BANK LOANS-SECURITY
March 18, 2009 by Muhammad Haidar
Filed under Business, House Mortgage, Loans, Muhammad Haidar, Other - Business & Finance
Introduction: Banks lend money to the public, for various purposes, like purchase or construction of a home, for purchase of consumer goods like a TV, Music System, etc. Banks also finance businesses, both manufacturing and services. Apart from all these, they also extend 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 defaults may occur for more than one reason, including reasons beyond the control of the borrowers, like for example, in case of floods or a Tsunami, that may wipe out the assets of the borrower, apart from rendering him incapable of restarting his business immediately. The most serious risk to Banks in the lending process is the risk of non payment of the loan by the borower. Imagine a situation where none of the borrowers of Banks repay the loans availed of by them! This could lead to a collapse of the Banking industry!
The current spate of Bank failures in America and elsewhere, is, in good part, on account of borrower defaults. Whereas, in an ideal situation, every borrower repays the loan availed by him, from the Bank, in real life, this does not happen. Many a time, borrowers, both individuals and institutions, fail to keep up their repayment committments, affecting the well being of the lending Bank. Sometimes, there are even genuine reasons why borrowers become defaulters.
This being the case, Banks invariably, have in place, norms and procedures that they follow before parting with money to a borrower. Banks examine and evaluate credit proposals, as to their viability and feasibility, both technically and financially, before taking a decision to grant a loan. Each loan is appraised individually to ascertain the soundness of the proposal and only then a decision to grant a loan is taken. Among the various precautions observed by the Banks to safeguard their interests in the lending process, is the obtention of security for the loan extended by them.
Definition of Security: Security, in relation to a loan extended by a Bank to a borrower, means, an asset, of any kind or description, having certain qualities, among them, monetary value, that can be possessed by the Bank, in the event of default, and applied toward repayment of the loan.
Having extended the loan to the borrower, Bank would naturally like to ensure that the loan is repaid with the interest thereon. That is, Bank would want to secure the loan. This is done by way of creating a charge against the asset financed by the Bank. The type of charge created depends on the nature of loan, and the security.
Basically, there are two types of securities availabe to Banks to secure a loan. They are Primary security and Collateral security.
Primary Security refers to the asset directly created out of Bank finance. For example, where a Bank finances the purchase of a home, the home is the primary security. In the same way, a car purchased with the help of a Bank loan, is the primary security for that loan. Bank creates a charge against this primary security, to secure its loan. This charge give the Bank the legal authority to dispose off the asset, and apply the proceeds therefrom, to the loan amount in default.
Collateral Security refers to certain additional security obtained by the Bank to secure the loan, in addition to the primary security. For example, say, a Bank has financed the purchase of machinery by a Pharmaceutical manufacturing company. This machinery would be the primary security for this loan. In addition, the Bank may obtrain collateral security in the form of the factory building and land owned by the company, as an additional security. This will secure the Bank further and safeguard its interests in the event of the primary security not having sufficient value to liquidate the loan. Many a time, it so happens, that on account of adverse market conditions, the value of the primary security gets eroded, exposing the Bank to a higher level of risk han it had originally bargained for.
In addition to the above discussed securities, there is also the scope of securing the loan with the help of personal security of the borrower. Obtaining personal security of the borrower enables the Bank to proceed against the borrower and his personal estate, in order to recover the loan.
Qualities of a Security: In order that a security may provide a real means of liquidation of a loan in part or in full, the concerned asset must have the following important qualities, among others:
1. Valuable Security: A security obtained as a cover against default, of the borrower, in repayment of the loan, must have some monetary value that can be realised and adjusted toward the loan. Intrinsic value alone would not be helpful to the Bank in mitigating the problem arising out of a default.
2. Marketable Security: Even though a security may have a monetary value, it may not be possible to encash the value as and when needed by the Bank, because it may not be easily marketable. That is, it may not be easy or even impossible to dispose off the security and realise its proceeds, for various reasons.
For instance, the asset obtained as a security for a loan, may not be in demand, at the time it is required to be encashed or realized and credited to the loan amount in default.
3. Stable Security: Stability of security here means the stability of the value of security. Certain securities have widely fluctuating values, depending on market and other conditions. As a rule, Banks prefer securities that are not prone to market gyrations, and offer a reasonable chance to the Bank to have it adjusted to repay a good part of the loan in default, if not the entire loan.
4. Transferable Security: The security offered by the borrower to secure the loan, must have the quality of transferability. That is , the ownership, or the interest in the security, must be capable of being transferred to the lender, without too much effort and expemses.
As can be seen from the above, securing the loan extended by the Bank is of vital importance and also necessity to the Bank, as otherwise, it may jeopardise the interests, or even the survival of the Bank. That apart, securing a loan with an asset of the borrower increases the stake of the borrower, who would have more reasons to make his venture a success by doing his best.
This home truth has been forcefully brought forth in the current economic crisis, in which many Banks have realized their folly in not properly securing their loans.
Bank Loan Funds
As interest rate climb, most bond owners are shaking their heads. The price of existing bonds falls when rates are on the rise. There is a way to offset the decline. You can invest in bank loan funds, also known as floating rate funds. There is a risk to these funds, but they can be a rewarding alternative to traditional fixed-income investments.
Bank loan funds are made up of loans made by banks or other financial institutions to companies. They are often below investment grade. They aren’t really fixed income; there is the potential of losing money. The funds can provide a return equal to or better than high-yield money market accounts. The loans that make up the funds are short-term. This allows the lenders the opportunity to frequently raise the interest rate. This helps the funds keep pace with interest rate changes and helps keep the principal more stable than with a typical bond fund.
According to many portfolio managers, the way the loans are structured removes a lot of the risk to investors. The loans are secured by cash or assets. The funds are not independently rated, but experts say the bank should be able to show you the performance of the fund. The bank will package the loans and sell them, and the funds come into play.
Ban loan funds are senior loans. If the company defaults, senior loans must be paid back before bond holders are. You may not receive enough to cover your initial investment, but something is better than the nothing you could receive with a high-yield bond. Typically, in the case of default, the investors will recover 75 to 80 cents on the dollar.
The change of losing principal is reduced because the interest rates on the loans reset very quickly. Short-term interest rates rise and fall in response to the Federal Reserve. That, combined with the short terms of the loans, makes for a fund that responds quickly to the rise and fall of interest rates.
Many brokerages, including Merrill Lynch and Eaton Vance, sell bank loan funds. In certain asset classes there may be a high expense ration. Make sure that you check every fund out carefully.
Many funds in this group allow investors to buy shares at any time. There are some funds that will allow you redemptions at any time, while others will restrict you to monthly or quarterly redemptions.
How To Get A Bank Loan
When someone is looking for a bank loan, it means that there is something that they want to buy but are not able to buy it right then. This can be something that is tough for you to figure out, and it might be something that you need. One of the ways that people get things that they cant currently afford to pay for is to get a bank loan to cover the costs. Then they go from there. This is a great way to make sure that they can get things that they want to get, and usually it is easy to get a bank loan. You simply have to follow the process.
The first thing that you have to do to get a bank loan is to apply for one. This is a process that is going to require a lot of information on your part. First of all, you have to know what kind of loan you are looking at, and how much money you are going to need. Next you have to be sure that you are going to be able to pay back the loan, so you have to know how much you want to make payments for. Also, you have to be able to tell the bank what you need the money for, how much money you need, and how you are going to pay them back.
The process of getting a bank loan can take a lot of time, and it can be very frustrating, but it is the best way to do it. If you get loans from other places, you might run into trouble with raised interest rates, extra fees, or even with money being demanded from you that you should not have to pay. Banks are reputable organizations that can afford to loan you money and that will always follow the rules of commerce. If you go with a bank loan, there are going to be rules and regulations that you will know about ahead of time and that cannot be broken. A bank loan is really the best way for you to make sure that you are getting the money that you need, and that you are finding ways to be as productive as you can be.
There are many benefits to getting a bank loan. First of all, you are going to be able to have the money that you need to get what you want. Also, you are going to have low monthly payments that you can make. And each bank loan that you get and are able to pay off is going to put good marks on your credit score and give you a chance to look even better the next time you apply for a bank loan. Bank loans are perfect for emergencies or when starting a new business. The list of positive reasons for getting a bank loan goes on and on for miles. Quite simply, there are many good reasons to get a bank loan.
The Key To Bank Loans
Bank loans are among some of the toughest loans to get. Banks are very picky about lending money. This is because loans are not their only line of business. They are, however, where they make the most money. They can also be the greatest source of loss and that is why they are so picky when it comes to approving loans.
Banks have very strict criteria for approving loans. Most banks are going to require good credit. They want to see a person who has multiple good reports on their credit report and no bad reports. They also want a person who has a steady and secure income source. Overall, they want the least amount of risk when lending to a person.
The key to a bank loan is knowing what they want. If a person is wanting to get a bank loan then they have to start analyzing their financial situation.
It starts with the credit report. A person must ensure they have absolutely no bad marks on their credit. They need to repair anything that could adversely affect their credit. Then they will need to wait at least six months before applying for a bank loan.
They should also look at their budget. They need to ensure their income is exceeding their expenses. It is likely the bank will want proof of income for six months or more. If a person has been employed for less then six months, then they should wait until they have been before applying for a bank loan.
When applying for a bank loan a person must have all their paperwork in order. They need to have pay stubs, bank statements and their credit report for the loan application. This way they can be sure they can provide the bank with whatever they need.
Additionally, bank loans are more often then not secured loans. At least for a person getting a bank loan for the first time, the loan is going to be secured. A secured loan is secured with either collateral or money. The bank requires this for two reasons. First, it allows the borrower to assume some risk. They are either risking losing their collateral or risking losing their money. Secondly, in the case of using money to secure a loan, the borrower is lowering the actual amount they need to borrow, which in turn lowers the risk to the bank.
One of the best things to do when trying to get a bank loan is finding out the banks general criteria for getting a loan. Most banks will gladly tell a person what they expect from a borrower. This can allow the person to make sure they adhere to the banks qualifications which can make the whole loan process go smoother and faster.
Bank loans can be difficult and very frustrating. It is hard to know exactly what a bank is wanting from a borrower. The best thing to do is call the bank and ask what their general criteria is for a loan. This way the person can make sure they qualify before they ever start the loan process.
Bank Loans – Necessary In Todays Material World?
The idea of a bank that loans out money to the public, totally metamorphosed the premise of ancient banks that stated that a bank was only a place to deposit money for safeguarding. Present day banks are synonymous with bank loans to such an extent that today practically every individual who has a bank account has a bank loan of some sort or the other.
It is improbable that in the present day and age anyone (unless born to money) has enough money lying around to make big ticket purchases like a flat or an apartment, without resorting to a bank loan.
Bank loans have attained the reputation of a necessity in todays scenario where temptations to own products are so great that one takes the recourse of a bank loan and in return enjoys the product or benefit from the appreciation of an asset purchased while paying backing installments. Be it an auto loan, a bank loan for a specific purpose or a home loan, present day banking system provides loans for practically anything and everything that one may want to own. Without these convenient bank loans lots of people would never been able to purchase that new car or a laptop or a home.
Factually, a bank home loan is similar to a mortgage with a collateral attached. The only matter of concern that remains is that one gets tied up for a long period and has to keep on paying interest on the loan.
With the passage of time, bank loans have become so versatile that there are bank loans for buying white goods, consumer goods like computers and even for repairs, renovations, marriages and celebrations. It is a case of you name it and that bank has it. There exist student loans too, where a bank advances money for studies with a condition of repayment after the student joins the mainstream and starts earning.
Broadly speaking, even credit cards are a form of a bank loan that you can repay and some banks even offer you loans to pay up other loans you may have taken in the past.
Bank loans issued to individuals for the purpose of housing probably out number other loans issued by banks. But they may not compare in volume or value to bank loans issued to businesses worldwide. Whether it is a small business operated out of the home or a large business that needs millions of dollars in order to tide over a cash flow problem or to acquire assets, bank loans issued to businesses far outstrip individual loans. In fact it will not be an exaggeration if one were to say that without bank loans the vast majority of business worldwide would collapse. Business in modern day thrives on the banking system and the investment, lending, finance and credit that it facilitates.