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Loan trading makes credit market diversified and efficient

Nironjan Roy | Published: September 29, 2019 21:53:30


Few months ago, local media published a report on Bangladesh Bank's consideration of introducing loan trading in the country's banking sector. The report further detailed that the central bank intends to allow this product as a measure towards addressing the NPL (nonperforming loan) situation. This is, of course, a timely initiative because historically our banking industry, particularly the credit market, has been moving without much diversification. Functionality of our banks is still confined to mobilising deposits from people and disbursing loans and advance to the borrowers. Disbursement of loan, realising interest and finally the principal amount from the borrowers are the core functionality of bank business in the country. In this context, loan trading can play an important role. It is a sophisticated credit product that makes overall credit market vibrant and efficient. However, to what extent this product will help improve NPL situation, as perceived by Bangladesh Bank, remains to be seen.

LOAN TRADING-THE PERCEPTION:   The term loan trading is not very familiar in our country's banking industry. Loan trading is the process whereby the lender party is changed from one bank / financial institution to another bank / financial institution. After granting credit facilities to the borrower, bank periodically evaluates its credit portfolio so as to keep it within desired level. Every bank maintains maximum portfolio cap as well as portfolio mix in its loans and advance business.

Ideal business objective of any bank is to maximise its loan portfolio cap and portfolio mix that can be achieved through loan trading option. If periodic evaluation reveals that a bank's loan portfolio cap remains underperformed with enough room to acquire new assets, it may buy loans from other lenders who may find their loan portfolio cap over-performed with excess assets. However, some may argue that availability under loan portfolio cap can easily be filled in through new disbursements. This is true but time consuming as selection of new borrowers and disbursing new loans take time.

LOAN TRADING MARKET IN THE WORLD: Loan trading is a popular credit product in the developed world, especially in North America. The product is equally popular and a widely accepted means of managing loan portfolio in the European markets. However, this loan product is not commonly found in the developed markets in Asia like Japan and Australia. However, loan trading is practised in a very limited scale by some banks and financial institutions in Japan, Australia, Singapore and Hong Kong.

No institutional loan trading market has developed in the South Asian region as yet and as such, formal loan trading is not practised in the emerging markets including ours. However, some loans are occasionally traded between two banks through mutual arrangements. This is not loan trading but loan transfer.

 LOAN TRADING VERSUS LOAN TRANSFER: There may be some confusion over the concept of loan trading and loan transfer. In many situations, the purpose of both loan trading and loan transfer may seem to be the same, yet there is a clear distinction between these two products. Loan trading is an institutional form of transferring the lender party of one particular loan while the loan transfer is the traditional way of shifting loan from one bank to another bank through approval of new credit facility. Through loan trading process, the borrower is not impacted at all while the borrower is directly affected by loan transfer. To speak the truth, the borrower himself is required to arrange new loan from one bank to transfer it from another bank. In order to execute loan transfer, new loan is granted with separate terms and conditions including collateral arrangement. Even the loan amount may be different depending on the arrangement between the bank and the borrower. New documentation is required under loan transfer. Even the status of credit facility is also changed because of transferring loan from one bank to another. As for example, if a borrower plans to transfer his outstanding loan from ABC Bank classified as SS (substandard) to XYZ Bank, the borrower will have to approach the latter to sanction new loan. XYZ Bank, if agrees to the borrower's proposal, will approve new loan to take over the borrower's outstanding loans from his former bank. The loan sanctioned by XYZ bank is new and as such will be treated as good loan, so through this loan transfer process, classified loan is changed into good loan. Therefore, loan transfer is considered a camouflaging means of manipulating NPL and as such is not recommended as a standard practice. Under loan trading, credit facility remains the same, so status of loan remains unchanged and no additional documentation is required for the borrower. Apart from this, discount or premium as a source of revenue in addition to interest, is associated with loan trading while there is no other source of income except interest accrued and earned on loan transferred. 

Loan is the only unique product, a credit facility comprising both funded and non-funded means of banking advance approved by bank or financial institution. Funded credit facility involves cash disbursement while non-funded credit facility does not instantly require cash disbursement viz., commercial LC (Letter of Credit), Standby LC / Bank Guarantee. However, this unique credit product when traded can take different forms which include primary loan trading and secondary loan trading. Besides, there are two other forms of loan trading and these are accrual loan trading and non-accrual loan trading.

PRIMARY VS SECONDARY LOAN TRADING: Like all other financial instruments, loan is also traded at both primary market and secondary market. Loan when acquired at the initial stage of approval or commitment to the borrower, is known as primary loan. In fact, when bank makes commitment of any loan to the borrower, this loan is termed as acquired from primary market. This primary loan trading is mostly practised in handling syndicated loan where the committed amount is fully or partially traded with other banks which might not participate in initial bidding stage. For example, five banks have qualified in one syndicated loan and two other banks in spite of having strong intentions could not do so. Those two banks may subsequently buy part or full amount of committed loan from other participating banks and can thus become lenders of that loan syndication.  This type of loan trading takes place between execution of the deal and closing of the loan, particularly prior to the listing of that loan in the trading platform i.e. LSTA (Loan Syndication and Trading Association) for public trading. Usually, two interested banks or financial institutions mutually arrange and execute primary loan trading without any third party involvement.

On the other hand, secondary loan trading involves buying and selling of existing loan through institutional platform i.e. LSTA. This type of loan trading takes place after the closing of the deal i.e., when the loan becomes fully operative after executing all relevant loan documents. Secondary loan trading is arranged and executed through bidding process among the traders. In order to trade loan in the secondary market, use of recognised institutional platform is inevitably required. Banks if and when decide to sell some of its loans, enlist those loans in the institutional loan trading platform with asking price. When loan price asked for and offered are matched, secondary loan purchase is executed. In a nutshell, loan when purchased from trading platform is known as secondary loan purchase.

Nironjan Roy is a banker based in Toronto, Canada.

nironjankumar_roy@yahoo.com

 

 

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