The wealth may sit in a private company, in a property jointly held with someone who will not sign, or in assets already charged to another lender.
Net Worth & Solvency Glossary · Lending
How Lenders Weigh Collateral Against Your Net Worth
noun · also "security"; "collateral value" is what the lender counts it at, not what it would fetch
Definition
Collateral is a specific asset a borrower gives a lender the right to sell if a loan is not repaid. It can be property, a deposit, shares, gold, stock or receivables.
Its "collateral value" for lending is what the lender counts it at after a discount, which is usually below its market value.
Six forms it can take
- Property
- A deposit
- Shares
- Gold
- Stock
- Receivables
Each is counted at its own discount, set by how quickly and reliably it could be turned into money.
What counts, and at what discount
01What lenders accept as collateral and at what haircut
What lenders accept, and the discount (the "haircut") they apply, follows how quickly and reliably the asset could be turned into money.
- 1A fixed deposit with the same bankUsually counted atclose to its face value, because the bank can simply appropriate it.
- 2GoldOften counted ata relatively high share of its value, because it is easy to value and sell.
- 3Listed sharesCounted witha wide haircut that moves with the market.
- 4Immovable propertyCounted ata substantial discount to market value, because selling it can take months.
- 5Stock and receivablesAccepted undera floating charge with regular reporting, because both change daily.
Collateral can also be given by a third party, as when a parent offers property for a child's loan. The haircut is the lender's estimate of what will be left after costs, delay and price movement. For most assets it is set by the lender's own policy and can change with market conditions.
Two phrases, one comparison
"Collateral amount""Collateral coverage ratio"
Both compare the lending value of the security with the loan it secures.
Two different questions
02Why a certified net worth figure is not the same as collateral cover
Net worth
What a person or business is worth after everything it owes.
Collateral cover
What this particular lender can take and sell.
The reverse also happens: one asset that is clean, unencumbered and easy to value.
Lenders look at both, because one measures what they could recover on default and the other measures overall financial depth. A net worth certificate for a bank loan shows the overall position and identifies which assets are free of charges. It does not replace the lender's own valuation of the collateral.
Establish what is chargeable before applying
- A jointly held asset needs the other holder's consent.
- An already mortgaged one needs the first lender's no-objection.
When there is no security
03Collateral-free limits, CGTMSE cover and Indian bank appraisal practice
Small borrowers in India can sometimes borrow without collateral. Under guarantee schemes such as the Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE), a bank lends against a guarantee from the scheme instead of against security. Smaller working capital limits are also sometimes sanctioned without collateral on the strength of the appraisal alone.
A guarantee scheme protects the lender, not the borrower. If the borrower defaults, recovery action still follows. No collateral does not mean no liability.
Where collateral is taken, the bank's appraisal note records
- What it is
- Its value
- Who valued it
- What charge was created
A certified net worth statement supports that note and is read for what is unencumbered.
Written by Subham Jhunjhunwala · Reviewed by CA Sundram Gupta
This entry describes Indian lending practice in general terms. Each lender's sanction terms govern the security it takes.
Need help with a certificate that uses collateral? See our Net Worth Certificate for Bank Loan.