Define Pledge

Pledge is used when the lender (pledge) takes actual possession of assets (i.e. certificates, goods ).  Such securities or goods  are movable securities.  In this case the pledgee retains the possession of the goods until the pledgor (i.e. borrower) repays the entire debt amount.   In case there is default by the borrower, the pledgee has a right to sell the goods in his possession and adjust its proceeds towards the amount due (i.e. principal and interest amount).  Some examples of pledge are Gold /Jewellery Loans, Advance against goods,/stock,  Advances against National Saving Certificates etc.

Borrowers may also keep immovable assets such as gold, advances against goods, advances from National Savings Certificate (NSC), and others as security against the loan. This practice is known as pledging, wherein the lender (pledgee) takes actual possession of the assets. In case the borrower defaults on payments, the lender has the right to sell the collateral and recover the unpaid amount.

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How it works (Example):

Let’s assume you would like to borrow $100,000 to start a business. Even if you have an excellent credit rating, a bank may be reluctant to lend you the money because it may be left with nothing if you default on the loan. Thus, although banks may attempt the lengthy and expensive process of suing you in that circumstance, the bank may require $100,000 of collateral. This collateral might consist of financial instruments, houses, cash, or even objects such as art, jewelry, or other items. When you sign the promissory note, you pledge these assets to the bank as collateral. You might also pledge your business receivables as well. As mentioned above, the lender might require the borrower to put its pledged financial assets into a separate account that the lender controls.

If you default, the loan agreement gives the lender the right to seize and sell the pledged assets to recover any outstanding balance.

Why it Matters:

Pledged assets give lenders a sense of security, which is why pledged-asset loans often receive better interest rates than unsecured loans.

The type and amount of pledged assets required for a given loan is often a matter of negotiation between the lender and borrower. For instance, a lender might require a borrower to pledge any assets purchased during the loan period.

Accounting & Finance for Banking

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