Collateral

Understand the idea

The agreement specifies eligible assets, valuation, custody and enforcement rights. A lender may lend less than the collateral's market value to allow for price falls and selling costs. Some arrangements revalue collateral frequently and require extra assets when its value drops. Legal enforceability and liquidity matter: an asset cannot provide full protection simply because an optimistic valuation has been recorded.

An example

Suppose a business borrows J$8 million against property valued at J$10 million. If it defaults and the lender recovers only J$7 million after sale costs, the collateral leaves a J$1 million shortfall before other recoveries. If the property instead sells for more than the secured obligation, the surplus is handled under the applicable agreement and law; it is not automatically the lender's profit.

Sources

• BIS: Credit-risk mitigation and collateral

In the news

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