DEPARTMENT OF TECHNICAL EDUCATION

ANDHRA PRADESH
Name :Sreenivasa Rao B.
Designation :Lecturer in CCP
Branch :Commercial and Computer Practice
Institute :S.U.V.R&S.R GPW,Ethamukkala
Semester :VI SEMESTER
Subject name :Banking II
Subject code :CCP 604 (B)
Major topic :Loans and Advances – Short Term
& Long Term
Duration :50 minutes
Sub topic :Various Modes of Creating Charge.
Teaching aids :PPT
CCP604(B).17 1
Objectives :
On completion of this period you would be
able to

 Explain the meaning of Hypothecation.

Define Hypothecation
 List the Features, Drawbacks, and
Precautions to be taken on Hypothecation.

CCP604(B).17 2
Recap

We have discussed
 The various types of creating charge an assets
 Mortgage- meaning
 Mortgage-definition
 Essential feature of mortgage
 Forms of mortgage

CCP604(B).17 3
Hypothecation

 Under Hypothecation, loans are granted on the

strength of movable assets like inventory of finished
goods, delivery van etc.,

 Hypothecation is otherwise called ‘Mortgage of

movable property’.

 It is an extended idea of pledge only.

 Manufacturing concerns cannot pledge their raw

materials which are required for daily production. In
such cases, hypothecation is the only answer.
CCP604(B).17 4
Hypothecation…

 Manufacturing concern can continue their

production without any interruption by
hypothecating their raw materials.
 Under this method, the banker is having the
least control over the security.
 It is very risky advance.
 It is granted only to respectable customers and
reliable parties.

CCP604(B).17 5
Hypothecation…

 It is also called “Open Loan Facility”.

 It is called so because, the loan is granted only
against an obligation to repay the money and not
against any tangible security, in the true sense of
the term.
 Since the banks do not obtain actual or
constructive possession of the goods, the
borrower has ample opportunity of dealing with
them fraudulently.

CCP604(B).17 6
Hypothecation – Definition

 Dr. Hart has defined hypothecation as

“Hypothecation is a legal transaction whereby
goods may be made available as security for a
debt without transferring either the property or
its possession to the lender”.

CCP604(B).17 7
Features
[a] No Transfer of Possession: Under hypothecation,
the physical possession of goods always remains
with the the borrower. Actually, the banker gets
only the constructive possession. Borrower
executes a document called Deed of
Hypothecation.

[b] No Transfer of Ownership: There is also no

transfer of ownership of goods to the banker.
The ownership always remains with the
borrower. CCP604(B).17 8
[c] Obligation to Repay a Debt: Under hypothecation,
there is an obligation on the part of the borrower to
repay a debt. In the event of non-payment, he
agrees to give the physical possession of the goods
to the banker. It is this obligation which constitutes
the real security for the loan.

[d] Right of Sale Through Court: In the event of non-

payment of money, the banker has to file a suit and
obtain a decree either to recover the money or to
sell the security.
 However, if the agreement provides for the sale of
the security in the event of non-payment of the debt,
the banker can do so without
CCP604(B).17the intervention of the 9

court.
Drawbacks
 [a] Least Control Over the Security: The banker is
having the least control over the security. Both
ownership and possession of the hypothecated
goods remain with the borrower. So, he can very
easily indulge in fraudulent activities.

 [b] False Stock Statements: The borrower may

give false and inflated stock statements, against
which, he may enjoy over-credit facilities. In fact,
some of the stocks may contain even obsolete
CCP604(B).17 10

items.
[c] Double Financing: The borrower may hypothecate
the same stocks of goods with different banks and
get different loans, since, there is no necessity of
physically transferring the goods to the banker.

[d] No Right of Sale: In the event of non-payment, the

banker can not sell the goods without the
intervention of the court. Again, it is very difficult to
realize them, since, most of the goods are in the
form of raw material or used vehicles etc.

CCP604(B).17 11
Precautions

 Letter of Hypothecation: While granting loans

against hypothecation, the banker should obtain a
letter of Hypothecation containing several clauses to
protect his interest.

 Undertaking: Besides, the banker should obtain an

undertaking from the borrower, stating that, he has
not obtained any loan from any other banker against
the same goods.

 Stock Statements: The banker must get correct

stock statements very frequently from the borrower
stating the quantity, quality and the price. He must
adjust the loan amount on the basis of the stock
statements.

CCP604(B).17 12
 Inspection: The banker must pay frequent visits to
the factory/godown and check the stocks and the
books of account. If there is any discrepancy, the
borrower must be put into task.

 Guarantees: During inspection, if the banker finds

that the financial position is weak, it is advisable to
get the personal guarantees of officers/directors to
strengthen the charge.

CCP604(B).17 13
 Insurance of Goods: The banker should insist upon
the borrower to insure the goods against all risks.

 Name Board: It is always advisable to display a

board pointing out “Goods Hypothecated to –
Bank”. It prevents double financing.

CCP604(B).17 14
Summary
 In hypothecation, the goods remain in the
possession of the borrower and are equitably
charged to the lender under documents signed
by the borrower.
 Hypothecation facility granted only to first class
customers.

CCP604(B).17 15
Summary…

 Certain precautions are to be taken to safeguard

the position of the banker like letter of
Hypothecation, stock statements, Insurance of
goods, financial soundness and business of the
borrower, Name Boards on hypothecation of
goods etc.,

CCP604(B).17 16
 Quiz

1) A charge where there is neither the transfer of

ownership nor the possession is called:

a) Lien

b) Pledge

c) Mortgage

d) Hypothecation

CCP604(B).17 17
Quiz

1) The most risky charge from a banker’s point of

view
 Lien

 Hypothecation

 Legal mortgage

 Pledge

CCP604(B).17 18
FREQUENTLY ASKED QUESTIONS

1. Define Hypothecation.

2. Distinguish between a lien and Hypothecation.

CCP604(B).17 19