| SECURITY
USE
Commercial
banks provide advances on a secured or unsecured basis. There
is a difference in the legal and economic meaning of the concept
of security. Legally, a secured advance or an advance made
on the security of assets, whose market value is not less
than the amount of loan. An unsecured advance does not carry
much security. Thus, in legal terms, loans against personal
security, or against book debts or bills receivables, are
unsecured advances. In economic terms, unsecured advances
defined in this manner are not necessarily a bad credit risk.
In many cases, they may be a first class banking risk. The
fully secured advances were 81 to 84 percent of total bank
advances till 1969, 75 to 79 percent during 1970 to 1986,
and 72 percent in 1995. Out of the unsecured advances in 1995,
9 percent were totally unsecured, and 19 percent were covered
by bank or government guarantees.
Securities in loan transactions can be divided into various
categories:
» Personal
and impersonal
» Tangible
and intangible
» Direct
and indirect
» Primary
and collateral
» Formal
and informal
» Specific
and continuing
In the case of personal security, the banker has a personal
right of action against the borrower. The common forms of
this type of security are promissory notes, bonds, personal
obligation of a mortgager, or a personal liability of a guarantor.
Personal security is also known as “intangible security”.
Impersonal security is in some physical or tangible form such
as movable or immovable property. Direct securities are furnished
by the borrowers themselves, while indirect securities are
given by a third party to secure a borrower’s account.
Guarantees are a good example of indirect securities. Any
goods or securities of the borrower coming into the banker’s
hands, and which he retains in the exercise of his right of
general lien, are known as “informal securities”.
Finally, specific securities are those that cover only an
existing or specific debt. Continuing securities cover all
sums that are due at present and which may become due in the
future.
Banks obtain legal claims to securities by way of lien, pledge,
hypothecation, mortgage, charge, assignment and set-off. These
methods differ in respect of transfer of ownership, possession,
and power of sale of securities. There is a long array of
securities, which are in vogue in the banking business in
India. In an agricultural country like India, the importance
of agricultural commodities as security is natural. However,
the diversification of financial instruments has resulted
in the use of certain new securities in bank lending, viz.
units, provident fund receipts, new small savings media, and
so on. Landless laborers used to obtain loans from smaller
banks against these goods. If the objective of providing more
loans to small borrowers were to be achieved, it would be
helpful if nationalized banks readily accept gold as security
The production of agricultural commodities is subject to significant
fluctuations from year to year. Trading in these commodities
has been subject to a great deal of speculation. These commodities
are also known as “sensitive” commodities. Bank
advances against the security of these commodities are regulated
through selective credit controls by the monetary authorities
in India. The RBI imposes minimum margin requirements on the
advances to be made by banks against the security of these
commodities. This brings us to the prevalent practices of
margin requirements in India. The loan made by a bank against
a given security is always less than the value of that security.
This difference is known as a “margin”. The extent
of margin differs from security to security. The major principles
that determine it are marketability, ascertainability of value,
stability of value, and transferability of title of the security.
Margin requirements in India are:
Gold bullion: 10 percent
Gold ornaments: 20 to 30 percent
Government and other trustee securities: 10 percent
Ordinary shares: 40 to 50 percent
Preference shares: 25 percent
Debentures: 15 to 20 percent
Life policies: 90 percent of surrender value
Commodities: 25 to 50 percent
Immovable property: 50 percent
CONCEPT
OF LENDING AND PORTFOLIO CHOICE
The
two important aspects of banking development in India are:
Extent of change in the concept of bank lending
How far the maturity pattern of assets & liabilities of
banks is in balance
Traditionally,
loan policies of banks are determined by three major principles:
safety, liquidity and profitability. There are two approaches
to bank lending, viz. the “liquidation approach”
and “going concern approach”. The “liquidation
approach” is also known as a “real bills”
doctrine. It looks after the assets of the borrower as security
for a loan. It implies a short-term view of the borrowers’
prospects and involves taking a charge of his assets. The
“going concern approach” lays great emphasis on
the borrower’s ability to repay the loan out of future
cash flow rather than his ability to offer some tangible assets
as security for the loan. The “liquidation approach”
implies lending against the security of “self-liquidating”
assets such as stock of commodities, and so on. Banking systems
follow a combination of these approaches across the world.
For e.g. US banks that lend on term basis emphasize the “going
concern approach”. British banks that lend in the form
of overdrafts emphasize the “liquidation approach”.
Indian banks also emphasize on the “liquidation approach”.
Before
independence, commercial banks in India adopted dual criteria
in their lending. Their loans to the private commercial sector
were made on the basis of security and profitability. When
they granted advances to the industrial sector, they did not
insist on security in the form of tangible assets. These loans
were made against guarantees from managing agents. The abolition
of the managing agency system and increasing professionalisation
of management resulted in a qualitative change in the risk
borne by banks because there was no guarantee that professional
managers would stick to the same organizations in times of
difficulty. With the abolition of the managing agency system,
banks adopted the “liquidation approach” in case
of industrial loans. The banks reorganized the relevance of
the principle of lending on the basis of actual needs of the
borrower, the purpose of borrowing, and so on.
After
nationalization of banks, the focus was shifted to the “going
concern approach”. One of the planks for the nationalization
of banks was that they should not provide credit on the basis
of the size of the assets of the borrower and his social status.
Cash credit remains a major method of bank lending. It implies
that security of tangible assets remains the most important
basis of bank lending. Similarly, when commercial banks have
surplus liquidity, it means that banks have been slow in extending
loans without tangible security. The concept of lending is
changing in India due to social compulsions. With the fixation
of targets in lending credit to priority sectors, the banks
have been increasingly made to change their lending attitudes,
procedures, and techniques.
The
official policy for unsecured lending by banks has been ambivalent.
While banks are expected to shift from security-based lending
to need-based lending, some central banking restrictions on
unsecured advances in terms of the Banking Regulation Act
continue to operate.
During
the past few years, banks in India have mooted and have been
trying to implement the idea of credit disbursal through credit
plans for individual banks and for the national economy as
a whole. They have been doing so under the leadership and
guidance of the RBI. Commercial banks have started preparing
credit budgets. The experience of formulation of credit plans
should enable banks to avoid imbalances in the demand and
supply of bank credit.
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