In a cash guarantee agreement, a borrower agrees to place money in a bank account or trust fund as a financial guarantee, so that the lender can regularly withdraw cash from that account to repay the loan. Essentially, the cash in the backup account no longer belongs to the debtor. For example, a bank accepts a $1 million secured loan from a company and asks executives to post guarantees in the form of long-term assets, short-term resources or cash. Senior management decided that it was strategically wise to use cash instead of equipment, and then ordered corporate treasurers to transfer $1 million to a newly created assignment account. During the amortization period of the loan, money will come from this account to pay off the debt. Lenders generally welcome the financial flexibility and appropriateness of risk management of collateral treasury agreements, as they provide security on the default front. In essence, creditors cannot lose in a cash guarantee financing agreement, because they always take money from the accounts of the defaulting borrower to be quite done. As a general rule, a lender can opt for a secured loan when interacting with a new business customer and monitor the organization`s account over time to determine if it is overwhelmed with respect to issues such as compliance with repayment plans, loyalty to credit pacts and overall financial strength. The money cannot be used by the debtor without the creditor`s consent or by court order. In practice, a creditor may be available to the debtor who uses the money to continue his activities in order to relieve his financial difficulties. However, if a new device is purchased with cash. B, the device will replace as collateral the cash. This type of substitution is governed by section 361 of the Bankruptcy Act, which requires “adequate protection” for an insured creditor to “ensure the loss of value of its security.” A debtor may be ordered by the court to grant a replacement guarantee, as in the figure above, or to make periodic cash payments when the value of the entire cash guarantee account begins to decline.
A cash guarantee agreement is part of the credit risk management arsenal used by a lender to ensure a quick repayment and cover potential losses that may result from the debtor`s defaults. Financial institutions use the agreement to assess the financial strength and solvency of potential borrowers, particularly those with poor credit hisism and repayment schemes.