If you have a private banking account, you may have noticed your bank offering “lombard loans” or “lombard lending facilities”. While less known to the wider public, lombard lending can represent an interesting financing alternative for those who have access to it.
What Is Lombard Lending?
In general, a lombard loan is a kind of loan that is backed by assets, which for the purpose of the loan are called “collateral”. The role of collateral is to protect the creditor from risk – if you fail to repay the loan, your bank may sell the assets to get the money back. This mechanism is similar to the way your house acts as a guarantee for your mortgage, but in case of the typical lombard loans provided to private banking clients, the assets used as collateral are mostly liquid assets such as stocks, bonds and other investments, often including life insurance plans.
Note that lombard lending is not limited to banks lending to their individual clients. Much greater volumes of lombard lending transactions flow among banks and other financial institutions on a daily basis. Thanks to its risk limiting advantages, asset backed lending is literally the lifeblood of the financial industry.
The name “lombard” has the same origin as Lombardy, the region in north Italy, whose people, the Lombards, were known as skilled bankers and lenders throughout the Medieval Europe.
Why Take Out a Lombard Loan?
When you need a bigger amount to spend or pursue an upcoming investing opportunity, a lombard loan can be a cost effective and flexible financing solution. Even when you have high liquid wealth, selling your existing investments to get the cash you need may not be the best option for various reasons (e.g. you may prefer to stay invested in anticipation of favourable market development, to continue to receive dividends, or for tax reasons). Instead of selling you can use the assets as collateral for the lombard loan.
Flexibility is one of the main benefits of lombard loans. Most banks offer them in all major currencies and across a range of maturities, typically from one week to 12 months. At maturity you can either repay the loan in full or roll it over (providing that you still have sufficient collateral).
Another key advantage is low cost. Because the risk is limited by the collateral, the bank can offer lower rates. This is again similar to mortgages, which also tend to have much lower rates compared to consumer loans and credit cards.
Lombard Loan Interest Rates and Costs
The interest rate typically consists of two portions:
- The bank’s cost of financing for the particular currency and term, usually represented by an interbank interest rate such as LIBOR. Luckily at present most of the world’s major currencies, including the dollar, euro, pound and yen, have very low interest rates.
- The bank’s margin, which is typically between 100 and 300 basis points (1 and 3 percentage points).
In addition to interest, commissions and other fees may apply in some cases. All the loan’s parameters, including the rate, flexibility of term, amount and fees, depend on the particular bank’s policy and the size and history of your business with them – the bigger and more important you are for your bank, the better they will treat you.
Limitations and Risks
While you don’t need to be a millionaire to have access to lombard lending facilities, minimum loan amounts apply ($100,000 is quite common, though far from a universal rule). The key prerequisite for taking out a lombard loan is having some assets eligible as collateral. Usually the market value of the assets needs to be higher than the loan amount, in order to provide a cushion for price fluctuations.
The key parameter that both you and your bank will be watching carefully is the loan-to-value ratio, or LTV. It is typically around 70% (you can borrow up to $70 for every $100 in assets), but can vary greatly, from as low as 15% to as high as 90%, depending on the bank, the customer, the maturity and the kind of assets (more volatile assets such as stocks require greater cushion and therefore lower LTV).
When taking out a lombard loan you should always keep the risks in mind, particularly when using the funds to buy additional investments. Leverage and flexible financing are a double edged sword and asset prices can go either way.