Should Indian banks lend basis an equity stake?
By Akshat Khetan
Imagine a corporate MSME, approaching a bank for a loan to meet some obligation. Now, what if the bank rather than provisioning this business with a loan decides to take an equity stake? Legally, traditionally-operating American and Indian banks are refrained from entering into such a relationship. That, although there are development banks, bank-subsidiaries, and special purpose vehicles lending on the basis of equity participation.
The interest in banks adopting an equity participation model is increasing and driven by a confluence of economic, regulatory, and technological factors. Primarily, there has been an acknowledgment that traditional debt financing has been inefficient in supporting business growth. Secondly, there has been a need to address lending practices in high-growth sectors such as technology or renewable energy where a traditional lending model can be limiting. More importantly, to the traditional banking model the new model could be a crucial diversification strategy.
One of the most compelling arguments for banks adopting an equity participation model is the alignment of interests between the bank and the borrowing company. In a traditional loan arrangement, the borrower bears the full risk of the business venture, while the bank is primarily concerned with the repayment of the loan and interest. Equity participation, on the other hand, transforms banks into stakeholders, incentivizing them to support the long-term success of the company.
This model also offers the potential for higher returns. Unlike fixed interest income from loans, equity stakes can yield significant dividends and capital gains if the company performs well. This can be particularly advantageous in high-growth
Read more on financialexpress.com
