Importance of security for bank loans
Banks lend money to the public, for various purposes, such as the purchase or construction of a home, for the purchase of consumer goods such as a television, stereo, etc. Banks also finance companies, both manufacturing and services. Apart from all this, they also extend personal loans to members of the public.
This service provided by banks, namely financing, or more commonly called a loan, is fraught with various inherent risks. Loan defaults can occur for more than one reason, including reasons beyond the control of borrowers, such as floods or tsunamis that can wipe out a borrower’s assets as well as leave them unable to restart their business. immediately. . The most serious risk for banks in the lending process is the risk of loan default by the borrower. Imagine a situation where none of the banks’ borrowers pay back the loans they benefited from! This could lead to the collapse of the banking industry!
The current wave of bank failures in the United States and elsewhere is due, in large part, to the delinquencies of borrowers. While, in an ideal situation, each borrower repays the loan that he has obtained from the Bank, in real life, this does not happen. Many times, borrowers, both individuals and institutions, do not meet their payment commitments, which affects the well-being of the lending bank. Sometimes there are even genuine reasons why borrowers become delinquent.
With this being the case, banks invariably have rules and procedures that they follow before parting with a borrower’s money. Banks examine and evaluate credit proposals, regarding their feasibility and feasibility, both technical and financial, before making the decision to grant a loan. Each loan is individually evaluated to determine the strength of the proposal and only then is a decision made to grant a loan. Obtaining guarantees for loans is one of the guarantees exercised by Banks to guarantee their interests. Among the various precautions observed by Banks to safeguard their interests in the loan process, is obtaining guarantees for the loan granted by they.
Collateral Definition: Collateral, in connection with a loan made by a Bank to a borrower, means an asset, of any type or description, having certain qualities, including monetary value, that may be held by the Bank, in the case of default, and is applied to the repayment of the loan.
Having made the loan to the borrower, the Bank would naturally want to ensure that the loan is repaid with the corresponding interest. That is, the bank would want to guarantee the loan. This is done by creating a charge against the asset financed by the Bank. The type of charge created depends on the nature of the loan and the security.
Basically, there are two types of securities available to banks to secure a loan. They are primary security and collateral security.
Primary security refers to the asset created directly from Bank financing. For example, when a bank finances the purchase of a house, the house is the main value. In the same way, a car bought with the help of a Bank loan, is the main guarantee of that loan. The bank creates a charge against this primary value, to guarantee your loan. This charge gives the Bank the legal authority to dispose of the asset and apply the proceeds thereof to the amount of the loan in arrears.
Collateral Security refers to certain additional security obtained by the Bank to guarantee the loan. For example, suppose a bank has financed the purchase of machinery by a pharmaceutical manufacturing company. This machinery would be the main guarantee of this loan. In addition, the Bank may obtain the factory building owned by the company as an additional guarantee. This will protect the interests of the Bank in the event that the principal title does not have sufficient value to settle the loan. Sometimes, due to adverse market conditions, the value of the primary security erodes, exposing the Bank to greater risk than originally negotiated.
Furthermore, the loans can also be secured with the help of the personal security of the borrower. Obtaining the personal security of the borrower enables the Bank to proceed against the borrower and his personal assets, to recover the loan.
Once a bank guarantees its loans with adequate security, the chance of default is reduced, and even in the event of a default, the amount of loss you are likely to suffer is less than otherwise.