Taking risks and adapting to various are just some of the very tough challenges changes in the global financial industry. For instance, giving and managing collateral could be a good solution to these. But what exactly is collateral and how do businesses and companies manage them in order to help them?
Basically, collateral management is simply offering financial products to cover the exposure of the asset. If that still made no sense, you can find more answers below.
What is collateral?
By definition, collateral refers to the property that a borrower gives the lender in order to protect the loan. Basically, collateral can be in a form of corporate debt, bonds, money market securities, or deposits.
- Among businesses, the use of collateral (in exchange for loans) in lending systems has long been practiced. Back in the 1980s, economists and business analysts suggested the use of collateral in order to avoid credit exposure. While such move was of great use, during that time, the calculations of credits were manually computed on spreadsheets and no legal basis existed. As a result, the scope of collateral management was very limited.
- Ten years after, the use of taking collateral against derivative exposures became even more popular. The advancements of technology as well as the growing number of institutions looking for credit have made a big impact on the improvement of collateral management. Thus, in 1994, collateralization became formally standardized.
Functions of collateral management
Basically, collateral management is done by giving and confirming collateral during financial transactions. The collateral can offer a sort of security because if ever the borrower failed to pay the loan, the lender can just claim the collateral to retrieve the loss. This right to confiscate is called a lien. Because of that, loans that are attached with collaterals have lesser interest rates as compared to loans with no secured collateral.
The following are some of its other functions:
1. Enhancement of credits
The management of collateral is primarily done in order to give the borrower more choices in borrowing rates. The idea behind this is very simple: to enhance the security of credits that are being passed from the borrower to the lender.
2. Assessment of credits
Aside from credit enhancement, collateral management also serves to assess credits in many financial operations and business situations. By assessing credits, asset liability is ensured and at the same time, the lender’s (bank) resources are maximized for lending additional assets in the future.
3. Operational risk management
One of the most important goals of collateral management is to manage the risks in businesses and as much as possible, make sure that they do not affect the involved parties. This is very crucial because a large business also means great responsibilities are put on the borrowers. As alluded to earlier, collateral management can help secure the lender in the event that parties failed to pay.
To date, collateral management is little by little becoming an important function in many financial investments and transactions. So if you are planning to setting up your own business or offering some loans, wouldn’t it be good to think about collateral management? What do you think?