The collateral ratio is a measure of the amount of collateral pledged compared to the value of a loan or obligation. It indicates the level of security provided by the collateral to the lender or creditor. The formula to calculate the collateral ratio is:
Collateral ratio > 100%: The collateral exceeds the loan value, providing more security to the lender.
Collateral ratio = 100%: The collateral matches the loan value.
Collateral ratio < 100%: The collateral is insufficient to cover the loan, increasing risk for the lender.
Use Cases:
1. Lending and Loans: Lenders use it to evaluate the risk of lending money. For instance, if you take a loan of $10,000 and pledge collateral worth $12,000, the collateral ratio is 120%, showing strong security.
2. Cryptocurrency and DeFi: In decentralized finance, collateral ratios are critical to ensure loans remain over-collateralized to prevent liquidation in volatile markets.
3. Corporate Finance: Companies may use it to assess the adequacy of pledged assets when securing financing.