Credit Risk Management

Credit Risk Management

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Product Structure: Key Concepts

Different aspects of asset product structures are security, basic terms and covenants & structures.

Security

Security refers to any additional comfort that the bank can draw from the company, which reduces its

loss in case of a default. The different factors considered by a bank with respect to security are:

1. Order of Importance for the Bank: The bank often takes multiple sources of security from

the client. The security can be classified into:

a) Primary Security: A primary security would usually be one that offers the highest degree

of comfort to the bank.

b) Secondary Security: Secondary security is usually additional security that the bank takes,

to mitigate risk even further.

2. Types of Security and Security Enforcement: According to this, security is classified as:

a) Tangible: Tangible security is that which has physical form. It can be possessed

and liquidated on default. Examples of tangible security are land and building,

machinery, stocks, book debts etc.

The different ways in which the bank’s rights over tangible security can be enforced are:

•

Mortgage: Mortgage is the legal structure used to define the rights of the lender

and borrower, whenever the asset is immovable property.

•

Hypothecation: ‘Hypothecating’ an asset gives the owner the right to use

it, and the lender the right to seize and sell it in case of default. Example all loans against vehicles and equipment – even computers.

•

Pledge: When a borrower ‘pledges’ an asset and borrows against it, she loses the

right to use it. This means usually that, the asset will lie with the lender.

•

Lien: ‘Lien’ refers to the right of the lender to retain any assets in its possession

for the purpose of security.

b) Intangible Security: Intangible security is usually secondary in nature. Often this is in

addition to a primary tangible security....