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Different Kinds of Finance — Transcript

by NPTEL-NOC IITM · 3,189 words · 469 segments · language en · Watch on YouTube

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0:21Welcome, welcome to banking and finance
0:24laws. This is the third week. We will
0:28discuss different kinds of finance in
0:31this week. This is the 11th session.
0:36Last week we discussed about hund and
0:38conventional transactions. And this week
0:41we will discuss about different kinds of
0:43finance. As part of this we will cover
0:46nature of finance, what is debt finance,
0:49kinds of debt finance, meznine finance,
0:53leverage buyout, project finance. In
0:57this class we will discuss debt finance.
1:03Finance would mean equity finance, debt
1:07finance, investment, saving, anything
1:09like that can be called as a finance.
1:12Basically when you manage money in
1:14whatever form it is that is called
1:16finance. So debt is one of the most
1:19popular form of finance that is
1:21prevailing and it's prevailing since
1:23very olden days because debt is
1:26generally required either to promote
1:28business to start a business or to buy
1:31out some other business or even to meet
1:33your household expenditures. Sometimes
1:36there may be a need of debt to start
1:38some new enterprising
1:40uh business opportunities, ventures etc.
1:43You may need debt for multiple reasons.
1:46And who provides this debt? Financial
1:49institutions do provide debt. Some of
1:52them many majority of them provides
1:54finance as a credit support. Sometimes
1:58debt is provided by formal and informal
2:01sectors also. Formal sectors are the
2:04institutional financial institutions
2:07providing debt is called formal source
2:09of financing. Whereas informal sectors
2:12are unorganized sectors like money
2:14lenders and other intermediaries who can
2:17provide debt to the people who generally
2:19don't go to these institutions or who
2:21don't have access to them or maybe the
2:24rules governing the financial
2:26institutions are so tough that they may
2:28not meet the eligibility criteria to
2:31take that debt. So they may approach the
2:34informal money lenders or other sectors
2:36where they can access that debt. The
2:40generally debt financing is known as
2:42loan, credit, debt, divor whatever all
2:45these are synonyms of debt financing in
2:48a way. Usually how does the debt we can
2:52categorize the debt as what kind of
2:54debts do we get or what is the broad
2:57categorization on the basis of the
2:59nature of debt provided we can call them
3:02as secured and unsecured debts. Secured
3:06debt usually means there is some other
3:08collateral besides the simple promise of
3:10that borrower to repay. The collateral
3:13could be in the form of a guarantee. It
3:15could be in the form of pledge. It could
3:17be in the form of a martage or some
3:20other hypothecation. So any kind of
3:22guarantee pledging collateral some
3:25property something like that. If you
3:27have collateral security which is
3:29promising to repay besides the borrowers
3:32to promise to pay is called secured debt
3:36and an unsecured debt on the contrary
3:38does not have any collateral supporting
3:41it excepting the borrowover's promise to
3:43repay. Now let us understand these
3:46different kinds of securities that are
3:49created or how is it different from each
3:51other. Pledge is one of the form of debt
3:54financing usually used by small
3:57borrowers or lower middle-class people
4:00or lowincome people usually and it
4:03involves movable property being pledged.
4:06There is no uh rule that rich people
4:09don't do pledge but majority of the
4:11usage I am talking about. So pledge is
4:13something where a movable property is
4:15given as collateral. Many at times it is
4:19gold or silver ornaments or gold jewelry
4:23or uh it could be other utensils, bronze
4:26utensils or anything like that, anything
4:28which has a value. So the main uh legal
4:33implications of a pledge is that the
4:36ownership of the uh property that is
4:40given as pledge will be with the
4:42borrower only but the possession of that
4:45good will be with the citor. Suppose I
4:48am taking loan and pledging my gold as a
4:53uh security for that loan. then I will
4:56give that gold to my citor and take the
5:00loan but the ownership in that gold
5:02still remains with me. So when I repay
5:05that loan I get back my gold. So goods
5:08will be transferred to the borrower on
5:10the satisfaction of the debt. And how
5:12much loan does a citor provides? It
5:15usually depends on the good that we have
5:18given. So it could be 75% of the value
5:21of that good or it could be 90% of the
5:24value of that good or it could be 60%
5:27depending upon the policy of that
5:29particular financial institution
5:31providing loan on pledges or on the
5:34money lenders who are providing that uh
5:36as a collateral for giving the loan. So
5:40if I am giving one lakh worth gold as
5:42pledge, I might expect to take 60,000,
5:4570,000 or 90,000 as loan from that
5:49pledge depending on the uh policy of
5:52that particular lender. Gold is very
5:55extensively used as a collateral in
5:57these kind of pledging loans even by the
6:01financial institutions. So when the loan
6:04remains unpaid. So if the borrower does
6:06not pay the loan, the creditor can file
6:10a case or can also sell these goods and
6:13recover his loan. So this is the biggest
6:15advantage of pledge to the citor. So he
6:19has the good readily available. He can
6:21sell it and realize the money that is
6:24due to him. Now what is the law
6:26governing pledge in India? It is the
6:29Indian contract act specifically section
6:32172 to 189 deals with bailment of
6:36pledges. This is the chapter that deals
6:39with the pledge law in India. When the
6:41borrower the law uses the word panard
6:44that is the person who is pledging the
6:46goods and defaults the payment to the
6:48creditor that is the pani in whose
6:51possession the goods are can sue the
6:53borrower that is he can file a case
6:56against the borrower or give a notice to
6:58the borrower and sell the goods. So it
7:01is enforcing security interest by
7:03himself. So the citor sells the goods
7:06and realizes the money just by giving a
7:08notice. What happens once the notice of
7:12sale is there also the borrower who has
7:14defaulted earlier can go can repay the
7:17loan repay the interest can repay the
7:20costs also to the citor and take back
7:22his goods. So borrower is still not
7:25prohibited from redeeming the loan
7:28redeeming his goods by repaying the loan
7:30amount. Now citor what will happen after
7:33a sale? Suppose the goods did not
7:36realize the amount the loan amount with
7:38interest has surpassed the value that
7:41the citor recovered on the sale of those
7:44pled goods then the citor can file a
7:47case and recover the remaining amount.
7:50If the citor receives more amount than
7:52what is due to him the remaining amount
7:55will have to be given to the borrower.
7:57This is how the pledge law uh applies
8:01and this is the law governing pledges in
8:03India. And the other form of uh uh debt
8:07financing more specifically used for
8:10movable property is called
8:11hypothecation.
8:13Now there is a charge that is created on
8:16the movable property in favor of the
8:18creditor but the ownership and
8:21possession both remain with the
8:23borrower. In pledge the possession is
8:26with the citor ownership is with the
8:29borrower. But in hypothecation both
8:32ownership and possession both of them
8:35are with the borrower only. But only an
8:38interest that is in the form of a charge
8:41is created in favor of the citor and the
8:44citor recovers this money by sale of the
8:47goods if the loan is not repaid. Just
8:50like the pledge thing only. Sometimes it
8:52is called as a kind of extension of
8:55pledge law only pledge related thing.
8:58There is a difference. How did this
9:00hypothecation emerge? What is the law
9:03governing? Generally it is the customary
9:06practice of the business people which
9:08developed this law and there is no
9:11specific provision in the law of
9:14contract act dealing with hypothecation.
9:17Generally the debt agreement governs the
9:19law. Now agreement is a contract. So the
9:23principles of contract law relating to
9:25the enforcement of agreement are
9:27generally applicable to this also. So
9:30general provisions of the contract law,
9:33property law and other laws will be
9:35applied to interpret and enforce the
9:37debt agreement in a way. It is broadly
9:40said to be a kind of extension of pledge
9:42law because only for movable property
9:45hypothecation is done. it. The only
9:48difference is the borrower retains the
9:50ownership also and possession also. Some
9:54people explain it as a special kind of
9:56mortgage relating to a mobile movable
9:59property while generally martigages are
10:02done for immobile property. Now this
10:05form of loan is very popular in the
10:07vehicular loan segment and sometimes to
10:10plant machinary loans also and many
10:14judicial decisions are there which laid
10:16the foundation of governing law relating
10:19to hypothecation in India. The other
10:22kind of uh loans that are given this is
10:26also relating to movable property given
10:28as collateral and debt financing is
10:31called the higher purchase. Now in this
10:34the ownership of the good remains with
10:37the seller and until the total price is
10:41paid by the uh purchaser that is the
10:46buyer the ownership does not get
10:48transferred. Now the buyer retains the
10:51possession of the mobile property. It
10:54could be vehicles, electronic goods,
10:56plant and machinery etc. Generally
10:58customer uh customer goods like
11:01electronic goods etc. This segment is
11:04very popular where the owner retains the
11:08seller retains the ownership and buyer
11:11retains the uh possession. Now sale
11:14becomes very easy because the owner is
11:17still having the ownership right the
11:19seller is having and for the buyer he
11:22will pay in easy installments and after
11:24the payment terms are completed the
11:26ownership gets transferred to him. So
11:29ownership generally transfers on the
11:31payment of last installment. This is
11:33also based on a binding agreement
11:36because again it is the agreement that
11:39is governing the law. The general
11:41principles of contract law, sale of
11:43goods and the judicial decisions are
11:46governing this particular kind of sale
11:48are financing a sale. This is usually
11:52used by the seller to finance a sale. So
11:55there is no specific provision that
11:57governs this particular form of loan in
12:00the contract law. But because it is
12:02governed by a specific form of
12:05agreement, the general principles of
12:08contract law becomes applicable to this
12:11form of sale also. Now let us try and
12:14understand what are the major
12:16distinctions between these three
12:19different forms and what are the major
12:21similarities also. Generally these three
12:24forms or loans are used for movable
12:28property loans. So when the collateral
12:31that is given is in the form of movable
12:34property unlike land building and others
12:37like a vehicle, gold or plant and
12:41machinery these kind of things when they
12:44are given as collateral. The kind of
12:47loan that is given is usually pledge
12:49hypothecation and higher purchase. This
12:52form of financing is generally used for
12:55mobile property. But there are
12:57distinction within each one of them. In
13:00pledge, the ownership is with the
13:02borrower. Similarly, in hypothecation
13:05also, the ownership is with the
13:07borrower. But in higher purchase, the
13:10ownership will be with the creditor
13:12until the transfer of the entire sale
13:16money is paid and then the ownership
13:19gets transferred to the buyer. That is
13:22the borrower. We can say now while the
13:25goods are pledged with the citor the
13:28possession the ownership remains with
13:30the borrower but the possession of those
13:32goods remain with the citor but in
13:35hypothecation as opposite to that both
13:39ownership and possession both are with
13:41the borrower only a charge is created
13:44but in higher purchase the ownership is
13:48with the creditor and possession is with
13:50the borrower. So if we observe with
13:53pledge and higher purchase it is exactly
13:56the opposite. Ownership is with the
13:58borrower ownership is with the creditor
14:00in higher purchase. Possession is with
14:03creditor but possession is with
14:05borrower. So it is a kind of reverse
14:07thing and hypothecation sits somewhere
14:09in between. Both ownership and
14:12possession both are with the borrower
14:14and a charge being created in favor of
14:16the citor. So this is one major
14:20distinction between these three and the
14:23law governing these three are also very
14:25very distinct. For example, the Indian
14:28contract act has specific provisions
14:31which govern the pledge and in
14:33hypothetic
14:37contract law and other laws govern what
14:39is the advantage to the creditor and why
14:42a creditor will enter into an agreement
14:45when ownership and possession both are
14:47with the borrower. For example, I am a
14:50citor of the vehicle or loan. Now I am
14:53just a financer. I am not bothered how
14:56the vehicle is driven what accidents the
14:59vehicle user will come into then what
15:02will happen if there is an accident
15:04because if the if it is in my name will
15:07I be sued I don't need to bother about
15:09all those problems so ownership and the
15:12possession both are with the borrower I
15:15am only bothered about recovering my
15:17money so this could be one reason I may
15:19prefer hypothecation over higher
15:22purchase where I don't want to keep the
15:24vehicle ownership with me. I might be a
15:27creditor who want ownership with me and
15:31I am not bothered of taking those risks.
15:33So I might give a vehicle or loan where
15:36I will tell the borrower that in a way
15:38if I am a seller of the vehicle I will
15:41tell him that I will transfer this
15:43vehicle to you after you pay entire
15:46money in a way I will give you the
15:48possession but ownership I will transfer
15:50later. So it is usually the kind of the
15:54choice between the citor and the
15:57borrower at the given point of time.
16:00Which kind of loan do they choose?
16:03And these are not just the financial
16:06institutions that are providing this
16:08kind of loans but there are also other
16:11kind of financial intermediaries like
16:13money lenders or other pawn brokers who
16:16are registered or unregistered and they
16:19all do these kind of businesses.
16:21Abundant informal sector lending happens
16:24in this kind of forms. All these kind of
16:27forms of loans like for example when a
16:30big company is purchasing numerous
16:33vehicles it may easily go to a big uh
16:37banker or to a financial institutions
16:40and take loan in the form of
16:41hypothecation or higher purchase. But
16:44when a small person is buying a vehicle
16:46in a second hand he might find it an
16:49informal source as a more easy access
16:52for the debt. So what happens is we need
16:55to have multiple forms of financers and
16:59multiple forms of finance. The reasons
17:02are the access to it will be very easy
17:05for the other people. Not everybody may
17:07be able to requirements may be similar
17:10to each other. So there is a multiple
17:13requirement, multiple lenders, multiple
17:16borrowers, multiple users, multiple
17:19purposes. These all govern the way in
17:22which the financing and a particular day
17:25or a particular type of financing that
17:28will be required for a particular
17:30situation. So pledge hypothecation and
17:33higher purchase are forms of debt
17:36financing used for obtaining loans
17:38providing movable property as a form of
17:41collateral and creditors. Major
17:44advantage with this is even before
17:48enforcement of security interest came as
17:50a law in itself in the 2002 through the
17:54introduction of surface act these forms
17:57of uh kind of enforcing security
18:01interest in the movable property is
18:03available since decades that is since
18:06even with the Indian contract act itself
18:09providing law governing pledge where in
18:12you can sue also and you can sell the
18:15goods also. It is a choice of the citor
18:18and if I am a citor having certain goods
18:21given as collateral to me imagine I got
18:2510 g of gold as a collateral for a loan
18:28I have given 60,000 and with interest
18:31the borrower is required to repay me
18:3480,000 rupees and I have a gold worth 1
18:37lakh 10,000 in my hand why should I
18:40prefer to go and file a case in the
18:43court instead I can sell that gold and
18:45realize the my due and pay the remaining
18:49amount to the borrower. So I will find
18:51it very very easy. I need not incur
18:55additional legal expenses to recover my
18:57due and I need not wait for long period
19:00of court decision to recover my due. So
19:03I can easily recover through the
19:06collateral which is pledged to me or
19:09hypothecated to me or higher purchase
19:11model sale. I can take back my good and
19:14recover my loan. So in a way these forms
19:17of loans are very very popular forms of
19:20loan. This is exactly the reason why
19:23even financial institutions use pledging
19:26as a very popular form of loan. There is
19:29mut gold loan schemes which provide
19:32extensively gold loans. So not only that
19:34one I am giving one example of an NBFC
19:38offering uh pledge as a form of loan. So
19:42there are many many finance companies
19:44and bankers and financial institutions
19:47which provide this form of loan to the
19:49vehicles and to plant and machinary
19:52purchase. So these forms of loans which
19:56are not just limited to very small
19:59borrowers even middle class or even for
20:01big big plant and machinery purchases
20:03also these forms are loans are used or
20:06these forms of financing is prevailing
20:09since decades or even before even for
20:12centuries in India. So this kind of
20:15financing and this kind of loan has
20:18major advantages to the creditors and
20:21the in vehicular loans of course there
20:23will be depreciation. So when they are
20:26giving loans they generally consider
20:28that and they will give lesser value
20:31than the loan like maybe 50% or 40% of
20:35loan only they may provide. But if there
20:37is a competition among the creditors and
20:40there are more financers and if there is
20:42a vehicular purchase loan which are more
20:44promptly paid and the rate of default is
20:47very less they might give up to 75 80%
20:50or 90% also. So they will consider the
20:54depreciation value and other
20:56considerations while giving the loans
20:58but not necessarily that that will only
21:01determine the uh lending process because
21:04as I said the amount of amount available
21:07with the lender to finance the kind of
21:10applications that he is getting to
21:12finance the amount of competition among
21:15the creditors and the market conditions
21:17and the history of repayments in the in
21:21that particular segment. ment of loan
21:23and the creditworthiness of that
21:25particular borrower. All of this will
21:28determine the lending or the debt
21:30decision that a citor will make in any
21:32given situation. But these particular
21:35forms of lending have been prevalent not
21:39just by the law governing it alone but
21:42even by the customary practices and
21:44judicial decisions. Law has evolved over
21:47a period of time in this kind of debt
21:49finance. And in the next class we will
21:52discuss other further forms of debt
21:55financing because we have seen a pledge
21:59hypothecation and higher purchase in
22:01this particular class and we will look
22:03at other kinds of debt financing in the
22:06next class. Thank you.

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