Question

1. One of the tools that is used to evaluate a potential borrower is collateral. What is collateral? Why can some assets not function as collateral?
2. One piece of evidence of how well a bank is managing its risks is the bank’s performance. What are two ways that a bank examiner can look to see how a bank is performing?

Answer 1

1. Collateral is a set that has been kept as a security for taking a loan with the lender by the borrower and the risk for issuance of the loan to the borrower by the lender will be reduced by having a collateral for that loan because in case of default by the borrower the lender will be entitled to seize the Asset which has been put as the collateral and then the lender will be selling that asset and recovering the money.

All assets are not used as collateral and hard assets which have low liquidity and they cannot be quickly recovered from the market are less preferred by the lender as the collateral, and those assets which value will diminish with time are also not preferred by the lender because that will not be helping them to recover their loan.

2. Two ways in which the bank examiners can look to see how the bank is performing as follows-

A. Non performing Assets of the bank will be reflecting the quality of the books of accounts of banking and if the non performing assets are higher than there is a low quality of the Assets on the banks books of accounts and vice versa.

B. Capital adequacy ratio is another factor which will be looked by the analyst in order to determine the performance of the bank and if the capital adequacy ratio is adequate enough then the bank is solvent enough and able to deal with economic shocks.