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In lending agreements, collateral is a borrower's pledge of specific
property Property is a system of rights that gives people legal control of valuable things, and also refers to the valuable things themselves. Depending on the nature of the property, an owner of property may have the right to consume, alter, share, r ...
to a
lender A creditor or lender is a party (e.g., person, organization, company, or government) that has a claim on the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided some property ...
, to secure repayment of a loan. The collateral serves as a lender's protection against a borrower's
default Default may refer to: Law * Default (law), the failure to do something required by law ** Default (finance), failure to satisfy the terms of a loan obligation or failure to pay back a loan ** Default judgment, a binding judgment in favor of ei ...
and so can be used to offset the loan if the borrower fails to pay the principal and
interest In finance and economics, interest is payment from a borrower or deposit-taking financial institution to a lender or depositor of an amount above repayment of the principal sum (that is, the amount borrowed), at a particular rate. It is distin ...
satisfactorily under the terms of the lending agreement. The protection that collateral provides generally allows lenders to offer a lower
interest rate An interest rate is the amount of interest due per period, as a proportion of the amount lent, deposited, or borrowed (called the principal sum). The total interest on an amount lent or borrowed depends on the principal sum, the interest rate, th ...
on loans that have collateral. The reduction in interest rate can be up to several percentage points, depending on the type and value of the collateral. For example, the
Annual Percentage Rate The term annual percentage rate of charge (APR), corresponding sometimes to a nominal APR and sometimes to an effective APR (EAPR), is the interest rate for a whole year (annualized), rather than just a monthly fee/rate, as applied on a loan, mort ...
(APR) on an
unsecured loan In finance, unsecured debt refers to any type of debt or general obligation that is not protected by a guarantor, or collateralized by a lien on specific assets of the borrower in the case of a bankruptcy or liquidation or failure to meet the t ...
is often much higher than on a
secured loan A secured loan is a loan in which the borrower pledges some asset (e.g. a car or property) as collateral for the loan, which then becomes a secured debt owed to the creditor who gives the loan. The debt is thus secured against the collateral, a ...
or
logbook loan A logbook loan is a form of secured lending in the United Kingdom and is the most common modern example of a security bill of sale. Borrowers transfer ownership of their car, van or motorcycle to the logbook lender as security for a loan. While maki ...
. If a borrower defaults on a loan (due to
insolvency In accounting, insolvency is the state of being unable to pay the debts, by a person or company (debtor), at maturity; those in a state of insolvency are said to be ''insolvent''. There are two forms: cash-flow insolvency and balance-sheet in ...
or another event), that borrower loses the property pledged as collateral, with the lender then becoming the owner of the property. In a typical
mortgage loan A mortgage loan or simply mortgage (), in civil law jurisdicions known also as a hypothec loan, is a loan used either by purchasers of real property to raise funds to buy real estate, or by existing property owners to raise funds for any pu ...
transaction, for instance, the
real estate Real estate is property consisting of land and the buildings on it, along with its natural resources such as crops, minerals or water; immovable property of this nature; an interest vested in this (also) an item of real property, (more genera ...
being acquired with the help of the loan serves as collateral. If the buyer fails to repay the loan according to the mortgage agreement, the lender can use the
legal process Legal process (sometimes simply process) is any formal notice or writ by a court obtaining jurisdiction over a person or property. Common forms of process include a summons, subpoena, mandate, and warrant. Process normally takes effect by ...
of
foreclosure Foreclosure is a legal process in which a lender attempts to recover the balance of a loan from a borrower who has stopped making payments to the lender by forcing the sale of the asset used as the collateral for the loan. Formally, a mort ...
to obtain ownership of the real estate. If a
second mortgage Second mortgages, commonly referred to as junior liens, are loans secured by a property in addition to the primary mortgage. Depending on the time at which the second mortgage is originated, the loan can be structured as either a standalone secon ...
is involved the primary mortgage loan is repaid first with the remaining funds used to satisfy the second mortgage. A
pawnbroker A pawnbroker is an individual or business (pawnshop or pawn shop) that offers secured loans to people, with items of personal property used as collateral. The items having been ''pawned'' to the broker are themselves called ''pledges'' or ...
is a common example of a business that may accept a wide range of items as collateral. The type of the collateral may be restricted based on the type of the loan (as is the case with auto loans and mortgages); it also can be flexible, such as in the case of collateral-based personal loans.


Concept

Collateral, especially within
banking A bank is a financial institution that accepts deposits from the public and creates a demand deposit while simultaneously making loans. Lending activities can be directly performed by the bank or indirectly through capital markets. Because ...
, traditionally refers to secured lending (also known as
asset-based lending Asset-based lending is any kind of lending secured by an asset. This means, if the loan is not repaid, the asset is taken. In this sense, a mortgage is an example of an asset-based loan. More commonly however, the phrase is used to describe lending ...
). More-complex collateralization arrangements may be used to secure
trade Trade involves the transfer of goods and services from one person or entity to another, often in exchange for money. Economists refer to a system or network that allows trade as a market. An early form of trade, barter, saw the direct excha ...
transactions (also known as ''capital market collateralization''). The former often presents unilateral obligations secured in the form of
property Property is a system of rights that gives people legal control of valuable things, and also refers to the valuable things themselves. Depending on the nature of the property, an owner of property may have the right to consume, alter, share, r ...
,
surety In finance, a surety , surety bond or guaranty involves a promise by one party to assume responsibility for the debt obligation of a borrower if that borrower defaults. Usually, a surety bond or surety is a promise by a surety or guarantor to pa ...
,
guarantee Guarantee is a legal term more comprehensive and of higher import than either warranty or "security". It most commonly designates a private transaction by means of which one person, to obtain some trust, confidence or credit for another, engages ...
or other collateral (originally denoted by the term ''security''), whereas the latter often presents bilateral obligations secured by more-liquid assets (such as
cash In economics, cash is money in the physical form of currency, such as banknotes and coins. In bookkeeping and financial accounting, cash is current assets comprising currency or currency equivalents that can be accessed immediately or near-imm ...
). Collateralization of assets gives lenders a sufficient level of reassurance against default risk. It also help some borrowers to obtain loan if they have poor credit histories. Collateralized loans generally have substantially lower interest rate than unsecured loans.


Marketable collateral

Marketable collateral Marketable collateral is the exchange of financial assets, such as stocks and bonds, for a loan between a financial institution and borrower. To be deemed marketable collateral, assets must be capable of being sold under normal market conditions w ...
is the exchange of
financial assets A financial asset is a non-physical asset whose value is derived from a contractual claim, such as bank deposits, bonds, and participations in companies' share capital. Financial assets are usually more liquid than other tangible assets, such as ...
, such as stocks and bonds, for a loan between a financial institution and borrower. To be deemed marketable, assets must be capable of being sold under normal market conditions with reasonable promptness at current
fair market value The fair market value of property is the price at which it would change hands between a willing and informed buyer and seller. The term is used throughout the Internal Revenue Code, as well as in bankruptcy laws, in many state laws, and by several ...
. For
national banks In banking, the term national bank carries several meanings: * a bank owned by the state * an ordinary private bank which operates nationally (as opposed to regionally or locally or even internationally) * in the United States, an ordinary p ...
to accept a borrower's loan proposal, collateral must be equal to or greater than 100% of the loan or credit extension amount. In the United States of America, the bank's total outstanding loans and credit extensions to one borrower may not exceed 15 percent of the bank's capital and surplus, plus an additional 10 percent of the bank's capital and surplus. Reduction of collateral value is the primary risk when securing loans with marketable collateral. Financial institutions closely monitor the
market value Market value or OMV (Open Market Valuation) is the price at which an asset would trade in a competitive auction setting. Market value is often used interchangeably with ''open market value'', ''fair value'' or ''fair market value'', although the ...
of any financial assets held as collateral and take appropriate action if the value subsequently declines below the predetermined maximum loan-to-value ratio. The permitted actions are generally specified in a loan agreement or margin agreement. Tokenization of securities like company shares, pharmaceutical & defence project patents and mining licenses is an emerging novel concept of dynamic investment despite still being considered and classified as relatively experimental. Spektral Investment Bank is currently the only example of above mentioned novel complete tokenization concept via establishment of 800.000.000.00 EU worth in-kind collateral based capital composed of exclusive pharmaceutical & bioceucal patent rights and reserve volume approved mining licenses.


Examples of collateral

Intellectual property Intellectual property (IP) is a category of property that includes intangible creations of the human intellect. There are many types of intellectual property, and some countries recognize more than others. The best-known types are patents, c ...
such as
copyrights A copyright is a type of intellectual property that gives its owner the exclusive right to copy, distribute, adapt, display, and perform a creative work, usually for a limited time. The creative work may be in a literary, artistic, education ...
,
patents A patent is a type of intellectual property that gives its owner the legal right to exclude others from making, using, or selling an invention for a limited period of time in exchange for publishing an enabling disclosure of the invention."A p ...
, and
trademarks A trademark (also written trade mark or trade-mark) is a type of intellectual property consisting of a recognizable sign, design, or expression that identifies products or services from a particular source and distinguishes them from others. ...
, as well as royalty streams from licensing revenue, are increasingly being used as collateral. The use of IP as collateral in IP-backed finance transactions is the subject of a report series at the
World Intellectual Property Organization The World Intellectual Property Organization (WIPO; french: link=no, Organisation mondiale de la propriété intellectuelle (OMPI)) is one of the 15 specialized agencies of the United Nations (UN). Pursuant to the 1967 Convention Establishin ...
.


See also

*
Auto-collateralisation Auto-collateralisation is a credit operation that is or can be triggered, when a buyer does not have sufficient funds to settle a securities transaction, in order to improve its cash position for the next settlement cycle. The credit provided can be ...
*
Consignment Consignment involves selling one's personal goods (clothing, furniture, etc.) through a third-party vendor such as a consignment store or online thrift store. The owner of the goods pays the third-party a portion of the sale for facilitating t ...
*
Credit Support Annex A Credit Support Annex, or CSA, is a legal document which regulates credit support ( collateral) for derivative transactions. It is one of the four parts that make up an ISDA Master Agreement but is not mandatory. It is possible to have an ISDA ag ...
*
Cross-collateralization Cross-collateralization is a term used when the collateral for one loan is also used as collateral for another loan. If a person has borrowed from the same bank a home loan secured by the house, a car loan secured by the car, and so on, these asse ...
*
Hypothecation Hypothec (; german: Hypothek, french: hypothèque, pl, hipoteka, from Lat. ''hypotheca'', from Gk. : hypothēkē), sometimes tacit hypothec, is a term used in civil law systems (e.g. law of entire Continental Europe except Gibraltar) or mixed ...
*
Intellectual asset finance An intellectual is a person who engages in critical thinking, research, and reflection about the reality of society, and who proposes solutions for the normative problems of society. Coming from the world of culture, either as a creator or ...
*
Security deposit A security deposit is a sum of money held in trust either as an initial part-payment in a purchasing process (often used to prevent the seller's selling an item to someone else during an agreed period of time while the buyer verifies the suitability ...
*
Security interest In finance, a security interest is a legal right granted by a debtor to a creditor over the debtor's property (usually referred to as the '' collateral'') which enables the creditor to have recourse to the property if the debtor defaults in mak ...
*
Shadow banking system The shadow banking system is a term for the collection of non-bank financial intermediaries (NBFIs) that provide services similar to traditional commercial banks but outside normal banking regulations. Examples of NBFIs include hedge funds, in ...
* Intangible asset finance


References

{{Authority control Business terms Credit Liability (financial accounting) Loans