What is a Lombard loan?

Pledging a gold watch at the pawnshop — that is how it began. Gold coins and gold pocket watches have accompanied pawnshops for centuries. Even today, the Lombard loan is still a short- to medium-term pawn loan, but it is usually granted by banks. In return for assignment (pledge) of movable items, bank deposits or securities, loans are granted to private or commercial borrowers.

Overview of the Lombard loan

The Lombard loan, already popular in the Middle Ages, derives its name from the Lombardy region in northern Italy. As a short-term loan, the Lombard loan is usually limited to a term of two years. It can be disbursed as a single total amount or in partial amounts. In all cases, however, the Lombard loan must be repaid in one sum by the agreed due date. The collateral items transferred by the borrower to the bank are characterized by a high degree of liquidity. Easily marketable assets that are provided as collateral in a Lombard loan, such as the surrender values of life insurance policies or delivery notes for traded goods, are easy to value according to objective principles and can be quickly sold on the market.

Terms of the Lombard loan

The amount of the Lombard loan is determined by the assessed lending limit. For this purpose, the pledged loan collateral is valued at market standards and thus determines the height of this lending limit. The agreed lombard interest rate or lombard rate, on the other hand, is not based on market interest rates for loans but is calculated by the bank. The more equity the lending institution must provide to cover the agreed loan amount, the higher the lombard rate will be. The most favorable lombard interest rate can therefore be achieved by pledging bank deposits (such as time deposits).

Types of Lombard loans

The collateral provided for a Lombard loan must be movable and have a high degree of liquidity. Depending on the pledged item, which often also determines the intended use, different types of Lombard loans are distinguished:

Issuance by the central bank

Banks themselves sometimes need additional liquid funds. Before the introduction of the European Central Bank, national banks in Europe obtained liquid funds via Lombard loans from their central banks. As security, the bank transferred lombard-eligible securities to the central bank. A security is lombard-eligible if the borrower is also the owner of the item, which meant that securities from customer portfolios could not be used to increase a bank's liquidity. The amount of the Lombard loan, which was granted for a term of up to three months, was determined by the lombard line. This line or lombard quota formed the total credit limit up to which the Deutsche Bundesbank would extend Lombard loans to a credit institution. In the ECB's monetary policy, the marginal lending facility replaces the Lombard loan. Here too, "central bank-eligible securities" are transferred to the ECB.

Securities Lombard loan

The collateral for a securities Lombard loan consists of marketable securities. Shares, bonds or entire securities portfolios of private borrowers are assigned to the bank with the securities Lombard loan. The intended use of the securities Lombard loan is limited to the pre-financing of securities transactions (margin trading). However, since market fluctuations in the value of the securities can change the lending limit during the term, margin calls may be triggered in the event of falling prices. The borrower is obliged to secure the agreed lending limit by further pledges to the bank in order to prevent termination of the securities Lombard loan (negative declaration) by the bank. The lending limit is usually 50 to 75 percent of the market value of the pledged securities.

Commodity Lombard loan

Goods can also be pledged to the bank. A tradition paper (a negotiated order paper under commercial law) for the pledged traded goods, which is transferred to the lending institution, is required. Negotiated tradition papers include the bill of lading, the loading certificate and the warehouse receipt. The commodity Lombard loan is also limited in purpose to the pre-financing of goods purchases or imports, and its repayment usually takes place from the resale of the pledged goods.

Bill Lombard loan

The bill Lombard loan is reserved for the refinancing of credit institutions at the Bundesbank. Bills that can be pledged at up to 90 percent of their nominal value must meet the Bundesbank's purchase conditions for domestic bills. Their rediscountability must therefore also be ensured.

Non-genuine Lombard loan

Of no significance in banking practice, this credit type described in business literature is an overdraft loan secured by rights or movable items. The only distinguishing feature from the "genuine" Lombard loan is the account to which the made available credit amount is paid out.

Precious metal Lombard loan

In a precious metal Lombard loan, precious metals such as platinum, gold and silver are pledged as securities. As one of the oldest forms of credit, the precious metal Lombard loan is still common practice in pawnshops. The lending value is based on the effective precious metal value of the pledged item. Depending on the pledged item, a discount is applied; for coins this is approximately 20 percent, so a loan amount of about 80 percent of the lending value can be granted. Even if the pledged item can fetch a significantly higher market price from collectors, this circumstance is generally not taken into account when determining the lending limit.

The Lombard loan in law

The Lombard loan is regulated in the Bürgerliches Gesetzbuch (German Civil Code), §488. As a loan with transferred loan collateral, the lending institution becomes the indirect (transfer of the item) or direct (transfer of rights) possessor of the item (regulated in §§1205, 1296 BGB). In all cases, however, the borrower remains the owner of the pledged item. If the borrower fails to meet their repayment obligations, the lending institution can realize the collateral. A one-month notice of intent must precede this realization. If the value achieved for the pledged item on the open market (sale on the stock exchange or through a broker) is higher than the remaining debt at the bank, the surplus is due to the borrower. If less is realized, the borrower remains liable for the remaining debt.

The Lombard loan in practice

If liquid funds are needed at short notice and easily marketable but not liquid assets are available, these can be pledged as collateral for a Lombard loan. A life insurance policy or a fixed deposit thus becomes the basis for raising capital without having to liquidate the existing holdings or reduce their value. The especially favorable interest rate of the Lombard loan makes it a particularly attractive form of financing. When financial assets are pledged as collateral for the Lombard loan, the most favorable lombard rates can usually be negotiated. The Lombard loan makes effective use of existing assets to acquire new funds on very advantageous credit terms in the short term.

Lombard loan — not just for short-term liquidity shortages

With its favorable terms, the Lombard loan is not only interesting in commercial transactions but also for private borrowers' purchases. Its particular strength is shown in securities transactions, where it provides liquidity to the securities buyer without requiring access to the pledged securities account or to funds tied up for the long term. Thus, the Lombard loan offers highest flexibility and favorable lending conditions in both the private and commercial sectors. In consumer lending practice, the Lombard loan is increasingly used. Equipped with financial products for private retirement provision, many borrowers have extensive collateral available that can be used for short-term financial bottlenecks.