Bank Collateral

Collateral Definition

Bank collateral is something deposited as a guarantee of an undertaking or loan. If the borrower fails to repay the loan then the lender can sale the security to recover the loan. Security is obtained as a line of last defense to get back the loan amount. Bank collateral means to be an insurance against emergency. By taking security bank acquires a claim over the particular asset(s) of the borrower if repayment is not made as per schedule. One of the most important functions of a bank is to invest its fund by way of loans and advances to its customers and a bank’s strength depends considerably on the quality of its loans and advances. In older times, when a banker knew his customers personally and intimately and had complete confidence in the integrity and honesty of a customer, they used to allow loans and advances without a security. The position is quite different today.

Banks having a large number of offices over a wide area cannot allow loans and advances without retention of security in one form or the other. Though the banks are now expected to give greater emphasis on the purpose for which the borrower needs money rather than security he can afford to give, security continues to be one of the most important factors which determine to a significant extent the banker’s willingness to lend money.

Bank Collateral Security is obtained as a line of last defense to fall back upon. It is meant to be an insurance against emergency. By taking security, bank acquires a claim upon the assets of the borrower if repayment is not made as planned. The most significant categories of security lodged as cover are: (i) Goods and commodities (ii) Fixed Deposit Receipt (ii) Real Estate (iv) Machinery (v) Gold and gold ornaments (vi) Documents of title to goods (vii) Book debts (viii) Supply bills etc.

Types of collateral

Security taken by banks may be classified into two broad categories: (a) primary security and (b) collateral security.

Primary securities are those securities or assets, which are created with the help of finance of the bank. For example the capital machineries purchased by the finance of the bank is a form of primary security, Primary security is deposited by the borrower himself and thus provides the main cover for the loan. Primary security may be either Personal Security or Impersonal Security. Personal security means personal guarantee against the loan whereas Impersonal security means security, which is tangible like land, building, machineries etc.

On the other hand, collateral security is the security against which finance is not available. A collateral security is a security belongs to and deposited by borrower himself or by third party to secure the loan. It is rather additional security, The lender needs such securities in the event of the value of primary security being insufficient against the loan amount. For example, in addition in the above case, if the borrower also mortgages his residence, which
would be considered as collateral security. Collateral security may be direct or indirect.

what can be used as collateral for a personal loan

Collateral security obtained from the borrower himself to secure the loan is known as direct collateral security, whereas security offered as collateral security belongs to third party known as indirect collateral security.

Primary Security

Personal Security: When personal advance is made, the borrower is personally liable to repay the advance for which he executes promissory note, accepts or endorses a bill of exchange and makes personal covenants in mortgage deed or loan agreements, Banker has the right of action to proceed against the borrower personally in the event of default or non-fulfillment of conditions as per agreements.
Impersonal Security: Impersonal security is given when a charge is created by way of hypothecation/pledge/mortgage over the borrower’s tangible assets-such as, goods and commodities, fixed assets, book debts and bills receivables etc. In case of default, the bank is empowered to proceed directly or through the intervention of the court to dispose of the impersonal security and realize the dues. Impersonal security may take the form of either specific security or continuing security, The specific security covers the specific loan alone and does not cover any other indebtedness of the borrower to the bank.

In case of continuing security for an advance in cash credit or overdraft account, the memorandum creating a charge on the assets is so worded as to make it a continuing one to cover all sums due now or in the future from the borrower until the ultimate balance is determined and regardless of whether the account may at times go into credit.

Collateral for a Loan

  1. Direct Collateral security obtained from the borrower himself to secure his own account is known as direct collateral security. Advance against hypothecation of stock-in-trade which is considered a weak security is strengthened by equitable mortgage of title deeds of house property of the borrower.
  2. Indirect Collateral security (Guarantee) means any form of security given by a third person to secure a customer’s account. A guarantee is an indirect collateral security because it is given by one person to secure another person’s indebtedness.

Collateral Characteristics

There are certain qualities which a good tangible security should possess. Some of the important attributes are-

(a) Marketability (b) Easy Ascertainment of Value (c) Stability of Value (d) Storability (e) Low Cost of labor and Supervision (f) Transportability (g) Durability (h) Ascertainment of Title (h) Easy transfer of title (i) Absence of contingent liability (j) Yield

Security Valuation

Valuation of securities is an important aspect for the banker since the advance value or withdrawal limit is fixed on the basis of value of securities, less stipulated margins. There are a number of methods of valuing securities depending upon the type of security offered. Valuation may be based on market value, invoice value or controlled value. Valuation of some common Items of security are as follows:

Govt. Securities, Shares and Debenture
As the market quotation given in the newspapers, there is no difficulty in ascertaining the price of these securities, where the price of a particular share suffers from wide fluctuation, the banker must fix its value slightly lower than the market value and also keep a higher margin.

Seasonal Commodities

Current market price or controlled prices may be accepted which one is lower. Higher margin is essential when market fluctuations are wide. Category includes Jute, Paddy, Wheat, Oil seeds etc. In Such cases, Finished Manufactured goods in factories. Valuation of such goods is usually undertaken on the basis of cost price of the goods, and the price at which the manufacturer sells his product to the wholesale less any discount made.

Finished goods with dealers

In such cases, wholesale market price or invoice price is accepted, whichever is lower. The invoices must be original and prepared by the manufacturer.


The verification and valuation of stock in process is rather difficult. It is usual to place restrictions on maximum borrowing against stock-in-process and to insist on higher margin thereon than that of raw materials or finished goods.

Immovable property

The valuation of immovable properties like land and house property would depend upon a number of factors including its location, tenure of land (whether freehold or leasehold), taxes and tenancy laws. The value for the purpose of a bank advance is not the present cost of construction of the building or the prevailing price of the land under it, but the value under a forced sale.


Valuation of metals is made on market price or control price, which may be lower. Imported metals have to be valued at landed cost or market value whichever is lower.

Imported Goods

The imported goods are valued at landed cost or market value whichever is lower. The landed cost includes invoice price of imported goods, import duty and sales tax (if any), freight, insurance, bank commission, clearing charges etc.

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