There are various options for bridging a liquidity shortfall using a loan. In the case of a lombard loan, for example, the borrower deposits collateral such as securities with the lender. We explain how a lombard loan works in principle as well as the opportunities and risks it holds.
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A lombard loan is a loan for which an asset is pledged as collateral. For example, account balances, life insurance policies, securities or other assets can be used as collateral. Lombard loans granted against securities are widespread. This involves the holder of securities pledging their shares or bonds (and similar assets) as collateral to obtain a loan.
A lombard loan enables borrowers to cover their short-term liquidity needs without having to sell their assets. As with a personal loan, a lombard loan is used as a means of averting a temporary liquidity shortfall.
The following example is intended to illustrate how a lombard loan works. Let’s assume that some time ago you invested part of your savings in securities because you wanted to benefit from the opportunities for returns on the financial markets. Your securities custody account now contains shares and bonds worth around 150,000 francs. You are unexpectedly presented with a major investment opportunity and need 60,000 francs to invest. But you only have half the amount you need in your savings account. A lombard loan makes it possible for you to obtain the money without having to sell your shares and bonds. This means you can skim off the returns on your securities if prices increase (though you also bear risk if prices fall). At the same time, you grant the bank the right to sell your shares if you cannot repay your loan debt on time.
The assets pledged as collateral are mortgaged at a percentage of their respective market value; this is also referred to as the lending rate. This is determined on an individual basis, partly because not all securities have the same risk. But also because the value of the collateral is impacted by how tradeable the individual investments are and the diversification of the portfolio.
The term “lombard” is derived from the northern Italian region of Lombardy, where money was being lent against collateral securities as early as the Middle Ages.
