UNIT 3 | EMPLOYMENT OF BANK FUNDS class 11 (part 2)| term 2 | Banking CBSE class 11

 Cash Credit Generally the facility given to the Industrial / Business customers is known as ‗Cash Credit‘ (CC) account in which the stock (raw material / work in process / finished goods) lying in the go down is pledged or hypothecated as the security by the bank. In a CC account, the bank fixes a ‗cash credit limit‘ for the borrower which is usually 75% to 80% of the values of stocks and book debts (minus creditors for purchase), as declared by the borrower in a prescribed format periodically. The bank conducts periodical surprise checks in the go downs of the borrower to ensure that the borrower declares the quantity and value of the stocks accurately and maintains the acceptable level of financial discipline. 3.7. Overdrafts An overdraft facility is an open-ended facility. Normally the limit is initially sanctioned for a period of one year and rolled over after a review by the bank of the facility utilised by the borrower. Bank charges interest on the actual amount utilised by the borrower. Generally, the term ‗Overdraft‘ is used for the unsecured open ended facility given to a borrower-for example to professionals like doctors, lawyers, advocates etc. or to any other individuals without security (depending on the creditworthiness of the borrower) or against security like Fixed Deposits, Government securities, Stocks and Bonds, Life Insurance Policies etc. Types of Overdraft facility available: Intraday Overdraft Limit: Maximum limit that can be overdrawn during the day is fixed. During the day, the account may be overdrawn up to this limit but before the end of the day, the outstanding balance

should come back to levels within the normal limit. It is normally bigger than EOD (End of the Day) overdraft limit. End of Day Overdraft Limit (Overnight): This is to help the borrower to tide over the mismatches of receipts and payments by one day. So the outstanding balance should be brought within the normal limits on the next day. Advantages of Overdrafts:  Flexible – An overdraft is there when you need it, and costs nothing (apart from possibly a small fee). It allows you to make essential payments and helps to maintain cash flow. You only need to borrow what you need at the time.  Quick – Overdrafts are easy and quick to arrange. Disadvantages of Overdrafts:  Cost – Overdrafts carry interest and fees; often at much higher rates than loans. This makes them expensive.  Recall – Unless specified in the terms and conditions, the bank can recall the entire overdraft at any time. This may happen if you fail to make other payments, or if you have broken terms and conditions;.  Security – Overdrafts may be secured by business assets, which put them at risk if you cannot meet repayments. 3.8. Purchase and Discounting of Bills This is another method of extending working capital finance to business entities.  Bank purchase or discount the commercial bills (drawn by the sellers on the buyers) and this provide finances. It is a widely used method of short term financing. It is a fund based activity. Bill of exchange Definition: According to the Negotiable Instruments Act, 1881, ―A Bill of Exchange or Trade Bill is an instrument in writing containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to, or the order of, a certain person, or to the bearer of that instrument.‖ Process of creation of Bill of Exchange (BE) and financing:

 Since a BE is a stand-alone instrument which is admissible in a Court of Law, the business community prefers to draw Bills of Exchanges on the buyers. If the buyers fail to honour their commitments, then it would be easy for the sellers to go to court and claim their dues/damages solely on the strength of the dishonoured Bill of Exchange.  The seller of the goods sends the transport documents and the invoices along with BE for the invoice amount to the buyer bank with the instruction to deliver the documents to the buyers:  Against payment if the agreement with the buyer is for immediate payment basis of the bill. (In this case, the buyer bank collects the money due from the buyer and delivers the documents.  Against the ‗acceptance‘ of the BE by the buyer, if the agreement with the buyers is to grant credit of 30 days, 45 days or 60 days. (In this case, the buyer accepts the BE, takes delivery of the documents and pays the dues to the bank on or before the due date.  The endorsement by the bank acts as a valid discharge for the buyers for having made the payment.  The sellers obtain lines of credit from their bankers to obtain finance against the bills thus drawn on their buyers by endorsing them in favour of the banks- so now the banks become the holders and have claim on the buyers for the payment.  At this stage, the sellers seek finance form their banks on the security of the BEs, so that they need not block their funds till the dues from their buyers are realised.  The banks ‗purchase‘ the bills which are payable on Demand (i.e. without any credit period) and ‗discount‘ the bills which are payable after a stipulated credit period. In both the cases, the banks deduct the interest at the contracted rates in advance for the period up to the due dates of payment. 3.9. Modes of creating charge on securities While extending credit, banker must secure his position. A wide range of securities e.g. Land, Building, Goods, Share Certificates, Life Policies, Fixed Deposit Receipts, Title Deeds etc. are accepted by banks as security for a loan. Types of charges on securities:

The important methods of charging securities are as follows: 1. Lien 2. Pledge 3. Hypothecation 4. Mortgage 5. Assignment 1. Lien: A lien is the right of a person in the possession of goods to retain them until debts due to him have been satisfied. A lien may be general or particular. General lien: arises out of the general dealings between two parties and covers any property that one party may be holding for the other. Particular (specific) lien: is a right to retain the goods in respect of which the debt arises. Thus, a particular lien can be exercised by a person who has spent his time, labour and money on the goods retained e.g., a scooter repairer may retain the scooter till the repair charges are paid. Banker‘s lien is a general lien. Bankers, in the absence of a contract to the contrary, can exercise general lien and retain as security for a general balance of account, any goods bailed to them. So, no agreement is necessary to create the right of lien. Bills and documents sent for collection are in the course of banker‘s ordinary business and he has a lien upon them. The lien also extends to all securities held by the banker as cover for any specific loan, but left with him after the loan has been repaid. Banker‘s lien is more extensive than an ordinary lien. No lien can be exercised in respect of documents or valuables left inadvertently with the banker. 2. Pledge: Pledge may be defined as the bailment of goods as security for payment of a debt or performance of a promise. Bailment means delivery of goods by one person to another for some purpose, under a contract that the goods shall, when the purpose is accomplished, be returned or otherwise disposed of according to the directions of the person delivering them. The person, who delivers the goods, as security is called the

 ‗pledger‘ and the person to whom the goods are so delivered, is called the ‗pledgee‘. The ownership of the goods remains with the pledger. A pledge is created only when the goods are delivered by the borrower to the lender or to someone on his behalf with the intention of their being treated as security against the advance. Delivery of goods may, however, be actual or constructive. It is constructive delivery where the key of a go down in which the goods are kept or documents of title to the goods are delivered to the Bank. Similarly, where the goods continue to remain in the borrower‘s possession but are agreed to be held as a ‗bailee‘ on behalf of the pledgee and subject to the pledgee‘s order, it amounts to constructive delivery and tantamount to valid pledge. Advantages of Pledge: To a banker, pledge is perhaps the most satisfactory mode of creating a charge on securities. It offers the following advantages:-  The goods are in the possession of the bank and, therefore, in case the borrower makes a default in payment, they can be disposed of after a reasonable notice is given to the borrower.  In the case of insolvency of the borrower, bank can sell the goods and lodge its claim for the balance of the debt, if any. Rights of a Pledgee: If the pledger fails to pay his debt or complete the performance, of an obligation at the stipulated time, the pledgee can exercise any of the following rights:  Bring a suit against the pledger upon default in the redemption of the debt or performance of promise and retain possession of goods pledged as collateral security; or  Sell the things pledged by giving the pledger reasonable notice of sale.  In case, the proceeds from goods pledged are not sufficient to meet the amount of the loan, the pledgee can file a claim for the balance. If, on the other hand, there is surplus, that has to be returned to the pledger. In addition to the rights mentioned above, a pledgee has following rights:  It is the duty of the pledger to disclose any defects or faults in the goods pledged which are within his knowledge.

The pledgee has a right to claim any damages suffered because of the defective title of the pledger.  In case of injury to the goods or their deprivation by a third party, he would have all such remedies that the owner of the goods would have against them.  A pledgee has a right to recover any extraordinary expenditure incurred for the preservation of the goods pledged. Duties of a Pledgee  The pledgee is required to take as much care of the goods pledged to him as a person of ordinary prudence would, under similar circumstances, take of his own goods of a similar nature.  The pledgee must not put the goods to an unauthorized use.  The pledgee is bound to return the goods on payment of the debt.  Any accruals to the goods pledged belong to the pledger and should be delivered to him. For example, if the security consists of equity shares and the company issues bonus shares to the equity shareholders, the bonus shares received by the bank are the property of the pledger and not the pledgee. Rights of a Pledger:  Before sale can be executed, a reasonable notice (notice of intended sale of the security by the creditor) must be given to the pledger so that;  The ledger may meet his obligation as a last chance.  He can supervise the sale to see that it fetches the right price The pledgee will be liable to the pledger for the damages.  The pledgee has a right to claim back the security pledged on repayment of the debt with interest and other charges.  In case of sale, the pledger is entitled to receive from the pledgee any surplus that may remain with him after the debt is completely paid off.  The pledger has a right to claim any accruals to the goods pledged.  If any loss is caused to the goods because of mishandling or negligence on the part of the pledgee, the pledger has a right to claim the same. Duties of a Pledger

A pledger must disclose to the pledgee any material faults or extraordinary risks in the goods to which the pledgee may be exposed.  A pledger is responsible to meet any extraordinary expenditure incurred by the pledgee for the preservation of the goods.  Where the pledgee has exercised his right of sale of goods, any shortfall has to be made good by the pledger.  The pledger is liable for any loss caused to the pledgee because of defects in his (pledger‘s) title the goods. 3. Hypothecation: Hypothecation means that some right created in favour of the banker on the goods or related documents without transferring their possession to the lender. In hypothecation, the goods remain in the possession of the borrower but, he binds himself under the hypothecation agreement to give possession of the goods to the creditor when called upon to do so. The goods are charged under hypothecation particularly where pledge is either inconvenient or impracticable. For example, where the security offered is either rawmaterials or work-in-progress. Under this arrangement, the borrower is allowed to use the stock, sell it and replenish it by new one. A ‗floating charge‘ is created over the movable assets of the borrower. 4. Mortgage: Mortgage may be defined as ―the transfer of an interest in specific immovable property for the purposes of securing the payment of money advanced or to be advanced by way of loan, an existing or future debt, or the performance of an engagement which may give rise to a pecuniary liability. The transferor is called the mortgagor and the transferee the mortgagee. The instrument by which the transfer is effected is called a mortgage-deed. Equitable Mortgage: An equitable mortgage is created by an agreement, express or implied, that an equitable interest in the property shall pass to the mortgagee as security for a debt due or to become due. An equitable mortgage is effected by deposit document of title. The legal title to the property is not passed on to the mortgagee, but the mortgagor undertakes, through a memorandum of deposit; to execute a legal mortgage in case he fails to

 pay the debt in time. Equitable mortgages accompanied by the deposit of title deeds do not require registration. Registration offers still better security for the bank but it adds cost to the borrower by way of stamp duty/Registration charges. Advantages of Equitable Mortgage: An equitable mortgage has the following advantages over legal mortgage:  It is easily and inexpensively acquired, as no stamp duty and registration charges are payable.  The mortgagor‘s credit does not suffer, as in the absence of registration; nobody knows the transaction except the mortgagee.  The mortgagee gets the same right in case of an equitable mortgage as are conferred in case of a legal mortgage. Risks in Equitable Mortgages:  The principal risk run by a banker as equitable mortgagee is that the borrower may subsequently execute a legal mortgage (transfer of title to the lender) in favour of another party. If a person lends upon a legal mortgage without either a sight of the deeds or a reasonable explanation of their disappearance, he will get a charge prior to the equitable mortgagee.  Even amongst equitable mortgagees, if the first equitable mortgagee has, through negligence, failed to obtain possession of the title deeds, he will be postponed to a second equitable mortgagee who has the deeds, and who advanced money without notice of the ―prior equitable charge‖. Transfer of Property Act reads, ―where through the fraud, misrepresentation or gross neglect of a prior mortgagee another person has been induced to advance money on the security of the already mortgaged property, the prior mortgagee shall be postponed to the subsequent mortgagee.‖ Rights of a Mortgagee  Right to sue for mortgage-money: under simple mortgage or wherever expressly so agreed the mortgagee has a right to file a suit in a court of law for the mortgagemoney.  Right of Sale: In case of simple, equitable and English mortgage, the mortgagee can cause through the court, the mortgaged properties to be sold in case of default by

the mortgagor in repayment of the mortgage-money. Transfer of Properties Act, however, confers upon the mortgagee right of sale without the intervention of the court under certain circumstances.  Right of possession: to any accession to mortgaged property. If any accession (addition) is made to the mortgaged property, the mortgagee, in the absence of a contract to the contrary is entitled to the possession of such accession for the purposes of security. For instance, if a person mortgages a plot of land and later erects a building on it, for the purposes of security, the mortgagee is entitled to the plot as well as the building.  Right of foreclosure: In case of mortgage by conditional sale, usufructuary mortgage or anomalous mortgage, a mortgagee may sue for foreclosure, i.e. may obtain a decree from the court debarring the mortgagor of his right to redeem the property. 3.10. Types of Security Loans have two categories: (a) secured, and (b) unsecured. Unsecured loans are those loans which are not covered by the security of tangible assets. Such loans are granted to firms/institutions against the personal security of the owner, manager or director. On the other hand, Secured loans are those which are granted against the security of tangible assets, like stock in trade and immovable property. Thus, while granting loan against the security of some assets, a charge is created over the assets of the borrower in favours of the bank. This enables the bank to recover the dues from the customer out of the sale proceeds of the assets in case the borrower fails to repay the loan. There are various types of securities which may be offered against loans granted, but all of those are not acceptable to the banks. The types of securities generally accepted by the bank are the following:  Tangible assets such as plant and machinery, fixtures, annuities, art, motor-van, Gold ornaments, jewels etc.  Documents of title to goods like Railway Receipt (R/R), Bills of exchange, etc.  Financial Securities (Shares and Debentures),  Stock (raw material / work in process / finished goods)  Life-Insurance Policy

Real estate‘s (Land, building, etc).

 Fixed Deposit Receipt (FDR)

Types of Securities available in the market are:

 Equity

 Bonds

 Mutual Funds

 Warrants

Equity share: Its owner owns a part of the capital of the company which has issued the

shares in question. The shares enable the shareholder the right to take part in the decisionmaking in the company. If the latter operates with profit, the owners of shares may receive

dividends. The amount of the dividend is decided upon by the shareholders at a General

Meeting of the Shareholders.

Bond: A bond is a debt security. When purchasing a bond, you have no right to participate in

the company's decision making but are entitled to the reimbursement of the principal and the

interest. Companies may decide that the principal be paid in regular annual instalments or on

the maturity of bonds.

Interest paid can be on fixed rate / floating rate. Issuers pay the interest Half Yearly / Yearly

Warrants: Warrants are options issued by a company, which give holders the right to

purchase a certain quantity of the respective company‘s shares at a pre-determined price. 

Questions

1. What is liquid asset and explain when an asset is considered liquid? 
2. What is difference between Fund based and Non fund based loans? 
3. What is the difference between Cash Credit and Overdraft facility?
4. Explain the difference between intraday overdraft limit and Overnight overdraft limit? 
5. Explain the 5C‘s of Lending.
6. Prepare a chart showing against which loans, Bank requires which types of asset?
7. Do a comparative study of one Public Sector Bank, one Private sector bank, one foreign bank and one cooperative for the Housing and Vehicle loan and present to the class? 
8. Discuss the difference between various types of charge created on an asset given for taking a loan?