BANKING CONSORTIUM



The existence of loans have revolutionized the world by allowing individuals or even companies that lack the required credit to lend it from a third party.

A big portion of the current day businesses take debt to expand, invest in research or even counter their losses and money lenders like banks make revenue by giving out those debts and earning an interest over the returning period. Small loans are simple to handle and usually don’t require any additional steps other than the routine. Banks have set interest rates for different ranges of amounts. However, There are certain individuals that require loans of big amounts. Banks protect themselves from credit risk by holding an asset of the borrowers as collateral. If an individual or a firm is in need of a big loan from a bank, Then according to the Reserve Bank of India(RBI) a single bank cannot give more than a

specified 50% of the loan amount.This arrangement setup by the RBI is called The banking consortium.


Introduction to banking consortium

Banking consortium is the practice in which more than one bank provides financial assistance to a borrower. Banking consortium only occurs when the loan amount asked by the borrower is very large. In the banking consortium there are three parties involved.

The first being the lead bank, the member bank and the borrower.

Lead bank is the bank who initiates the process for lending. Member banks provide the remaining portion of the funds required by the firm.


Purpose of banking consortium

Banking consortium is undertaken by banks due to the following reasons:


Risk-Sharing - This is the main advantage of a banking consortium. If a bank single handedly lends such a hefty amount and the borrower defaults on the loan, Then that one bank is at a huge loss. However the same risk is shared by multiple banks when a banking consortium is formed.

Maintaining the Exposure Limit- RBI has given guidelines with respect to banking consortium that no bank can lend more than 50% of a loan in this arrangement reducing the exposure

limit of the bank and ultimately preventing a bank from going bankrupt. Therefore it maintains the exposure limit.


Procedure Involved In Banking Consortium

Under this arrangement, a prospective borrower approaches one particular bank for availing financial assistance. The bank will then evaluate the proposal and decide on the members along with whom they will enter into the banking agreement. The member banks will evaluate the proposal and decide on their share in the amount which will be lent for the purpose of the financial assistance to the borrower.

The banks under consortium are bound by the following procedures:

Evaluation of proposal

Whenever a borrower comes to the bank for a potential loan and the loan is an amount that falls under the RBI Guidelines, The lead bank will follow an arrangement of banking consortium. The lead bank evaluates the party who has asked for a loan and it checks the credibility of the party to assess the credit risk. If the borrower passes all criteria, Then a banking consortium is formed and the loan is issued.

Documentation

The lead bank will scrutinise the documents of the borrower and check

for the authenticity of the document. Banks are wary of misleading or incorrect information since that is a potential scam in the making.

Credit Information Exchange

After examination of the documents, the bank will ask the borrower for any loans or financial assistance that they may have taken in the past. The bank will also cross check the same with the Lender of that credit and will confirm whether the borrower made late payments during the tenure in the previous loan. 

Consortium agreement

After being satisfied with the credit information report of the borrower, the lead bank and member banks enter into a consortium agreement with the borrower.


Difference Between Loan Syndication and banking consortium

There are not a lot of differences between a banking consortium and a loan syndication with respect to the arrangement. The only difference being that loan syndication is used for sanctioning of multi currency loans.


Conclusion

Banking consortium is a key element to the banking sector worldwide. A banking consortium protects banks from the risk of default by big loanees. It works on the concept of risk sharing as multiple banks come together to pitch in a portion of a big loan being lent. Banks are an important institution in the economy and benefit almost everyone. Hence it makes it crucial for regulatory bodies like RBI to put into effect elements like banking consortium to protect banks.


Sources-

https://www.investopedia.com/terms/c/consortium-bank.asp

https://www.mondaq.com/india/financial-services/965138/banking-consortium-and-it39s-legal-aspects

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