Sources of funding for the corporate sector (pt 2)
This feature is a continuation of an earlier publication on various funding sources available to corporate bodies; and the usefulness of these funds to the expansion and growth of firms in an economy.
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Discussions in the previous write-up ended on sources of funding for the corporate sector in the short term.
Long-term borrowing instruments
These include equity finance, company bonds, bank loan and documentation, debentures and lease financing, and others. For competitive reasons, banks tailor their financial or loan packages to suit the needs of their teeming corporate borrowers.
Provision of adequate services helps banks to expand their clientele base. Definition of long-term borrowing varies from one financial institution to the other.
Commercial banks define term-to-maturity beyond one year as long term; a term-to-maturity up to one year as short term. To Development banks, term-to-maturity up to five years is short term; and maturity above five years is long term.
Some banks define medium term to include one to five years; long term from one to ten (10) years.
Mortgage contracts may be signed from ten to thirty years. A term loan may be retired earlier than its maturity date. When this occurs, an early cancellation fee is usually charged by the bank or financial institution.
Types of interest rates
Interest charged on long-term loans may be fixed or variable. A fixed interest rate remains stable for a considerable period of time, usually over the life of the loan facility.
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The life of a loan may be fixed if it is for a short period, usually three years. Loan terms that extend beyond this period may have a portion being fixed and another being variable. An interest rate that has both fixed and variable components can be described as semi-variable interest rate.
A variable interest rate changes with the level of economic financial factors; variable interest rate increases when there is inflation and decreases when there is a fall in prices. A fall in price leads to lower inflation rates.
Loan security and covenants
Most banks require a security to back corporate or individual customer loan agreement. A security is often in a form of assets. The lender may institute floating charges against the assets of the borrower. In addition to the floating charges, there may be specific charges for maximum loan protection.
Covenants in a loan agreement may compel the borrower to maintain minimum financial ratios. An example is the capital gearing ratio, which measures the proportion of debt to equity.
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Bank charges on loans
Most banks charge commitment fee for arranging the loan facility; they charge other fees to off-set tying of their funds or capital in the loan to the borrower. The capital adequacy concept requires banks to maintain certain amount of money to meet specific demands at all times.
In some cases, commercial banks’ lending exceeds the maximum threshold. When the foregoing occurs, that is, if the commercial bank does not meet its capital adequacy requirement, the central bank may impose a cost, fine or penalty on the commercial bank.
Sometimes, a loan amount required by a corporate customer may be exorbitant for one bank. Here, the bank may try to form a syndicate with one or more banks to raise the needed funds for the borrower.
The organising bank plays a leading role and negotiates with the borrower on behalf of the syndicated banks contributing to the finance of the corporate loans.
Use of commercial paper
In some cases, the loan amount required by the borrower may not be too high for the lender. However, the lender may not wish to be exposed to one borrower or one sector of the market.
Use of commercial paper becomes more popular in booming economic periods than bank loans. This becomes the case when commercial paper facility does not involve an intermediation. The reverse is true.
Syndicated loans
Syndicated loans allow banks to enter into new transactions or contracts and earn selling participation fees.
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The cost of borrowing becomes lower for corporate borrowers under syndicated loans than it may cost when smaller amounts are raised from a number of individual bank.
Use of commercial paper
In some cases, the loan amount required by the borrower may not be too high for the lender. However, the lender may not wish to be exposed to one borrower or one sector of the market.
Use of commercial paper becomes more popular in booming economic periods than bank loans. This becomes the case when commercial paper facility does not involve an intermediation. The reverse is true.
Syndicated loans
Syndicated loans allow banks to enter into new transactions or contracts and earn selling participation fees.
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The cost of borrowing becomes lower for corporate borrowers under syndicated loans than it may cost when smaller amounts are raised from a number of individual banks.