What is Lombard lending
Lombard lending, also known as portfolio financing, is a process which allows private banking clients to take loans from their bank at competitive interest rates using their securities as collateral. The borrowed funds are typically used to pursue other investing opportunities, thus enriching the client’s portfolio. The minimum loan amount is typically USD$100,000 and the maximum loan amount is usually based on a percentage of the market value of the portfolio.
Lombard loans can come in the form of either a Current Account loan or a Fixed Advance Loan. A Current Account loan allows for a flexible loan amount and time period but at generally higher interest rates based on capital market conditions. On the other hand, a Fixed Advance loan has a set loan amount, time period and interest rate.
Benefits of Lombard lending:
Quick and easy access to capital
As Lombard loans are backed by existing securities deposited into the bank through the client’s custody account, banks generally incur little to no risk in approving a loan. This means that the lending process is generally straightforward and can be completed within a very short time frame. This is especially beneficial for borrowers who require immediate cash for reasons such as financing a business. Finally, the loans also tend to have very competitive interest rates and can be granted in a variety of different currencies.
Ability to optimise portfolio
Making use of a Lombard Loan for investment is a prudent strategy as the borrower does not have to sell off any of his existing assets for capital. Thus they are able to continue making money for the client. Using the money to invest in a good company can also benefit the borrower as the capital appreciation and dividends generated could be used to cover the accrued interest from the loan.
Some countries provide tax deductions on the interest charged on loans. Therefore, it is possible to minimise a borrower’s tax burden through the use of a Lombard loan.
Risks of Lombard lending
However, there are important risks that borrowers should take note of as a result of using their assets as collateral. One example is, if the value of the client’s portfolio decreases in value, either due to market or currency fluctuations, the client might be required to increase the assets as collateral or reduce the value of the loan. Another risk is that the banks are entitled to liquidate the borrower’s assets if the loan terms are breached or the borrower is unable to repay the loan. This could result in significant losses as the client loses the potential income and capital appreciation of the securities as well as existing assets in the account. Lastly, tax laws differ from country to country and there is always the possibility that they can change in the future. Thus borrowers should keep abreast of changes in tax laws so as to prevent taking an undesirable tax position.