Common Loan Types Offered by Banks and Their Securitization Requirements
When it comes to financial institutions like banks, there are a variety of loan types available to meet different needs and scenarios. Here, we will explore the three most common types of loans and the securitization requirements associated with them. This knowledge helps borrowers make informed decisions and align their financial needs with available loan products.
Types of Loans Offered by Banks
Cash Credit Facility
The first type of loan that typically does not require a repayment schedule and is focused solely on interest recovery is the cash credit facility. This loan is ideal for businesses that need short-term working capital to manage their cash flow without committing to a regular repayment plan. The primary advantage of this type of loan is its flexibility and the fact that repayment is based on the borrower's ability to generate cash and repay the interest.
Secured and Unsecured Loans
The second major category of bank loans is further divided into secured and unsecured loans.
Secured Loans
Secured loans involve the provision of collateral to secure the loan. Common examples of secured loans include:
Home Loan: This is one of the most common secured loans, where the borrower secures the loan with the mortgage of their home. The collateral here is the real estate. Car Loan: Another typical secured loan is the car loan, where the car itself is the collateral.The requirement of collateral in secured loans is straightforward. The primary security (car, home, etc.) is used to ensure repayment in case the borrower defaults on the loan. This makes secured loans relatively safer for the bank, although the borrower might have to pay both interest and a higher risk premium.
Unsecured Loans
Unsecured loans, on the other hand, do not require collateral. Instead, they rely on the borrower's creditworthiness and financial standing. Some common examples of unsecured loans include:
Personal Loan: This loan is typically unsecured, meaning the borrower can receive funds without offering any tangible security. Bank Overdraft: A flexible line of credit that can be used and repaid within a set period, without the need for collateral.While unsecured loans offer convenience and flexibility, they usually come with higher interest rates because the bank assumes a higher risk of default. The absence of collateral means the bank requires other means to recover its investment if the borrower fails to repay the loan.
Securitization Requirements and Discretionary Coverage
Despite the categorical division of loans into secured and unsecured, there are certain nuances regarding securitization requirements. For instance, if the primary security is not sufficient or accessing the primary security is challenging, collateral is often necessary. This is particularly relevant in cases where even a 100% security coverage is required for higher-risk advances.
Under loan policy documents, banks have discretion in granting loans based on security coverage. If the securities coverage (prime plus collateral) falls short of the required levels specified in the policy, applications must be escalated to higher administrative authorities, even if the application involves amounts within their discretionary powers.
Therefore, understanding the distinctions between secured and unsecured loans and the securitization requirements is crucial for borrowers to make informed decisions and select the most suitable loan product. Whether it is the flexibility of a cash credit facility or the security of a secured loan, the right choice depends on the borrower's financial situation, goals, and needs.