No doubt, the advancing of credit involves great risk for the bank. Therefore, to cover this risk, the bank keeps different tangible and non-tangible securities, before sanctioning the credit facility to a customer.
The bankers prefer such securities that carry less risk of depreciation due to market fluctuations and are easily scalable, even under changing market conditions.
Common Securities Against Banker Advances are
PLEDGE
Pledge is the actual delivery of the movable & tangible property to the lender, as a security for the credit. In a pledge, the possession of movable assets is with the bank but the ownership remains with the client. Pledge is against short-term finances and is considered to be the best security for the bank. The commodities that are pledged include generally, raw material, consumables, finished goods and in certain cases work in process (WIP).
MARGIN
For every credit, the bank needs security with margin or cushion. Similar is the case with the pledge.
For example, if, there is a 25% margin requirement then to obtain a loan of £.1 million, the security that is to be pledged should be worth £. 1.25 million.
Since, in pledge, the possession of the goods is with the bank, so bank keeps these goods in the godowns under the custody of Mucaddams.
MUCADDAMS
People who look after the pledged goods for the bank are called Mucaddams. If cotton (raw material) is to be pledged by the bank, it doesn’t mean that this cotton will be kept in the bank; such type of goods is kept in the godowns of the company. To these goods security, banks do not rely on other sources. They hire or appoint their own manpower called Mucaddams.
PRECAUTIONS
There are certain factors that a banker must take into consideration before advancing against the pledge.
1) Client
In the case of pledges, godowns are in the premises of the clients under the custody of Mucaddams, whose honesty can be bought at any time. The therefore greater risk is imposed by the client. So, it is necessary to be satisfied with the honesty and credibility of the client.
2) Nature of Commodity
The banker must be aware of the nature of the property i.e. whether the commodity is a perishable item like sugar. Also, the commodity being pledged should be easily saleable so that in case of default of client, the bank can easily sell it in the market.
3) Market Awareness
A banker must have market awareness e.g., Fluctuation in prices. Such commodities should not be pledged that might have low demand in the market and have many associated risks.
4) Suitability of Godown
The suitability of Godowns depends upon the nature of the commodity. The banker must be fully satisfied with the appropriation of godowns. Like in the case of medicines to be pledged, the godowns should have a clean environment and proper mechanism of cooling, to maintain the temperature.
5) Proper Valuation
Whenever goods are pledged, the banker should be aware of the true cost of the product as the client always overvalues his products. Sales taxes, excise duties are also paid on the finished goods. So a banker must have knowledge regarding all these things.
6) Insurance
The goods offered for security must be properly insured. The banker must analyze all the associated risks of the goods. So, to cover these risks bankers should first decide which insurance company in the UK suits their needs and what are further commodity’s insurance requirements.
HYPOTHECATION
When an immovable property is offered for security against a credit but both the ownership and possession are left with the borrower, the goods are said to be ‘hypothecated’. Securities like machinery, stocks, etc. are offered for hypothecation. Lending against hypothecation of goods is very risky. The control of banks is weak so the greater risk is involved in hypothecation.
In case of hypothecation
The banker reserves the right to inspect the goods hypothecated to him and can ask for periodic stock reports, where necessary.
The banker, for his protection, may ask the borrower to insure. The banker may himself do so and recover the expenses from the borrower.
The banker may ask the borrower to maintain a balance of goods sufficient to fulfill the margin requirements.
Matthew is a Co-Founder at BusinessFinanceArticles.org. Matthew was a floor manager at a local restaurant in Wales. He lost his job after the pandemic and took initiative to make a team and start the project.
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