The business sector “Participation” covers all transactions directly connected to the processing of participations. The participation can be linked to a letter of credit or a guarantee.
Example of participation under letter of credit:
An issuing bank has opened a letter of credit and requested the advising bank to add confirmation to the letter of credit. The advising bank is not willing or in a position to cover the confirmation risk on its own and looks for banks which are prepared to participate in the risk for part of the confirmation amount.
By offering other banks a participation in the risk, the advising bank is able to limit its proportion of the asset that is tied up in the risk to one particular customer. The advising bank acts as a correspondent bank that sets up and administers the participation deal.
The terms and conditions of the participation deal are negotiated between the correspondent bank and the participating bank and recorded in a mutual agreement. Usually, no standard forms are available for such agreements. The terms and conditions of the agreement usually stipulate whether it is an open or silent participation. An open participation means that the issuing bank (and maybe the beneficiary) is informed that the risk has been spread to one or more participants. A silent participation means that the parties involved in the letter of credit (e.g. applicant, issuing bank, beneficiary etc.) are not informed that the risk has been spread.
In return for the participation, the correspondent bank pays a risk commission to the participating bank. According to the terms of the participation agreement, the risk commission is paid in advance, pro rata basis or at the expiry date of the deal. Depending on the terms of the participation agreement, the participation is valid up to expiry of the letter of credit or until a certain point in time after the expiry date.
The participation amount is reduced by notice from the advising bank after the LC has been drawn or expired. In the application, this is handled through an amendment of the contract or a payment.
On receipt of a claim being made by the correspondent bank, the participant is required to pay an amount up to the extent of the partial amount if requested to do so by the advising bank. In the event of a claim, the correspondent bank will handle all matters necessary with the issuing bank. Even in such a case, the participant will generally not contact any of the parties to an L/C directly.