Importance of Security For Bank Loans

Banks lend cash to the public, for varied purposes, like purchase or construction of a home, for purchase of consumer merchandise like a TV, Music System, etc. Banks also finance businesses, both producing and services. Other than all these, they also extend personal loans to members of the public.

This service provided by Banks, specifically, financing, or more commonly known as lending, is fraught with several inherent risks. Loan defaults may occur for more than one reason, together with reasons beyond the management of the borrowers, like for instance, in case of floods or a Tsunami that may wipe out the assets of the borrower, except for rendering him incapable of restarting his business immediately. The most serious risk to Banks in the lending process is the chance of non payment of the loan by the borrower. Imagine a state of affairs where none of the borrowers of Banks repay the loans availed of by them! This might cause a collapse of the Banking business!
The current spate of Bank failures in America and elsewhere is, in good half, on account of borrower defaults. Whereas, in an ideal situation, each borrower repays the loan availed by him, from the Bank, in real life, this does not happen. Several a time, borrowers, each individuals and institutions, fail to stay up their compensation commitments, affecting the well being of the lending Bank. Sometimes, there are even real reasons why borrowers become defaulters.
 
This being the case, Banks invariably, have in place, norms and procedures that they follow before parting with money to a borrower. Banks examine and evaluate credit proposals, on their viability and feasibility, each technically and financially, before taking a call to grant a loan. Each loan is appraised individually to determine the soundness of the proposal and only then a decision to grant a loan is taken. Obtaining of security for loans is one of the safeguards that Banks exercise to secure their interests.Among the varied precautions observed by the Banks to safeguard their interests within the lending process, is that the obtention of security for the loan extended by them.
 
Definition of Security: Security, in relation to a loan extended by a Bank to a borrower, suggests that, an asset, of any kind or description, having bound qualities, among them, financial price, that may be possessed by the Bank, in the event of default, and applied toward reimbursement of the loan.
 
Having extended the loan to the borrower, Bank would naturally like to ensure that the loan is repaid with the interest thereon. That's, Bank would need to secure the loan. This can be done by way of making a charge against the asset financed by the Bank. The type of charge created depends on the character of loan, and the security.
 
Primarily, there are 2 types of securities on the market to Banks to secure a loan. They're Primary security and Collateral security.
Primary Security refers to the asset directly created out of Bank finance. For example, where a Bank finances the purchase of a home, the home is the first security. In the identical means, a car purchased with the assistance of a Bank loan, is the first security for that loan. Bank creates a charge against this primary security, to secure its loan. This charge offers the Bank the legal authority to dispose off the asset, and apply the proceeds therefrom, to the loan amount in default.
 
Collateral Security refers to sure additional security obtained by the Bank to secure the loan.   For instance, say, a Bank has financed the acquisition of machinery by a Pharmaceutical manufacturing company. This machinery would be the primary security for this loan. Additionally, the Bank may obtain collateral security in the shape of the factory building owned by the company, as additional security. This will guard Bank's  interests within the event of the primary security not having sufficient worth to liquidate the loan.   Sometimes, on account of adverse market conditions, the value of the primary security gets eroded, exposing the Bank to a higher risk than it had originally bargained for.
 
Additionally, loans can conjointly be secured with the assistance of private security of the borrower. Getting personal security of the borrower permits the Bank to proceed against the borrower and his personal estate, to recover the loan.
 
Once a Bank secures its loans with proper security, the likelihood of default is reduced, and even in case of default, the number of loss it is doubtless to suffer is lesser than otherwise.

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