OC Full Form

Over-Collateralisation is important for both the banks and the customers for the following reasons:

• The banks insist on over-collateralization because they can cover the risk of the loans going bad due to default or non-repayment. They can sell the security and recover the dues. The periodical interest applied on the loan will also be considered while estimating the risk involved. They should be able to recover even the unpaid interest if the loan goes bad. 
• The lender's risk will be reduced if the stake of the borrower by way of margin is higher.
• When the LTV ratio, that is, the loan to value ratio, is lower, the bank offers the customer a better deal in terms of interest, service charges, and the repayment period.
• OC will help in improvising the credit profile of the borrower.
• The borrower's credit score will improve depending on the extent of over-collateralization. 
• Assessment of the creditworthiness of the borrower will be better.

The lenders apply the Loan to Value Ratio while deciding the loan amount on secured loans. The loan amount will always be a percentage of the security value and never 100% of the security value. Over-collateralization is to cover the risk involved when the borrower defaults.

The loan to value stipulated will depend on the type of security offered. For example, in the case of a mortgage where there is an appreciation of the asset's value, the margin set will be 10% to 30%. In the case of securities that depreciate with time or depend on the market scene, like a vehicle where the value depreciates with time and shares/debentures where the value is market-related, the margin will be higher. In the case of shares, the margin will be as high as 50%.

A few examples for the calculation of OC are given below:

If X has availed a home loan of Rs 50.00 lakhs against a property worth 75.00 lakhs, there is an over-collateralization of Rs 25.00 lakhs. This margin is stipulated to cover any losses that might incur due to the non-repayment of the loan. For example, suppose when X stops repayment, the outstanding balance in the loan account is 45.00 lakhs, and if he/she continues to default for a longer period, there will be an accumulation of interest. After exhausting all the recovery measures, the bank will take possession of the property and sell it to recover the dues. The property should be able to fetch a value adequate to cover the principal amount as well as the interest. This is the reason over-collateralization is insisted upon.

If Y has availed a loan against shares/debentures, the loan provided will be 10 lakhs for security with a market value of Rs. 20.00 lakhs at the time of providing the loan and has stopped paying the loan, then the bank has to sell the securities to recover the dues. But then, the market value of the security could have been slashed at the time when the bank wanted to sell the security. In this case, the value of the security is market-related. So there will be an over-collateralization to the extent of 50% of the security value at the time of sanctioning the loan.

But this is not the case if the loan is against Insurance Policies. The surrender value will never decline over a period. Instead, the surrender value will increase with time due to the bonus earned on the policies. So the over-collateralization in the case of insurance policies will be only to the extent of 5% of the loan amount, i.e., a loan to the extent of 95% of the policy's surrender value will be approved.

The lender's responsibility does not end by providing a loan after marking a lien on the security. Instead, the lender has to ensure the quality of assets as well. The following steps will be taken periodically:

• Inspection of the security will be done at regular intervals in the case of securities like mortgage and hypothecation where the ownership will be with the bank, whereas the borrower will be in possession of the security.
• Regular payment of home loan tax in case of property and insurance cover in case of a vehicle will be ascertained by obtaining a copy of the tax paid receipt and insurance policy on a regular basis till the loan is cleared.
• In the case of securities like shares and debentures, the value of the asset will be monitored on a weekly basis to review the movement of the value. If the value goes below the outstanding liability, the party will be asked to remit the differential value immediately to avert erosion.
• Where Insurance Policies are taken as security premiums, paid receipts should be submitted to the bank. This is to ensure that the policy is in force at all times till the loan is fully recovered.

No. Banks do not provide unsecured loans easily to customers even if they have a high score. They do a lot of groundwork with respect to the repayment capacity of the applicant. There are various other aspects besides the credit score that the banks have to assess before providing an unsecured loan, as they will have no recourse other than the legal proceeding against the borrower in case of default or non-repayment of dues. The legal process is tedious and will take a long time, so the banks refrain from providing unsecured loans easily.

You have learnt about the OC Full Form and why banks insist on over-collateralization in this article. You are also now aware of the extent of over-collateralization insisted depending on the security. You are now in a position to approach the loan with the appropriate security depending on your funds' requirements.