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Increasing The Flexibility of Bank Lending

By Edited Nov 12, 2016 0 0

Two new market instruments are examples of financial innovation that help increase the liquidity of banks' port-folios and encourage banks (especially in the second tier) to maintain a lending relationship with developing countries.

(1). Transferable loan instrument (TLI). The TLI provides a standardized means by which a transfer of lending commitments can take place from a primary lender to a secondary market. In effect, TLIs create a secondary market for bank loans. When a bank makes a loan commitment, it can sell one or more TLIs to another bank or financial institution. The TLI entitles its holder to receive interest and other benefits of the original loan agreement, just a though the holder had itself been the primary lender. The TLI would be sold in various denominations, subject to some minimum size. It would typically be repaid in one lump sum on a date determined by the scheduled repayment dates on the original loan. From the borrower's standpoint, TLIs offer international banks scope for managing their assets more flexibly. And because TLIs can be sold in packages of varying maturities and denominations, they are potentially attractive to second-tier banks.

Although TLIs have thus far been used for industrial-country loans, they could be extended to developing-country finance as well. However, borrowers and lenders will have to move gradually, so that the market value of developing-country debt is not abruptly reduced when TLIs are traded.

(2). Note issuance facility (NIF). The NIF combines the characteristics of a traditional syndicated credit and a bond. The NIF is one of a set of hybrid instruments which have recently been launched in the market. A NIF is a medium-term loan which is funded by selling short-term paper, typically of three or six months' maturity. A group of underwriting banks guarantees the availability of funds to the borrower by purchasing any unsold notes at each roll-over date or by providing a standby credit. As funds are drawn, the underwriter either sells the securities or holds them for its own account. The borrower has guaranteed access to long-term funds; the underwriter holds a liquid, marketable security, potentially attractive to a wide range of investors. The facility has the added attraction to the borrower that it can be substantially cheaper than a standard Eurocurrency loan. The Korean Exchange Bank and the Republic of Portugal have, for instance, recently arranged Euronote facilities.

The fast pace of growth of NIFs and similar hybrid instruments-which totaled $9.5 billion in 1983 and increased to about $20 billion in 1984-has raised concerns among banking regulators. Banks could have to take on their books high-risk loans if a borrowing entity (faced with, say, a fall in its creditworthiness) were not able to refinance its Euronotes in the market.

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