15-10-22-CER-Lesson 03

Lesson 03
Types of credit facilities and collaterals
By Nadun Sooriyaarachchi
(ACMA,CGMA,FICM(SL),AIB(SL),BA(Hons) IBF(2nd class)-
UWS(UK),Cert in counselling psychology(University of
Peradeniya)
This session will cover
• Types of credit facilities

• Types of collaterals and features of a good collateral
By Nadun Sooriyaarachchi(ACMA,CGMA,FICM(SL),AIB(SL),BA(Hons) IBF(2nd

2
class)-UWS(UK),Cert in counselling psychology(University of Peradeniya)
There are many credit facilities granted by the financial institutions for different purposes. Those facilities
can be broadly categorized in to two main Types.
Funded credit facilities Non-Funded Credit facilities

• A cash out flow from the lender to the borrower. • No cash out flow from the lender to the borrower.
• An Interest cost is incurred by the borrower. • Lender will issue a guarantee certificate on behalf
• Repayments are possible in instalments. of the client.
• Fee based an income is possible for the lender.
• No repayment is required for the borrower.
By Nadun
Sooriyaarachchi(ACMA,CGMA,FICM(SL),AIB(SL),BA(Hons) IBF(2nd
class)-UWS(UK),Cert in counselling psychology(University of 3
Peradeniya)
1. Overdraft facilities
2. Loans
3. Trust receipts Loans
4. Pledge loans
5. Project loans
6. Margin Trading
7. Leasing
8. Hire Purchases
9. Pawning/Gold loans
By Nadun
Peradeniya)
This facility is available only from the commercial banks.
Facility is available only for the current account holders.

Bank will honor cheques exceeding the current account balance.
Interest charge will be calculated for the period. This is a main source of income to the commercial banks.
This is a kind of revolving facility.
Temporary overdrafts (TOD) Permanent overdrafts (POD)

• This is kind of an unplanned credit facility. • This is a Pre-approved credit facility.
• Current account holder can withdraw cash even if • Collateral will be offered by the client for this
the account balance is zero. facility.
• This Facility will consider to a customer depending • Other features will remain as temporary overdraft.
on the relationship with the bank. • Interest rate is lower than the rate applicable for a
• Interest rate is higher than a pre-approved facility. temporary overdraft.
• High risk is for the bank.
• No collaterals are offered.
By Nadun
Peradeniya)
Short term loans Medium Term loans Long Term Loans
• Repayment period is limited • Loan repayment period is 1 to • Loan repayment period is

to 1 year. 5 years. more than 5 years.
• Used for working capital • Securities/Collaterals are • Granted for Development
requirements required. purposes and investment
• Granted for consumption and purposes.
• Advantages to borrower Investment purposes. • Credit granting process is
• Less interest amount will pay • Loan granting process is little longer than medium term loan
to the lender longer than short term loan granting process.
• No significant collaterals are granting process. • Advanced techniques are
required used, such as investment
• Process is easy and short appraisals (NPV, PV, IRR,
By Nadun Cash flow forecasting,
class)-UWS(UK),Cert in counselling psychology(University of
financial statement analysis 6
Peradeniya) and financial ratio analysis).
Project finance is the funding (financing) of long-term infrastructure, industrial projects, and public services using a
non-recourse or limited recourse financial structure. The debt and equity used to finance the project are paid back
from the cash flow generated by the project.
Nature of the facility Evaluation criteria

• If Entrepreneur/Investor needs to undertake a • Forecasted cash flows are taken in to
project, bank or financial institution will fund the consideration when evaluating the project loan.
project based on the viability of the project. • Other possible techniques to evaluate a project
• Usually a long term loan facility. loan are net Present value calculations, payback
• Bank or the financial institution encourages lender period, accounting rate of return, internal rate of
to bring up an equity. return (IRR).
• Environmental and social impacts of the project
should be analyzed
By Nadun
Peradeniya)
Leases are legal and binding contracts that set forth the terms of rental agreements in real estate and real and personal property. These contracts
stipulate the duties of each party to effect and maintain the agreement and are enforceable by each. For example, a residential property lease includes
the address of the property, landlord responsibilities, and tenant responsibilities, such as the rent amount, a required security deposit, rent due date,
consequences for breach of contract, the duration of the lease, pet policies, and any other essential information
Finance leases Operating Lease

• Leases are granted under Finance lease act No.56 of 2000 and leasing • Operating leases are used to use assets for temporary
act No.24 of 2005.
period.
• Rights of the lessee and lessor are mentioned in the act. Lessee is the
client (Person who borrower money) and lessor is the lender. • Lessee will pay a rent to lessor for the usage of the asset.
• Under a lease the lessor is providing capital for buy an asset with an • Legal ownership is remaining with lessor.
agreement of repaying the amount as installments.
• Installment will determine based on the interest and capital component. • Maintenance of the asset is done by the lessor.
• After the final installment received to the lessor from the lessee, the • No legal ownership transferred to lessee at the end of the
ownership of the asset will be transferred to lessee from the lessor.
period.
• Maintenance of the asset is done by the lessee according to the
agreement. • Asset will be replaced at the expiry of the lease
• Absolute ownership of the asset is remaining with lessor and current agreement.
owner of the asset will be the lessee.
By Nadun
Peradeniya)
These type of facilities are not involved of cash out flows to the lender, but those are services such as guarantee
letters.
Letter of Credit Letter of guarantee

• Letter of credit is involved in international trade. • This type of letter gives a guarantee to a 3rd party
person, on a payment on goods received.
• Importer, exporter, opening /Issuing bank and advising
bank are the parties to a letter of credit.
• Fee and service charges are involved in letter of credit. • Parties to Letter of Guarantee
• Letter of credit is fully relied on the documentation but not
on the goods. • Principle-The party who requests a letter of
• Opening bank-The bank which issue the letter of credit on guarantee from a bank to issue a letter of guarantee
the request of importer on behalf of him.
• Advising bank-The bank which advising the letter of credit • Beneficiary-The party, who will receive the letter of
to Exporter, but it is not bearing any liability of the payment. guarantee.
• Guarantor-It is the bank, that issues the letter of
• Exporter can ask advising bank for irrevocable letter of guarantee on demand of the principle.
credit by paying additional fee.
By Nadun
Peradeniya)
By Nadun
Peradeniya)
The term collateral refers to an asset that a lender accepts as security for a loan. Collateral may take the form of real estate or other
kinds of assets, depending on the purpose of the loan. The collateral acts as a form of protection for the lender. That is, if the
borrower defaults on their loan payments, the lender can seize the collateral and sell it to recoup some or all of its losses.
Purpose of a collateral Features of a good collateral

• Collateral is an item of value used to secure a • Marketability
loan. • Realisability
• Collateral minimizes the risk for lenders. • Storability
• If a borrower defaults on the loan, the lender can • Stability in value
seize the collateral and sell it to recoup its losses.
• Mortgages and car loans are two types of
collateralized loans.
• Other personal assets, such as a savings or
investment account, can be used to secure a
collateralized personal loan.
By Nadun
Peradeniya)
Marketability Realisability Storability Stability in value
• Marketability is the Realisability means • Storability is • Stability in value
possibility of possibility of acquiring possibility of storing means the
disposing the asset assets for sale. the assets without consistency of
at any given point of exposing for waste. market value.
time. • Those are Lockable • Low depreciation
• No extra effort safes, warehouses rates and charges
should be put on for goods such as should be
selling process of paddy, maize. considered
collaterals. Vehicle yards to park according to financial
• There should be vehicles. treatments.
considerably high • Storage cost should • Value appreciations
amount of buyers to be reasonable. according to market
buy the asset when it
By Nadun conditions.
is disposing.
• Attractive price bids

Peradeniya)
for the assets.

• Collateral can be simply defined as all immovable and movable assets used as collateral to reduce the risk of
the borrower defaulting on the loan facility granted by a financial institution.
• An important point for the loan officers to understand in the loan evaluation process is borrower's future cash
flows as confirmed by a formal credit evaluation. Only a second source or additional cover is available for
recovery from a security or collateral.
By Nadun
Peradeniya)
• Unsecured loan is a facility provided by a financial institution to more trustworthy and financially strong
customers without obtaining the above security,
• But these credit facilities expose financial institutions to severe credit risk in the event of default.
By Nadun
Peradeniya)
Securities can be broadly categorized into two as follows
Immovable properties Movable properties

• Land includes its existing and growing natural • Assets that are not classified under immovable assets and assets
resources as well as any asset permanently fixed that can be moved are classified under movable properties.
to the land which is classified under immovable • Movable asset can be further classified into two sub categories such
property. as
i) Human properties
• For example, the graphite deposits in the land,
trees, etc., Buildings and machineries fixed to the Ex: Personal guarantees, Indemnities
land. ii) Physical properties
Ex: Savings and fixed deposit accounts, Government
securities(Treasury bills and bonds),debentures, share stocks, Life
insurance policies,Inventories,Gold,debtors,Motor vehicles and
machineries
By Nadun
Peradeniya)
1. Savings and fixed deposit accounts
2. Treasury bills and bonds
3. Debentures
4. Shares of quoted companies
5. Life Insurance policies
6. Immovable assets
7. Movable assets
8. Personal guarantees
9. Indemnities
10. Corporate guarantees
11. Promissory notes
12. Pledge
13. Trust Receipts
14.Nadun
By Books Debts
Peradeniya)
• This an agreement between 3rd party person/suitable person on granting a facility to borrower and the 3rd party
may agrees legally to pay in the event of default by the borrower.
• Therefore the guarantor is having secondary level of obligation to comply.
By Nadun
Peradeniya)
Borrower is legally bound to repay the principal and interest amount of the loan regardless of whether the borrower
makes a repayment or not, the indemnifier entering into an agreement which makes the him/her primarily
responsible for the debt obligation similarly the borrower.
By Nadun
Peradeniya)
• When obtaining securities related to credit facilities granted by a financial institution, special attention should be
paid to the value of the relevant assets. Because when the borrower fails to repay the loan, the outstanding
balance can be settled through realising collaterals.
• Therefore asset valuation is vital important when processing secured loan facility.
By Nadun
Peradeniya)
• In order to access the eligibility and acceptability of an asset/security, It is required to obtain valuation report from an
authorized and professional valuer.
• Then the financial institutions grant facilities based on the market value mentioned in the authorized valuer’s report,
However some financial institutions seeking further expertise 3 rd party opinion on the market value of the asset to verify
the authenticity of the given values in the report.
Types of values in asset valuation
Market value
• This indicates the current market value of the asset and this could be the highest possible selling value of the asset in
current market.
Insurance value
• This is the maximum value which can be obtain an insurance policy/cover for the asset.
Forced sale value
• This is the value that the asset can be immediately sell in the event of repossessing action taken. This value is usually
less than market value of the asset in valuation report.
By Nadun
Peradeniya)
There are four key factors which determine the value of an asset ,those are as follows
1. Demand
2. Utility
3. Scarcity
4. Transferability
By Nadun
Peradeniya)
1.Cost approach
It will consider the asset cost and other related expenses to arrive the final value of the asset.
Ex: If there is a machinery fixed in a production plant ,the value of the machinery will be inclusive of the cost of the
machine, transportation cost and related cost which incurred to fix the asset and make it to usable status.
2. Income approach
It consider all revenues generated through asset to arrive the value of the asset
3. Market or comparability approach

This approach will consider the current market value of a similar asset and compare to decide the value of the
asset.
By Nadun
Peradeniya)
4. Professional valuers
They are professionally qualified and reputed valuers acceptable by financial institutions for asset valuation in their
credit granting process.
As per the CBSL directions following criteria's to be complied by a valuer, to be eligible for asset valuation process
to a financial institution.
• A chartered valuation surveyor
• A fellow member of IVSL(Institute of valuers of Sri Lanka) with minimum of 5 years of experience
• Graduate member of IVSL with minimum of 10 years experience
• An associate member of IVSL with minimum of 20 years of experience
Special Note
Apart for all above valuers and their valuation report bank/Financial institution may have authorized officers to
inspect the property and obtain their inspection report as well.
23
1.Sri Lanka Auto mobile association
2.Reputed/accepted vehicle importers
3.Authorized repair/service providers
Special Note
Apart for all above valuers and their valuation report bank/Financial institution may have authorized officers to
inspect the asset/vehicle and obtain their inspection report as well.
By Nadun
Peradeniya)
Free-hold properties Lease hold properties Donated by government
1.Transfer deeds 1.Crown lease 1.Government
deeds(Janmaboomi deeds)
2.Deed of gift 2.Semi-Government lease 2.Jayaboomi and swarnaboomi
deeds
3.Partition judgements 3.Private leases
By Nadun
Peradeniya)
• Reports should be in letter head format with valuer’s seal
• Report should be addressed to the financial institution
• Status of the title of the asset((Free hold/lease hold or government donation etc...)
• Identification of the asset and name of the current owner
• Unobstructed legal access routes should be checked
• Other constructions located in the property
• Details of the residents in the property
• Methods of valuing the property and forced sale values
• Recommendations of the valuer
By Nadun
Peradeniya)
There are three types of vehicle in the market
1.Brand new vehicles(Un-registered)

2.Un-registered(Reconditioned)
3.Registered vehicles
Important points in a vehicle valuation report

• Reports should be done by a reputed and accepted panel valuer as per the company credit policy
• Report should be addressed to the financial institution and present in letter head format with valuer’s seal.
• Confirmation that the motor vehicle presented for the loan/lease facility has been thoroughly inspected
• Valuation amounts and observations of the valuer
By Nadun
Peradeniya)
• Photos of the vehicle
• Vehicle registration number(If a registered vehicle)
• Engine number and chassis number
• Make and model of the vehicle
• Cylinder capacity
• Gross weight
• Color
• Country manufactured
• Year of manufacture(YOM)
• First date of registration(Only of a registered vehicle)
• Millage
• Seating capacity
• Market and forced sale value
• Special remarks(Any other observations by the valuer)
• Taxation class 28
• Whether the certificate of registration is duplicate or original
• Special conditions mentioned in the CR
• Make/Model/YOM/Millage/date of 1st registration
• Status when first registration(Branch new or reconditioned)
• Taxation class(Luxury or semi-luxury)
• Number of previous owners and last transferred date
By Nadun
Peradeniya)
• This ratio will be calculated to see whether the financial institution can be covered granted loan amount through
asset’s forced sale value.
Security cover ratio= Forced sale value x100%
Loan amount
If the SCR(security cover ratio) less than 100% ,asset should not be accepted as a security for granting the loan as
client can request to set off the loan facility through forced sale value or realizing the asset. Since the value is less
than the asset value ,borrower’s motivation to pay off the installments will be less.
By Nadun
Peradeniya)
• Biased valuation amounts(financial institution/borrower)
• Over or under valuations
• Improper valuations –such valuations are prepared without proper inspection of the asset
• Language errors and printing errors
• Less focus on future value of the asset
• Less attention to other environment factors such as political/legal factors related to the asset
By Nadun
Peradeniya)
Nadun Sooriyaarachchi
(ACMA,CGMA,FICM(SL),AIB(SL),BA(Hons) IBF(2nd class)-
UWS(UK),Cert in counselling psychology(University of
Peradeniya
0773822174
Email:
nandun.sooriyaarachchi.ns@gmail.com

15-10-22-CER-Lesson 03

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Lesson 03

Types of credit facilities and collaterals

• Types of credit facilities

By Nadun Sooriyaarachchi(ACMA,CGMA,FICM(SL),AIB(SL),BA(Hons) IBF(2nd

Funded credit facilities Non-Funded Credit facilities

Facility is available only for the current account holders.

Temporary overdrafts (TOD) Permanent overdrafts (POD)

• Repayment period is limited • Loan repayment period is 1 to • Loan repayment period is

Nature of the facility Evaluation criteria

Finance leases Operating Lease

Letter of Credit Letter of guarantee

Purpose of a collateral Features of a good collateral

• Attractive price bids

for the assets.

Immovable properties Movable properties

3. Market or comparability approach

1.Brand new vehicles(Un-registered)

Important points in a vehicle valuation report

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