Before we dig into the concept of the pledge in banking, you need to understand some other terms and conditions regarding debt/loans.
Whenever an individual or business firms require a loan/advance from any commercial banks or financial institutions or companies, then there are two kinds of loan available secured loans and unsecured loans.
In case of unsecured loans, no collateral is required, on the other hand, when it comes to secured loans collateral (security) is required to obtain such loans from any banks or financial institution.
The banks or other financial companies perform some legal formalities to possess one’s personal assets/ property/ goods against advances/loans before disbursing the amount approved. This process of possession of someone else’ property to avail the loan is called the Creation of Charge on security.
There are different mode of charges creation on property/ goods depending on the types of properties/assets (movable & Non-movable property).
Thus Pledge in banking is one of the modes of creating a charge on security to avail the advances to individuals or business enterprises.
Pledge in Banking:
The Pledge (in Banking) refers to the mode of creating a charge over movable security to avail the secured debt from any banks or financial institutions/companies.
In other words, Pledge is the process of creating a charge over movable assets/ property of borrower against the availed loan by the banks or financial institutions/ companies/ lenders.
In case of a pledge, the property/goods/assets on which the charge has to be created is kept with the lender itself. Moreover, if borrowers default during repayment of loans, the lender/ banks have rights to sell the property by sending a prior notice to the borrower for recovery of advance/loan.
Contract of Pledge:
As per Section 172 of the Indian Contract Act, 1872 Pledge is defined as follows:
“The bailment of goods as security for payment of debt or performance of a promise is called Pledge. The bailor is called Pawnor whereas bailee is called Pawnee.”
Some important points have to keep in mind regarding Pledge (in banking).
- Pledge is defined in section 172 of the Indian Contract Act.
- The lender/ bank is known as pledgee whereas the borrower is called pledger.
- The possession of pledged goods/ assets is with the lenders/banks itself whereas ownership of goods/property remains with the borrower.
- If the borrower defaults or unable to repay the debt/ loan, the lender has rights to sell the pledged goods without the intervention of court for the recovery of debt by issuing a prior notice to the borrower.
- The banks/lender has to take care of pledged goods as the goods will have been returned (original condition) to the borrower after repayment of debt.
- Even if the bank/lender as a pledgee has a priority in custody over pledged goods but the lender doesn’t have rights to sell the goods in any circumstances until the borrowers deny/ unable to repay the loan.
Pledge in Banking Example:
Let us consider a real-life example to understand the concept of pledge more clearly.
Suppose Mr A needs a loan of Rs 1,00,000/- for his expenses. He approaches HDFC bank and bank offered him two kinds of loans viz Personal loan (interest rate 15%) and Gold Loan @12% per Annum.
Now Mr A has two options either take the personal loan or gold loan. But to take Gold Loan he has to pledge the gold of value Rs 1,00,000/- Approx. with the HDFC bank.
As the Gold loan is secured loan, the bank will create a charge on the gold (1,00,000/-) of Mr A and keep the gold with itself until Mr A will repay the debt of HDFC bank.
In a nutshell, we can conclude the concept of a pledge in banking from the above example as follows.
- A Pledge is a process of creating a charge on movable assets to avail the secured loan.
- Mr A would be pledger whereas HDFC Banks will be pledgee.
- Gold being a movable property and gold loan as a secured debt has to be pledged with the bank.
- As gold is pledged, hence it is kept with the bank itself till the repayment of debt.
- To avail the personal loan no collateral is required as personal loan is an unsecured loan.
Difference between Pledge and Hypothecation