Collateral loans are also referred as secured loans because the loan requested to the lender will be secured by an asset that the customer owns. The financial institutions operationalized it placing a lien on the property, and holding the deed or title of the property until the loan is repaid in full. Therefore, if the borrower decides to sell the asset before the loan is paid, then the financial institution as a lien holder gets paid before the owner of the asset. A lien is a formal of legal claim to secure the payment of a debt or other obligations. Liens can be consensual and non-consensual. It is a consensual lien when a client requests a loan from a financial institution. The lender uses its own valuation criteria to estimate the market value of the asset being used as collateral, and usually the market value estimated by the lender is lower than the value that could be obtained if the asset is sold at the moment of getting the loan and lower than the amount of money paid to obtain the asset. In a secured loan, the lender will use the asset to make sure that they will not lose the money that they are lending in case the customer is unable to pay the loan back. If the customer is unable to pay the loan back, then lender can use the asset to recover their money. Even after the lender sells the asset to recover its money, it is possible that the client is still responsible for the full amount of the loan. This is common practice in the banking industry, and bank use this policy to minimize the risk that maybe taking when lending money. Depending on the financial institution, the types of assets accepted as collateral may differ, but in general terms, the following assets are usually accepted as collateral: real estate, automobiles, saving accounts, certificate of deposits (CDs), stocks, bonds, annuities, valuables and collectibles. In contrast to collateral loans or secured loans, unsecured loans also exist. In the case of a customer that cannot pay back an unsecured loan and given the fact that the financial institution does not have any asset as collateral, then financial institution can take legal actions against the customer or report the customer to a credit bureau as a non-paying client and therefore the credit score of the client will be reduced and as consequence other loans requested by the same client may be denied by other financial institutions or the client may need to face stricter requirements in order to reduce the risk of the other financial institutions. In the case of some financial institutions, it may be easier to get a secured loan rather than an unsecured loan, and usually in unsecured loans the interest rate is higher, the repayment period is shorter, and the amounts are smaller in comparison to secured loans because financial institutions are taking more risks. Some examples of secured loans are as follows: home equity loans, home equity lines of credit, home or business improvement loans, vehicle loans (for personal use or business use), and boat loans. Some examples of unsecured loans are as follows: credit card lines of credit, personal lines of credit, business lines of credit, and student loans.
Published in Chapter:
Accounting Standards in the U.S. Banking Industry during the Financial Crisis
Copyright: © 2016
|Pages: 14
DOI: 10.4018/978-1-4666-9484-2.ch007
Abstract
The global financial crisis became evident when U.S. house prices fell related to the subprime mortgage-backed securities crisis. In the years preceding the financial crisis of 2008, there was a real estate bubble that pushed U.S. real estate prices to high levels, and at the same time financial institutions were holding large amounts of subprime mortgage-backed securities. Fair value accounting (FVA) and its link to the recent global financial crisis has been a focus of discussion and interest for accounting researchers, financial analyst and policy makers. During the financial crisis, a large percentage of assets in the balance sheets of banks were calculated using fair value. The main concern was that those assets were calculated using mark-to-model accounting (Goh, Ng, & Yong 2009). There are still contradictory conclusions on the implications of fair value accounting and the global financial crisis (Laux & Leuz, 2009). The main objective of this chapter is to provide a better understanding of the global financial crisis and of the mechanisms of fair value accounting.