank overdraft.

Son-funded credits or documentary credits are given through issuing various

documents, this form of credit banks provide the loan by not extending cash but by
lending their reputation and good names, Examples of non-funded credit include a
letter of credit (LC), bank guarantee, etc

Cannons of a good Banking Security

A bank is one kind of financial institution which deals with money and other
monetary instruments and conducts business. Generally, it is said that what a bank
does is banking. Banking means the activities undertaken by banks which include
personal banking and commercial banking and corporate banking. Economic
development of a country is dependent on sound banking.

There exist some cannons which should be considered, by a banker while making
secured advances for his safe position are stated below:

The validity of the title of the owner:

When a customer applies for a loan against some security, the banker must
ascertain the validity of the title of the borrower. If he gets a defective title, he
cannot enforce his against the debtor. The banker must also get the title transferred
to him by executing appropriate documents.

Liquidity:

The main feature of secured loan is reliance on security and not on the
creditworthiness and financial standing of the borrower. So a banker must consider
whether the security offered is easily marketable without loss. He should reefer
only liquid assets such as manufactured goods, raw materials.

Free from disabilities:

A banker should disqualify securities crippled with certain disabilities; like party
paid up shares, life insurance policy without surrender value and so on. He should
see before accepting that the security is free from such disabilities.

Documentation:

Documentation is a salient feature of sound lending. The terms and condition under
which the loan is sanctioned and the security accepted are put down in writing and
signed by the borrower. Obtaining such agreement is called documentation. Such
agreement specifics the rights and liabilities of the banker and the customer. So
there is no room for misunderstanding of the terms between both the parties.

Margin:

A margin is a provision for safety maintained by the banker while advancing

against securities. • A banker does not lend the full value of the security offered by
the borrower. He retains a margin over it

Realization of advance:

If the borrower fails to repay the debt within the time specified, the banker after
serving reasonable notice can sell the securities and recover his duties. If the
banker is unable to recover the full amount from the sale proceeds, he can file a
suit against the borrower for the recovery of the balance within the 3 years from
the date of sanction of the advance.

Stages in the Credit Analysis Process

The credit analysis process is a lengthy one, lasting from a few weeks to months. It
starts from the information-collection stage up to the decision-making stage when
the lender decides whether to approve the loan application and, if approved, how
much credit to extend to the borrower.

The following are the key stages in the credit analysis process:
 

1. Information collection

The first stage in the credit analysis process is to collect information about the
applicant’s credit history. Specifically, the lender is interested in the past
repayment record of the customer, organizational reputation, financial solvency, as
well as their transaction records with the bank and other financial institutions. The
lender may also assess the ability of the borrower to generate additional cash flows
for the entity by looking at how effectively they utilized past credit to grow its core
business activities.

The lender also collects information about the purpose of the loan and its
feasibility. The lender is interested in knowing if the project to be funded is viable
and its potential to generate sufficient cash flows. The credit analyst assigned to
the borrower is required to determine the adequacy of the loan amount to
implement the project to completion and the existence of a good plan to undertake
the project successfully.

The bank also collects information about the collateral of the loan, which acts as
security for the loan in the event that the borrower defaults on its debt obligations.
Usually, lenders prefer getting the loan repaid from the proceeds of the project that
is being funded, and only use the security as a fall back in the event that the
borrower defaults.

2. Information analysis

The information collected in the first stage is analyzed to determine if the

information is accurate and truthful. Personal and corporate documents, such as the
passport, corporate charter, trade licenses, corporate resolutions, agreements with
customers and suppliers, and other legal documents are scrutinized to determine if
they are accurate and genuine.

The credit analyst also evaluates the financial statements, such as the income
statement, balance sheet, cash flow statement, and other related documents to
assess the financial ability of the borrower. The bank also considers the experience
and qualifications of the borrower in the project to determine their competence in
implementing the project successfully.

Another aspect that the lender considers is the effectiveness of the project. The
lender analyzes the purpose and future prospects of the project being funded. The
lender is interested in knowing if the project is viable enough to produce adequate
cash flows to service the debt and pay operating expenses of the business. A
profitable project will easily secure credit facilities from the lender.

On the downside, if a project is facing stiff competition from other entities or is on

a decline, the bank may be reluctant to extend credit due to the high probability of
incurring losses in the event of default. However, if the bank is satisfied that the
borrower’s level of risk is acceptable, it can extend credit at a high interest rate to
compensate for the high risk of default.

3. Approval (or rejection) of the loan application

The final stage in the credit analysis process is the decision-making stage. After
obtaining and analyzing the appropriate financial data from the borrower, the
lender makes a decision on whether the assessed level of risk is acceptable or not.

If the credit analyst assigned to the specific borrower is convinced that the assessed
level of risk is acceptable and that the lender will not face any challenge servicing
the credit, they will submit a recommendation report to the credit committee on the
findings of the review and the final decision.

However, if the credit analyst finds that the borrower’s level of risk is too high for
the lender to accommodate, they are required to write a report to the credit
committee detailing the findings on the borrower’s creditworthiness. The
committee or other appropriate approval body reserves the final decision on
whether to approve or reject the loan.