When banks lend money, they need assurance that the loan will be repaid. This assurance often comes in the form of securities—assets pledged by the borrower that the bank can claim if repayment fails. The law relating to securities and modes of charge provides the legal framework for creating, protecting, and enforcing these rights.
For both banking professionals and borrowers, understanding these principles is crucial. It ensures clarity on legal protection, risk management, and the overall transparency of financial transactions.
Legal Framework Governing Securities
In banking, a security represents a legal claim or interest in property offered by a borrower to secure debt repayment. Several legislations govern securities in India, including:
* Banking Regulation Act, 1949 – Governs banking operations and lending practices.
* Companies Act, 2013 – Regulates the creation, registration, and enforcement of charges by companies.
* Securities Contracts (Regulation) Act, 1956 & SEBI Act, 1992 – Deal with capital market instruments and investor protection.
Together, these laws form the backbone of how securities are created, managed, and enforced in the financial system.
Types of Securities Accepted by Banks
Banks accept a wide variety of securities to secure loans. These include:
* Immovable property– land, houses, or commercial buildings.
* Movable property – goods, stock, machinery, or vehicles.
* Financial instruments– shares, bonds, fixed deposit receipts (FDRs).
* Guarantees– third-party undertakings to repay if the borrower defaults.
* Debt instruments – such as bonds or certificates of deposit.
* Hybrid securities – like convertible preference shares, combining debt and equity features.
Modes of Creating a Charge
A **charge** is the method by which banks secure their interest in a borrower’s asset. Different modes apply depending on the nature of the asset:
* Pledge – Borrower delivers possession of movable property (e.g., gold, goods) to the bank. Possession remains with the lender until repayment. Governed by the Indian Contract Act, 1872.
* Hypothecation– Borrower retains possession of movable assets (e.g., vehicles, inventory), but the bank has the right to seize them if default occurs. Widely used for working capital loans.
* Lien – Bank retains the right to hold securities already in its possession until dues are cleared. No transfer of ownership.
* Mortgage – Security over immovable property (land/buildings). The bank acquires a legal interest, enabling sale if the borrower defaults. Types include simple mortgage, English mortgage, and equitable mortgage.
* Charge – A broader term for rights created over assets. Can be fixed (on specific assets) or floating (on assets like stock that change over time).
Legal Requirements for Registration of Charges
Under Section 77 of the Companies Act, 2013, any company creating a charge over its assets must register the charge with the Registrar of Companies (RoC) within 30 days.
This ensures:
* Legal enforceability of the charge.
* Public notice of encumbrances on company assets.
* Protection of lender’s rights in case of disputes or insolvency.
Priority of Charges
In lending, priority determines which lender has the first right over secured assets. Common types include:
* Fixed Charge – Attaches to specific assets like machinery or property.
* Floating Charge – Covers fluctuating assets such as stock or receivables; crystallizes into a fixed charge if the borrower defaults.
* First Charge – Gives the lender primary claim over the secured asset.
* Second Charge / Pari Passu Charge – Secondary or equal rights shared by multiple lenders, often in consortium lending.
Conclusion
The law relating to securities and modes of charge plays a central role in **protecting banks’ interests, reducing credit risk, and ensuring fair practices** in lending. For borrowers, awareness of these provisions provides clarity on their rights and obligations.
Summary Table: Types of Charge in Banking
| Type of Charge | Asset Covered | Possession | Ownership | Key Features / Legal Effect |
| Pledge | Movable property (gold, goods, securities) | With lender | With borrower | Created by delivery of goods; governed by Indian Contract Act, 1872. |
| Hypothecation | Movable property (vehicles, stock, inventory) | With borrower | With borrower | Bank has right to seize on default; common in working capital finance. |
| Lien | Any property/securities already with bank | With lender | With borrower | Bank can retain possession until dues are cleared; no transfer of ownership. |
| Mortgage | Immovable property (land, building) | With borrower | With borrower | Bank gets legal interest; can sell property on default. Several types (simple, equitable, English, etc.). |
| Fixed Charge | Specific assets (machinery, land) | With borrower (unless pledged) | With borrower | Charge attaches permanently to identified assets; cannot be sold without lender’s consent. |
| Floating Charge | Fluctuating assets (stock-in-trade, receivables) | With borrower | With borrower | Charge hovers over assets until crystallization (on default/closure); then becomes fixed. |
| First Charge | Any asset | Depends on mode | Depends on mode | Gives lender primary right of recovery from secured asset. |
| Second / Pari Passu Charge | Any asset | Depends on mode | Depends on mode | Secondary or equal rights among multiple lenders, common in consortium loans. |
In today’s financial landscape, where lending forms the backbone of banking operations, understanding these legal principles is key to building trust and maintaining stability in the credit system.
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