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 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 disti ...

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 ...

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 ...

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 p ...

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 ...

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 mor ...

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 seco ...

is involved the primary mortgage loan is repaid first with the remaining funds used to satisfy the second mortgage. A pawnbroker 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, 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 exch ...

transactions (also known as ''capital market collateralization''). The former often presents unilateral obligations secured in the form of

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-imme ...

securities A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In some countries and languages people commonly use the term "security" to refer to any fo ...

, often known as

margin Margin may refer to: Physical or graphical edges *Margin (typography), the white space that surrounds the content of a page *Continental margin, the zone of the ocean floor that separates the thin oceanic crust from thick continental crust * Leaf ...

. 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 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, 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 other ...

, 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 ...

References

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

Concept

Marketable collateral

Examples of Collateral

See also

References