Banks generally do not provide working capital finance without adequate security. The following are the modes of security that a bank may require.
- Hypothecation
- Pledge
- Mortgage
- Lien
Table of Contents
Hypothecation
Under hypothecation, the borrower is provided with working capital finance by the bank against the security of movable property, generally inventories. The borrower does not transfer the property to the bank; he remains in the possession of property made available as security for the debt.
Thus hypothecation is a charge against property for an amount of debt where neither ownership nor possession is passed to the creditor. Banks generally grant credit hypothecation only to first-class customers with the highest integrity. They do not usually grant hypothecation facilities to new borrowers.
Pledge
Under this arrangement, the borrower is required to transfer the physical possession of the property offered as a security to the bank to obtain credit. The bank has a right of lien and can retain possession of the goods pledged unless payment of the principal, interest, and any other expenses is made.
In case of default, the bank may either (a) sue the borrower for the amount due, (b) sue for the sale of goods pledged, or (c) after giving due notice, sell the goods.
Mortgage
A mortgage is the transfer of a legal or equitable interest in a specific immovable property for the payment of a debt. In the case of a mortgage, the possession of the property may remain with the borrower, with the lender getting the full legal title. The transferor of interest (borrower) is called the mortgagor, the transferee (bank) is called the mortgagee, and the instrument of transfer is called the mortgage deed.
The credit granted against immovable property has some difficulties. They are not self-liquidating. Also, there are difficulties in ascertaining the title and assessing the value of the property.
There is limited marketability, and therefore, security may often be difficult to realize. Also, without the court’s decree, the property cannot be sold. Usually, for working capital finance, the mode of security is either hypothecation or pledge. Mortgages may be taken as additional security.
Lien
Lien means the right of the lender to retain property belonging to the borrower until he repays credit. It can be either a particular lien or a general lien. The particular lien is a right to retain the property until the claim associated with the property is fully paid. A general lien, on the other hand, is applicable till all dues of the lender are paid. Banks usually enjoy general lien.
