Meaning
A banking arrangement provides immediate security for credit extensions through the dedication of liquid currency to a specific debt obligation. Under the terms of cash deposit collateral, a borrower maintains funds in an account that is restricted for the benefit of a lender. This ensures that the lender has immediate recourse if the borrower fails to perform.
It terminates when the debt is paid.
Risk Mitigation
Secured parties demand cash rather than illiquid assets to eliminate the valuation fluctuations and transaction costs of asset disposal. Having cash deposit collateral in place reduces credit risk to near zero for that portion of the exposure. The lender receives protection from market volatility.
Account Control
Control is established by a three party agreement that binds the depository institution to follow the instructions of the secured party. This prevents the borrower from accessing the cash deposit collateral without permission. The bank agrees to ignore instructions from the account holder once the secured party issues a notice of exclusive control.
This ensures the funds remain isolated from the general operations of the debtor.
Fund Release
Return of the funds occurs only after the underlying liability is discharged or expired. In a typical transition, the secured party directs the bank to release the cash deposit collateral back to the debtor once all payments are complete. If default occurs, the secured party instructs the bank to transfer the funds to its own account.
