In order to get a loan from a bank, the borrower has to provide some form of security. This security is in the form of an asset, which can be sold by the bank in case of loan default in order to recoup its losses.
Types of Charging Securities:
There are different types of charging securities, which are as follows-
Loan Security type – Hypothecation
Hypothecation is the pledging of an asset as collateral without transferring the ownership rights. In the context of loans, this means that the borrower pledges an asset as security for the loan, but does not transfer ownership of the asset to the bank. Example: Security used in Car loan.
Important Points of Hypothecation
– Hypothecation is defined in Section 2 of SARFAESI Act 2002.
– Hypothecation is also done on moveable property like stocks.
– In case of hypothecation both ownership as well as possession remains with the borrower i.e. neither ownership nor possession is transferred to the bank.
– The charge created in Hypothecation is equitable charge.
– When stocks are hypothecated to the bank, the charge is floating charge.
– Basic difference between pledge and hypothecation is on account of possession.
Loan Security type – Pledge
A pledge is a type of security in which the ownership rights of an asset are transferred to another party as collateral for a loan. In the event of loan default, the asset can be sold by the pledgor to repay the loan. Example: Security against Gold loan.
Importnat Points of Pledge
– Pledge is defined in Indian contract Act 1872.
– In the case of pledge, ownership remains with the borrower, only possession is transferred to the banker.
– It is a contract of bailment.
– The bank as a pledge must take care of the goods pledged as a person of ordinary prudence would take of his own goods of the same value.
– Bank can sell the goods without intervention of the court in case the pledgor fails to repay the bank loan. But the sale can be done only after giving reasonable notice to the pledgor.
– Bank as a pledge has priority in right over the goods and Bank’s right of sale under pledge cannot be extinguished even by lawful seizure of goods pledged to it.
Loan Security type – Mortgage
A mortgage is a type of security in which the ownership rights of a property are transferred to another party as collateral for a loan. In case of loan default, the property can be sold by the mortgagor to repay the loan.
Example of Mortgage: Assuming that Mr. A takes a loan of Rs. 1 lakh from Bank X. As per the agreement, he has to provide his house as security for the loan. This means that if Mr. A defaults on the loan, Bank X can sell his house to recover the loan amount.
Loan Security type – Lien
A lien is a legal claim or right on an asset. In the context of loans, this means that the bank has the right to seize the asset in case of loan default and sell it to recover the loan amount. Example: Loan against Fixed deposit.
Loan Security type – Assignment
The assignment is the transfer of ownership rights of an asset from one person to another. In the context of loans, assignment is when the borrower assigns the ownership rights of an asset to the bank. This means that in case of loan default, the bank can sell the asset and recover the loan amount. Example: Security against LIC Policy loan.
Important Points of Assignment
– Provisions relating to Assignment in section 130 of Transfer of Property Act 1882.
– Assignment is the transfer of right or interest to recover the debt.
– The transferor of the claim is called as the assignor and the transferee is called the assignee.
– Assignment is done on Book Debts, Supply Bills, LIC policy etc.
– Assignment is possible through writing only.
What is Set-off?
Set-off is a process where two parties exchange claims against each other. In the context of loans, set-off occurs when the borrower has another account with the same bank. The bank can then use the funds from this account to offset the amount of the loan.
What is the Right of Appropriation?
The right of appropriation is the right of the bank to seize and sell the asset in case of loan default. This right is given to the bank by law and is known as the right of appropriation.
Example of Right of Appropriation: Assuming that Mr. A has taken a loan of Rs. 1 lakh from Bank X and Ms. B has taken a loan of Rs. 2 lakhs from the same bank. Both Mr. A and Ms. B have deposited Rs. 50,000 each in their respective accounts with the bank. If both Mr. A and Ms. B do not intimate the bank about how the payment is to be used, the bank can exercise its right of appropriation and apply the payment in discharge of any debt. In this case, the payment will be first used to offset the interest on both loans and then towards the principal amount of the loans.