Secured loans are the cornerstone of the modern financial system. The ability for a lender to advance funds in return for a charge over specified collateral has revolutionized finance. The ability, furthermore, to package these loans as securitized tranches of bonds was a key force in credit creation from the 1970s onwards. The credit crisis from 2007-9 and the temporary ice age in the asset-backed securities market only demonstrated that healthy lending is essential to economic growth.
The concept of secured loans originated in medieval Italy, although until legal systems were robust enough to enforce moneylenders’ security the market was necessarily imperfect. The rise of the joint stock corporation and the advent of limited liability in the nineteenth century saw the inexorable rise of secured lending. British Prime Minister Gladstone famously invaded Egypt, it was rumoured, to enforce security when the Egyptian government defaulted on its Suez canal bonds.
Today banks will typically take a charge over a residential property as collateral for unsecured loans. Secured financing should theoretically offer lower borrowing costs than unsecured, provided that the ability to execute the collateral is effective in the relevant jurisdiction. Indeed the ability of banks, many ironically supported by government funding programs, to foreclose on residential properties has caused significant political controversy, as well as the quintessentially American phenomenon of “jingle mail”.
With any secured loan, the lending bank will employ a range of methodologies to assess customer credit risk, ranging from requiring proof of identity to checks with credit bureaux to aggregated analysis on proprietary statistical scorecards. Famously, many statistical models intended to accurately predict loss and delinquency came unstuck once the asset bubble of 2002-2007 ended and the Case-Shiller property price index declined for the first time in American history. The sub-prime credit losses endured by the banks and the ensuing closure of the asset backed securities markets proved that secured loans only work as a concept when supported by strong underwriting standards and robust origination criteria.
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