Wholesale & Interbank Lending

Wholesale Banking

Wholesale banking refers to banking services provided by banks to  large corporate entities, public authorities. A loan may be advanced by single bank or by a syndicate of banks. It covers a range of service including treasury, cash management and lending requirements. Finance may be required in relation to mergers and acquisitions as well as working capital and other financial needs.

Types of Facility

An overdraft is intended to meet working capital requirements.  It is payable on demand.  Because of this, events of default and acceleration clauses and warranties, representations etc. are less extensive and may not be required.

A revolving facility is for a fixed period but may be drawn down and repaid and redrawn provided there is no event of default.

Contingent facilities are advanced,  typically to meet guarantee bond and letters of credit obligations in favour of a third parties.  The examples include letters of credit in the context of importing and bond requirements in the context of building, construction and development.

Treasury facilities allow the management of interest rates and foreign exchange risk.  They may involve a hedging arrangement under which a floating rate is exchanged for a fixed rate.

Project finance is generally non-recourse financing, where repayments are backed by particular assets or projects.  The lending is commonly to a special purpose vehicle.  See separate chapter on project financing techniques.

Acquisition financing may lead to the acquisition of a business or a corporate.  The lending is usually to a special purpose company which requires shares in the target company.  The repayment is based largely on revenues generated from the acquired target business.

Financing may involve number or layers of debt.  The senior debt is repaid in priority and may be advanced by a credit institution.  Mezzanine debt may be advanced by investors.  It will carry a greater risk but achieve a greater range of return.

Interest Rate

The  loan agreement shall define the applicable interest rate.  This may be a rate published by the lender with reference to market rates from time to time.  In corporate loans it is usually calculated with reference to the Euribor in euro.

Euribor is generally defined by reference to rates published daily. Generally, the rate is fixed two days before the interest period commences. The interest is the rate for the period generally three months plus the margin.

Some loan agreements measure the interest rate by reference to the lender’s costs of funds.  In the financial crisis, many banks were unable to access funds on commercial terms.  Many lenders were forced to rely on official lenders, the Irish Central Bank and the European Central Bank. It is preferable that the interest rate is defined by reference to some objective benchmark such as the Euribor in commercial lending or the European Central Bank refinancing rate, than by reference to actual costs of funds to the bank.

If the loan is repaid before an interest date, the lender will mostly incur break costs in relation to the funding of the loan.  This may be passed on to the borrower on demand.  It represents the sums payable on an equivalent deposit by reason of having to repay early.

Default interest may be applicable on breach.  There is a risk that if the rate is excessive, it may be deemed a penalty and accordingly be void.

The provision for repayment should be provided for.  There may be regular repayments through the term of the loan or there may be repayment or refinance at the end of the loan. The loan may be amortised regularly over the term in accordance with amortizing payables applicable to the term and interest rate.

Short Term Funding

Interbank lending provides short-term funds for banks.  Financial centres publish rates at which major banks are prepared to lend funds to each other for various periods.  The Euribor is interbank offer rate for deposits in euro.  The London interbank offer rate is the LIBOR   LIBED is the London interbank bid rate being the rate at which banks are prepared to borrow funds from each other.

Interbank loans were traditionally given unsecured.  However, the financial crisis has led to interbank lending being undertaken through collateralised transactions, to a greater extent, due to counterparty credit risk. During the financial crisis, in late 2008, the market largely dried up.

Issuing Debt

Financial institutions as well as large corporations and governments issue debt directly to the markets, in order to finance their requirements.  The debt may be purchased and sold in the secondary market. Debt securities may be short-term, securities of less than a year, referred to as money market instruments or longer-term debt securities (bonds) with maturities of five years or more.

Certificates of deposits are negotiable and re-issued in denominations with a maturity of at least seven days.  They are effectively funding on deposit.  Interest rates on commercial paper tend to be lower than bank rates and can be accordingly a financially beneficial form of funding.

Debt issues were rated by credit agencies.  In the financial crisis, many of the ratings of debt ratings were found to be highly flawed.  The EU has taken steps to regulate rating agencies.

Repo

A repo may have the effect of a credit or security transaction.  It involves the purchase and sale of the asset. The EU has made a regulation on transparency and reporting of financial transactions.  It applies to counterparties to securities financial transactions in order to reduce risk in the so-called shadow banking sector.

A repo is a transaction by which the seller agrees to sell securities to the buyer for cash and agrees to buy back the equivalent securities from the buyer at a future date.  The repurchase price margin effectively comprises the interest. The return on the cash is the repo rate which would generally be less than the interbank lending rate, Income and distributions are paid to the seller.

Repo transactions can vary from being overnight to two years or longer.  Most are generally very short being less than a month.

A repurchase is effectively a method of raising finance.  It gives the seller the effective ability to borrow cash at relatively low rate.  The buyer in effect has security.

Repos are used by Central Banks to manage liquidity.  They can be used to add or take from liquidity of banks.

Global Master Repurchase Agreement

The global master repurchase agreement is published by the bond market association and ISMA.  The provisions in relation to margin provide that if the value of securities held fall, the bank may make a margin call requiring transfer of additional cash or securities.  This provides additional collateral.  Parties must mark to market each transaction daily, making margin calls.

Close out netting provides in the event of default by one “borrowing” entity, that all transactions are accelerated and terminated, and the net sum is payable.  The repo involves the transfer of securities from the sellers’ custodians to the buyers’ custodian and the transfer of equivalent securities back on the repurchase date, third parties may administer and manage the exchange of cash and securities.

The collateral directive provides a repo transaction shall not be re-characterize the securities transaction.