In the previous issues, we learned the first seven things for a business looking for a bank loan to consider. We stressed that effective preparation to accessing a bank loan for a business takes time; even up to three years.
- First, ensure that your business is formally established in terms of regulatory and compliance requirements as well as internal operations and business undertakings.
- Second, your business needs to maintain a good governance system – Board of Directors that advices the business and not for compliance purposes.
- Third, ensure that your business maintains a good management team and structure.
- Fourth, ensure that your business has a strategy to focus you and your team on the core business undertaking.
- Fifth, understand your enterprise business model. Key focus is on your customers and the main aim is how (the fashion/style with which) your business generates profit.
- Sixth, conduct a feasibility study – in terms of the product/service proposed, market feasibility, technical feasibility, environmental impact assessment, design parameters, as well as financial viability of the project you intend.
- Seventh, business plan – Business plan is probably the most known requirement from a bank for those seeking business loans. However, business plan seems to be summary of all the previous steps with inclusion of financial plan and other necessary information regarding the operation of the business.
Today we will discuss about the last step which is collateral. Collateral is a security against the loan. Normally, collateral will be considered by the bank at the very end of the loan process. This is because banks do not lend their customers based on their collateral they possess – no matter how good is the collateral. What is considered by the bank is the business case. When approaching a bank for a business loan banker(s) will not talk about collateral in the first place – may be because it is obvious that you might have considered it before approaching the bank, but also because it is the last thing they will consider after providing you have sound business case.
Should the bank determine that its worth that they can lend to your business, they will consider assessment of collateral. To do this, they will require you to provide evidence on the type and fair market of what you will pledge as collateral. A business plan for the loan should have considered this fact. Normally, a loan which is secured with a requirement to undertake a business plan is likely to be secured by a collateral.
In Tanzania, collateral is a legally backed up in various laws including the Banking and Financial Institutions Act, Cap 342 and the Land Act, Cap 113 R.E. 2019 and associated regulations. According to the Banking and Financial Institutions (Credit Concentration and Other Exposure Limits) Regulations, 2014; a loan is fully secured if its collateral value is at least 125 per cent of the credit accommodation deemed by it. This means normally, if you are business requires say 100m/-, you will need a collateral of at least valued to 125m/-. To determine the value, the bank normally maintains a list of independent valuers who may determine value of the collateral. Collateral can be moveable or immovable (mortgage). Immovable securities are like motor vehicles, machinery, etc. Banks they will prefer more of immovable securities due to the risk and when it is acceptable, immovable securities are highly discounted.
For mortgage-backed loans – whereby there is a creation of an interest in a right of occupancy (piece of land or house) for securing the payment of the loan, a mortgage deed must be registered with the Registrar of Titles to be effective. To be effective, such mortgage also must be signed by the client and interest parties including spouse consent. If you borrow as a company such must first be registered with the Registrar of Companies (i.e, the Business Registrations and Licensing Agency – BRELA) before they are registered with the Registrar of Titles. Upon arrangement, several lenders can enter to security sharing – several lenders can share security, although there is a lot of legal process required including aspects of seniority on the claim of the shared security.
Land act requires that a loan secured by a mortgage of an undeveloped or underdeveloped land be applied either wholly or partially towards developing that particular piece of land. So, if you own a piece of land somewhere, you cannot use it to finance fully your business of trading without considering developing the land secured against the loan.
There are other collaterals which can be considered for business loan such as cash deposits, financial market instruments such as share certificates (of listed companies) or bond /treasury bills certificates, assets/machinery, stocks and other valuables e.g, a piece of mineral. Banks may also consider combination of various assets and securities to secure the loan. Collaterals are not considered as stand alone. Normally collateral must be fully insured against various risks such as fire, theft and accidents.
As indicated in these steps, to get prepared, you need time and resources for each type of step to ensure that the bank understands your business and when you need a loan to boost your capital you are able to access such a loan without much delays. All the best in your quest and process for a bank loan.
Author: Dr. Tobias Swai is a Senior Lecturer and Head of Department of Finance, at the University of Dar es Salaam, Business School. Email: tobias@udsm.ac.tz Telephone: +255 75 4300 495.
