Consortium lending was introduced by RBI in 1974 as a process in which more than one bank could finance a single borrower which requires large credit limit. The lending banks formally join together, by way of an inter-se agreement to meet the credit needs of a borrower.
This approach was introduced with an objective to help the banks to spread the risk of lending and also break the monopoly of big banks to have the capacity to lend a big amount.
It involves common documentation, joint supervision and follow-up exercises between all banks /financial institutions.
PURPOSE OF CONSORTIUM LENDING
Banks undertake consortium lending for the following purposes-
- Risk- Sharing : When the amount of loan extended is higher, the greater will be the risk involved. Hence, in such cases the banks decide to enter in a consortium agreement with other banks to share the risk.
- Maintain the exposure limit : As per RBI regulations, banks have to maintain the credit exposure limit and cannot lend finance beyond the limit. So, the banks enter into consortium agreement with other banks in order to maintain this limit.
HOW CONSORTIUM LENDING WORKS ?
Consortium arrangement involves three parties namely, lead bank, member banks and a borrower.Lead bank is the bank which initiates the banking consortium while member banks are those which agree to contribute their share in the amount of loan to be lended to the borrower.
The lead bank would assess the borrower’s funds requirements, set common terms and conditions and share information about borrower’s performance to other lenders. The member banks will evaluate the proposal and decide on their share in the amount of loan to be extended to the borrower.
The bank which assumes the highest risk by giving the maximum share acts as an intermediary between the consortium and the borrower.
Thus, in simple words, Banking consortium is an arrangement wherein several banks join together to finance a single borrower thereby dividing the risk involved since the entire loan amount is divided among the banks forming the consortium.