PENTECOST UNIVERSITY COLLEGE

KOFI GYIMAH
kngyimah@pentvars.edu.gh
Accounting and Finance Department
Course: Retail Lending
PUBF 303

1
Bank Security (Collateral)

Lecture Objectives

The following should be achieved by the end of the class:

Definition of loan securities

Role of collateral and importance of securities

Qualities of a good security

Types of securities

Matching securities to facilities

 Definition
 A security or collateral is an item of value provided by a borrower to

provide assurance of an alternative source of repayment in the event that

the borrower defaults on his commitment to pay back a facility.
 It may also be defined as a pledge of property or other assets that must

be surrendered if the terms of the loan are not met.

 Securities are taken as an insurance against unwarranted situations

 The loans are called secured loans

 The lender acquires certain rights including right to sale over the

property in the event that the borrower is unable to pay as promised.

 Role of collateral
 Collateral stabilizes financial intermediation

 Collateral better aligns interests of the lender and borrower because:

 The lender can maximize the safety of repayment

 The borrower will minimize the risk taking

 Without collateral:

 The lender will solely rely on borrower’s cash-flow generated by the project

(business) for the repayment.

 The borrower tends to take more risks in the project (business), which may

cause instability in generating cash-flow.

 Role of collateral
 There will be more vulnerable banks and more risky businesses in the
economy, otherwise, resulting in shallow financial intermediation.
 Lender (specifically)
 Encourage willingness of payment to reduce expected loss
 Substitute the repayments to reduce loss given default.
 Protects against borrower’s over-borrowing.
 Borrower (specifically)
 Access to credit: let borrowers monetize their illiquid assets to raise
funds
 Cost of Credit: potentially reduce funding costs for the lower
expected loss calculated by the lender
 Overcoming asymmetric information problems: access to funds even
in a financially difficult time, or even without audited financial
reports
Importance of Collateral
It is a good credit management practice to lend against customers

capabilities and not the security he is offering. However, security is

required because:
Notwithstanding the present capabilities of customer, the future is

uncertain and certain eventualities may occur

The business environment may change for worse, government policies

may adversely affect the business.

The business may suffer from natural disasters like flood.

The purpose of the security is therefore to serve as a safety net so that

the bank would not be exposed when these eventualities occur

 Qualities of a good security
 Good security should have the following qualities:

 Marketability:

A good security should be marketable. In other words, it should be an item that is

capable of being sold in a market. A security over shares of a private company

is not easily marketable in the sense that there is no organized market for such

shares unlike shares of listed companies that can be sold on an organized stock

exchange.

 Ascertainability of Value:

A good security should have a value that can easily be ascertained.

 Qualities of a good security
 Stability in Value

Good securities must be stable in value otherwise its value will fall below
the advance granted and will no longer be adequate as a security. Shares
are not a good security because their values may fluctuate significantly
on the market. On the other hand landed property is a good security
because the value appreciates over time
 Transferability

A good security must also be easily transferrable so that the lender can
obtain value easily for it. The transfer of title to landed property is
cumbersome as compared to shares
Types of Securities
Securities used could include the following:
 Landed Property including Plots of land and buildings

 Financial Securities including shares and bonds

 Insurance Policy

 Business and business Assets

 Stocks and guarantees

 Other movable properties eg. car

Landed Property including Plots of land and buildings
Advantages:
 High value
 May appreciate over time
 Motivates customer to perform
 A secure form of collateral if due procedures are followed
Disadvantages:
 It is cumbersome and tedious taking the security
 Value may fall in bad times
 There may be beneficial or overriding interest
 The bank may not want to sell for emotional interest
Financial Securities
Advantages:
 Easy to sell
 Easy to take as security
 Easy to transfer
 In some circumstances easy to ascertain value
Disadvantages:
 Value tends to be volatile
 It is difficult in valuing those that are not traded
 They may be duplicated
 The issuer of the security may default
Insurance Policy
Advantages:
 Easy to take
 Value appreciates overtime
 Easy to transfer
 Easy to value

Disadvantages:
 May be duplicated and granted to another lender
 It may be void if certain vital information is not disclosed to
the insurer
 There may be lack of insurable interest
Business and Business Assets
Advantages:
 High value
 Value may appreciates overtime
 Motivates customer to perform
 Can be readily realized
Disadvantages:
 Some assets may be specialized and therefore difficult to
sell
 Value could also depreciate due to wear and tear
 Could be used to secure multiple interest.
Collateral and Security Documentation
Banks should ensure that all security documents are kept
in fireproof safe which should be under dual control.
Details of such documents should be kept in a register for
record purposes and to keep track of any movement.
Procedures should also be put in place to track and review
relevant insurance coverage for certain facilities and
securities.
Inspection of documents should be conducted on regular
basis
Evaluating A Loan Request: A Report to Mgt.
 A credit write-up template that addresses the following key
areas should be used.
 Request
Amount
Purpose
Reasonability of purpose for the facility
Source(s) of Repayment
 Background
General: company, operations, recent trends
Industry, Market, & competition Analysis
Management Assessment
 Financial Analysis: The reasons behind the fluctuations in the

ratios of the firm, issues of overtrading. The ratios should

specifically focus on:

Profitability ratios

Liquidity/Activity ratios

Leverage/Coverage ratios

Bank and Cash balances:

 Risk Assessment: Discuss the leverage or gearing ratio to

identify any risk in the trend. Any risk of default should be noted.
The following ratios should be included in the discussions.
Gearing

Interest Cover.

 Security: You should work out the suitability of the security

offered.
 The state of the security, the discounted values should be

considered and compared with the total exposure in arriving at a

decision.
Recommendation

 Credit decision

 Proposed Terms and Conditions

 Additional requirements

Recommendation: A recommendation for EITHER approval

or rejection of the credit request by the could be supported

from an analysis considering trends in financial performance,
well organized management team, deteriorating market
situation and the company’s efforts to improve its position.
The company’s long track record with the bank balanced

against its breach of the loan terms that seems to have

affected its liquidity are also important. Based on the
student’s well-organized argument either recommendation
is acceptable.