Collateralization and bank lending

Collateral is simply any asset that used to secure borrowing and takes the form of a property, cash or securities. The history of collaterals date back to primitive economies where one has to provide personal valuables for private borrowings. Over the years the issue of collateral have received prominent attention in credit risk management. Collateral management has become an integral part of credit administration.

The recent financial crisis and increasing default rates have made collaterals the first requirement for credit requests. This is no fault of the banks since experiences with unsecured facilities have been quiet frightening. In our part of the world, many do not attached seriousness to managing borrowed funds when it is unsecured and also when it is coming from state banks. The resultant effect is that more emphasis are now being placed on collaterals without looking into the merits of the request. Many good business deals are left unfinanced due to non availability of collaterals.

The hard hit in this arena are start-ups and young entrepreneurs who for lack of collaterals are not able to secure funding to support their initiatives. Many doable business plans do not see light of day due to the issue of non-existing collaterals. This is one reason why in Africa indigenous start-ups are not encouraging culminating in serious unemployment issues. Also micro businesses will have to starve for cash for a very long a time before they create assets for borrowing.

To circumvent the collateral obstacle, some SME and micro businesses deprive their businesses of the needed funds at the initial stages all to build assets in order to access borrowed funds for expansion in future. Good working capital are then tied up in assets which take a long time to complete and thereby stifling growth.

To overcome this, banks would have to review their credit culture to reflect the real needs of their segments. Financial institutions should be able to handle unsecured deals by looking at every request on its own merits than a wholesale neglect of such deals. Borrowers will have to be truthful and committed to the terms of the lending agreement. Proper addressing systems would aid KYCs and limit default. The growing credit referencing bureaus also would scare potential unsecured borrowers from defaulting. Personal guarantee from family and friends would be a good alternative to collaterals where it is non-existing in the cases of start-ups and micro-level businesses.