Syndicated Lending (Loan Markets): Customer Problem and Banking Solution
Let us start with the customer’s problem. In the area we are talking about the customer is almost certainly a large company with turnover and income worth many tens of millions of euros per annum. Let us call him ABC PLC and he needs a lot of money (e.g. £1Bn) to buy another company or create a big new project (e.g. new factory). The customer has crudely got three types of finance available to him; he can;.
- borrow from a bank
- issue bonds
- issue shares
Each type of finance has different characteristics in terms of price (required rate of return and fees) and control. For the purposes of this article we are going to focus on the bank lending aspects, however it may well be that in practice the customer would choose a mixture of the types of finance, and what is more, the amount of each type might change over time. Investment banks live by coming up with appealing financing solutions for companies like ABC PLC.
In our imaginary case study we will assume that within the overall finance package ABC PLC need a £200 million revolving credit facility (like a big overdraft which ABC can draw upon and repay at will).
From ABC’s point of view, in many respects, the best answer would be for a single bank to lend them the whole £200 million. However, any one bank would probably be unwilling to lend such a large sum to a single customer. The failure of ABC to repay the loan would represent a catastrophic event for the bank. This is called concentration risk, and banks like to diversify the risk of default across lots of different customers.
Because of concentration risk the interest rate a single bank would charge ABC would be high. However, if a gang of banks club together to lend the money to ABC, say four banks at £50 million each, the risk to each individual bank is reduced and so is the interest rate to ABC. This ganging together by banks to lend is called syndicated lending and the club of (in this case 4) banks is called a syndicate. Because there are lots of customers wanting big loans and lots of banks willing to participate in syndicates a market has formed, the loans market.
More from the Syndicated Lending (Loan Markets) report: