During the PNB Fraud case, one of the Banks made a statement that:

“It is an active participant in the secondary market for buyer’s credit transactions and it has sold “all the referred transactions’’.

This article tries to throw some light on what is buyers credit secondary market, how the structure works and why banks do transaction in secondary market.

What is Buyers Credit Secondary Market

Secondary market is a market between banks where assets are exchanged based on consideration. In case of buyers credit, overseas branches enters into agreement with various bank / branches and asset exchanged is buyers credit outstanding.

In layman’s term, Bank A sells buyers credit outstanding to Bank B for X amount over and above principal  plus interest of buyers credit.

Structure of Buyers Credit Secondary Market

1. Bank A’s overseas branch enters into a master agreement with Bank B’s overseas branch. Master agreement has details like products which can be purchased and sold, terms like: with recourse or without recourse, jurisdiction etc.. Bank A’s Overseas branch enters into such agreement with multiple banks to create secondary market.
2. Bank A’s overseas branches generates buyers credit business (other product can be Letter of Credit, syndication loans etc) against LOU issued by Indian banks.  For example Bank A generates buyers credit of $1 Million at 6 Month Libor + 40 basis points (bps).
3. Bank B in order to build up it books wants assets where as Bank A has additional assets which it is ready to part away with.  After adding margin it offers the asset to Bank B.
   • Cost of Buyers Credit to Bank A was : 6 Month L + 40 bps
   • Selling price : 6 Month L + 50 bps (10 bps margin added by Bank A. Margin varies from case to case)
   • Bank B accepts the offer of Bank A
4. Referring master agreement, another agreement is entered into between Bank A and Bank B via SWIFT . MT799 is sent from Bank A to Bank B for transfer of assets and Bank B transfer funds.
5. On maturity there can be two options:
   • Bank A on sale of assets send swift to LOU issuing bank informing about the sale of asset and assignment of maturity payment to Bank B directly. On maturity LOU issuing bank makes payment directly to Bank B with interest.
   • Incase where first option is not possible, Bank A collects the funds from LOU issuing bank and transfers the funds to Bank B.
6. This assets can be with recourse and without recourse. Without recourse means Bank A has no liability in case LOU issuing bank does not make payment for the buyers credit on due date. With Recourse means if LOU issuing bank does not make payment, Bank B can claim funds from Bank A.

Why Secondary Market

1. Income for Bank A overseas branch without deployment of capital.
2. Free up capital for Bank A which can be deployed for new requirement.
3. Bank B wants to increase Asset size in its books.

Operational Guide

1. In secondary market each buyers credit transactions is sold individually.
2. Period and consideration of sale will be based on outstanding period.
   • Bank A Buyers Credit Period (Origination) :  180 days
   • Bank A offer Buyers Credit Outstanding after : 91st day
   • Bank B acquires buyers credit for remaining 90 days and pays accordingly.
3. Such transaction is not done for small transactions. Normally amount involved in such secondary market is transactions around $1 million and above.

Reference

• PNB case: Axis Bank says it has ‘sold down all buyers’ credit transactions’
• Implication on Buyers Credit because of PNB Fraud
• RBI 2016 Circular : Frauds Related to Trade Finance Transactions – Misuse of SWIFT