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Banks lend money to the public for various purposes, such as purchase or construction of a house, for the purchase of consumer goods such as televisions, music systems, etc. Banks also finance both manufacturing and services businesses. In addition to all this, they also offer personal loans to members of the public.
This service provided by banks, namely, financing, or more commonly called lending, is fraught with several inherent risks. Loan default can happen for more than one reason, including reasons beyond the control of the borrower, for example, in case of flood or tsunami which may destroy the property of the borrower, besides requiring him to resume his business immediately Can make unable to do. , The most serious risk for banks in the lending process is the risk of the borrower not paying back the loan. Imagine a situation where none of the borrowers of the banks will repay the loan taken by them! This could lead to the collapse of the banking industry!
The current spate of bank failures in the US and elsewhere is due, in good part, to borrower defaults. While in an ideal situation every borrower repays the loan taken from the bank, in real life this does not happen. Many times, borrowers, both individuals and institutions, fail to meet their repayment commitments, affecting the well-being of the lending bank. Sometimes, there are genuine reasons as to why borrowers become defaulters.
That being the case, banks certainly have norms and procedures that they follow before lending money to a borrower. Banks examine and evaluate loan proposals as to their feasibility and viability, both technically and financially, before deciding to extend the loan. Each loan is individually assessed to ascertain the strength of the proposal and only then the lending decision is taken. Getting security for loans is one of the safeguards that banks take to safeguard their interests. One of the various precautions taken by the banks to protect their interests in the process of lending is to obtain security for the loans given by them.
Definition of security: Security, in relation to a loan granted by a bank to a borrower, means an asset of any kind or description, having certain properties, of monetary value, that may be held by the bank. Is. Event of default, and applied for repayment of loan.
After lending a loan to a borrower, the bank would naturally want to ensure that the loan is repaid with interest. That is, the bank would like to secure the loan. This is done by creating a charge on the asset financed by the bank. The type of charge created depends on the nature and security of the loan.
Basically, there are two types of securities available with the banks to secure the loan. They are primary security and collateral security.
Primary security refers to the assets created directly out of bank finance. For example, where a bank is financing the purchase of a house, the house is the primary security. Similarly, a car bought with the help of a bank loan is the primary security for that loan. The bank makes a charge against this primary security to secure its loan. This fee gives the bank the legal right to dispose of the property, and apply the proceeds from it to the loan amount in case of default.
Collateral security refers to some additional security obtained by the bank to secure the loan. For example, suppose a bank has financed the purchase of machinery by a pharmaceutical manufacturing company. This machinery will be the primary security for this loan. In addition, the bank may obtain collateral security in the form of a factory building owned by the company as additional security. This will protect the interest of the bank in case the primary security does not have sufficient value to liquidate the loan. Sometimes, due to adverse market conditions, the value of the primary security decreases, exposing the bank to a higher risk than originally bargained for.
Additionally, the loan can also be secured with the help of personal security of the borrower. Obtaining personal security of the borrower helps the bank to take action against the borrower and his personal assets for the recovery of the loan.
Once the bank secures its loans with proper security, the chances of default are reduced, and even in case of default, the quantum of loss is likely to be less than otherwise. Is.
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