What is collateral coverage ratio and why is it important?

• A. Interest rate on collateral
• B. The ratio of daily cash flow to loan size
• C. Collateral value relative to loan amount; ensures sufficient security and helps determine buffer for potential losses
• D. The reserve requirement for the bank

Answer: (C)

Collateral coverage ratio measures how much collateral backs the loan by comparing the collateral’s value to the loan amount. It’s calculated as collateral value divided by the loan size. This matters because it shows how much security there is if the borrower defaults or if the collateral’s value falls. A higher ratio means a bigger cushion to absorb losses, while a lower ratio signals greater risk and less protection for the lender. This ratio helps determine the maximum loan amount that can be supported by the collateral, influences pricing and loan terms, and guides risk management decisions about whether to require additional collateral or adjust exposure.