Bands

In many countries banks make significant use of collateral to ease the information problems associated with a lending decision. Among other things, collateral provides a means of recovering at least some of their investment should a venture fail.

In practice realising security in the event of default can be difficult and may attract adverse publicity. Banks are nevertheless careful to ensure that the realisable value of collateral is greater than or equal to the value of the loan.

This can present problems, particularly, in relation to business assets. In the event of default these commonly command a much lower price (at auction for example) than their value to the company as a going concern.

 

Thus the value of collateral required will often be much greater than the finance provided. One consequence is that companies purchasing plant and equipment add far more to their costs than they do to the value of business assets for collateral purposes.

The more rapidly companies expand the larger the gap between the two and the more likely their proprietors are to rely on personal assets (houses, shares etc) to secure additional debt.

Businesses often resist the idea of surrendering control over personal assets, particularly where this means limited liability status is eroded.

The tables show the pattern of collateral taking over the past eight years based on data provided by the UKs Forum of Private Business. Although the use of purely personal collateral has declined the use of personal and business collateral has increased.

The UKs Small Business Loan Guarantee scheme was introduced in 1981 in order, among other things, to address the collateral issue. Despite many changes in the schemes design it is primarily concerned with providing debt to businesses where all available security is already pledged. It does not tackle the question of personal as opposed to business asset collateral except in as much as some personal assets may be deemed unavailable if a partner or family not involved in the project has a claim on the assets.

The scheme is still valuable, though possibly underutilised because companies and some bankers are not aware of it.