Answer: Option A
Answer: (a)
The best way for a bank to avoid loss is to accept only sound collateral.
In lending agreements, collateral is a borrower’s pledge of specific property to a lender, to secure repayment of a loan. The collateral serves as protection for a lender against a borrower’s default - that is, any borrower failing to pay the principal and interest under the terms of a loan obligation.
If a borrower does default on a loan (due to insolvency or another event), that borrower forfeits (gives up) the property pledged as collateral - and the lender then becomes the owner of the collateral.
In a typical mortgage loan transaction, for instance, the real estate being acquired with the help of the loan serves as collateral. Should the buyer fail to pay the loan under the mortgage loan agreement, the ownership of the real estate is transferred to the bank.
The bank uses a legal process called foreclosure to obtain real estate from a borrower who defaults on a mortgage loan. Collateral, especially within banking, traditionally refers to secured lending (also known as asset-based lending).