Sole banking is a lending by single bank to a large borrower, subject to the resources available with it and limited to the exposure limits imposed by the Reserve Bank of India. Many a times when you propose to approach to new bank for funding, they propose for sole banking that their complete banking should be transferred to their bank. This is done for two reasons one is to get complete business and second is very important is having complete monitoring of fund flow and cash flow of the firm.
Multiple Banking Arrangement
As looked into above example of sole banking, it is also happening that it continues with existing bank facility and take additional from other (new) bank. When the credit requirements of a borrower are beyond the capacity of a single bank or that the bank does not want to take more exposure on a particular borrower, he may then resort to multiple banking. It is an arrangement where a borrower borrows simultaneously from more than one bank independent of each other, under separate loan documents with each bank. Securities are charged to each bank separately.
There are various loopholes in multiple banking arrangements, and also it can lead to frauds so consortium banking is better for economy. Each banker is free to do his own credit assessment and old security independent of other bankers.
Consortium lending also called joint financing or participation financing. It is a system of financial emerged due to consequential increase in demand for funds of substantial magnitude and inability of individual banks to take care of the entire fund requirement of large borrowers. The system of consortium lending provides scope and opportunity to share risk amongst banks. The system is considered to be mutually beneficial to the banks as well as customers. Under multiple banking, there is no coordination among banks regarding appraisal, documentation, other terms and advances. In such a situation borrowers got the upper hand by playing one bank against the other. It was, therefore, necessary to formalize these credit arrangements to safeguard the interest of the banks. It is mainly catered in case of large corporate and certain mid-sized borrowers.
As per the consortium lending approach, the group of banks would have a common agreement wherein the lead bank (the bank that bears major risk) would assess the borrower’s fund requirements, set common terms and conditions and share information about borrower’s performance to other lenders.
The bank which takes the higher risk (by giving the highest amount of loan) will act as a leader and thus it acts as an intermediary between the consortium and the borrower.
Reserve Bank of India has permitted the banks to adopt syndication route to provide credit in lieu of consortium advance. A syndication credit differs from consortium advance. A syndicated credit differs from consortium advances in certain aspects. The salient features of a syndicated credit are as follows:
- The prospective borrower gives a mandate to a bank, commonly referred as a lead bank (lead manager), to arrange credit on his behalf. The mandate gives the commercial terms of the credit and the prerogatives of the mandated bank in resolving contentious issue in the course of the transaction of complete syndication.
- It is an agreement between two or more banks to provide a borrower a credit facility using common documents of the borrower.
- The mandated bank prepares an information Memorandum about the borrower in consultation with the latter and distributes the same amongst the prospective lenders, inviting them to participate in the credit proposal.
- On the basis of information Memorandum each bank makes its own independent economy and financial evaluation of the borrower. It may collect additional information from other sources also. Generally, lead banker plays important role as rest just follows.
- Thereafter, a meeting of the particular banks is convened by the mandated bank and discuss the syndication strategy relating to co-ordination communication and control with the syndication process and to finalize the deal timing, charges for management, cost of credit, share of each participating bank in the credit etc.
- A loan agreement is signed by all the participating banks.
- The borrower is required to give prior notice to the Lead Banker (Lead Manager) of his agent for drawing the loan amount so that the latter may tie up disbursement with the other lending banks.
- Under the system, the borrower has the freedom in terms of competitive pricing. Discipline is also imposed through a fixed repayment period under syndicated credit.