Subordinated Debt

Banks often request that a liability be “subordinated” as a pre-condition to making new finance available to a borrower. In practice, the condition to “subordinate” debt often comes into focus with respect to shareholder’s loans in SME businesses.

What does it mean?

If a liability is subordinated to bank debt, the hierarchy of creditors on the balance sheet is changed. In effect any subordinated debt would rank below the bank debt. This means that the bank debt has a higher priority in terms of when it must be repaid. Because of this subordinated debts are deemed more risky as they are repayable after the bank debt is repaid.

Why would a bank seek subordination of shareholder loan?

In a scenario where a shareholders loan is subordinated, the bank’s position is improved as their loan will effectively be repaid ahead of the subordinated debt.

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