What does the term Collateral mean when used in conjunction with a Loan?
What is Collateral in Loans? This can be broken down into two distinct sectors of Collateral Financing. The first is where a bank lends against collateral or security that an individual or company already owns. This is a straight bank loan or line of credit granted to a client against cash, a home, bonds, shares, commodities or goods receivable.
The second is Collateral Transfer. This is where a company “leases” a bank instrument. These instruments are usually a Bank Guarantee or a Standby Letter of Credit. Collateral Transfer is popular amongst companies who do not have security or collateral for a credit line or loan.
The bank in both cases is lending against collateral but there is a subtle difference as explained below.
Collateral Financing for Bank Clients who own Collateral
There are two types of bank loans, one for private individuals and another for corporate clients. In both cases the bank will assess the risk and decide what kind of collateral they will accept.
Private/Individual Loans
Collateral Financing for individuals or private clients is fairly straightforward. A client may wish to upgrade their home and accordingly applies for a loan. The bank will usually grant the loan against equity in the property. The collateral is referred to as a second mortgage.
Alternatively, the client may ask for a loan to buy a car. In this case the car becomes the collateral. A client may apply for a holiday loan. This is usually granted against their salary and broken down into monthly repayments. In this case the salary effectively becomes the collateral.
Corporate Loans
Providing Collateral Finance for corporates has a completely different risk profile. Therefore, collateral offered against loans can come in different forms. The client may wish for a loan to fund a Letter of Credit. If granted, the bank will take paper possession of the imported goods. Once the goods are sold the bank will be repaid.
If the loan is particularly large, then charges against fixed and floating assets can become the collateral for a loan. The bank can even put a charge on the company shares. Alternatively, they can take personal guarantees from the directors as collateral against a loan.
Collateral Financing for Clients who ‘Lease’ Collateral
A bank can refuse loans to clients who cannot put up sufficient collateral. However, companies can “Lease” bank instruments in order to garner adequate collateral. The two collateral types are a Standby Letter of Credit and a Bank Guarantee – most leased instruments tend to be Bank Guarantees.
Companies can enter into a contract with a SBLC Provider or a Bank Guarantee Provider in order to obtain one of these instruments. The provider will transfer the Standby Letter of Credit or Bank Guarantee to the beneficiary’s account. The beneficiary can then obtain collateral financing from their bank. This usually takes the form of a loan or line of credit often referred to as Credit Guarantee Facilities.
Conclusion
In both cases the bank will be lending against security or collateral. The difference is that with Contract Transfer the collateral is “leased” and is usually returned after one year. The company will then have to renegotiate for a second year.
IntaCapital Swiss SA, have been providing access to loans and lines of credit for over a decade with the last two years, showing an explosion in requests to “lease” Bank Guarantees. Company’s who lack cash flow have turned to IntaCapital Swiss to aid them in their search for credit facilities.
