best project finance banks

best project finance banks

The Role of Project Finance Banks in Infrastructure Development

1. Introduction to Project Finance and Infrastructure Development

Cassel’s Dictionary of Finance defines project finance as “a method of financing a special, long-lived capital investment by financing it from a variety of sources with cashflows and resources as its only security.” This simple introduction is both accurate and useful. However, we must add two further points. The first is that project finance implies a financial structuring different from that for other kinds of projects. If we look at a project like a mining or manufacturing venture, we usually find that it is all within the same corporate group. Also, the holding group has a financial structure of the conventional kind – shares, debentures, bank loans, reinvested profits, etc. The same holding company structure can be observed in some of the very large infrastructure projects like the Channel Tunnel, where the Eurotunnel finance package involved £515m of senior debt, £310m of subordinated debt, and 19m shares. However, in more normal project finance operations, the different shares in the total risk are owned in quite different ways. Normally, there is no overall group bringing these different bits of capital together; that is one of the problems solved by the project company itself.

2. Key Functions and Services Provided by Project Finance Banks

Financing the various stages of the project requires the project bank to, although construct the entire project during the development stage, it is then able to fulfill the project’s requirements for services during the construction stage. In addition to the bank, the project proposal will also require the use of a bond underwriter to carry off the operating portion of the construction bond issue and/or any project debt, the development and procurement advisers, the project’s commercial bank arranger, the other project participants, and the commercial bank, insurance broker, and financial adviser. In the secondary market, projects do not generally require the services of a commercial bank, but they do require the services of a secondary market trading group, which would be willing to price and arrange for the financing and/or historical trading of the project.

The project finance bank is thus a source of advice and assistance to large industrial firms, while they evolve from a concept to the actual, successful, independent operation of international projects. Without the services of the project finance bank, project developers would be unable to convert various infrastructure needs into viable independently operating businesses. This is why project developers require the bridge to the international capital markets that the project finance bank provides. The project developer may require equity and/or long, fixed-rate government-supported funding in a variety of currencies to construct a project. Initially, the project may not even support a full commercial bank loan and servicing during the construction period could be a problem, as long-term debt-to-equity ratios or reserve requirements may increase project costs and/or engineering risks so that their rates of return and/or insurance premiums are unattractive. The result is a need for either government or development assistance and a limited recourse bank facility. Later, when government assistance decreases with time, the bank or the bank and the bondholders construct a longer maturity (usually tax-exempt or non-recourse) project bond to increase the total amount of funds necessary to permit the project to operate. A much larger portion of the project’s operating risks are then transferred to the international capital markets.

The size and complexity of project finance proposals require the various services of a project finance bank. Project developers originating these proposals are typically industrial firms and new entrepreneurs with little or no practical experience in arranging and participating in large complex financings. Additionally, almost all of these developers are from non-financial sectors and are therefore not familiar with the entire array of available debt, bond, or equity securities. Project proposals, however, do require the combined services of a commercial bank, an investment bank, an export credit agency, government assistance or encouragement, and an auxiliary officer to provide equity. They also require the assistance of underwriting, trading, commercial lending and investment management services, as well as the unique services created for each individual project proposal.

3. Case Studies of Successful Project Finance Bank Engagements

Conclusion: There is no doubt the use of the project finance technique can be a catalytic force in increasing the impact of international banking on the economic development of the less developed nations at a time when classic lending methods have proved of limited utility. The mobilization of substantial non-syndicatable funds evidences the value of the bank for the increasing number of less-developed countries who can use funds for this purpose. However, the truth is that most of these countries cannot find either the operating environment or the technically suitable projects that can be financed. The possible businessmen, industries, and projects need both the “packaging” technique and the financial and management expertise of project finance banks to help them structure suitable projects, arrange suitable financing packages, mobilize suitable equity investment, and manage the diverse elements of risk. The many investors, producers, and services who are willing to do the work that more nearly meets the modern needs towards the end of winning and realizing acceptable rewards from use of their funds, labor, or capital shall increasingly need the help of these specialist banks.

3. Case studies of successful project finance bank engagements: Various multilateral development banks have been successful in promoting the project finance technique, not only through financing projects directly, but also by other innovations. The establishment of project finance development enterprises and project finance funds was originated by the Asian Development Bank, and has been taken over on a selective basis by the World Bank and the Inter-American Development Bank as well. The International Finance Corporation, the funding arm of the World Bank Group for international investments in the private sector, has also established funds which use the project finance technique to structure and arrange investment portfolios to serve institutional investors not already involved in the developing nations.

4. Challenges and Opportunities for Project Finance Banks in the Current Economic Environment

The disruptions to the global financial market have been particularly severe in the areas of infrastructure finance that rely on market liquidity instruments. Coping with the current environment will, therefore, be challenging and difficult for project finance banks. Without further reform or long-term solutions, the capacity, consistency, and participation of the project finance banks in the project finance market could be diminished, leading to a decline in infrastructure supply and continuing deficiencies in the provision of infrastructure. In overcoming the current crisis, the crucial role that the export credit agencies played in mitigating the liquidity crisis in various industrial sectors indicates the potential for a similar extended role in infrastructure supply. Some of the usual forms of economic intervention might also be available.

Near-continuous changes in the international and domestic regulatory environment have been built up over the past few years. The Basel III reforms, which have been agreed upon by the Governors and Heads of Supervision, are designed to address the regulatory weaknesses that were so cruelly exposed by the crisis that began in 2007 and to promote a more resilient banking sector. These, together with local prudential frameworks that add quantitative and qualitative overlays, increase the quality and quantity of capital that banks are required to hold and require banks to hold more liquidity over a longer time horizon. While these changes are necessary to promote a more resilient banking sector, they will result in higher costs of capital and a change in the risk-return trade-off, likely influencing project economics. To make matters worse, many of the other regulatory changes discussed earlier are also likely to result in increased cost of capital and change the risk-return trade-off further in a way that could influence the desirability of project investment.

5. Future Trends and Innovations in Project Finance

The onset of currency crises underscores how domestic monetary policy can aggravate the instability of private capital markets. The tumult occasions a revisiting of general ideas or project finance, in order to assess the performance elsewhere of Japan’s hybrid approaches and globalization’s implications for them. Furthermore, new financial products are constantly being developed and sold, usually amidst great hoo-ha. The real tests, however, are how products hold up under stress. If insurance derivatives could protect, at reasonable cost, the basic risks that project finance banks now internalize, the way would be open for the capital market to play a role in infrastructure development precluded today by the bad name project finance rightly now has.

The good times for project finance end, and the dismal times for it begin, when the economy turns a tick for the worse. The tune of the “infrastructure crisis” is sung time and time again. Granted, a case can be made for going easy on such a fragile flower as project finance. After all, it usually exists at the sufferance of such deep-pocket patrons as Japan’s Ministry of Finance. But at the same time, a strong case can be made for burying it. The fact that an inefficient institution is better than no institution at all cannot be an argument against designing a better project. It should rather make it that much more imperative to do so. At times like the present when infrastructure development in the Third World is off the international economic agenda, such questions may smack of pounding twice on the poor. Yet these are the times when good work can alert the relevant actors to the need to act more intelligently when more benign times return.