What Is Loan Syndication And Why It Is Beneficial For Borrowers?

When a borrower needs a considerable amount as a loan (loans that run to triple-digit crores or more), it may not be as easy to avail of credit. This is because it may be beyond a lender’s risk tolerance or resource capacity to furnish the entire sum alone. This is where loan syndication can help. Under this process, when a borrower approaches a lender with such a request, the lender brings in other lenders on board to fulfil their client’s requirement. It allows better and heterogenous loan terms and efficient loan management. 

Read on to know how loan syndication works, examples, types and benefits.

What is Loan Syndication?

Loan syndication is the process of multiple lenders coming together to fund a large loan requirement of a single borrower. This process is required when the loan amount is so large that a single lender cannot extend it for two reasons. First, it does not have enough resources, and second, the risk associated with extending such an amount is too high. 

Thus, multiple lending institutions come together – or syndicate – and collectively extend the loan to the borrower. In most cases, the borrowers are big companies or businesses looking to fund large projects. 

How Does Loan Syndication Work?

The loan syndication process starts with the borrower approaching their preferred bank for a loan or inviting bids from multiple lenders to get the process started. The borrower then finalizes – or mandates – one lender, the lead bank or the arranger. This is called the pre-mandate stage. 

The lead bank curates a loan structure for the borrower and prepares an information memorandum. This document contains the borrower’s information, the structure of their finances, business performance and industrial overview, and other relevant information. 

On completing this document, the lead bank invites other lenders to join in on extending the loan. All the lenders involved and the borrower sign an agreement promising confidentiality. This is followed by the preparation of a proper loan structure. The interested lenders are then shortlisted, and the syndication is finalized. 

Once a loan structure is established, the loan amount is sanctioned collectively and disbursed. The repayment by the borrower is monitored by keeping a tab on an escrow account. This is the account where the borrower deposits its revenues. The lender must check this account regularly to ensure that the loan is repaid before the amount is used for any other purpose

Let us take the example of loan syndication to understand this process better.

Also Read: What are Pre-Approved Personal Loans: Interest Rates, Benefits And Eligibility

Example of Loan Syndication

Assume that Company X operates in the automobile industry and is introducing a new range of cars, which requires a loan of Rs. 1000 crore. It approaches its bank, say HDFC in this case, requesting the funds. HDFC approves the loan but informs Company X that it is beyond its risk appetite to disburse such a large sum. They decide to syndicate the loan and prepare all the necessary documents for it. 

On reaching out to other lenders, several other banks – Canara, ICICI, Bank of India, and IDBI – agree to give out the loan collectively. With HDFC as the lead bank, the loan structure is prepared, and each bank agrees to supply 20% of the total loan requirement. This reduces the risk exposure for each lender, and Company X gets its required sum. 

The critical thing to note here is that there is only a single contract between the lenders and the borrower. This means that Company X does not have separate agreements with every bank, but only the lead bank. The duty of HDFC as the lead bank is to monitor the escrow account until the amount is repaid in full.

Types of Loan Syndication

There are three types of loan syndication:

Underwritten Deal

In an underwritten deal, the lead bank, or the arranger, guarantees the entire loan amount. This effectively means that the arranger is under the obligation to take over any amount that other lenders do not subscribe to. It may later try to reach out to other investors if the conditions related to the loan improve. 

This form of loan syndication is quite common and is taken up by lead banks for two primary reasons – it makes the lender an attractive candidate for giving the mandate to, and the lender also gets a lucrative payment for taking on the guarantee.

Club Deal

In this case, a club of lenders is formed by the borrower or the lead bank on the indication of the borrower. Every club member extends an equal amount that adds to the total loan and gets an equivalent portion of the fee. 

Best-efforts Syndication  

In a best-efforts syndicate, the lead bank operates as usual but does not guarantee the loan amount to the borrower. It finds other banks to participate in extending the loan and takes advantage of the market conditions to bring a lender on board. However, despite its best efforts, there may be a situation where the loan remains undersubscribed. In this case, the borrower may be forced to take up the lower amount or cancel the loan itself. 

Benefits of Loan Syndication

Here’s a list of benefits of loan syndication: 

• It facilitates the borrowing of a large amount by companies and businesses to fund big projects.
• It reduces the effort of the borrower to arrange a large sum of money.
• Since multiple lenders are involved, the borrower can benefit from the heterogeneity of loan terms. It allows the borrower to enjoy varying interest rates and different loan structures.
• Since there are bids by many lenders, the lead bank helps the borrower avail of competitive interest rates. This also boosts the borrower’s reputation since many lenders are seen as willing to extend a loan to them. 
• The lead bank oversaw the loan process execution and completion, allowing for better and more efficient management. 

Limitations of Loan Syndication

The limitations of loan syndication are: 

• The process of bringing multiple lenders on board is a time-consuming process, which may delay the project for which funding is required. 
• It may be challenging to satisfy every lender’s terms and conditions. 
• If the borrower encounters any financial difficulty, it can be challenging to honour the requirements of all lenders at once. 

Also Read: Emergency Loans In India: How To Apply For Urgent Loans

Final Word

Loan syndication is a helpful process for borrowers looking for considerable funding. When the borrower approaches a preferred bank making it the lead bank, it brings multiple lenders together to gather the amount. This process allows easy execution and seamless management of the loan, providing the borrower with the desired funds, and minimizing risk at the bankers’ end. 

FAQs on Loan Syndication

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Disclaimer: This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information, and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.