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(Securing a Debt Obligation)

Collateral within a financial context is used to indicate assets that secure a debt obligation. For example, in the case of a mortgage, the house serves as the collateral for the mortgage loan. This way, the bank is secured against the default risk of the borrower not being able to meet the interest payments. In case of default, the bank can sell the house and get its money (or at least a part of it) back.

Concept of "collateral"

Collateral, especially within banking, may traditionally refer to secured lending (also known as asset-based lending) as well as more recently as collateralisation arrangements to secure trade transactions (also known as capital market collateralization). The former often presents unilateral obligations, secured in the form of property, surety, guarantee or other as collateral (originally denoted by the term security), whereas the latter often presents bilateral obligations secured by more liquid assets such as cash or securities, often known as margin. Another example might be to ask for collateral in exchange for holding something of value until it is returned (ie, I'll hold onto your wallet while you borrow my cell phone).

In many developing countries, the use of collateral is the main way to secure bank financing. The ease of getting credit is associated with the opportunity to use movable and immovable assets as collateral.

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