BANKING THEORY AND

PRACTICES
DR. KETAN MULCHANDANI, FRM, FIII, FMVA
ASSOCIATE PROFESSOR
GITAM – SCHOOL OF BUSINESS – GITAM (DEEMED TO BE UNIVERSITY)
 UNIT 2
MODES OF CREDIT DELIVERY

• CONTENTS TO BE COVERED :

 MODES OF CREDIT DELIVERY : CASH CREDIT, LOANS, OVERDRAFTS AND BILL FINANCE

 PRICING OF LOANS

 TYPES OF SECURITIES AND ITS FEATURES: PLEDGE, HYPOTHECATION, ASSIGNMENT, LIEN

AND MORTGAGE
 CASH CREDIT
 DOMINANT MODE OF LENDING
 CREDIT LIMIT SANCTIONED TO THE BORROWER AND BACKED BY PRIME SECURITIES SUCH AS
INVENTORIES OR BOOK DEBTS OR RECEIVABLES AND COLLATERALS AND GUARANTEE, IF BANKS
SO INSISTS
 CASH CREDIT OPERATED IN SAME MANNER AS CURRENT ACCOUNTS OPERATE EXCEPT THE
BALANCE IS DEBIT IN CASH CREDIT ACCOUNT
 WITHDRAW FUNDS FOR OPERATING EXPENSES AND DEPOSITS CASH RECEIVED FROM SALES
 PERIODICALLY ACCOUNT SHOULD BE BROUGHT IN CREDIT
 THE SUM OF CREDIT BALANCE IN A PERIOD REFLECT THE SALES ACHIEVEMENT OF THE FIRM AND
CAN BE VERIFIED BY BANKS PERIODICALLY CALLING SALES DATA OF BORROWERS
 IF DIFFERENCE OCCURS BETWEEN ACTUAL SALES VS. CREDIT BALANCE BANK CAN QUESTION THE
BORROWER AS WELL (DIVERSION OF FUNDS SHOULD NOT HAPPEN)
 COMMITMENT CHARGE ON THE UNUTILIZED PORTION CAN ALSO LEVIES BY BANK
 FLEXIBILITY AND OPERATIONAL CONVENIENCE CRATES HIGHER COST TO BANKS DUE TO HIGH
MONITORING AND OPPORTUNITY COST
• NEW SYSTEM INTRODUCED IN BANK CREDIT IN 1990S
• IT IS MANDATORY FOR BORROWERS ENJOYING WORKING CAPITAL OF OVER RS. 10 CRORES
• TWO COMPONENTS OF LOAN WILL GIVEN TO BORROWER : 80% WCDL AND 20% CC
• RBI GUIDELINES – LOAN COMPONENTS AND CASH CREDIT COMPONENTS
• APPROPRIATELY PRICING OF EACH COMPONENTS
• LOAN COMPONENT CAN BE HIGHER THAN CC COMPONENT WOULD BE LOWER
• BANK CAN PERSUADE BORROWER TO CONVERT IN THE NEW LOAN SCHEME EVEN THEY
HAVE LESS THAN RS. 10 CRORES OF LIMIT AND OFFER LOWER RATE OF INTEREST AS AN
INCENTIVE
• BANK CAN ALSO EXEMPT FROM NEW LOAN SCHEME TO CYCLICAL INDUSTRIES WITH
BOARD OF DIRECTOR’S APPROVAL
• WCDL CAN BE ASKED BY BANK TO REPAID IN EVERY QUARTER AND REPLENISH IN THE
NEXT QUARTER
• MORE DISCIPLINED VERSION OF CASH CREDIT
 OVERDRAFTS

 OVERDRAFTS ARE LIKE CASH CREDITS BECAUSE THEY ARE PERMITTED AS WITHDRAWALS
OVER AND ABOVE THE BORROWER’S CREDIT BALANCE IN HIS CURRENT ACCOUNT
 UNLIKE CASH CREDITS, OVERDRAFTS ARE NOT PURPOSE ORIENTED
 URGENT CREDIT REQUIREMENT CAN BE SATISFIED BY PROVIDING COLLATERAL SECURITY
OR GUARANTEE
 EXPRESS OR IMPLIED OVERDRAFT CONTRACT
 PAST TRACK RECORD AND INTEGRITY OF BORROWERS PLAY A VITAL ROLE
 CONTINUING FACILITY : SUITABLE COLLATERAL REQUIRED, NUMBER OF TIME ACCOUNT
SHOULD BE BROUGHT IN CREDIT OR MINIMUM REPAYMENT REQUIREMENT DURING THE
OVERDRAFT PERIOD
 RISK IS HIGHER BECAUSE SECURITIES MAY BE TANGIBLE OR INTANGIBLE
 HIGHER INTEREST RATE THAN OTHER TYPES OF LOANS
• IMPLIED OVERDRAFT
• WHEN CUSTOMER OVERDRAWS DRAWN ON THE BALANCE IN HIS ACCOUNT AND THE BANK
DOES NOT DISHONOUR THE PAYMENT
• HE IS LIABLE TO PAY INTEREST AND ALSO REPAY THE AMOUNT OVERDRAWN
• BANK CANNOT UNILATERALLY TERMINATE THE CONTRACT, EVEN IF IT IS CALLED A
TEMPORARY OVERDRAFT
 CASH CREDIT VS OVERDRAFT
Sr. Cash Credit Overdraft
No.
1 Interest rates are lower compared to OD. Interest rates are higher than CC.
2 Cash credit is offered based on available The OD amount is determined based on the
stocks and inventory. client’s relationship with the bank,
investments like insurance policies, FDs,
credit history, etc.
3 The funds should be used only for business
The usage of funds is not as strict as CC.
needs.
4 A new account must be opened to receive the The OD facility can be applied to the existing
cash credit loan. account of the borrower.
5 The tenure is generally one year (minimum). The tenure is much shorter and can be for a
month, quarter, or half-year. The maximum
tenure is one year.
6 It can be availed by traders, distributors,
companies, sole proprietorships, partnerships, It is available only for account holders of the
LLPs, and even individuals. respective bank.
 TERM LOANS
• TERM LOAN IS A SHORT TERM OR LONG TERM LOAN APPROVED AND DISBURSED BY
ANY FINANCIAL INSTITUTIONS
• CAN BE PAID IN EMI
• FIXED OR FLOATING RATE OF INTEREST
• 12 MONTHS TO 84 MONTHS AND DEPENDING ON FINANCIAL INSTITUTION
• PURPOSE
• BUSINESS EXPANSION TO PURCHASE EQUIPMENT
• MACHINERY OR RAW MATERIAL
• MANAGE CASH FLOWS
• MEET WORKING CAPITAL REQUIREMENT
• BUYING OFFICE OR BUSINESS SPACE
• DEBT CONSOLIDATION ETC.
• TYPES OF TERM LOANS
• SHORT TERM REPAID WITHIN 12-18 MONTHS
• INTERMEDIATE LOANS UPTO 84 MONTHS
• LONG TERM LOANS REPAID IN LONGER DURATION SUCH AS 10 YEARS ETC.

• TERM LOAN CATEGORY

• SECURED LOAN
• UNSECURED LOAN

• TERM LOAN INTEREST

• VARY FROM BANK TO BANK
• DEPENDS ON CUSTOMER'S PROFILE AND BUSINESS REQUIREMENT
• LOWER INTEREST OFFERED WITH GOOD CIBIL AND CREDIT HISTORY
• BANK OFFER LOWER INTEREST RATE AS COMPARED TO NBFCS AND OTHER LENDING
INSTITUTION
• FIXED OR FLOATING RATE OF INTEREST
 ADVANTAGES AND DISADVANTAGES OF TERM
LOANS

• ADVANTAGES
• FLEXIBILITY OF TENOR
• EASE OF REPAYMENT THROUGH AFFORDABLE EMIS
• COST OF LOAN LIMITED
• TAX SHIELD

• DISADVANTAGES
• OPTIMUM USE REQUIRED OF LOAN
• NEED TO PAY INSTALLMENT ON TIME
 CONCEPT CHECKER

1. ONE OF THE DIFFERENCES BETWEEN CASH CREDIT AND OVERDRAFT IS:

A. THERE IS NO LIMIT IN CASE OF CASH CREDIT WHERE THERE IS LIMIT IN CASE OF
OVERDRAFT
B. DRAWING POWER IN CASE OF CASH CREDIT IS LIMITED WHILE IN CASE OF OVERDRAFT
IT IS NOT LIMITED
C. CASH CREDIT IS A SEPARATE ACCOUNT AND OVERDRAFT IS ALLOWED ON AN EXISTING
CURRENT ACCOUNT.

2. INTEREST RATE CHARGE LOWER ON WHICH TYPE OF CREDIT DELIVERY MODE

A. OVERDRAFT
B. CASH CREDIT
3. …………… IS A CREDIT FACILITY GRANTED BY COMMERCIAL BANKS TO
CURRENT ACCOUNT HOLDERS
A. CASH CREDIT
B. OVERDRAFT
C. DISCOUNTING OF BILLS OF EXCHANGE
D. DEMAND LOANS

4. ------- IS A TEMPORARY FINANCIAL ARRANGEMENT BY THE BANK TO DRAW MORE

THAN THE AMOUNT STANDING TO HIS CREDIT.
A. OVERDRAFT
B. BRIDGE LOANS
C. CASH CREDIT
D. NONE OF THESE.
 BILL OF EXCHANGE

• HTTPS://WWW.YOUTUBE.COM/WATCH?V=QBMDLJHS1YW

• ACCORDING TO THE NEGOTIABLE INSTRUMENTS ACT 1881, A BILL OF EXCHANGE IS DEFINED

AS “AN INSTRUMENT IN WRITING CONTAINING AN UNCONDITIONAL ORDER, SIGNED BY THE
MAKER, DIRECTING A CERTAIN PERSON TO PAY A CERTAIN SUM OF MONEY ONLY TO, OR TO
THE ORDER OF A CERTAIN PERSON OR TO THE BEARER OF THE INSTRUMENT”.

• BILL FINANCING OCCURS WHEN BILLS OF EXCHANGE (BOE) DRAWN BY THE BORROWER OR BY
COUNTER PARTIES ON THE BORROWERS, ARE DISCOUNTED BY THE BANKS
 BILL FINANCE
• METHODS OF BILL FINANCE ON THE BASIS OF PAYMENT OBLIGATIONS ON THE PART OF BANKC
• PURCHASE OF BILLS
• DISCOUNTING OF BILLS
• DRAWEE BILL ACCEPTANCE
• BILLS C0-ACCEPTANCE

• FUNDS BASED FACILITIES

• PURCHASE OF BILLS
• DISCOUNTING OF BILLS
• THE ABOVE TWO ARE ARISING OUT OF SALE OF GOODS OR SERVICES- SCORE OVER OTHER CASH
CREDIT AND OTHER TYPES OF WORKING CAPITAL FINANCE ON THE FOLLOWING BASIS:
• BILL ENSURE DEFINE PAYMENT DATE
• TRANSACTION CAN BE EASILY TRACKED AND IDENTIFIED
• BILLS ARE BACKED BY LEGAL PROVISION, BETTER CONTROL
•
 CATEGORIES OF BILL PURCHASED OR
DISCOUNTED

• CLEAN BILLS
• NOT SUPPORTED BY ANY DOCUMENTS OF TITLE OF GOODS BECAUSE GOODS AND DOCUMENTS
ALREADY DELIVERED BY SELLER TO THE BUYER
• UNSECURED ADVANCES BY BANK
• REALIZATION DEPENDS ON THE HONESTY AND CREDITWORTHINESS OF THE COUNTER PARTIES

• DOCUMENTARY BILLS
• BOE ACCOMPANIED BY DOCUMENTS OF TITLE OF GOODS IS A DOCUMENTARY BILL
• GOODS DISPATCHED BUT TITLE OF GOODS HAS NOT YET TRANSFERRED
• EXAMPLE LORRY RECEIPTS, RAILWAY RECEIPTS, AIRWAY BILLS AND BILL OF LADING
• CONSIDERED SAFER THAN OTHER BILL BECAUSE BACKED BY THE SECURITY OF DOCUMENTS
AND TITLE MADE IN FAVOR OF BANK OR ENDORSED IN FAVOR OF BANK.
• BANK CAN LIQUIDATE THE GOODS AND REALIZED DEBT IN CASE THE BILL IS NOT PAID
 TYPES OF DOCUMENTARY BILL

• DOCUMENTARY DEMAND BILL OR DOCUMENTS AGAINST PAYMENT (D/P)

• SIMILAR TO CASH SALES
• BUYER NEEDS TO PAY THE BANK BEFORE COLLECTING THE DOCUMENTS AND TAKING DELIVERY OF GOODS
• SELLER DRAW BILLS ON THE BUYER AND SENDS THE BILLS TO HIS BANK ALONG WITH DOCUMENTS OF TITLE OF
GOODS AND INSTRUCT ONLY WHEN BUYER PAY THE MONEY

• DOCUMENTARY USANCE BILL OR DOCUMENTS AGAINST ACCEPTANCE (D/A)

• SIMILAR TO CREDIT SALES WITH A SPECIFIDED CREDIT PERIOD OR USANCE PERIOD
• USANCE BILL SUPPORTED BY DOCUMENTS OF GOODS BEARS INSTRUCTION TO THE BANK THAT THE DOCUMENTS CAN
BE GIVEN ANLY HE ACCEPTS IN BILL IN WRITING
• BANK FINANCE AGAINST THE ACCEPTED BILL AND HOLD TILL IT IS PAID ON THE SPECIFIED DATE
• ON THE DUE DATE BILL IS PRESENTED AND CREDIT IS ADJUSTED

• D/P ARE SAFER THAN D/A

• USANCE BILL CONVERTED INTO CLEAN BILL ONCE IT IS ACCEPTED BY BUYER
 SUPPLY BILLS

• IT IS NOT A NEGOTIABLE INSTRUMENTS AND DEBTS CAN BE ASSIGNED IN FAVOUR OF

THE BANKS
• THEY ARE IN THE NATURE OF DEBT AND CAN BE ASSIGNED IN FAVOUR OF BANK
• SUPPLY BILLS ARE RAISED WHEN THE BUYER IS GOVERNMENT OR A LARGE CORPORATION
• SELLER DELIVER GOODS AGAINIST SPECIFIED WORK ORDER AND PRODUCES EVIDENCE
OF DELIVERYING GOODS EX. RAILWAY RECIEPTS OR BILL OF LADING
• IF BUYER IS SATISFIED WITH GOODS INVOCED RAISED AGAINST HIM
• INVOICE SUBMITTED WITH BUYER’S CERTIFICATION OF ACCEPTANCE TO BANK FOR
FINANCING
• CREDIT PERIOD TILL THE INVOICE PROCESSED AND PAYMENT RECEIVED FROM BUYER
• PROVEN TRACK RECORD REQUIRE FOR CREDIT
•
 PRECAUTIONS TO BE TAKEN WHILE PURCHASING/DISCOUNTING
BILLS

• ONLY TO CREDITWORTHINESS BORROWERS

• CREDIT REPORT SHOULD BE OBTAIN BY THE BANK BEFORE DOING BILL FINANCE
• MAXIMUM AMOUNT SHOULD BE FIXED ON PER BUYER
• GENUINENESS NEEDS TO VERIFIED BY BANKS FOR THE TRANSACTIONS
 ADVANCES AGAINST BILLS SENT ON
COLLECTION

• BANK ALSO GIVE ADVANCES AGAINST THE BILLS WHICH ARE PROCESS IN COLLECTION
AFTER RETAINING A SUITABLE MARGIN
• BANK BECOMES “HOLDER IN DUE COURSE” IF BANK PURCHASE, DISCOUNT AND
ADVANCES AGAINST COLLECTION OF BILLS

• DRAWEE BILLS
• WHEN BANK FINANCES THE BUYER, THE DRAWEE, THE BUYER’S BANK ITSELF DISCOUNTS
THE BILLS AND SENDS THE AMOUNT TO THE SELLER IT CALLED DRAWEE BILL
• IT IS AN ACCEPTANCE CREDIT
• DRAWEE BILLS FINANCE PURCHASE OF INPUTS OR RAW MATERIALS ETC.
 CONCEPT CHECKER

1. A BILL OF EXCHANGE INCLUDES.

• A) AN ORDER TO PAY
• B) A REQUEST TO PAY
• C) A PROMISE TO PAY
• D) ALL THE ABOVE

2. WHAT IS THE PERSON KNOWN AS WHO DRAWS A BILL OF EXCHANGE

• A) DRAWER
• B) PAYEE
• C) DRAWEE
• D) NONE OF THE ABOVE
3.  WHEN THE DRAWEE SIGNS THE BILL, IT IS CONSIDERED AS
• A) ACCEPTED
• B) RETIRED
• C) RENEWED
• D) ENDORSED

4. THE PARTY WHICH IS ENTITLED TO RECEIVE THE PAYMENT OF THE BILL IS KNOWN AS
• A.    DRAWER
• B.    DRAWEE
• C.    BANK
• D.    PAYEE
5. ______________ BILLS DO NOT FALL UNDER THE NI ACT. THEY ARE DEBTS __________ IN
FAVORS OF BANKS.
6. SUPPLY BILLS ARE BILL OF EXCHANGE (T/F)

7. THE DRAWEE OF A BILL IF THE SELLER OF GOODS (T/F)

8. CLEAN BILLS ARE SUPPORTED BY DOCUMENTS OF TITLE OF GOODS (T/F)

9. DOCUMENTARY BILL MEANS SIGNING A BILL ACCOMPANIED BY DOCUMENTS OF TITLE OF

GOODS (T/F)

10. A BOE IS AN UNCONDITIONAL DIRECTION TO THE DRAWER TO PAY A CERTAIN AMOUNT

(T/F)
 PRICING OF LOANS
• DEREGULATION OF INTEREST RATE AND INTENSE PRICE COMPETITION,
BANKS WILL HAVE TO PRICE SUITABLY NOT ONLY TO GARNER PROFIT
MARGINS, BUT ALSO BALANCE RISK-RETURN TRADE-OFF
• LOAN PRICING = PRODUCT PRICING
• FIRST COVER VARIABLE COST (COST OF BANK’S LIABILITIES)
• THEN A PART OF FIXED COST (TRANSACTION SERVICING COST + OVERHEAD FOR
MAINTAINING AND MONITORING THE ACCOUNT)
• THEREAFTER YIELD A NET POSITIVE RETURN (PROFIT MARGIN INBUILT)

• DIFFERENCE BETWEEN PRODUCT AND LOAN PRICING

• SINGLE PRICE CANNOT BE FITTED TO A PRODUCT LINE DUE TO UNIQUE RISK PROFILE
• PRICE DEPENDS ON THE PROFITABILITY OF THE CUSTOMER. “RELATIONSHIP PRICING”

LOAN PRICE = COST OF FUNDS + SERVICING COST + RISK PREMIUM +

DESIRED PROFIT MARGIN
 STEP 1 : ARRIVE OF COST OF FUNDS
• THE MATURITY PROFILE OF BANK A IS DEPICTED BELOW. THE BANK’S FIRST CLASS CUSTOMER WANTS AN ADDITIONAL
LOAN OF RS. 50 CRORE TO BE REPAID OVER THE NEXT 3 YEARS. THE BANK SEEKS TO HAVE A NET PROFIT MARGIN OF 3%
ON ALL TRANSACTIONS. WHAT SHOULD BE THE MINIMUM INTEREST RATE IT PROPOSES TO THE CUSTOMER ?
THE MATURITY PROFILE OF BANK A
MATURITY OF LIABILITY LIABILITY AMOUNT RATE (%)
NIL 10 0
6 MONTHS 25 5
1 YEAR 25 9
2 YEAR 10 11
3 YEAR 20 12
OVER 3 YEARS 10 13
TOTAL 100
AVERAGE COST OF FUNDS = 8.30%
LOAN PRICE = AVERAGE COST OF FUNDS + PROFIT MARGIN
CASE 1 CALCULATE LOAN PRICE
CASE 2 IF BANK NEEDS TO BORROW FROM THE MARKET TO MEET THE CUSTOMER’S REQUEST AND FUNDS WITH
MATURITY ARE AVAILABLE AT 12%. CALCULATE LOAN PRICE?
 STEP 2 : DETERMINING SERVICING FOR THE
CUSTOMER

• IDENTIFY FULL LIST OF SERVICES USED BY CUSTOMER

• ASSESS THE COST PROVIDING EACH SERVICES
• NON CREDIT SERVICES : IF RS. 10 IS THE COST TO MAKE TRANSFER PAYMENT AND 500
TIMES USED BY CUSTOMER THAN COST WOULD BE 10 X 500 = RS. 5000
• COST OF CREDIT DEPENDS ON LOAN SIZE AND FORMS A MAJOR PORTION OF THE
SERVICING COST
• LOAN ADMINISTRATION ETC.
 STEP 3 ASSESS DEFAULT RISK AND ENFORCEABILITY OF
SECURITIES

• E (R) = P(R) + P (D) X [R (P + PI)/P – 1]

• E (R) IS THE EXPECTED RATE

• P(R) IS THE PROBABILITY OF RECOVERY
• I IS THE CONTRACTED RATE OF INTEREST
• P(D) IS THE PROBABILITY OF DEFAULT
• P IS THE PRINCIPAL AMOUNT
• R IS THE RECOVERY RATE IN THE EVENT OF DEFAULT
• A BANK CONDUCTED RISK ASSESSMENT OF THE BORROWER AND IS CONFIDENT THAT
THERE IS A 95% PROBABILITY OF THE BORROWER REPAYING THE PRINCIPAL AND
INTEREST AS SCHEDULED. IN CASE OF DEFAULT, THE BANK RECOVER ABOUT 85% OF
PRINCIPAL AND INTEREST DUE. RATE CANNOT BE QUOTED LOWER THAN 14% ON THE
LOAN. PRINCIPAL AMOUNT RS. 50 CRORE. WHAT SHOULD BE THE RATE IT QUOTES TO THE
BORROWER TO INCLUDE THE DEFAULT RISK? ASSUME BANK’S COST OF FUNDS IS 12% AND
SERVICING COST IS .25%
• THIS IMPLIES THAT THE BANK WILL EFFECTIVELY OBTAIN A RETURN OF 13.145% FROM A
LOAN CONTRACTED TO YIELD 14%.
• THE DIFFERENCE BETWEEN 14% - 13.145% = .855% IS RISK PREMIUM
• LOAN PRICING WOULD BE = 12% (COST OF FUNDS) + .25% (SERVICING COST) + .855% (RISK
PREMIUM) + 3% (DESIRED PROFIT) = 16.105%
 FIXING THE PROFIT MARGIN

• ROE = ROA X ( SHAREHOLDER’S EQUITY / TOTAL ASSETS)

• ROE = RETURN ON EQUITY
• ROA = RETURN ON ASSETS

• IF THE BANK DESIRES TO GIVE ITS SHAREHOLDERS A RETURN OF 20%, ITS ASSETS
AMOUNT TO RS. 10,000 CRORES AND EQUITY IS RS. 1,000 CRORES, WHAT SHOULD BE THE
PROFIT MARGIN IS SHOULD TARGET FOR THE BORROWER SEEKING RS. 50 CRORE CREDIT.
DESIRED RETURN = .20 X (1000/10000) = .02 OR 2%

THE SHOULD TARGET A MINIMUM OF RETURN OR PROFIT OF 2%.

 FIXED VERSUS FLOATING RATES

• FIXED RATES OFFERED BY BANKS IF INTEREST RATES ARE

RELATIVELY STABLE
• FLOATING RATES OFFERED BY BANKS OF INTEREST RATES ARE
VOLATILE
• VOLATILITY OF INTEREST RATE TRANSFERRED FROM BANKS TO CUSTOMERS
• IT INCREASES HEIGHTENED CREDIT RISK FOR BANK

• ALTERNATIVES OFFERED BY BANKS IN FLOATING RATE SYSTEM

• INITIALLY FLOATING RATE SET BELOW THE FIXED RATE
• INTEREST RATE CAP FOR ANY INTERVAL OR FOR THE ENTIRE MATURITY OF
THE LOAN
 PRICING FLOATING RATE LOAN

• TWO BASIC MODEL

• PRIME PLUS
• PRIME RATE + BASIS POINTS
• PRIME TIMES
• PRIME RATE X ADJUSTMENT FACTOR

• BANKS CHARGES FLOATING RATES FOR ITS BORROWERS SINCE IT EXPECTS INTEREST
RATE VOLATILITY IN THE NEAR FUTURE. THE PRESENT PRIME RATE IS 10%. THE BANK
WANTS TO CHARGE A PREMIUM OF 400 BASIS POINTS OVER THE PRIME RATE. CALCULATE
INTEREST RATE OFFERED USING PRIME PLUS AND PRIME TIMES?
 PRICING OF LOANS

• IN 2010 THE CONCEPT OF “BASE RATE” WAS INTRODUCED AS THE INTERNAL BENCHMARK
RATE

BASE RATE = COST OF DEPOSITS/FUNDS + NEGATIVE CARRY ON CRR/SLR + UNALLOCATED

OVERHEAD COSTS + AVERAGE RETURN ON NET WORTH
• BASE RATE SERVED AS THE MINIMUM LENDING RATE TO BORROWERS
• RISK PREMIUM WOULD BE ADDED TO THE BASE RATE THAT WOULD BE QUOTED TO THE
BORROWER
• BASE RATE USED PREDOMINANTLY THE “AVERAGE COST OF FUNDS” DUE TO WHICH IT
COULD UNDERSTATE THE INTEREST RATE.
 MARGINAL COST OF FUNDS BASED LENDING RATE
(MCLR)

• MCLR = MARGINAL COST OF FUNDS + NEGATIVE CARRY ON CRR + OPERATING COSTS +

TENOR PREMIUM

• MARGINAL COST OF FUNDS = (92% * MARGINAL COST OF DEPOSITS AND BORROWINGS) + (8%
* RETURN ON NET WORTH)
• NEGATIVE CARRY = (REQUIRED CRR * MARGINAL COSTS OF FUNDS) / 1-CRR

• LOAN INTEREST RATE WILL BE = MCLR + 3%

 SECURITY

• THE PROVINCIAL INSOLVENCY ACT DEFINES A “SECURED CREDITORS” AS ONE WHO

HOLDS A MORTGAGE, LIEN OR CHARGE ON THE PROPERTY OF A DEBTOR, AS SECURITY
FOR A DEBT DURE FROM DEBTOR

• SECURITIES ACCEPTED BY BANKS FALL INTO THE FOLLOWING CATEGORIES:

• PLEDGE
• HYPOTHECATION
• ASSIGNMENT
• LIEN
• MORTGAGE
 PLEDGE
• AS PER SECTION OF 172 OF THE INDIAN CONTRACTS ACT 1872, DEFINES “PLEDGE”
AS BAILMENT OF GOODS AS SECURITY FOR PAYMENT OF A DEBT OR PERFORMANCE
OF PROMISE.
• BANK (PLEDGEE) AND BORROWER (PLEDGOR)
• SECURITIES OR GOODS ARE MOVEABLE EX. GOLD, ADVANCE AGAINST STOCK,
ADVANCE AGAINST NSC ETC.
• SECURITIES DELIVERED TO BANKS AND SUCH DELIVERY OF POSSESSION CAN BE
ACTUAL OR CONSTRUCTIVE
• PREVENT SECURITY DILUTION BY THE BORROWER DUE TO POSSESSION
• ANY LOSS RELATED TO THE POSSESSED GOODS WILL BE COMPENSATED BY BANK
• HIGHER MONITORING AND INSPECTION COST ATTACHED TO IT, DUE TO WHICH THIS
TYPE OF SECURITY IS UNPOPULAR
 HYPOTHECATION

• HYPOTHECATION IS A LEGAL TRANSACTION INVOLVING MOVABLE ASSETS, AMOUNT TO

AN “EQUITABLE CHARGE” ON THE ASSET.
• DIFFICULTIES HOLDING THE SECURITIES IN THE BANK’S CUSTODY ARE REMOVED
• SECURITY REMAINS IN THE POSSESSION OF THE BUYER, AND CHARGE IS IN FAVOUR OF
BANK THROUGH DOCUMENT EXECUTED BY THE BORROWER
• ACCORDING TO DOCUMENTS IT OBLIGATES THE BORROWERS TO GIVE POSSESSION OF THE
GOODS TO THE BANK ON DEMAND.
• ONCE POSSESSION OVER THE GOODS IS RELINQUISHED BY THE BORROWER,
HYPOTHECATION BECOMES SIMILAR TO PLEDGE
• HYPOTHECATION IS MORE RISKY AS COMPARED TO PLEDGE (IT MAY BE AS RISKY AS
UNSECURED OR CLEAN ADVANCES)
• FLOATING CHARGE CREATED ON IF STOCKS HYPOTHECATED WITH BANKS
• PRECAUTIONS NEED TO BE TAKEN CARE BY BANK IN CASE OF
HYPOTHECATION
• CREDITWORTHINESS AND INTEGRITY OF THE BORROWER NEEDS TO
ASCERTAINED
• FULLY PAID STOCK WILL BE HYPOTHECATED
• PERIODICAL INSPECTION SHOULD BE DONE BY BANK TO CHECK THE STOCKS
• STOCKS SHOULD BE INSURED
• PERIODICAL STOCK STATEMENT SHOULD BE GIVEN BY BORROWER TO
ASCERTAIN THE CREDIT LIMIT
• STOCK SHOULD NOT BE HYPOTHECATED TO OTHER LENDER FOR THAT
BANKS DISPLAY AT PREMISES ABOUT HYPOTHECATION
• BANK SHOULD TAKE POSSESSION OF THE HYPOTHECATED PROPERTY ON ITS
OWN OR THROUGH COURT
 ASSIGNMENT
• BORROWER ASSIGN “ACTIONABLE CLAIMS” TO THE BANK.
• A CLAIM TO ANY DEBT, OTHER THAN A DEBT SECURED BY MORTGAGE OF IMMOVABLE
PROPERTY OR BY HYPOTHECATION OR BY PLEDGE OF MOVEABLE PROPERTY

• ACTIONABLE CLAIMS A BORROWER CAN ASSIGN TO BANKS

• BOOK DEBTS
• MONEY DUE FROM GOVERNMENT DEPARTMENTS OR SEMI GOVERNMENT ORGANIZATIONS
• LIFE INSURANCE POLICIES

• PARTY A GIVES AN ABSOLUTE ASSIGNMENT TO PARTY B OF AN INSURANCE POLICY OF

RS 5 LAKH. HERE A BECOMES THE ASSIGNOR AND B BECOMES ASSIGNEE
• TYPES OF ASSIGNMENT
• LEGAL ASSIGNMENT : WRITTEN BY ASSIGNOR TO TRANSFER ABSOLUTE TRANSFER OF THE
ACTIONABLE CLAIMS ASSIGNOR INFORMS HIS DEBTORS OF THE ASSIGNEE’S INTEREST, WHICH IF
FOLLOWED UP BY THE ASSIGNEE SEEKING CONFIRMATION FROM THE DEBTORS OF THE
BALANCES ASSIGNEE
• EQUITABLE ASSIGNMENT: THE ABOVE CONDITIONS ARE ABSENT.
• BANKS GET ABSOLUTE RIGHT OVER THE FUNDS ASSIGNED TO IT.

• ONCE THE BANKS GET ASSIGNMENT ON CLAIMS OTHER

CREDITORS CANNOT GET PRIORITY OVER THE BANK IN THE
REALIZATION OF THEIR DUES FROM THE ASSIGNED DEBTS
 MORTGAGE
• SECTION 58 OF THE TRANSFER OF PROPERTY ACT, 1882 DEFINES A MORTGAGE AS “THE
TRANSFER OF INTEREST IN SPECIFIC IMMOVABLE PROPERTY FOR THE PURPOSE OF
SECURING THE PAYMENT OF MONEY ADVANCED OR TO BE ADVANCED BY WAY OF LOAN,
ON EXISTING OR FUTURE DEBT OR THE PERFORMANCE OF AN ENGAGEMENT, WHICH
MAY GIVE RISE TO A PECUNIARY LIABILITY.”
• TRANSFEROR OF THE PROPERTY IS THE “MORTGAGOR”. THE ENTITY TO WHOM THE
TRANSFER TAKE PLACE IS THE “MORTGAGEE”. THE DOCUMENT THROUGH WHICH
MORTGAGE EFFECT IF THE “MORTGAGE DEED”

• TWO IMPORTANT POINTS ARE AS FOLLOWS:

• THE TRANSFER OF INTEREST IN THE MORTGAGED ASSET
• TRANSFER IS TO CREATE A SECURITY FOR THE AMOUNT PAID OR TO BE PAID BY THE BANK AS
LOAN
• TRANSFER OF “INTEREST” DIFFER FROM “SALE” WHERE THERE IS A
TRANSFER OF OWNERSHIP. SOME RIGHTS OF THE OWNER ARE
TRANSFERRED, AND SOME ARE RETAINED WITH OWNER. RIGHT OF
REDEMPTION IS RETAINED WITH THE OWNER.
• BANK IS NOT ABSOLUTE OWNER, BUT ONLY HAS THE RIGHT TO RECOVER
ITS DUES FROM SELLING THE MORTGAGED PROPERTY.
• EVERY CO-OWNER OR JOINT OWNER OF THE PROPERTY IS ENTITLED TO
MORTGAGE HIS PROPERTY SHARE
• THE MORTGAGE SHOULD BE SPECIFIC AND IDENTIFIED BY LOCATION, SIZE,
BOUNDARIES ETC.
• TRANSFER OF PROPERTY IN DISCHARGE OF DEBT A DEBT IS NOT MORTGAGE
• IT IS NOT NECESSARY THAT THE ACTUAL POSSESSION OF THE PROPERTY BE
TRANSFERRED TO THE BANK
 TYPES OF MORTGAGE
• SIMPLE MORTGAGE [SECTION 58 (B)]
• BANK IS NOT IN POSSESSION OF THE PROPERTY, BUT REGISTRATION IS MANDATORY
• BANK IS NOT ENTITLED TO ANY INCOME (RENT OR PROFITS)
• BANK CANNOT SELL THE PROPERTY FOR RECOVERING DUES WITHOUT THE
PERMISSION OF THE COURT

• MORTGAGE BY WAY OF CONDITIONAL SALE [SECTION 58 (C)]

• NO PERSONAL COVENANT
• NOT REAL SALE OF THE PROPERTY
• ON THE CONDITION THAT ON DEFAULT OF PAYMENT OF THE MORTGAGE MONEY
(LOAN) ON A CERTAIN DATE THE SALE SHALL BECOME ABSOLUTE OR
• BORROWER LOOSE THE RIGHT OF REDEMPTION
• ON CONDITION THAT ON SUCH PAYMENT BEING MADE THE SALE SHALL BECOME VOID
OR,
• USUFRUCTUARY MORTGAGE [SECTION 58 (D)]
• THAT THE POSSESSION OF THE PROPERTY IS DELIVERED TO THE MORTGAGEE;
• THAT THE MORTGAGEE IS TO GET RENTS AND PROFITS IN LIEU OF THE INTEREST OR PRINCIPAL OR BOTH;
• THAT NO PERSONAL LIABILITY IS INCURRED BY THE MORTGAGOR AND
• THE MORTGAGEE CANNOT FORECLOSE OR SUE FOR SALE
• BORROWER FAILS TO REDEEM PROPERTY WITHIN 30 YEARS THROUGH THE COURT, BANK BECOMES
ABSOLUTE OWNER

• ENGLISH MORTGAGE [SECTION 58 (E)]

• THAT THE MORTGAGOR SHOULD BIND HIMSELF TO REPAY THE MORTGAGE MONEY/LOAN ON A CERTAIN DAY;
• THAT THE MORTGAGED PROPERTY SHOULD BE TRANSFERRED ABSOLUTELY TO THE MORTGAGEE ; AND
• THAT SUCH ABSOLUTE TRANSFER SHOULD BE MADE SUBJECT TO A PROVISO THAT THE MORTGAGEE WILL
RECOVER THE PROPERTY TO THE MORTGAGOR, UPON THE PAYMENT BY HIM OF THE MORTGAGE MONEY ON
THE APPOINTED DAY

THE DIFFERENCE BETWEEN THE MORTGAGE BY CONDITIONAL SALE AND ENGLISH MORTGAGE IS THAT IN
ENGLISH MORTGAGE, THE MORTGAGOR BINDS HIM PERSONALLY TO REPAY THE MONEY.
• EQUITABLE MORTGAGE OR MORTGAGE BY DEPOSIT OF TITLE DEEDS [SECTION 58 (F)]
• MOST PREFERRED MORTGAGE TYPES IN INDIA
• TITLE DEEDS ARE DELIVERED BY THE BORROWER TO THE BANK
• “TITLE DEEDS” ARE DOCUMENTS OR INSTRUMENTS THAT ENABLES THE OWNER OF THE
PROPERTY TO ENJOY THE RIGHT PEACEFUL AND ABSOLUTE POSSESSION OF THE PROPERTY
DESCRIBED IN THE DOCUMENTS.
• THERE ARE NO REGISTRATION OR STAMP CHARGES INVOLVED IN MANY INDIAN STATES AND ALSO
LESS TIME CONSUMING FOR CREATING OF MORTGAGE
• RISK ARISES FOR BANK IN RESPECT OF AUTHENTICITY OF DOCUMENTS AND THE BORROWER’S
STANDING IN RESPECT OF THE PROPERTY
• BANK SHOULD CONDUCT PHYSICAL INSPECTION OF THE PROPERTY AND VERIFY THE
AUTHENTICITY

• ANOMALOUS MORTGAGE [SECTION 58 (G)]

• A MORTGAGE THAT DOES NOT FALL INTO ANY OF THE CATEGORIES DISCUSSED IT IS CONSIDERED
ANOMALOUS MORTGAGE
• IT CAN BE COMBINATIONS OF TWO TYPES OF MORTGAGES
 BANKER’S LIEN

• LIEN IS THE RIGHT OF THE BANK TO RETAIN SECURITIES GIVEN BY THE BORROWER UNTIL
DEBT DUE IS FULLY PAID
• TYPES OF LIEN
• GENERAL LIEN
• PARTICULAR LIEN (LOAN AGAINST FIXED DEPOSIT)

• SECTION 171 OF THE INDIAN CONTRACT ACT, 1972 CONFERS THE RIGHT OF GENERAL LIEN
ON THE BANK
 • FEATURES
• GENERAL LIEN CAN BE EXERCISED BY BANK ONLY ON THE “ALL THE GOODS
AND SECURITIES ENTRUSTED TO IT IN ITS CAPACITY AS “BANKER” AND IN THE
ABSENCE OF A CONTRACT INCONSISTENT WITH THE RIGHT OF LIEN
• LIEN CANNOT BE EXERCISE IN FOLLOWING CASE :
• GOODS AND SECURITIES HAVE BEEN ENTRUSTED AS A TRUSTEE OR AN AGENT
• GOODS AND SECURITIES HAVE BEEN ENTRUSTED FOR A SPECIFIC PURPOSE

• BANKER’S LIEN IS TANTAMOUNT TO AN IMPLIED PLEDGE

• BANKS TAKE A LETTER OF LIEN FROM THE BORROWERS ACKNOWLEDGEMENT
THE RIGHT OF LIEN OVER SECURITIES FOR EXISTING AS WELL AS FUTURE
• RIGHT OF LIEN EXTENDS TO SECURITIES AND GOODS BELONGING SOLELY TO
THE BORROWER
• EXCEPTIONS TO THE RIGHT OF GENERAL LIEN
• GOODS ENTRUSTED FOR SAFE CUSTODY
• SECURITIES EARMARKED FOR A SPECIFIC PURPOSES
• GENERAL LIEN IF REPLACED WITH SPECIFIC LIEN
• NO LIEN ON SECURITIES LEFT WITH OVERSIGHT OR NEGLIGENCE
• SECURITIES FOR A COLLATERAL FOR A LOAN BEFORE SUCH LOAN IS
ACTUALLY GRANTED OR DISBURSED
• ONLY ON SECURITIES OR GOODS AND NOT TO MONEY DEPOSITED WITH
THE BANK, OR THE BORROWER’S CREDIT BALANCES.
 RIGHTS TO SET OFF

• THE BANK’S RIGHT TO SET OFF ENABLES IT TO ADJUST THE CREDIT BALANCE IN ONE
ACCOUNT OF A CUSTOMER WITH THE DEBIT BALANCE IN ANOTHER ACCOUNT OF THE
SAME CUSTOMER.
• THE BANK’S RIGHT TO SET OFF CAN BE EXERCISED UNDER THE FOLLOWING CONDITIONS
• THE ACCOUNT MUST BE IN THE SAME NAME
• SAME RIGHT
• DEBT SHOULD BE ALREADY DUE FOR PAYMENT AND NOT FOR FUTURE DEBTS OR CONTINGENT
DEBTS
• EXACT AMOUNT SHOULD BE ASCERTAINABLE
• IF AN EXPRESS CONTRACT IF THERE WHICH IS INCONSISTENT WITH SUCH A RIGHT OF LIEN
• BANK CAN COMBINE ACCOUNTS OF SAME CUSTOMER WITH VARIOUS BRANCHED OF SAME
ACCOUNT
• IN CASE OF GARNISHEE ORDER, THE BANK CAN FIRST EXERCISE ITS RIGHT OF SET OFF AND
THEN SURRENDER THE REMAINING AMOUNT TO THE JUDGEMENT CREDITOR.
• THE BANK HAS ANOTHER RIGHT – THE RIGHT OF APPROPRIATION OF PAYMENTS RECEIVED
FROM THE BORROWER, WHERE THE LATER HAS TAKEN MORE THAN ONE LOAN FROM THE
BANK, OR HAS MORE THAN ONE ACCOUNT WITH THE SAME BANK.

• THE RIGHT IS GOVERNED BY SECTIONS OF 59 AND 61 OF INDIAN CONTRACT ACT, 1872, BY

WHICH THE BANK CAN APPROPRIATE PAYMENTS RECEIVED TO DEBTS THAT HAVE
ALREADY FALLEN DUE FOR PAYMENT

• PAYMENT SHOULD BE FIRST APPROPRIATED TOWARDS INTEREST AND THEN TOWARDS

PRINCIPAL REPAYMENTS, UNLESS THERE IS A CONTRACT TO THE CONTRARY

• IN CASE OF DEATH, RETIREMENT OR INSOLVENCY OF A PARTNER OF A FIRM, THE THEN

EXISTING DEBT OF A FIRM IS SET OFF BY SUBSEQUENT CREDIT INFLOWS TO THE ACCOUNT

• BANK LOSSES RIGHT TO CLAIM DEBT FROM THE ASSETS OF THE OUTGOING PARTNER