Bridge Finance

                        Bridge Finance

 

    The main way of earning income of banks and financial institutions is by giving loans and charging interest on them. These loans are of various types. Some are short-term and some are long-term, some are unsecured and some are secured. One type of such loan is 'Interim or Bridge Loan'. (Bridge loan) Many times, individuals, companies or organizations expect to receive money in a short period of time. But it takes some time for that money to arrive. Until then, they need temporary money to sustain their liquidity, meet daily expenses or miss out on an opportunity to buy some property in the meantime. The type of loan to meet this requirement is called Bridge finance / Gap finance / Swing loan or Interim loan / Setu loan.

 

   The main purpose behind the interim loan is to bridge the gap between the source of money and the cost. Let's say money will come after 90 days but money will be needed for expenses after five days. It is certain that money will come but there is a time gap between money coming and going. A bridge loan can bridge this gap. Interim loans are available for many reasons. E.g. Buying a new home by selling your old home. Suppose 'A' has his own house in Nashik but 'A' wants to move to Mumbai permanently for work. He wants to buy a house in Mumbai. Need to pay for it immediately. But suppose it will take six months to get the money after selling the house in Nashik, now one option for 'A' is to take a long term home loan as usual by mortgaging the house in Mumbai or take a short term bridge loan for six months till the money comes after selling the house in Nashik. 'A' will buy a house in Mumbai from which an interim loan can be obtained by submitting the documents related to the ownership rights of the new house and the income of 'A' to the bank and also by giving the new house purchase agreement (Sathekhat). Suppose Nashik's house is typical.

 

   If not sold within a period (usually 6 to 12 months), this interim loan is converted into a mortgage loan. Interim loans are for a short period of time. Also, the interest rate on the interim loan is higher than the mortgage loan as the bank incurs some costs and fees for it. If the house in Nashik is sold within a certain time, then the loan account can be closed by paying the money received in the interim loan account.

    Another example of a bridging loan is a loan taken by a company after its initial public offering (I.P.O.) to cover the gap until the actual amount of shares is available. E.g. A company paid Rs. 10 crores decided to issue shares and obtained legal permissions for the same. Now he would actually announce the issue in the market. Potential investors used to apply for it, send the application money along with the application, after the deadline for application, the company used to decide about allotment of shares in the meeting of the board of directors. Then the allotment letter is sent to all the applicants asking for the allotment money (the second installment of the capital), giving them time to pay, the process takes a lot of time. Even if it is certain that the money will come after the issue of shares, it takes 4/6 months. But during that period the expenses of the company continue, the business continues and therefore the company needs money (cash) in the meantime. Banks fulfill this need through bridge loans. Of course, the loan amount and terms are determined based on the previous history of the borrower and his credit rating. Similarly, short-term loans are provided on the basis of potential cash flows from issuance of non-convertible debentures, external commercial loans (ECBs), global depository receipts and foreign direct investment (FDI). Of course, the company should have a solid and legal commitment to receive money from such a source. Usually the tenure of such bridge loans is less than 12 months.

 

Interim loans are likely to be provided for certain prospective funds from the government. Many individuals, firms, institutions and companies of GovtWorks, provides goods or services to the government. But after that it takes some time to get the bills for the said works. In the meantime, such individuals, organizations, companies can request an interim loan from the bank. Government often announces some incentive schemes for industries. Agrees to give some amount in the form of grant. But after the application of the industry, it takes a long time for it to be approved and accordingly the grant or incentive amount falls in his hands. In between, their cash requirement can be met by the bank through bridge finance/loans. E.g. Incentive Scheme announced by West Bengal Government for Industries. According to this scheme, the industries whose claim for incentive has been approved by the state government. Bengal Industrial Development Corporation (WBIDC) provides 60% of sanctioned incentive amount as bridge finance. Its interest rate is currently 12.75% and repayment is to be made in 15 months. Types of Interim Loans:

       There are two types of interim loans depending on the repayment term of the loan.

1 )Closed bridge finance and

2 ) open bridging interim

      loans. It is easy to understand the meaning from their name, for fixed term interim loans, the repayment period is fixed and the repayment date is fixed at the time of granting the loan. From the point of view of the bank, therefore, the date of loan repayment is certain. Obviously, this reduces the bank's risk and hence the interest rate on this loan is slightly lower than open bridging. On the other hand, in open bridging, there is no specific term or date of loan repayment. Therefore, the bank's risk is slightly higher and the date of loan repayment remains uncertain.

    E.g. As mentioned above, 'A' wants to pay off the interim loan by selling his Nashik house.

      Now, as there is no specific date when 'A's Nashik house will be sold, the date of repayment of that interim loan also remains uncertain. Due to this uncertainty, the interest rate of open bridging loans is high.

 

Investment banks or venture capital firms also provide interim finance to companies at the time of IPO. can supply. As security for that loan, he can get shares of that amount from the company in his own name. Such shares can be sold in the market or retained. After allotment of shares, companies no longer need to repay loans in cash.

 

In short, bridge finance is used as a way to maintain liquidity until your fixed source of cash flow is operational. A bridging loan is also useful for bridging the gap between money exchange when selling an old property and buying a new one. Also, bridging is used for intermediate periods of money that is sure to come from the government. Companies also use this source in the interim while issuing their IPOs, ECBs, bonds etc. Although an interim loan is a good solution for a short period of time, the interest rate on it is higher than other types of loans. Also, this type of loan is easily available only for borrowers with good credit and reputation.