What is funded risk participation ?

Risk participation is a type of off-balance-sheet transaction in which a bank sells its exposure to a contingent obligation, such as a banker's acceptance, to another financial institution. Risk participation allows banks to reduce their exposure to delinquencies, foreclosures, bankruptcies and company failures.

• Sometimes a party will not want to take a direct novation of a loan but for one reason or another will want a commercial exposure in the loan. It may be motivated to do this because it has taken a positive credit position on the borrower and would otherwise be prohibited for one reasons or another from lending directly to the borrower as a lender of record.
• Under a funded participation the existing lender (as grantor) and the participant enter into a contract providing that in return for the participant paying the existing lender an amount equal to all or part of the principal amount of the loan made by the existing lender to the borrower – it is a separate back-to-back contract which creates a debtor-creditor relationship between the existing lender and the participant
• The ‘commitment’ that the participant provides is often referred to as a deposit. The existing lender agrees to pay to the participant principal and interest due under the loan (proportional to the participant’s commitment or deposit) and which is received by the existing lender from the borrower.
• Because the funded participation agreement is made between the existing lender and the participant the borrower will be unaware of the arrangement. The participation creates a new contractual rights between the existing lender and the participant which are drafted to emulate the same rights that the lender has with the borrower.

• However a participation is not an assignment of those existing rights and the existing lender remains in a direct contractual relationship with the borrower. In a funded participation, the participant agrees that its deposit will be serviced (in terms ofpayment of interest) and repaid only when the borrower services and repays the loan from the existing lender.
• The participant has effectively taken on the risk of the first loan.
• The participant effectively faces two credit risks although the quantum of risk is the same.
• However a participation is not an assignment of those existing rights and the existing lender remains in a direct contractual relationship with the borrower. In a funded participation, the participant agrees that its deposit will be serviced (in terms ofpayment of interest) and repaid only when the borrower services and repays the loan from the existing lender.
• The participant has effectively taken on the risk of the first loan.
• The participant effectively faces two credit risks although the quantum of risk is the same.
• Firstly, if the borrower does not pay the existing lender under the loan.
• The second risk is that the lender does not pay the participant under the participation agreement.
• The first risk is a credit risk attributed to the borrower which the participant may have assessed before entering into the participation, so presumably would have comfort on that risk.
• The second risk is the risk that the lender becomes insolvent. As we mentioned earlier the participation is only a contractual agreement between the participant and the lender therefore the participant will only have a contractual claim against the lender for amounts owed by it under the participation agreement.

Risk participation means that "Bank of (*****)", as a risk participating bank, bears parts or all of the credit risks of the obligor under international settlement and trade finance, on a funded or unfunded basis.

Risk participation is a type of off-balance-sheet transaction in which a bank sells its exposure to a contingent obligation, such as a banker's acceptance, to another financial institution. Risk participation allows banks to reduce their exposure to delinquencies, foreclosures, bankruptcies and company failures.