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 which is outside this list, the branch should take permission of the head office.
In case of lending some principles should be followed by banker against goods. Some advisability of Sending by a banker against goods is stated below:
- Quality of goods: Generally, bank should accept goods which could be marketed easily, quickly and standard quality in nature. Because there exists a greater risk, if the goods are not good quality which are taken as security.
- Marketability: Goods are tangible securities and are better than guarantee and bill of exchange. If a borrower makes a default, the banker can realize his duties by disposing of the goods in the market.
- Price: Banker should take those goods which have ready market. They can be sold of easily than other kind of securities. The existence of ready market makes the 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 long period.
- Stability: Generally, banks accept goods which are necessaries 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, gains, pulses etc. Market trends and reports are available in respect of almost all commodities in newspapers. So banker should take these types of goods as security.
- Margin: In 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 case of 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 the prior consent of the bank.
Under its selective credit control scheme, the central bank issues from time to time directives regarding granting of loans against selective commodities. 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 case of 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 case of pledge the godown should have a bank lock with the bank’s name engraved on it. Some name plates declaring that the goods are pledged should be prominently displayed in the godown.
- In case of payment of 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 account of ‘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. In case the bank permits the borrower to process the raw materials hypothecated into a finished product, an appropriate name plate 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 taking into account the value of the goods (calculated on the basis of market price or cost whichever is lower) and appropriate margin in respect of those goods. While valuing the goods both 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, 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 in nature. They are repaid before the commencement of the next season. Therefore, there is no unnecessary locking up of funds.
- In case of commodities which are used as necessaries of life, there is not much of price fluctuations.
Limitations of Advances against Goods
- Effective supervision over goods may not be possible particularly when they are hypothesized. Dishonest persons may cheat the banks.
- Qualify of goods is difficult to verify. The goods actually pledged may be quite different than those which were promised to be pledged.
- Goods deteriorate in quality with the passage of time. ‘This results in erosion in hank’s security.
- Heavy transportation costs may have to be incurred for realizing the best possible price for the goods.
Finally, we can say that these above points are considered as the principles of lending by a banker against goods.