November 21, 2017
Surendra Jagwan
A rough
idea about the concepts of Loan Syndication and Consortium is necessary. “A setup in which group of
individuals or entities decides to pool resources towards fulfilling a debt or
financing a single borrower wherein the setup is governed by a legal contract
that delegates responsibilities among its members, is known as Consortium” whereas
a Loan Syndication is somewhat a similar process, the term is
generally reserved for loans that involve international transactions, different
currencies and a necessary banking cooperation to guarantee payments and reduce
exposure, this setup is headed by a managing bank that is approached by the
borrower to arrange credit.
Loan Syndication
Syndicate as term in general
sense has originated in the U.S. Loan Syndication refers to a lending process
wherein a borrower approaches a bank for a loan amount that is comparatively
heavy and also involves international transactions and different currencies.
Here, as and when a bank is approached by a client for availing a loan, the
said bank fixes up the interests and other borrowing terms and conditions of
the loan with the client and itself approaches other banks for selling of this
loan. The other banks, if agree, “Purchase” a part of the loan on the same or
different terms and conditions.
In a Loan Syndication process, the client deals
with one Bank only. The bank approached by the borrower to arrange credit is
referred to as Managing Bank that is responsible for
negotiating conditions and arranging the loan amount. Here it is important to note
that the Managing Bank need not be the “Majority lender” or “Lead bank” but
only plays the role of manager in arranging the loan amount in association with
other banks. Depending on the terms and conditions of the agreement any bank
can play the role of Managing Bank. The lead bank acts as recruiting bank of
other sufficient banks in the process of producing of loan, negotiating the
terms, negotiating details of the agreement and preparing documentation. The
bank that is awarded/ given the mandate by prospective borrower and is
responsible for placing and managing the loan process, its terms and conditions
and finalizing the same is known as Lead Manager, Lead Bank, Syndicate Bank. They are entitled to arrangement fees and
undergo a reputation risk during this process.
The banks that participate in
process of lending a portion of total loan amount entitled to receive interest
and participation fees are Participating Banks.
The manager/lead bank is
responsible for repayment and disbursement of the loan amount and also for
providing the borrower’s financial statements to the banks involved in the
syndicate lending process. The manager/ lead bank is paid a fee by the borrower
for these services. The Managing bank may hire one or more other banks as
co-managers to assist in the process, who share in the fee in return for
helping with the manager’s duties.
A borrower takes resort of Loan
Syndication for Working Capital credit, Export Finance, Capital goods
financing, Mergers and Acquisitions, Project Finance, Standby facility, Trade
finance, guarantees etc.
Advantages
1.
Allows the borrower to access from diverse group of financial
institutions.
2.
Saves funds. The interest rates, other terms and conditions are
agreed upon by one bank that has to approach the pool of banks for the loan;
this process saves money and time on part of the borrower.
3.
Raise substantial financing facilities on pre-agreed terms which
would exceed the capacity of any single bank
Disadvantages
1.
Each bank has to come to an understanding about business and how
its financial activities take place.
2.
Comfort level must be arrived at, that requires time and effort.
3.
Negotiating the documents and other terms with one bank takes
days. Here the borrower has to negotiate with numerous banks and is time
consuming.
Consortium
There arise cases where a
borrower approaches a bank for huge loans; this high amount means high risk to
a single lender. In such cases banks resort to a lending mechanism known
as Consortium to reduce the risk involved in the Loan Process. A consortium is
successful where it is not possible for a single bank to finance the loan
amount to the borrower; it has nothing to do with international transactions
unlike Loan Syndication, simply the
loan amount is too large or risky for a single lender to provide.
Consortium financing occurs for transactions that might not take place
with a single lender. Here when a borrower approaches a bank for loan, several
banks club together to supervise the said loan amount. A
common appraisal, documentation, joint supervision and follow-up play the key
role.
These banks have a common agreement
between them. Sometimes the participating banks form a new consortium bank to
look after the process of funding of loan, leveraging assets from each
institution and ultimately disbanding after completion of the project. The
lender who has taken the highest risk (by giving the highest amount of loan)
acts act as a leader and administers all the transactions, agreements etc.
between the consortium and the borrower. The consortium agreement is a crucial
document and not easy to draft. It must be clear on the rights and obligations
of the parties, which need to be focused firmly on the purpose of the
consortium.
Advantages of consortium
1.
No capital is required to create a consortium.
2.
Ease of formation, no formal procedures need to be followed.
3.
It is easy to terminate because it can be set to expiry on a
particular date and happening of an event without any formal requirements.
4.
It is easy to terminate, can be set to expiry on a given date or
on the occurrence of certain events without the formal requirements needed in
the case of dissolution of a corporation.
5.
The individual members are subject to tax and not the
consortium.
Disadvantages of consortium
1.
A consortium member can’t restrict or limit its liability.
Members may even become liable to third parties for the non-performance of
other members of the consortium or the debts of such members incurred in
undertaking the common project.
2.
Third parties often find it difficult to enter into contract
with a non-legal entity like a consortium. Because it is a non-legal entity
funding is also normally only available to the individual members and not the
consortium itself. So it becomes difficult to maintain External relationship
and funding.
3.
The lack of a permanent structure makes it difficult for a
consortium to establish long-term business relationships with third parties.
Conclusion
To conclude, every syndicate is
a consortium, but not every consortium is a syndicate. When it comes to loans,
the big difference (in my opinion) is when the lender cannot repay. With a
consortium the lender can repay one bank and fail on another. With a syndicate
there is only one loan, the lender will have to fail on the whole loan which
may create legal complexities and make the borrower face other legal
consequences. They may look alike and both the terms are used as synonyms to
each other yet there exist technical differences when it comes to operations,
procedures, relationships, legal complexities etc.
