Banks: Collateral — based loans VS Securities — based lines of credit.

The most common obstacle faced by investors, entrepreneurs, and shareholders seeking credit from banks is their lack of collateral required by banks. Big financial institutions are the most compliant and traditionally a safe bet to apply for credit or liquidity. They always toe the line. When a loan "is approved and offered", the interest rates demanded are prohibitively high.

The failure of borrowers to meet the collateral requirements might be because they do not have any assets to pledge as collateral; it can also arise when borrowers have assets of value, but the bank has difficulty accepting them as collateral. Well, in both cases, banks have declined or rejected loan applications not accompanied by the offer of collateral acceptable to them. Approaches to ease the risk change from applicant to applicant, with variations from no collateral strategies to government interventions. 

In the last few decades, we have witnessed a change in the think tank of conventional banking practices to address the issues that contributed to market failure. The formal banking sector long held the prejudiced assumption that loan risk is inversely related to ownership. The obvious experience of the last 3 decades, however, became more clear. The lack of ownership does not mean that there is a high risk of default on loans. 

The inability to offer collateral that is acceptable to a bank as security for a loan may arise when the applicant of the loan has assets of value but is in a form that makes it difficult, if not possible, for a bank to accept it as collateral. This could be that the legal and regulatory environment is inadequate to enable the use of certain assets as collateral. 

The asset should meet 3 requirements to be acceptable collateral by a bank. 

1. It must be possible to create a security interest in the asset.

2. It must be possible to perfect the security interest created.

3. It must be possible to enforce the security interest created.

Problems of a lack of collateral and acute interest are inter-linked. If adequate collateral to cover the full extent of the loan is provided, they shift then much of the risk that the bank might otherwise have to carry to the borrower. Banks have a tendency to ease risk, by having the borrower hooked, line, and sinker. 

On the flip side, instead of providing collateral as security, why not use security to gain a line of credit or liquidity? 

Let's talk about risk and a solution.

Securities based lines of credit have adjustable interest rates, meaning payments commensurate with such changes.

• Typically, the interest rate charged adjusts over time based on an algorithm that uses a widely available benchmark. For example, the interest rate might be adjusted monthly on a fixed spread over 1 month LIBOR.

A drop in the market may cause partial repayments or additional collateral - or might cause the lender selling of holdings.

• Every security has a Loan to Value(LTV), which is an amount less than the market value. For example, $200 USD in stock may have an LTV of $65 USD. A drop in the value of the pledged collateral may warrant a "maintenance call" because the lendable value of the securities in the custodian account has fallen below the borrowed amount. For this reason, the borrower may be obligated to deposit more collateral, sell securities to raise cash, or pay down a portion of the outstanding balance.

Changes in the collateral account asset allocation of individual holdings could cause a reduced borrowing capacity.

• Some lenders allow borrowers to continue to trade in the collateral accounts, but this means changes in the account could lead to a lower lendable amount. For example, if the borrower shifted a portion of the pledged account from short-term Treasury bills to stocks, the lendable value of the collateral may decline. A lender also might not accept some types of securities for pledging. And the lendable amount could fall because of a change in the risk of a particular security, such as if a bond declines from investment-grade to a speculative credit rating or a stock’s price falls below a minimum threshold.