edges lend money to the public, for various purposes, like buy or construction of a home, for buy of consumer goods like a TV, Music System, etc. edges also finance businesses, both manufacturing and sets. except all these, they also extend personal loans to members of the public.
This service provided by edges, 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, except rendering him incapable of restarting his business closest. The most serious risk to edges in the lending course of action is the risk of non payment of the loan by the borrower. Imagine a situation where none of the borrowers of edges repay the loans availed of by them! This could rule to a collapse of the Banking industry!
The current spate of Bank failures in America and in other places is, in good part, on account of borrower defaults. while, 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 commitments, affecting the well being of the lending Bank. Sometimes, there are already genuine reasons why borrowers become defaulters.
This being the case, edges always, have in place, norms and procedures that they follow before parting with money to a borrower. edges examine and estimate 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. Obtaining of security for loans is one of the safeguards that edges exercise to obtain their interests.Among the various precautions observed by the edges to safeguard their interests in the lending course of action, 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, method, 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 obtain the loan. This is done by way of creating a charge against the asset financed by the Bank. The kind of charge produced depends on the character of loan, and the security.
Basically, there are two types of securities obtainable to edges to obtain a loan. They are dominant security and Collateral security.
dominant Security refers to the asset directly produced out of Bank finance. For example, where a Bank finances the buy of a home, the home is the dominant security. In the same way, a car purchased with the help of a Bank loan, is the dominant security for that loan. Bank creates a charge against this dominant security, to obtain its loan. This charge gives 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 obtain the loan. For example, say, a Bank has financed the buy of machinery by a Pharmaceutical manufacturing company. This machinery would be the dominant security for this loan. In addition, the Bank may acquire collateral security in the form of the factory building owned by the company, as additional security. This will guard Bank’s interests in the event of the dominant security not having sufficient value to liquidate the loan. Sometimes, on account of negative market conditions, the value of the dominant security gets deteriorated, exposing the Bank to a higher risk than it had originally bargained for.
Additionally, loans can also be secured 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, to retrieve the loan.
Once a Bank secures its loans with proper security, the possibility of default is reduced, and already in case of default, the amount of loss it is likely to suffer is lesser than otherwise.