It is a general case now-a-days that the borrowers need big money for their big projects. But what if they get this money or loan amount from a single bank? What if they are not able to pay it off i.e. it becomes a bad loan? The whole bad loan will get added to that bank’s book.
But there is a solution to it for the banks called consortium financing.
In Consortium financing, several banks (or financial institutions) finance a single borrower. In this case there is a common documentation, joint supervision and follow-up exercises between all banks/financial institutions. So the participating banks form a new consortium bank. The whole loan amount is divided among those banks forming consortium, so the risk also gets divided.
As per the consortium lending approach, the group of banks would have a common agreement wherein the lead bank (the bank that bears major risk) would assess the borrower’s fund requirements, set common terms and conditions and share information about borrower’s performance to other lenders.
The bank which takes the higher risk (by giving the highest amount of loan) will act as a leader and thus it acts as an intermediary between the consortium and the borrower.
Multiple banking is an arrangement where a borrower takes loan amount from several banks. In this case no bank knows that his borrower has taken loan from other banks too. There is no contractual relationship between various banks like that in consortium banking and each bank holds its individual security and own credit rates.
There are various loopholes in multiple banking arrangements, and also it can lead to frauds so consortium banking is better for economy.Each banker is free to do his own credit assessment and old security independent of other bankers.