Why Do Banks Require Cheques When Applying for Personal Loans?
When individuals apply for personal loans, banks often request cheques as a part of the application process. This may seem a bit unusual, but there is a significant reason behind this practice. Banks require cheques because they offer a form of security in the event of default. Cheques can serve as a valuable tool for recovering the amounts owed to the bank.
Understanding Personal Loans and Security
Personal loans are a type of unsecured loan that individuals can apply for to cover a variety of expenses. Unlike secured loans, which involve collateral such as a property or vehicle, personal loans do not require any physical asset to be pledged. This flexibility is one of the main advantages of personal loans, but it also poses a significant challenge for banks. Without any tangible asset to seize, banks have fewer options in case of default.
Why Cheques Are Requested
The primary reason banks request cheques during the loan application process is to have a legal mechanism for recovery. Cheques act as a safeguard because they can be presented in court if the borrower fails to make the scheduled payments. If a cheque bounces (dishonors), the bank can pursue legal actions based on the Negotiable Instruments Act (NI Act). This act provides a framework for the legal enforcement of monetary obligations.
What Happens in Case of Default?
If a borrower defaults on the loan by failing to make the required payments, the bank can take the following steps:
Presenting the Cheque: The bank can present the cheque that the borrower signed during the loan application process to the borrower's bank. If the cheque bounces, it indicates that the borrower does not have the funds to make the payment.
Legal Action: If the cheque bounces, the bank can initiate legal proceedings under the Negotiable Instruments Act. This act authorizes banks to pursue criminal and civil actions against individuals who dishonor cheques, which can result in fines and imprisonment.
This measure is particularly important because personal loans are unsecured, meaning that the bank cannot directly seize the borrower's assets to recover the loan amount. By requiring cheques, banks create a mechanism that allows them to take the borrower to court for non-payment, thereby increasing the likelihood that the loan will be repaid.
Additional Peculiarities and Real-Life Scenarios
Sometimes, individuals may wonder why banks request cheques even when the loan is granted. The reasoning behind this is simple: it provides an additional layer of security. If a borrower defaults and fails to make the required EMI (Equated Monthly Installment), the bank can deposit the cheque that the borrower signed during the application process. If the cheque bounces, the bank can then take legal action against the borrower.
For instance, suppose a borrower applies for a personal loan and signs a cheque as part of the application process. In the event that the borrower fails to make payments, the bank can deposit the cheque. If the cheque bounces (dishonors), the bank can use this as a basis to go to court, initiating legal proceedings under the Negotiable Instruments Act.
This practice is a common safeguard used by banks to ensure that they have a backup method to recover their loan amounts in case the borrower defaults. It is a legal and effective way for banks to protect themselves against non-payment and maintain a balance between customer convenience and risk management.
Conclusion
In summary, banks require cheques when personal loans are applied for because they offer a crucial safeguard against default. Cheques provide a legal and effective means for banks to recover the amounts owed in case of non-payment. Understanding the role of cheques in the personal loan application process can help individuals make informed decisions and manage their finances more effectively.
By grasping why banks ask for cheques, individuals can better understand the importance of maintaining a good payment history and the potential consequences of defaulting on their personal loans.