A covenant refers to an agreement or promise outlining the terms and conditions of a loan agreement and the obligations of the parties involved. Moreover, bank loan covenants might outline the actions the borrower must avoid or discontinue.

Banks expect that borrowers will remain financially sound during the loan's duration. Sometimes, bank loan covenants prevent borrowers from entering into another loan agreement with another lender. Therefore, covenants serve as clauses in bank loan documentation that specify what borrowers can and cannot do.

In addition, covenants serve as tools that help ensure the lender will receive full repayment of the debt. They protect lenders by ensuring that the borrower adopts measures to make paying back the debt possible. For example, the covenant might require that the lender maintains a sufficient cash flow.

Not all loan agreements have covenants attached, so whether a loan agreement has one will depend on the loan size, its overall risk assessment, and the loan type.