Prepare for the Credit Risk Management Exam. Enhance your skills with flashcards, detailed explanations, and a comprehensive quiz format designed for effective learning. Achieve exam readiness!

Each practice test/flash card set has 50 randomly selected questions from a bank of over 500. You'll get a new set of questions each time!

Practice this question and more.


Which of the following is a role of collateral in credit risk management?

  1. Decrease the interest rate of loans

  2. Provide a repayment guarantee

  3. Serve as a backup payment method if the borrower defaults

  4. Facilitate faster loan approval

The correct answer is: Serve as a backup payment method if the borrower defaults

Collateral plays a critical role in credit risk management by serving as a backup payment method if the borrower defaults. When a lender requires collateral, they obtain a security interest in an asset that can be seized and sold to recover the outstanding loan amount in the event that the borrower is unable to fulfill their repayment obligations. This reduces the risk associated with lending because the lender has a tangible asset to draw upon if the borrower fails to repay the loan. While collateral may indirectly influence interest rates through the reduced risk it presents, the primary function is not to decrease rates directly. Similarly, while collateral can provide some assurance about repayment, the role of a repayment guarantee is more directly related to assurances given by the borrower or third parties. Lastly, the presence of collateral does not inherently facilitate faster approval of loans; that process typically depends more on the overall credit assessment and underwriting process rather than just the existence of collateral.