What is a bank loan covenant?

• A. An interest rate setting by bank.
• B. Contractual restrictions on borrower behavior.
• C. A fee for late payment.
• D. A type of asset impairment.

Answer: (B)

A bank loan covenant is a contractual restriction on borrower behavior in a loan agreement that protects the lender. Covenants set rules the borrower must follow, which can be financial—like maintaining certain ratios (for example, debt-to-EBITDA or current ratio) or minimum earnings—and negative—like not taking on additional debt, not selling major assets, or not paying large dividends without consent. If a covenant is violated, the lender can trigger remedies such as demanding immediate repayment, increasing collateral requirements, or renegotiating terms. This concept is about controlling actions and financial position to reduce risk, not about how the loan is priced, fees for late payments, or asset impairment.