Last week on this series we discussed two other security/ collateral items for bank loans: Pledge of goods or property and stocks/ shares.
In case of pledge of goods or property we had noted that the goods if imported has to be consigned to the bank or warehoused by the bank from where it is sold and proceeds going straight to the bank. In the case of property we had noted that such property with appropriate value would be kept in the custody of the bank in lieu of loan security. All the key requirements of a good security would apply in all cases of pledge of any form of property or goods as security for loan. We also noted in case of shares/ stocks that banks select only those with good track record of stock market performance and in particular shares of companies known for strong financial position. Related to this is that the discounting or mark-down would be more adverse for shares of less reputable companies. We advised that the prospective borrower should invest in blue chip companies for the purpose of bank loans. We noted, however, that banks can make-up for the inadequacies of shares as security for loans by requesting for additional security in forms other than shares. In today and the concluding part of this series next week we shall discuss some other forms of security LIFE ASSURANCE POLICIES A life assurance policy is as a contract whereby the insurer in consideration of a certain premium payable monthly or annually undertakes to pay to the beneficiary of the policy or the holder a lump sum at the terminal date predetermined or annually upon the death of the life assured. The policy can be pledged for loan under conditions and terms that do not undermine the existing assurance policy contract. Specifically the borrower who should be the policy holder can assign the benefits thereof subject to fulfilled premium obligations. In other words the outstanding premium obligations do not count for the purpose of determining the loan amount and repayment obligations. GUARANTEES This is a typical collateral form of security in bank lending. A guarantee is a collateral security involving three parties, in which the third party, the guarantor, agrees to be liable for the debts of a second party, the borrower, if he does not pay the first party, the bank. It is a promise in writing made by the guarantor to the creditor to be liable for the debt of the debtor. In most cases the bank would require the third party, the guarantor to back-up the guarantee with tangible security, assets or cash as a form of additional securities like land and building, stocks and shares, life policy etc. If this is not done the security or collateral remains intangible and clearly it is an unsecured lending to the third party, guarantor. CASH SECURITY/A LETTER OF SET-OFF Most banks treat cash as the best type of security for loans probably because there are no obvious problems of valuation, depreciation and realization in case of default. There are two ways by which cash could be held as security. (a) Where the customer uses the credit balances in an account as security for a credit facility. (b) When cash is deposited by a third party e.g. guarantor expressly to secure the debt of the customer, e.g. the principal debtor. We shall be discussing more on this in our concluding part next week.