Companies operating in any industry or market segment may need to obtain loans from banks. At this stage, many questions may arise, such as: what information do I have to present to the bank to obtain a loan? What collateral is needed for a bank loan? Is it better to take GEL loan, USD loan or EUR loan? What is the effective interest rate?
This article answers the above questions and provides useful information on bank loans and their characteristics.
What information do I have to present to the bank to obtain a loan?
In order to obtain loans from banks, the following information is often required:
What collateral is needed for a bank loan?
Bank typically needs certain collateral to approve a loan. Collateral is the property that a company pledges as a guarantee for loan repayment. For instance, if you decide to take a loan to buy an office for your company, typically the bank would request the subject office to be pledged as a collateral for the loan. An alternative way would be to pledge a different property owned by the company as a collateral. In case the company fails to repay the loan, the bank would be entitled to possess the pledged collateral and sell it to cover the loan. Value of the property, which is intended to be pledged as a collateral, should typically be higher than the loan amount. For instance, if the property value is 100,000 GEL, bank may be able to only issue 80,000 GEL loan. This is necessary since, in case loan is not repaid by the borrower and the pledged property is to be sold to repay the loan, the selling process may take significant amount of time. To accelerate the sale, the bank may be forced to sell it for a discount to market value and price it at the so-called “liquidation value”. Another reason why the collateral value shall exceed the loan amount is that the bank assumes certain risks e.g. property devaluation risk.
Is it better to take GEL loan, USD loan or EUR loan?
As in the most cases, the answer to this question is – “it depends”. Both approaches – taking GEL denominated loan and taking foreign currency denominated loan – have its pros and cons as discussed below: key advantage of foreign currency loans (USD/EUR) is that they carry typically less interest rate as compared to GEL loans. For instance, USD denominated loan may carry interest rate of 8%, while GEL loan interest rate may be as high as 16%. The reason for this is that USD and EUR currencies are more stable, and GEL is less stable, which is natural and is caused by the fact that Georgia’s economy is less strong compared to that of the USA or EU.
On the other hand, key disadvantage of foreign currency denominated loans is that the borrower assumes exchange-rate risk, if, of course, its revenues are not earned in the same foreign currency as the loan itself. For instance, if company takes 100,000 USD loan when USD-GEL exchange rate is three to one (3/1) and in several months the exchange rate becomes three and a half to one (3.5/1), then in GEL terms, loan amount increases by 50,000 GEL and 100,000 USD is no longer 300,000 GEL as it was at the date of loan issuance, but instead is 350,000 GEL now.
What is the effective interest rate?
In accordance with Georgia’s law, any bank is obliged to let the borrower know the information about the effective interest rate. Typically, the effective interest rate exceeds the nominal interest rate. For instance, if a bank approves company 1,000 GEL loan with 10% nominal interest rate and 2% up-front loan issuance fee, the company will receive 980 GEL as net proceeds from the bank as opposed to the approved loan amount of 1,000 GEL. The 980 GEL is derived after subtracting 2% commission from the approved loan of 1,000 GEL i.e. 20 GEL. Therefore, the effective interest rate is calculated from the 980 GEL net proceeds which leads to higher interest rate as compared to the nominal interest rate. In other words, loan issuance fee increases the effective interest rate. Besides, sometimes banks have other fees and commissions as well, which cause the effective rate to be higher at say 10.5% or 11%.