What Is Secondary Loan?

I have checked on Google and youtube about secondary loan but couldn’t find much on the topic since it is known by several names in different countries and possibly searched using low-level terminologies used during the process. So, I’ve decided to write something about it so that people interested in this area might get benefited. As knowledge sharing is my idea, I will continue to share knowledge in a general way considering the confidentiality and sharing limitation been regulated in united states.

Selling debt and secondary loan market


Most of the time, people get confused with the term selling debt and secondary loan market. We know that it might be related with loan given by the middle/secondary group of bodies, and it is different from first degree loan. However, this is apparently true but it is too general to brought-in in this secondary loan market. Allow me to explain in a layman term to you.

Let’s start with, how organizations sell debts?? And to whom and who all comes into the process really matters. I am writing this to help people who really bother to understand how it works. Finance is a straight forward business which is mostly regulated by self understanding and some agreed laws (viz LSTA etc, could be different in different countries), and unlike bonds, loan has no such obligations. Loan is an independent practice which is there for investments. It does the same thing what it is designed for, it basically help poor organizations, I am sorry I have been little sarcastic, okie lets call them needy organizations. Guess we have learned something during MBA, BCG matrix with Cows, dogs, stars and the bullshit…. It does the same thing, taking money from the wealthiest organizations and gives it to needy organizations so that they can expand or strive. During the course of action, banks can play “inception” I liked that movie a lot? This will help in describing secondary loan mechanism which is extremely different from primary loan because of loan-debt and debt again and again from one to another hedge funds/fund managers or sometimes the investment banks.

How inception? Loan is once given can become debt and this debt can be sold to other banks or hedge funds/fund managers for generating profits. This is how it becomes complex, loan after loan after loan. I will try to make it simple with an example, say there are 3 people, A (AB myself), B (investment bank) and C (Hedge funds/fund manager). A asked B for lending him 4 dollars, and B lend A 4 dollars with an agreement of returning in a week time with 1 dollar interest. Now A has a debt of 4 dollars which he has to give it to B by the end of this week with 1 dollar interest. B has decided to borrow money from C and will seek someone else who can ask for loan again. B asked for 4 dollars from C and both agreed for a period of 1 week and $.50 interest. B gets a new guy D asking for loan and they agreed for another 1 dollar and a week payback. So, considering only these many loan/debt transfers B gets $1.50 as profit at the end of this week.

Note: B is the lender and A is the borrower. In secondary loan market, B is the assignee, C is assignor (transferring the paper) and A is the borrower.

In complex scenarios with bigger budget and uncertainties of the assignors and borrowers, due to LSTA (Loan syndicate trade association) it becomes transparent who all are different parties, and there is a whole set of approval system for the process. In this scenarios B (Investment Bank) will interact with C (Fidelity investments) asking their concerns of doing deal with A being the borrower. When C agrees then B hires an agent [agent could be someone from B (investment bank as well), or it could be from different institution, JP Morgan charges $XXXX for signing as an agent]. Agent now go to A (AB – myself) asking would you like to have a deal with C? Do you think C will be faithful? It solely depends upon A to accept (yes) or reject (No). If it is yes, the deal is done and debt is sold. This is how secondary loan market works; there are plenty of other stuffs with it.

I can understand the agony of not having finance background, but trust me finance is so simple and straight forward industry compared to other industries but yes it can become complicated at times.

What Is Secondary Loan?

Whats new in Basel III

BCBS (Basel committee on banking supervision) was established in 1960 for Banks to deal with globalization and is situated in Basel, Switzerland. It focuses on exchanging information on national/international banking related issues, process and techniques. These recommendations are just made for the banks benefit but not mandated by any legal force. The countries taking part in BCBS are Argentina, Australia, Belgium, Brazil, Canada, China, France, Germany, Hong Kong SAR, India, Indonesia, Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, Russia, Saudi Arabia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States. BCBS recommends certain standards and regulations for banks. Why it is necessary? Yes, it is for lowering credit risk, banks should hold enough capital to equal at least 8% (which depends on countries to countries) of its risk-weighted assets.  BCBS members meet four times a year at Bank for international settlement (BIS) in Basel, Switzerland. The role of the community is quite clear to bring best practice in banking supervision. There happen information exchange on banking supervisory and issues related to banking. Basel II is more detailed written and documented motif for bank’s supervision, which bring recommendations that are more detailed for banks adding to previous documentation done in Basel I. Basel II includes recommendations on risks, supervisory review and market discipline. There are banks trying to implement these recommendations of Basel II, and it might take time till 2015. Basel I and Basel II which are primarily related to the required level of bank loss.

Basel III is also a set of standards and practices created to help international banks maintaining adequate capital for sustainability. This sustainability is mainly concerned at tough economic situations. Basel III attempts to add more control in banking industry those are required by Basel II which in turn the refinement of Basel I. As per Basel II, banks should declare both risky investments and risk management practices. Basel III establishes more strict regulations, tripling the amount of cash reserves must be present to deal with financial crisis. It also requires banks to maintain higher common equity than before including capital conservation buffer of 2.5% of their assets.

Basel III has been appreciated in many parts of the world for regulating banks and reducing systematic risk (beta), but also attracted plenty of criticism. There are studies suggesting it results in increased bank capital requirements on loan volumes and rates, also resulting in higher equity to debt ratios which causes higher lending costs, even there are plenty of implications to be seen due to Basel III regulations.

Source: http://chicagopolicyreview.org/2012/04/24/will-basel-iii-help-or-hurt/

“In their study of banks from 2001 to 2009, Cosimano and Hakura rely on a core principal of the academic finance literature, the Modigliani–Miller Theorem (MMT), and argue that the higher equity-to-debt ratios required by Basel III will likely increase borrowing costs for banks. This is because banks can raise money in two ways: by borrowing it (issuing debt) or by selling the rights to their future profits (issuing equity). According to the MMT, under ideal conditions an increase in the proportion of equity (which is historically more expensive than debt) should be offset by a decline in the cost of debt due to lower risks of insolvency.”

However, empirical results contradicts MMT and find that it is extraordinary expensive for a bank to raise funds by higher equity to debt ratio. Basel III regulations threatens to dramatically increase the cost of lending money. For example 1.3% increase in the required equity to debt ratio will increase loan rates by 16 basis points (.16%) across the worlds’ 100 banks.

This post in under construction………………