JAIIB PPB Paper-2 Module-B Unit 4: Types of Collaterals and their Characteristics

JAIIB Paper 2 (PPB) Module B Unit 4: Types of Collaterals and their Characteristics (New Syllabus) 

The Institute of Indian Banking and Finance (IIBF) has recently announced the revised syllabus and exam format for the JAIIB Exam 2023. The upcoming exam will comprise of four papers, with Paper 2 (Principles & Practices of Banking) covering Unit 4Types of Collaterals and their Characteristics. This particular unit holds significant importance for candidates, as it will greatly impact their performance in the exam.

To assist candidates in comprehending the topic, we will provide all the necessary details related to Unit 4: Types of Collaterals and their Characteristics of JAIIB Paper 2 (PPB) Module B: Functions of Banks. We strongly recommend candidates to refer to this article and also utilize our Online Mock Test Series to enhance their understanding of Foreign Currency Accounts for Residents and other related aspects.

For candidates appearing for the JAIIB Certification Examination 2023, it is essential to comprehend each unit in the syllabus, including the Marketing unit. This unit holds great importance in the banking industry, and candidates must prepare thoroughly to excel in the exam and establish a successful career in the banking sector.

Introduction 

Banks are financial intermediaries where the resources of the public are mobilized and lent to various sectors of the economy. The Money mobilized from the public by way of deposit is repayable as and when demanded by the depositors. Therefore, bankers take utmost care to see that the money lent to various types of borrowers is repaid as per the repayment schedule along with interest. In order to safeguard the advance, bankers normally take securities, on which they fall back in case the borrowers commit default.

There are different types of Collaterals and their Characteristics.

Land and Buildings

This type of security is not self- liquidating nature. In the event of the bank wanting to sell the property for recovering its advance, it can do so through the legal process. Normally, banks have to file a suit before the civil court for recovery, if the amount due in the loan account is less than Rs 10 lakhs and before the Debt Recovery Tribunal (DRT), if the amount due is Rs. 10 lakhs and above.

Characteristics of Land and Building

  • Examining the Title to the Property
  • Document to be called for from the Mortgagor
  • Valuation of Property
  • Leasehold Properties

GOODS

Banks advance loans routinely against the security of goods such as agricultural goods, raw material, semi finished goods. An advance goods may be extended by way of keeping goods as pledge Hypothecation. i.e, key cash credit or open cash credit. The nature of the change created may be either a pledge or hypothecation. When the possession of the goods is transferred to the banker, as in the cash of key cash credit, the nature of charge created is pledge.

Characteristics of Goods

  • Precautions of advance against Goods

(a)The borrowers should be dealing in the goods for a sufficient period

(b)No advance should be made for speculation or hoarding purpose

(c)The goods charged to the bank should have been fully paid

(d)The goods should command good demand in the market

(e)The age of the stock should be taken into consideration

  • Storing of Goods
  • Inspection of stocks
  • Stock Audit
  • Valuation
  • Margin of Stock
  • Recovery in case of Default

Advantages 

  • Goods have a ready market and as such can be easily sold, unlike other kinds of security.
  • Valuation of the goods can be easily done.
  • The banker gets a tangible form of security compared to unsecured advances, which in case of default by the borrower, can be realised by sale of pledged goods.
  • Advances against goods are normally given for short periods and therefore the risk of the banker is considerably reduced.
  • Barring a few states where the stamp duty is heavy, creating a charge on the security is less costly and involves minimum formalities.
  • Banker acquires a good title to the goods when dealing with customers of repute and standing.

Disadvantages 

  • Certain goods are liable to perish or deteriorate in quality over a period of time, thus resulting in reduction in the value of the security.
  • There are possible risks of fraud or dishonesty on the part of the borrower. For example, when 10,000 tins of cashew nuts are shown in the godown as security for an advance, it is not possible for the banker to verify the quality and quantity in every tin. It is not even possible to verify whether all  the 10,000 tins contain cashew nuts. A fraudulent borrower may manipulate the stock statement in  terms of quantity, quality and also the nature of item.
  • The value of the security in certain cases, more particularly in electronic consumer goods, is subject to wide fluctuations. Therefore, determining security cover for such goods is difficult. Even in the case of necessities, there being several varieties, unless the banker has expert knowledge, the valuation may be misleading.

Documents of Title to Goods

Section 2(4) of Sale of goods Act defines a document of title to goods as “a document used in the ordinary course of business as a proof of possession or control of goods authorising or purporting to authorize either by endorsement or delivery, the possessor of the documents to transfer or to receive the goods there by represented.

Characteristics of Document of title to goods

  • The Essential Requisites of a Document of Title to Goods
  • Merits of this Security: By mere pledge of the instruments, goods are pledged and serve as a good security. The person in possession of the document can transfer the goods by endorsement and delivery.  The Transferee thereafter is entitled to take delivery of goods in his own rights. The Document are easily transferable and the formalities involved are minimum.
  • Demerits of this Security: Possibly for fraud and Dishonesty, Forged and Altered Documents
  • Precautions to be taken by the Banker

Advances Against Life Insurance Policies

Life insurance policies are acceptable either as a primary or collateral Security for an advance.

Points to be taken in to Consideration

Before making an advance, the point to be taken in to consideration are:

  • The Policy must be in force and the premium paid up to date. The latest premium receipt must be kept on record by the bank.
  • The policy should be an original, duly stamped and signed by the issuing authority.
  • The policy should be free from restrictive/ onerous clauses.
  • The insurance company should have admitted to the age of the assured.

Generally, The following life policies are not acceptable as security

  • Children endowment policy.
  • Policies taken out specifically for purposes like estate duty,
  • Children Deferred policy
  • Policies with nominations under Section 6 of the Married Women’s Property Act.

Advantages 

  • Life insurance business being highly regulated and permitted only to companies having sound financial health, the banker need not doubt the realisation of the policies, which will be done without  any difficulty, if the policy and the claim are in order.
  • The assignment of the policy in favour of the banker requires very few formalities and the banker obtains a perfect title.
  • The longer the period for which the policy has been in force, the greater the surrender value. It is also useful as an additional security because, in the event of the borrower’s death, the debt is easily liquidated from the proceeds of the policy.
  • The security can be realised immediately on the borrower’s default of payment by surrendering the policy to the insurance company.
  • The policy is a tangible security and is in the custody of the bank. The banker only has to ensure that regular payment of premiums is made.

Disadvantages

  • If the premium is not paid regularly, the policy lapses and reviving the policy is complicated.
  • Insurance contracts being contracts of utmost good faith, any misrepresentation or non- disclosure of any particulars by the assured would make the policy void and enable the insurer to avoid the
  • The person (proposer) who has obtained the policy must have an insurable interest in the life of the assured or the contract is void.
  • The policy may contain special clauses, which may restrict the liability of the insurer.

Advance Against Share

General guidelines applicable to advances against shares/debentures/bonds

  • Statutory provisions regarding the grant of advances against shares contained in sections 19(2) and (3) and 20(1)(a) of the Banking Regulation Act’, 1949 should be strictly observed. Shares held in dematerialised form should also be included for the purpose of determining the limits under sections 19(2) and 19(3), ibid.
  • Banks should be concerned with what the advances are for, rather than what the advances are against. While considering grant of advances against shares/ debentures banks must follow the normal procedures for the sanction appraisal and post‑sanction follow‑up.
  • Advances against the primary security of shares/debentures/bonds should be kept distinct and separate and not combined with any other advance.
  • Banks should satisfy themselves about the marketability of the shares/ debentures and the net worth and working of the company whose shares/ debentures/bonds are offered as security.
  • Shares/debentures/bonds should be valued at prevailing market prices when they are lodged as security for advances.
  • Banks should exercise particular care when advances are sought against large blocks of shares by a borrower or a group of borrowers. It should be ensured that advances against shares are not used to enable the borrower to acquire or retain a controlling interest in the company/ companies or to facilitate or retain inter‑corporate investments.
  • No advance against partly paid shares shall be granted. Whenever the limit/ limits of advances granted to a borrower exceeds Rs. 10 lakhs, it should be ensured that the said shares/debentures/bonds are transferred in the bank’s name and that the bank has exclusive and unconditional voting rights in respect of such shares. For this purpose the aggregate of limits against shares/ debentures/bonds granted by a bank at all its offices to a single borrower should be taken into account. Where securities are held in dematerialised form, the requirement relating to transfer of shares in bank’s name will not apply and banks may take their own decision in this regard. Banks should however avail of the facility provided in the depository system for pledging securities held in dematerialised form under which the securities pledged by the borrower get blocked in favour of the lending bank. In case of default by the borrower and on the bank exercising the option of invocation of pledge, the shares and debentures get transferred in the bank’s name immediately.
  • Banks may take their own decision in regard to exercise of voting rights and may prescribe procedures for this purpose.
  • Banks should ensure that the scripts lodged with them as security are not stolen/duplicate/ fake/benami. Any irregularities coming to their notice should be immediately reported to RBI.
  • The Boards of Directors may decide the appropriate level of authority for sanction of advances against shares/debentures. They may also frame internal guidelines and safeguards for grant of such advances,
  • Banks operating in India should not be a party to transactions such as making advances or issuing back‑up guarantees favouring other banks for extending credit to clients of Indian nationality/origin by some of their overseas branches, to enable the borrowers to make investments in shares and debentures/bonds of Indian companies.

Advantages 

  • Value of the security can be ascertained without any difficulty.
  • In normal times, stocks and shares enjoy stability of value and are not subject to wide fluctuations.
  • Stocks and shares require very little formalities for taking them as security, especially in demat form.
  • It is easier compared to real estate to ascertain the title, more so with the advent of depositories.
  • Creating a charge on shares is less expensive than real estate.
  • They yield intermittent income by way of dividends, which can be appropriated towards the loan account.
  • Being a tangible form of security, they are more reliable.
  • The release of such securities involves very little expense and formality.

Disadvantages 

  • Being easy to realise, they are fraud prone and as such they must be properly secured.
  • Partly paid shares carry several disadvantages like –

− The banker may have to pay the calls.

− Partly paid shares are subject to violent price fluctuations.

− They are not easily realisable because of the restricted market for such shares.

Advance Against Debentures

Debenture is a document issued by a company acknowledging its indebtedness to the bearer or a registered holder. A fixed rate of interest is payable at stated periods on debentures. In case of mortgage debentures, a charge is created on the assets of the company issuing such debentures in favour of a trustee who is  responsible to take care of the interest of individual investors.

Advantages 

  • Debentures are easy to sell especially when these are listed.
  • They are not subject to violent price fluctuations, as their price is a function of the market interest rate and not market demand.
  • They can be transferred at minimum cost.
  • Bearer debentures are fully negotiable.
  • They rank higher in priority to shares and are generally secured by a charge on the company’s property.
  • No issuer shall make a public issue of debentures, if as on the date of filing of draft offer document or offer document, the issuer is in default of payment of interest or repayment of principal amount in respect of non-convertible securities, if any, for a period of more than six months.

Disadvantages

  • If interest is not paid regularly on the debentures, it would affect its price and marketability.
  • If the charge on property of company is not registered, the subsequent charges will get a priority.
  • Debentures may have been issued by companies having no power to borrow money.

 Precautions 

The nature of the debentures must be ascertained, i.e., whether they are unsecured or secured, the latter being preferred.

  • The borrowing powers of the company issuing the debentures must be ascertained and to verify the same has not been exceeded.
  • Deposit of the debentures plus a memorandum of deposit is necessary. When in dematerialized form pledge to be created in the demat account.
  • The nature and value of the assets charged must be examined frequently.
  • The banker must find out whether there are any uncancelled redeemed debentures.

Loan Against Term Deposits

Eligibility Criteria for Availing Loan Against Fixed Deposit

To be eligible for a loan against FD, the basic criteria is that you must hold a fixed deposit with the bank you are availing the loan from and any of below-given individuals/entities can avail the loan:

  • Resident Indian citizens
  • Family Trusts
  • Hindu Undivided Family (HUF)
  • Clubs, societies, and associations
  • Sole proprietorships, group companies, and partnership firms

Documentation Required to Avail Loan Against Fixed Deposit

To avail a loan against fixed deposit, you will need to provide the below-given documents:

  • Application form duly signed
  • Duly signed agreement
  • Fixed/Term Deposit receipts duly discharged in favor of the bank
  • Please note that these may vary from lender to lender.

How to Obtain Loan Against Fixed Deposit

Most lenders allow you to avail a loan against fixed deposit online except in few cases where you will need to visit the nearest branch of the bank. Some of the banks that offer the facility of availing a loan against fixed deposit online through their respective websites are the State Bank of India, HDFC Bank, Axis Bank, and Deutsche Bank. In the case of Federal Bank, you will need to visit the nearest branch of the bank.

Features and Benefits of Loan Against Fixed Deposit

  • Lower interest rates – Since your fixed deposit acts as a security for a loan, the interest rate charged on these loans are lower. The interest rates on these loans are usually lower than the interest rates on personal loans by about 2% to 2.5%. Hence, the equated monthly instalments (EMIs) on these loans are also lower.
  • Minimal paperwork – Since banks already have your details which you furnished during the opening of your FD, the documentation required for availing the loan against your FD will be minimal. You will not be required to submit documents such as your proof of income, Income Tax Returns (ITR), etc.
  • No credit score check – When you apply for any kind of loan, lenders will have a look at your credit score before they offer you a loan. However, in the case of a loan against FD, your CIBIL or credit score will not be considered while evaluating your eligibility. Hence, such loans can be a good option for people who have low or no credit score.
  • The loan amount will depend on the FD amount – If you have to avail a personal loan, the maximum loan amount that you can avail will depend on various factors such as your credit score, income, tenure, etc. However, in the case of loan against FD, the maximum loan amount will depend on the money you have invested in the FD account. This means that if you have invested a higher amount in your FD, you will be eligible for a higher loan amount.
  • No prepayment penalty – When you prepay any loan, the banks lose out on the interest and hence, they will charge you a penalty for the same. However, in the case of a loan against FD, no penalty is charged as banks do not lose out on the interest amount. Instead, they profit from it as they do not have to pay you any interest on the loan amount.

Loan against gold ornaments

A gold loan is a method of availing finance/loan against your gold ornaments or jewellery such as bangles, necklaces, bracelets, earrings, pendants, watches, gold coins, etc.

Who can avail a gold loan?

Any Indian citizen can avail a gold loan from banks or non-banking financial institutions (NBFCs) and generally the age criteria ranges from a minimum of 18 years to a maximum of 75 years. This might vary from lender to lender.

Features of Gold Loans

  • Purpose: You can avail a gold loan from any available lender in order to finance various needs, such as for educational purposes, medical emergencies, going on a holiday, and so on.
  • Security: The gold that has been pledged with the bank or the financial institution acts as the security or collateral against which the loan amount is provided.
  • Tenure options: The tenure options can range from a minimum of 3 months to a maximum of 36 months.
  • Fees: The other fees and charges that might be applicable on a gold loan are – processing fee, late payment charges/ penalty for non-payment of interest, valuation fees, etc.
  • Repayment Options: There are three main options offered by lenders to borrowers for the repayment of a gold loan. These are:

i)Repayment in Equated Monthly Installments (EMI)

ii)Payment of interest upfront and repayment of the principal loan amount at the end of the loan tenure.

iii) Payment of interest on a monthly basis and repayment of the principal loan amount at the end of the loan tenure.

Supply Bills

  • A supply bill arises in relation to transactions with Government and Public Sector Undertakings. A party might have taken a contract for execution and he is entitled for progress payment-based on work done, for which he has to submit bills in accordance with the terms and conditions of the contract.
  • Similarly, parties who have accepted tenders for supply of goods are entitled for payments on the supply of goods for which they submit bills in accordance with the terms of contract. These bills are known as ‘Supply Bills’.

Vehicle Finance

  • Vehicles are being financed by banks for personal use as also for commercial purposes viz. for transport operators. Various aspects connected with vehicle loan to individuals have been discussed in section 24.11.2. In respect of financing transport operators for acquisition of vehicles certain aspects assume significance.
  • Vehicles have several distinctive features that affect their desirability as a security for loan. Their valuation is easier as these are made public by the manufacturer. They are durable though they are prone to accident. Being mobile they may be difficult to trace if the borrower plays truant.
  • The ownership of vehicles is registered with the Regional Transport Authority making its ownership definite and transfer without the owner’s consent difficult. Vehicles are charged as security through hypothecation. The lender’s charge is registered with the Regional Transport Authority (VAHAN).
  • It makes it difficult for the security to be charged to another lender when a prior charge subsists. On taking possession of the vehicle the lender has the right to dispose the vehicle for recovery of its dues. The value of a vehicle depreciates quickly and hence the security cover available depletes rapidly. Therefore, the loan against vehicle should be for a tenor less than the utility life of the vehicle say 3 to 5 years.

JAIIB PPB Module B Unit 4 Types Of Collaterals and their Characteristics (Ambitious Baba) PDF

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