Process Bank follow 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 which is outside this list, the branch should take permission of the head office.
In the 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, the 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 a good quality which is 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 a ready market. They can be sold off easily than another kind of securities. The existence of a 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, grains, 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 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 the 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 the pledge, 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 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 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 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, 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 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 are not much of 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.
- Quality 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.
Precautions required to be taken by a banker in case of advances against the security of goods.
In granting advances certain precautions are necessary.
1. 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.
when a customer offers 100 bags of paddy as security it is impossible to inspect each and 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 have a working knowledge of some of the special features of the commodities offered as security.
The commodities which could be disposed of easily, the quality of goods which are not subject to deterioration and price of goods which are almost steady should be preferred by a banker as security.
4. Knowledge of different markets
A banker should be conversant with the markets for different commodities. This is essential to regulate the margin for the goods according to the price prevailing in the market.
Failure to have knowledge of 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 sale margin to avoid loss resulting from market fluctuation. In some cases, the price mentioned in the bill may be an inflated one.
So. it is advisable to compare the price which those prices prevailing in the market. If the goods are packed the banker should insist on a certificate from reliable packers.
6. Ascertain the title of owner
Before accepting goods as security, the banker should ascertain the title of the borrower to the goods by inspection of the original invoice or cash memos.
7. Proper storage
The banker should select warehouse which is properly built and safe in every way for the storage of goods.
The roof and flooring should be situated near the bank so that the bank’s representative can have direct and free access to them at any time.
All goods stored in bags or bales should be so arranged as to facilitate inspection easily.
A careful selection should be made of godown keeper & Watchmen. They should be honest & posses a high sense of responsibility.
8. Rented godown
If the borrower makes use of 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 relative insurance policies should be held by the bank.
10. Creation of charge by Pledge and Hypothecation
A banker may create a charge over the goods either by pledge or hypothecation.
In the pledge, the goods or title thereto is delivered 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 till 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 go 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.
Periodical inspection of the go down should be undertaken as to the quantity and quality of the goods.
The quantity of stock in go down should be tallied with the record in the bank and with the books of the borrower.
13. Supervision regarding the release of goods
When the borrower is allowed to 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 the amount a part of the goods when they get parties to sell.
14. Reserve bank directives
The Reserve Bank issues directives from the time to time prohibiting advances against specific goods or stipulating minimum margin against certain commodities.
The directives may also specify the level up to and conditions on which bank may grant credit. The bank should follow the conditions in the directives while lending against goods.
Finally, we can say that these above precautions should be taken by a banker in case of advances against the security of goods.