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 borrowers’ control, 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 non-payment of the loan by the borrower. Imagine a situation where none of the banks’ borrowers pay back the loans they took advantage of! 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 borrower defaults. 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.
 
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 for their viability and feasibility, both technical and financial, before making a decision to grant a loan. Each loan is individually evaluated to determine the strength of the proposal and only then is the decision to grant a loan made. Obtaining guarantees for loans is one of the guarantees that Banks exercise 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.
 
Definition of Guarantee: Guarantee, in relation to a loan granted by a Bank to a borrower, means an asset, of any type or description, that has certain qualities, among them, monetary value, that can be owned by the Bank, in the case of default, and applies to repayment of the loan.
 
Having made the loan to the borrower, the Bank would naturally want to ensure that the loan is repaid with 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 fee 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 the Bank’s financing. For example, when a bank finances the purchase of a house, the house is the main value. In the same way, a car purchased with the help of a Bank loan is the main collateral for that loan. The bank creates a charge against this primary security, to guarantee your loan. This charge gives the Bank the legal authority to dispose of the asset and apply its proceeds to the amount of the loan in arrears.
 
Collateral Guarantee 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 as additional guarantee the factory building owned by the company. This will protect the Bank’s interests in the event that the principal is not of sufficient value to pay off the loan. Sometimes, due to adverse market conditions, the value of the primary security erodes, exposing the Bank to greater risk than it had originally traded.
 
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.