My finances, my projects, my life
May 18, 2024

Lombard loans: a tried-and-tested product

  Compiled by myLIFE team myWEALTH October 25, 2021 1843

The perfect tool for wealthy and experienced investors

A Lombard loan is a versatile asset management tool for experienced investors, which can be used to create leverage in specific financial transactions, cover a temporary liquidity shortfall or resolve some tax issues. The key feature of this instrument is its flexibility, which is appreciated by many entrepreneurs and investors around the world.

Originating in Italy, popular worldwide

The name of the Lombard loan is derived from the collateralised loans granted in the Middle Ages. These transactions originated in the Lombardy region of Italy. Over the centuries, this type of loan spread out across the world from Italy.

A Lombard loan is appropriate for wealthy clients – in principle, very wealthy clients – offering them a credit line that can be used to cover temporary liquidity requirements without the need to touch their own capital. A Lombard loan facility is easy to set up and can be tailored individually as regards currency, amount, maturity, etc.

A Lombard loan is backed by the pledge of a securities portfolio held at the bank granting the loan. The word “pledge” may sound slightly worrying, but all it means is that a part of your assets (cash, bonds, equities, etc.) must be deposited at the bank in return for the credit line. The size of the credit line represents a proportion of the assets pledged. The amount depends on a variety of parameters such as the value, type, liquidity and volatility of the pledged assets. These parameters are analysed to determine the loan-to-value ratio, i.e. the collateral cover, which determines the size of the credit line granted. As market conditions are constantly changing, this ratio requires regular review and adjustment where necessary.

The major risk is a capital loss if markets fall.

Depending on the form chosen, the principal is repayable either on a fixed maturity date that is defined in advance (on average between one and four years), or whenever the client wishes and without any surcharge. This flexibility is possible because the pledged assets have a higher value than the cash that is made available. As interest is payable on this cash, the financial institution is in no rush to see the credit repaid.

The origins of the term “Lombard” date back to the Middle Ages. It refers to the banking services offered by Italian traders in Lombardy from 1400 onwards. In the wake of economic expansion in the Western world in the 12th century, these traders were the first to satisfy the demand for consumer credits, thus laying the foundation stone of the bank lending business.

The desired leverage

A Lombard loan is only suitable for experienced clients who wish to leverage their assets to raise liquidity, without having to sell those assets (e.g. equities or bonds). In concrete terms, it means that you can finance the acquisition of additional financial products via bank loans. The aim is to generate a higher return on the investment financed by the credit line than the loan interest payable.

But that isn’t the only advantage. A Lombard loan offers liquidity in various situations and doesn’t require you to change your own asset strategy. It provides:

    • the leverage effect mentioned above;
    • investment diversification from the availability of additional liquidity in your securities portfolio; and
    • substantial liquidity in various currencies available for the purchase of attractive investments in the near term.

As well as a flexible term, amount and currency, another key advantage of the Lombard loan is that the available credit line can be changed at any time by a simple adjustment in the structure of the pledged assets. The size of the credit line depends on the cover value, i.e. the type and amount of assets pledged to the bank that grants the credit line.

There may also be tax advantages associated with investments financed by loans. Experts know best which options are available.

Speculative risks

A Lombard loan is directly linked to financial markets and its risks. The leverage that it provides gives it a speculative nature. This means that the major risk is a capital loss if markets fall. Depending on the currencies agreed, a Lombard loan may also be subject to exchange risk.

Additionally, the loan-to-value ratio changes over time, and depending on changes in the assets in the portfolio, you must be prepared to increase the level of assets deposited as collateral, or even to accept a reduction in the credit line granted. If you are not in a position to meet these requirements, the bank will liquidate the pledged assets, i.e. sell them, in order to recover the loan capital.