Saturday Brain Storming Thought (122) 17/07/2021

COMPILED BY ER. AVINASH KULKARNI

COLLATERAL SECURITY

The term collateral refers to an asset that a lender accepts as security for the loan

The collateral acts as a form of protection for the lender

If the borrower defaults on their loan payments, the lender can seize the collateral and sell it to recoup some or all of its losses

Collateral security meaning

An asset which a borrower is required to deposit with, or pledge to, a lender as a condition of obtaining a loan, which can be sold off if the loan is not repaid

Types of Collateral

1) Real estate
Home or part of land normally high value and low depreciation, risky if the property is in default

2) Cash secured loan
In the event of default, the bank can liquidate his accounts in order to recoup the borrowed money

3) Inventory financing
The items listed in the inventory can be sold by the lender to recoup its loss

4) Invoice Collateral
Invoices to customers of the business that are still outstanding – unpaid – are used as collateral

5) Blanket liens
Lien, which is a legal claim allowing a lender to dispose of the assets of a business that is in default on a loan

Borrowing without Collateral

1) Unsecured loans
Usually involves smaller accounts that might be loaned without security, ie credit card debts

2) Online loans
Filling of application forms with the loan amount, interest rates, and payment schedule

3) Using a co-maker or co-signer
Another individual besides the borrower co-signs the loan

Primary and collateral security

Primary security is the asset created out of the credit facility extended to the borrower and/or which are directly associated with the business/project of the borrower for which the credit facility has been extended

Collateral security is any other security offered for the said credit facility

Understanding of Five C’s of Credit

1) Capacity
Ability to repay loans

2) Capital
The cash you put towards starting your business is called capital, this may come from deposits or money from other sources

3) Collateral
A secondary source of repayment for the loan

4) Conditions
The market for your business and clear purpose of the loan, type of industry, and your experience in it

5) Character
Educational background, business experience, and personal credit history

Collateral security as per RBI

Cash
Gold
Government security

Offline Collateral

Time deposit
Bank Guarantee
Stock Exchange
Government Bonds
BI Treasury bills

Cash as Collateral Security

Valued at 100%
Acceptable securities
Lowest price

Advantages of Land & building as collateral security

1) it is immovable property

2) generally appreciation value is high

3) mortgage in buildings can also satisfy government goals or targets

4) eg – Aawas Yojana

Disadvantages of land & building as collateral security

1) it is not easy to access the title of the property

2) legal disputes can be assigned on land & buildings

3) there may be any disputes on the title of a property

4) it depends on the market value rate

Advantages of Collateral Security

1) reduced credit risk

2) higher trading efficiency

3) improved liquidity

4) higher profits

5) diversification

Disadvantages of Collateral Security

1) increases operational and legal risks

2) reduced trading activity

3) concentration risk

4) legal risks

5) increased overheads

Life policies not accepted as collateral security generally

Children endowment policy

Policies are taken out specifically for purposes like estate duty

Children deferred policy

Policies with nominations under section 6 of Married Woman’s Property act

Marketing Collateral

It is a collection of media used to inform, educate, guide prospects and customers about how their Challenges can be solved

Characteristics of collateral security

1) value of the security should be easily ascertainable

2) availability and transparency of pricing is a must to verify the value at periodic intervals

3) the security should be easily transferable to the lender’s name

4) such ownership should be legally transferable

5) high liquidity and easy marketability

Collateral Value

Collateral value refers to the fair market value of the asset used to secure a loan

Collateral value is typically determined by looking at the recent sale prices of similar assets or having the asset appraised by a qualified expert

Lenders often use this value to estimate the risk level associated with a particular loan application

Collateral risk

The risk of loss arising from errors in the nature, quantity, pricing or characteristics of collateral securing a transaction with credit risk

Institutions that actively accept and deliver collateral and are unable to manage processes accurately are susceptible to loss

Collateral can be used as a down payment

Can be liquidated for cash equal to 20% down payment

Selling of collateral security

You can’t sell an asset pledged as collateral on a small business loan unless you have the lenders consent and you have paid the appropriate price for the release

If you have sold the collateral without the lender’s consent, the lender has legal resources against you and the buyer

Compiled by:-

Avinash Kulkarni

Chartered Engineer
Govt Regd Valuer
IBBI Regd Valuer

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