Bankers' Advances Against Security of Goods

Process Bank follows in Sanctioning Advances In Goods.

The bank should keep in mind the following points while advancing money on the security of goods.

Selection of the borrower

The banker should satisfy himself regarding the character, capacity, and capital of the borrower. Since in ease of goods, chances of fraud are more, this is all the more important.

Selection of the commodities

Commodities should be such which have fairly stable prices.

The head office should prepare a list of such commodities, and in case a branch wants to lend money on the security of a commodity outside this list, the branch should take permission of the head office.

In the case of lending, bankers should follow some principles against goods.

Quality of goods: Generally, the bank should accept goods that could be marketed easily, quickly, and of standard quality in nature. Because there exists a greater risk if the goods are not of good quality, which is taken as security, some advisability of Sending by a banker against goods is stated below:
Marketability: Goods are tangible securities and are better than guarantees and bills of exchange. If a borrower defaults, the banker can realize his duties by disposing of the goods in the market.
Price: The banker should take those goods which have a ready market. They can be sold off easier than other kinds of securities. The existence of a ready market makes goods reliable and safe security.
Short period: Normally, advances against goods are for short periods because of seasonal character. Therefore, there is no necessity to lock up funds for a long period.
Stability: Generally, banks accept necessities of life, such as Rice, Wheat, sugar, cotton, etc. The price of such goods does not fluctuate widely.
Evaluate: It is easy to evaluate the prices of goods such as wheat, rice, grains, pulses, etc. Market trends and reports are available in respect of almost all commodities in newspapers. So bankers should take these types of goods as security.
Margin: In the case of goods, demand, and nature determine the margin. Depending upon the quality and risk, the margin is prescribed.

Charging the security

Goods can be deposited by way of security, either in the form of a pledge or hypothecation.

In hypothecation, the borrower must be dependable since the banker has little control over the movement of goods.

The banker must also obtain a declaration from the borrower stating that (i) the borrower is the owner of the goods hypothecated, and (ii) he shall not charge the same goods to any other person without prior consent of the bank.

Legal Requirements

Under its selective credit control scheme, the central bank issues directives regarding granting loans against selective commodities from time to time. The banker should abide by these directives.

Storage of goods

The following points should be taken into account while storing the goods offered by way of security:

The godown must be safe from water, fire, etc., and situated in a good locality.
In the case of the hypothecation of goods, the borrower should give an undertaking that he will allow inspection of godown and stock books as and when desired by the bank’s officials.
In the pledge case, the godown should have a bank lock with the bank’s name engraved on it. Some nameplates declaring that the goods are pledged should be prominently displayed in the godown.
In the case of payment of the loan in installments, it should be seen that the goods released are in proportion to the amount paid by the borrower.
The goods should be insured for full value so that the bank may not have to suffer on the ‘average clause’ in case of under insurance.

Conduct of the account

No loan should be granted before the bank obtains either actual or constructive delivery of goods. If the bank permits the borrower to process the raw materials hypothecated into a finished product, an appropriate nameplate that the goods are hypothecated with the bank should be prominently displayed.
The balance in the borrower’s account should not be allowed to exceed the drawing limit.
The drawing limit should be fixed by considering the value of the goods (calculated based on the market price or cost, whichever is lower) and an appropriate margin in respect of those goods. While valuing the goods, both the quantity and quality of goods should be considered.
The borrower should clear the old debt before the commencement of the next season. In case he has not done so, a necessary explanation should be called for.
The advances should be made for genuine trade needs and not for speculative activities.

Advantages of Advances against Goods over Other Forms of Securities

They are easily marketable due to having a ready market.
Their value can be easily ascertained from the market.
They are tangible assets and, therefore, can be realized in case the necessity arises.
Loans against commodities are seasonal. They are repaid before the commencement of the next season. Therefore, there is no unnecessary locking up of funds.
In the case of commodities used as necessaries of life, there are not many price fluctuations.

Limitations of Advances against Goods

Effective supervision of goods may not be possible, particularly when they are hypothesized. Dishonest persons may cheat the banks.
The quality of goods is difficult to verify. The goods pledged may be quite different than those who were promised to be pledged.
Goods deteriorate in quality with the passage of time. ‘This results in erosion in hank’s security.
High transportation costs may have to be incurred to realize the best possible price for the goods.

Finally, we can say that these above points are considered the principles of lending by a banker against goods.

14 Precautions for Advances Against Security of Goods

Precautions are required to be taken by a banker in case of advances against the security of goods.

In granting advances, certain precautions are necessary.

1. The integrity of the borrower

The banker should ascertain that the borrower is trustworthy, honest, and a man of sufficient experience in his business. Such a precaution is necessary to avoid fraudulent dealings.

For example, when a customer offers 100 bags of paddy as security, it is impossible to inspect every bag. He has to rely on the honesty of the borrower.

Further, he should see whether the borrower has adequate practical experience in his business.

An experienced businessman is conversant with risks and the profitable areas of the business. An inexperienced one may incur a loss and be a potential risk.

2. Purpose of the loan

The repayment mostly depends upon the purpose for which the loan is obtained. To a borrower who is engaged in speculation, the chances of loss are greater. As such, the loss will have to be shared by the banker. So advances should not be allowed for speculative purposes.

3. Nature of the commodity

The banker should know some of the special features of the commodities offered as security. A banker should prefer commodities which can be disposed of easily, the quality of goods that are not subject to deterioration, and the price of almost steady goods as security.

4. Knowledge of different markets

A banker should be conversant with the markets for different commodities. This is essential to regulate the goods’ margin according to the market’s prevailing price. Failure to know the market will put him at the mercy of the borrower, who may inflate the value to get more advances.

5. Proper care in valuation

The banker should appoint experts to value the goods. Care should be taken to provide sufficient sales margin to avoid loss resulting from market fluctuation. In some cases, the price mentioned in the bill may be inflated.

So. it is advisable to compare the price which those prices prevailing in the market. The banker should insist on a certificate from reliable packers if the goods are packed.

6. Ascertain the title of the owner

Before accepting goods as security, the banker should ascertain the borrower’s title to the goods by inspection of the original invoice or cash memos.

7. Proper storage

The banker should select a properly built and safe warehouse in every way to store goods. The roof and flooring should be near the bank so that the bank’s representative can have direct and free access to them anytime.

All goods stored in bags or bales should be arranged to facilitate inspection easily. A careful selection should be made of godown keepers & Watchmen. They should be honest & possess a high sense of responsibility.

8. Rented godown

If the borrower uses a rented godown, the bank must obtain an undertaking from the owner of the building stating that the bank has a prior lien.

This is necessary because, at times, the building owner may have a prior claim for rent due & the position of the banker will be at stake.

9. Insurance up to the full market value

Goods should be insured against all known risks up to their full market value. The bank should hold relative insurance policies.

10. Creation of charge by Pledge and Hypothecation

A banker may create a charge over goods by pledge or hypothecation. The pledge delivers the goods or title to that to the banker. In hypothecation, neither possession nor goods are transferred to the banker.

So a written undertaking from the borrower should be obtained that the goods are not charged to any bank and will not be charged until the agreement continues with the bank.

11. Handling of go down keys

Under no circumstances should the keys of godowns be allowed to pass into the hands of the borrower.

The keys of the going down should be kept in a strong room under dual control and taken out at the commencement of the business and received back at the close of the business.

12. Inspection

Periodical inspection of the going down should be undertaken as to the quantity and quality of the goods. The quantity of stock in going down should be tallied with the bank’s record and the borrower’s books.

13. Supervision the release of goods

When the borrower can repay the debt in installments, the banker should release the goods only in proportion to the amount repaid.

It is also possible that the customers may request the banker to release a part of the goods when they get parties to sell.

14. Reserve bank directives

The Reserve Bank issues directives continuously, prohibiting advances against specific goods or stipulating minimum margins against certain commodities.

The directives may also specify the level and conditions on which the bank may grant credit. The bank should follow the conditions in the directives while lending against goods.

Finally, we can say that a banker should take these above precautions in case of advances against the security of goods.