Collateral is a property or other asset that a borrower offers as way for a lender to secure the loan. However, banks and other lenders do not really want your collateral - they are not in the collateral business - they are in the money business.
Bankers say it is too costly for them to take ownership over such collateral should one's business default on payments.
To understand why banks may turn down a person seeking for loan despite having collateral, Daily Monitor spoke to some bankers and experts who offered some insights on this matter.
In an interview, Mr Charles Katongole, Standard Chartered bank's head financial markets & treasury market, said banks are not in the business of buying and selling off collaterals but financing businesses in form of loans which have to be paid back.
"The first primary thing that banks look for is viable business because what we are financing is business, collateral is just for securing the loan. A collateral is a secondary security," he stated.
One thing that all businesses have in common is that they exist to make money. In business sense, there is no other foundational point to any business aside or apart from making a profit.
Mr Katongle explained: "Banks in the first place prefer lending to businesses that have the ability to pay back the loan in a prescribed period."
This is the case because banks exist to provide finances needed by the business people to grow their businesses.
There are various types of businesses that people seek bank loans for. However, Mr Katongle said the types of business also matters when it comes to getting a loan despite one having collateral.
"If your business is in the areas which they (banks) are not focusing, even if you have the best collateral they may not give you the loan," he said.
He said banks may not focus in a specific business segment because they may consider that area as being very risky.
Banks remain important in the financial system of every country, although other financial intermediaries are growing in importance. First, Banks are vital to economic activity because they reallocate money or credit, from savers who have a temporary surplus of it, to borrowers who can make better use of it.
They accept deposits in several forms according to requirements of different sections of the society, advancing loans. The deposits received by banks are not allowed to remain idle. So, after keeping certain cash reserves, the balance is given to needy borrowers and interest is charged from them, which is the main source of income for these banks.
The managing director of Housing Finance Bank, Mr Mathias Katamba, told Daily Monitor recently that banks don't lend against collateral because it is just a security.
"Collateral is the last thing. What is very important is your business and your cash flows, banks see no reason to offer money to a business that has serious cash flow problems," he said.
Mr Katamba explained that banks take in money as deposits, on which they sometimes pay interest, and then lend it to borrowers, who use it to finance investment or consumption.
He said banks also borrow money in other ways, generally from other banks in what is called the interbank market so the cash flow of a borrower from the bank should be consistence. In other aspects they (banks) make profits on the difference, called the margin or the spread, between interest paid and received.
Mr Katamba said a credit record of a borrower is considered more than collateral because a poor credit record is a sign that a borrower, or their business does not prioritise repaying their debt.
"Banks have what is called 'unsecured lending' and is based on one's credit record worthiness over time which is good record history," he said.
Unsecured loans are approved with the need for collateral. Instead of pledging assets, borrowers qualify based on their credit history and income.
Banks are financial intermediaries because they stand between two parties - the borrowers and lenders. The executive director of Enterprise Uganda, Mr Charles Ocici, told Daily Monitor recently that banks are intermediary agents - financial institutions that operate between a saver who deposits money in a bank and a borrower who receives a loan from the bank.
"So professional bankers are always very careful when they are giving out loans. They don't quickly give loans to an interested party based on the collateral he or she has whose long term cash flow is not stable. Bank lending is based on cash flow of the business," he said.
All assets created by a bank (loans and advances) have a probability profile, ranging from very low to high probability of performance. These probability outcomes are a function of many other factors, some economy wide, others industry specific yet others are uniquely loan specific, creating a probability density function for any asset portfolio, which varies based on the assets performance.
Mr Ocici explained that banks have no way of knowing in advance, which particular asset may or may not perform. But they must, out of prudence, have a fallback position in case of nonperformance.
"That fall back is security, hence collateral," he said.
However, Mr Ocici said banks are not in the business of real-estate and other securities because bank loans are based on a self-financing mechanism, whereby a business generates money and pays it back.
Mr Ocici warned banks saying: "Any bank which is interested in real-estate (collateral, land title) will not last in the market because it will reach a time when it will have no cash (capital). Then it will lack liquidity which will result into its failure."
In life, almost everyone needs to apply for at least one loan-and probably much more-at some stage in their lives. Bankers say doing so is often a sound financial move as long as the monthly repayment is affordable and fits into a carefully considered budget.
In this regard to the borrowers, Mr Ocici advised: "Many people go to banks of minding about thei underlying principles. But whenever ones goes to borrow from the bank, they must take into consideration the interest cost and be ready to meet the interest and loan repayments."