Types of Collaterals and Their Characteristics | PAPER II – PRINCIPLES & PRACTICES OF BANKING | MODULE B: FUNCTIONS OF BANKS
Types of Collaterals and Their Characteristics
Collateral refers to an asset that a borrower offers to a lender to secure a loan. If the borrower defaults, the lender can seize the collateral to recover the loan amount.
1. Types of Securities
- Tangible Securities: Physical assets such as land, buildings, goods, and vehicles.
- Intangible Securities: Non-physical rights like book debts, shares, debentures, and life insurance policies.
2. Secured vs. Unsecured Loans
Secured Loans: Backed by collateral. Example: Home loans, gold loans.
Unsecured Loans: Not backed by any asset. Based on creditworthiness. Example: Personal loans, credit card debt.
3. Effectiveness of Securities
- Marketability: Should be easily saleable.
- Legal enforceability: Should be supported by valid legal documents.
- Value stability: Value should not fluctuate drastically.
4. Specific Types of Collaterals
Land and Buildings
Common collateral for term loans. Requires proper title and valuation.
Example: Mr. A pledges a residential property worth ₹50 lakhs for a loan of ₹30 lakhs.
Goods
Includes raw materials, finished goods. Risk of perishability must be considered.
Documents of Title to Goods
Includes bills of lading, warehouse receipts. Transferable documents that prove ownership.
Advances against Life Insurance Policies
Only policies with surrender value are accepted. Assignment of policy is required.
Advance Against Shares
Loan against dematerialized shares. Prone to market volatility.
Illustration: If 1,000 shares of ₹100 each (market value ₹120) are pledged, and margin is 40%, eligible loan = 60% × ₹1,20,000 = ₹72,000.
Advance Against Debentures
Accepted if listed and actively traded. Interest-bearing instruments.
Loan against Book Debts
Firms can get advances against receivables. Requires ledger scrutiny.
Mathematical Example: If book debts = ₹10,00,000 and margin = 25%, loan = 75% × ₹10,00,000 = ₹7,50,000.
Loan against Term Deposits
Fully secured loans with low risk. Example: Loan up to 90% of FD value.
Loan against Gold Ornaments
Popular among individuals. Loan amount depends on purity and market price of gold.
Illustration: Gold weight: 50g, purity: 22K, rate: ₹5,500/gm, margin: 25% → Eligible loan = 75% × (50 × 5,500) = ₹2,06,250.
Supply Bills
Used in government contracts. Must be supported by performance certificate.
Vehicle Finance
Vehicle serves as the security. Registration and insurance are necessary.
Multiple Choice Questions (MCQs)
- Which of the following is an intangible collateral?
a) Land
b) Vehicle
c) Shares
d) Gold
Answer: c - What percentage of book debts is usually considered for loan after 25% margin?
a) 100%
b) 25%
c) 50%
d) 75%
Answer: d - Which loan does not require any collateral?
a) Home Loan
b) Education Loan
c) Personal Loan
d) Vehicle Loan
Answer: c - The risk of value fluctuation is highest in loans against:
a) Life Insurance Policies
b) Shares
c) Fixed Deposits
d) Book Debts
Answer: b - What document is required to transfer ownership of goods while in transit?
a) Insurance Policy
b) Bill of Lading
c) Sale Deed
d) Share Certificate
Answer: b - A loan against ₹1,00,000 FD at 90% advance will give how much loan?
a) ₹1,00,000
b) ₹90,000
c) ₹80,000
d) ₹70,000
Answer: b - Vehicle loans require:
a) Insurance Certificate
b) Land Valuation Report
c) Book Debts Ledger
d) Demat Account
Answer: a - Loan against gold ornaments is influenced by:
a) Market Rate and Weight
b) Debenture Interest
c) Surrender Value
d) Vehicle Registration
Answer: a - Margin is defined as:
a) Total loan given
b) Part retained by bank
c) Interest charged
d) Fee on loan
Answer: b - Debentures are:
a) Equity instruments
b) Collateral documents
c) Fixed-income securities
d) Term Deposits
Answer: c
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