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Securities Loan - Legal foundations and framework
Securities Loan as a term loan
Securities loan replaced by the marginal lending facility
Pledging movable or immovable tangible assets to secure a loan is one of the oldest forms of financial activity, with origins dating back to the 16th century. Soon, not the object itself but merely a paper certifying the right of possession changed hands. What options exist today for securing a loan with assets, how do they differ, and what should be considered in such transactions?
Securities Loan - Legal foundations and framework
Securities loans and Lombard credits rank among the oldest forms of collateralizing a loan. Already in the Middle Ages money was lent in exchange for a pledge; corresponding records date back to around 1500. The term Lombard credit derives from the Lombardy region in northern Italy, which at that time was a significant financial center. Legally, a securities loan is a loan secured by pledging securities held in a custody account; the lender (e.g., a bank) thus becomes the holder of the securities until the loan is properly repaid. The securities loan therefore solely involves collateralization by securities, whereas Lombard credits as security instruments to hedge default risk can also include indorsed (made transferable by endorsement) so-called tradable certificates that evidence ownership rights in movable or immovable property but are not tradable on the financial market.
Securities Loan as a term loan
A Lombard credit is granted as a term loan, with typical maturities of up to 2 years. The loan amount can be drawn once as a lump sum or in partial amounts; in any case, the outstanding amount on the maturity date must be repaid in a single payment. The maximum loan amount is always below the lending limit of the securities or other assets pledged as collateral. Since the lending institution does not refinance such a Lombard credit on the capital market, such a loan must be priced on a calculatory basis rather than according to market principles, which directly affects the interest rate calculation. The level of interest therefore depends, among other things, on whether the lending institution must back the pledged loan collateral with equity capital. Except for commodity Lombard credits, the assets used as collateral cannot be further used until the loan is properly repaid, since they pass into the possession of the lending institution. Legally, however, the borrower remains the owner of the pledged assets.
Types of Lombard credits
Basically, securities loans are distinguished by the type of collateral. Goods covered by a certificate that not only entitles the holder to delivery of the goods but also, by endorsement, transfers ownership of the goods themselves, can be financed by a commodity Lombard credit. In this role, the Lombard credit serves to pre-finance the purchase of goods and is then repaid from the proceeds of the goods sales. Since the bill discount credit, in which a bill is originally used as security for a loan, plays practically no role in modern finance, bills are today used by credit institutions only as a bill Lombard credit. Besides meeting the formal legal requirements for a bill, such bills must meet the purchase conditions for domestic bills set by the Bundesbank; they can then be pledged up to a maximum of 90% of the nominal value. The collateral function of such a bill is always derivative in nature, since in practice it is used only together with tradable certificates endorsed in favor of the lending bank that evidence a tangible asset corresponding to the loan amount. In a securities loan (securities loan) the loan transaction is secured by pledging shares. There are two ways to make use of this. In the actual securities loan, securities listed on the capital market are used directly for short- or medium-term collateralization of a loan, whereby the amount of the loan granted in this way is always below the maximum lending limit of the pledged securities. In the form of a securities-backed loan, a securities loan can also be used to finance the purchase of securities. The acquired securities are then retained as collateral for the loan but remain the property of the borrower. Due to the risk of price fluctuations in the securities deposited as collateral, the loan amount may be set by the lending bank significantly below the lending limit of the share depending on the assessment of price risk; the bank or lending institution also typically reserves the contractual right to demand additional collateral from the borrower in the event of substantial price declines.
Securities loan replaced by the marginal lending facility
Since the founding of the European Central Bank (ECB) in June 1998, which acts as the central institution for all national central and commercial banks of the EU member states, it has ceased to be the task of national central banks like the Deutsche Bundesbank to provide Lombard credits against the pledge of listed securities as part of refinancing measures. By transferring responsibility for national money market policy to the European Central Bank, the securities loan was superseded by the so-called marginal lending facility. This gives national commercial banks the possibility to obtain needed capital from the ECB at any time at the marginal lending rate set by the central bank. According to its statutes, the ECB is also authorized to enter into arrangements with the credit institutions of the EU member states for so-called central bank-eligible collateral. The uniform list of eligible collateral that has been in effect since January 2007 includes marketable as well as non-marketable collateral and specifies concrete lending limits for the individual types of collateral depending on liquidity, maturity, and interest rate type. A special form of Lombard credit is the so-called securities lending. This is an in-kind loan in which the borrower, in his capacity as the borrower, simultaneously becomes the owner and possessor of the securities and, in return, provides the lender with the agreed equivalent in cash or also in the form of other securities. Such a securities lending can also be the subject of a securities loan between central banks, since the borrowing credit institution can obtain capital from the central bank by pledging central bank-eligible securities. Precious metals can also serve as collateral for a loan; such a loan transaction is called a precious metal Lombard credit. Although this form of lending is one of the oldest types of loan transactions, the precious metal Lombard credit has lost importance today and is mostly handled only in pawnshops. The lending value is calculated from the effective precious metal value (market value) of the pledged item; the maximum loan amount is usually 80% of the lending value. In the context of a so-called receivables Lombard credit, both rights and receivables can be pledged to secure a loan. In practice, pledging receivables from life insurance contracts and the assignment of salary claims for collateral purposes are particularly common.