Question

22.1

Is collateral required for all credit facilities? Please explain.

Answer 1

No, collateral is required only for long term credit needs, which having huge amount money as loan.

Collateral

• The term collateral refers to the security deposited by the third party to secure advance for the borrower.
• It also refers to any type of security on which the creditor has a personal rights of action on the debtor in respect of the advance.
• In lending agreements, collateral is a borrower's pledge of specific property to a lender, to secure repayment of a loan.
• If a borrower does default on a loan (due to insolvency or other event), that borrower forfeits (gives up) the property pledged as collateral, with the lender then becoming the owner of the collateral. In a typical mortgage loan transaction, for instance, the real estate being acquired with the help of the loan serves as collateral. Should the buyer fail to pay the loan under the mortgage loan agreement, the ownership of the real estate is transferred to the bank.

Credit facility

It constitutes the second function of a commercial bank. Out of the
deposits received, a bank lends money to the traders and businessmen.Credit facility can be classified as;

• Short term
• Medium term
• Long term

Money is lent usually for short periods only. A commercial bank lends in any one of the following ways:
(a) Loans: In case of loan, the banker advances a lump sum for a certain period at an agreed
rate of interest. The amount granted as loan is first credited in the borrower’s account. He can
withdraw this amount at any time. The interest is charged for the full amount sanctioned
whether he withdraws the money from this account or not. Loan is granted with or without
security.
(b) Cash credit: Cash credit is an arrangement by which the customer is allowed to borrow
money up to a certain limit. The customer can withdraw the amount as and when required.
Interest is charged only for the amount withdrawn and not for the whole amount as in the
case of loan.
(c) Overdraft: overdraft is an arrangement between a banker and his customer by which the
customer is allowed to withdraw over and above the credit balance in the current account up
to an agreed limit. The interest is charged only for the amount sanctioned. This is a temporary
financial assistance. It is given either on personal security or on the security of assets.
(d) Discounting of bills: Bank grants advances to their customers by discounting bills of
exchange or pronote. In other words, money is lent on the security of bill of exchange or
pronote. The amount after deducting the interest (discount) from the amount of the bill is
credited in the account of the customer. Thus in this form of lending, the interest is received
by the banker in advance. Bank, sometimes, purchases the bills instead of discounting them.