Last week on this topic we introduced the element of security which most people call collateral for loan.
Here we shall be focusing on how to prepare security for the purpose of a bank loan. But before we go straight into that lets recap on what security is all about. Ordinarily, every business loan should pay back if it is sound and healthy, it should stand by itself without a security support against default. The bank would want to ensure that the loan is ‘good’ or ‘secured’ in itself without security. This means the business the loan is supposed to finance should be able to repay according to plan.
However, the industry normal practice and in line with the prudential guidelines (regulatory requirements on banks from Central Bank of Nigeria) for every lending the bank still asks for suitable security from the borrower in case the loan should go bad, either, beyond all the business plan’s calculated circumstances. In this connection it is clear that security is required as a safety net, that is, something the bank falls back upon should the borrower find himself unable to repay the loan due to unforeseen circumstance. Invariably, for the bank the security is never seen as the source of repayment, but only as something to fall back on if the expected source of repayment fails; something like an insurance against unforeseen adverse developments not captured in the loan assessment.
Though many banks believe they can lend based principally on cash flow of the business, both prudence and regulatory requirements compel a healthy security to meet the requirements of a secured lending. Hence any prospective borrower should better prepare what is called, ‘bankable security’ if he wishes to get loan from any bank. And how do you do that?
To prepare a bankable security some key requirements are as follows:
VALUATION STANDARD: the security should be easy to value, and usually it is based on market price/ value.
LEGAL OWNERSHIP: Ownership should easily be established, the security should be easy for the bank to obtain a good legal title, ownership.
CASHABILITY: That is it should be readily marketable or realizable, that is to say the bank should be able to easily convert the security to cash.
DEPRECIATION/ APPRECIATION: It is expected that the security should appreciate in value over time, otherwise its depreciation would be discounted against the loan amount. In any case, most securities are booked on discounted value, implying that the bank recognizes the depreciation rather than appreciation. Next week we focus on how to prepare this standard security.