Syndication of Loan Meaning
Where a group of lenders collaborate together usually through an intermediary being a lead financial institution, or syndicate agent, which organizes and administers the transaction, including repayments, fees, etc to provide financial requirements to a single larger borrower (usually out of the capacity of single lender) where division of risk and returns takes place between each other takes place is known as loan syndication.
In Loan Syndication, a group of Banks provides loans jointly to a single borrower because one single bank cannot meet the huge requirement of the borrower as it may be beyond its risk exposure. This type of loan syndication process is required by large companies that are working on a large project and that project requires a huge amount of capital for their business.
Features of Loan Syndication
- Large Amount.
- No separate agreement between an individual bank and the borrower.
- No ambiguity is used to be there.
- The Length for the agreement generally uses to between 3 to 15 years.
- Low risk is found in loan Syndication.
- Each bank is not necessarily to contribute an equal amount.
Example of How Loan Syndication Works
Suppose EFG Ltd is a single national organization and now wants to be a multinational organization in order to run the business company requires a large amount of Capital and the company has a good relationship with one bank. This large amount of capital is so high that a single bank cannot finance and cannot take that high risk alone.
EFG ltd approaches his preferred bank (lead bank) with which the company has a good relationship and says our company requires $ 2 billion. Bank gives an option to the company for syndication of loan because it is not feasible to finance such a large amount individually. The preferred bank now introduces other banks with Client (company) and all together will decide how to segregate amount between them (it may or may not be equally) and one of the banks will be appointed as agent bank and all other banks will be known as participating banks
Participants of Loan Syndication
Below are the participants of loan syndication.
#1 – Lead Bank can also be called as Arrange Bank
- Lead bank act as a manager and responsible by a borrower to organize funding based on a specific term that is decided by parties of the loan.
- The lead bank has to find other banks as lending parties that can willingly participate in this syndication and willing to bear risk together.
- The lead bank has to discuss details of the agreement and responsible for preparing loan documentation with participating banks.
#2 – UnderWriting Bank
- The lead bank may underwrite the unsubscribed portions of the required loan or a different bank may also underwrite the loan.
- Underwriting banks will take the risk that will likely to occur.
#3 – Participating Bank
- All banks who participate in loan syndication are known as a participating bank.
- Participating banks will charge fees for their participation.
#4 – Agent Bank
- The work of the agent bank is to ensure that loan syndication is operating effectively.
- The agent bank acts as a mediator between the borrower and lender and also had a contractual obligation for both the parties (borrower and lender).
- In some cases, the agent bank has some additional duties stated in the agency agreement.
- The basic work of agent banks to channel the funds from all participating banks to the borrower and channel back interest and principal amount from the borrower to participating banks.
Types of Loan Syndication
The following are the types of Loan Syndication.
Type #1 – UnderWritten Deal
Under this arrangement, the lead agent guarantees the entire loan. If the loan is not been fully required, then the lead agent has an option to absorb the undersubscribed portion. This loan syndication attracts the higher service fees and these kinds of loans have a high risk and it will make a huge profit for the bank.
Type #2 – Best- Effort Deal
Under this arrangement, the lead bank is not committed or guarantee the full amount of loan that is required by the borrower and undertakes to their best to find other lenders to provide commitments for the remainder. Any undersubscribed portion of the loan will be filled up by taking advantage of the changes in the market condition. If the loan is continuous undersubscribed, the borrower may be forced to accept a lower amount of loan or loan can be canceled.
Type #3 – Club Deal
In this type of syndication is of a smaller amount up to $ 150 million. In this, all the members of the club have an equal share. In this borrower may arrange the club itself or arranger may be involved.
Process of Loan Syndication
Here is the process of loan syndication.
- Initial discussion with promoters should be there.
- Then, Project Assessment needs to be done.
- Availability of alternatives for Sources of funds needs to be done.
- Then, Preliminary discussion with lenders should be done.
- Then there is a requirement of preparation of loan application and follow-up of it.
- Providing assistance in Project Appraisal by doing financial analysis.
- Lastly, the Letter of CreditLetter Of CreditA letter of credit is a payment mechanism in which the issuer's bank gives an economic guarantee to the exporter for the agreed payment amount if the buyer defaults. In international trade, buyers employ LC to reduce credit risk. should be obtained from a lending institution.
- Financing takes less time and effort.
- The administration of the loan is Extremely Efficient.
- It is beneficial for borrowers to establish a good market image.
- Borrowers have flexibility in structure and pricing.
- The borrower need not go in each bank and also need not to apply separate application to all of the banks.
- The purpose and time period of the loan is fixed.
- The system is simple.
- Time-consuming Process since negotiating with the bank can take various days, thus loan syndication is a time-consuming process.
- Borrowers may also be adversely affected by syndicated loan agreements.
- If the problem arises, it may be difficult for borrowers to satisfy all banks at the same time.
- Managing the relationship between multiple parties is a difficult task.
- If profitability fails then the smallest bank wants to withdraw its capital.
In Loan Syndication, several different lenders provide various portions of a loan. Every lender has a responsibility towards their share of the loan. Every lender has a less risk due to sharing a loan (big amount) between more than one lender. Banks or financial institutions profit from loan syndication.
This has been a guide to Loan Syndication and it’s Meaning. Here we discuss features of loan syndication along with examples, types, process, and participants. We also include some of its advantages and disadvantages. You can learn more about accounting from the following articles –