By Emeka Anaeto

LAST week we focused this series on Guarantees or Surety where a third party signs up to repay the loan in the event that the borrower fails to or couldn’t repay. I can always go online to read up the eight previous editions. In this edition we move on to use of cash as security for a business loan.

Security for a business loan

Most banks treat cash as the best type of security for loans probably because there are no obvious problems of valuation, depreciation and realization in case of default.

There are two ways by which cash could be held as security; 1.) Where the customer uses the credit balances in an account as security for a short term credit facility (an overdraft), and 2.) When cash is deposited by a third party, e.g. guarantor, expressly to secure the debt of the customer, e.g. the principal debtor.

Note that when cash is used as security the borrower would need to maintain two or more accounts (whether current, savings or deposit or any other account).  One of them will have to be in credit usually savings or deposit account while the other will be in debit which means it is the latter that incurred the loan liability. The former is then used to secure or as security for the latter. Needless to say that the amount in credit in the former account should always be in excess of the amount outstanding in debit in the latter account.

In cash security, the borrower would enter into a written agreement with the bank stating the terms of the transactions.  The written agreement can also be referred to as a Letter of Set-off.  In other words a Letter of Set-off is a written agreement through which a bank obtains a borrower’s consent to seize his or her deposit(s) for non-payment of a loan or other obligations, or to offset credit balance of one account with the debit balance of another. It is also called lien letter. In the event of the borrowing account (the latter account) falling short of required inflow within the period set out in the Letter of Set-Off the bank would automatically debit the former account with the required balance amount and credit itself as loan repayment transaction.