Project Finance ( Banks v/s NBFC )

Executive Summary Considering the growing use of project finance, we undertook this project wit h ano bject ive of understanding the salient features of project finance. It is a method of financing very large capital intensive projects, with long gestation period, where thel e nd e r s r e l y o n t h e a s s e t s c r e a t e d fo r t h e p r o je c t a s s e c u r it y a nd t h e c a s h f lo w generated by the project as source of funds for repaying their dues.As project financing is adopted by a majorit y of companies at least once in t heir lifet ime, we decided to study this concept in detail. Banks as well as non-bankingfinancial companies provide project financing.Banks enjoy a major market share among the borrowers and the NBFC firms arelagging far behind and will slowly loose their market share if adequate steps are nottaken. Banks are usually preferred over NBFC firms due to the security aspect and brand

name. also the documentation process is one such aspect which the borrowersfind lengthy and tiresome in both the banks and NBFC.Awareness regarding the nationalized banks providing project finance is more thanthe NBFC firms providing the same. Also a borrower chooses a project finance p r o v i d e r m a i n l y d u e r e f e r e n c e a nd t i m e fr a m e w it h i n w h i c h t he lo a n w o u l d be approved.The NBFC firms need to take adequate steps to improve their position in the mindsof the borrowers so as to stay in the market. The NBFC firms should try to inculcatein the minds of the borrowers that NBFC is as safe as any bank and should try anddevelop a feeling of security among borrowers with regard to NBFC. Table of Contents

Development In the early 1980s The convergence of a number of factors by the early 1980s led to the search for alternative ways to develop and finance infrastructure projects around the world.These factors include: Cont inued populat ion and economic growth meant that the need for addit io nalinfrastructure- roads, power plants, and water-treatment plants-cont inued togrow. T h e d e b t c r i s i s m e a nt t ha t ma n y c o u nt r i e s h a d l e s s bo r r o w i n g c a p a c it y a n d fewer budgetary resources to finance badly needed projects; compelling them tolook to the private sector for investors for projects which in the past would have been constructed and operated in the public sector Major internat ional contracting firms, which in the mid-1970s had been kept busy, particularly in the oil rich Middle East, were, by the early 1980s, facing as i g n i f i c a nt d o w n t u r n i n b u s i n e s s a n d lo o k i n g fo r c r e a t i v e w a ys t o p r o mo t e additional projects. Competition for global markets among major equipment suppliers and operatorsled them to beco me promoters of projects to enable them to sell their productsor services. Outright privat izat ion was not acceptable in some countries or appropriate insome sectors for political or strategic reasons and governments were reluctant torelinquish total control of what maybe regarded as state assets. D u r i n g t h e 1 9 8 0 s , a s a nu m b e r o f g o v e r n m e nt s , a s w e l l a s i nt e r na t io n a l l e n d i n g i n s t it u t io n s , be c a m e i n c r e a s i n g l y i nt e r e s t e d i n p r o mo t i ng t h e d e v e lo p m e nt fo r t he private sector, and the discipline imposed by its profit motive, to enhance the efficiencyand productivit y of what had previously been considered public sector services. It isnow increasingly recognized that private sector can play a dynamic role in acceleratingg r o w t h a nd d e ve l o p m e nt . M a n y c o u nt r i e s a r e e n c o u r a g i n g d i r e c t p r i v a t e s e c t o r i n vo l v e m e nt a nd m a k i n g s t r o ng e f fo r t s t o a t t r a c t ne w mo n e y t h r o u g h n e w p r o j e c t financing techniques.Such encouragement is not borne solely out of the need for additional financing, but ithas been recognized that the private sector involvement can bring with it the ability toimplement projects in a shorter time, the expectation of more efficient operation, better management and higher technical capability and, in some cases, the introduction of anelement of competition into monopolistic structures.However, the private sector, driven by commercial objectives, would not want to takeup any project whose returns are not consumerate with the risks. Infrastructure projectst yp i c a l l y h a v e a lo n g g e s t a t io n p e r io d a nd r e t u r n s a r e u n c e r t a i n . W ha t t he n a r e t he incentives of private capital providers to participate in infrastructure projects, which arefr a u g ht w it h h u g e r i s k s ? P r o j e c t f i n a n c e p r o v i d e s s a t i s f a c t o r y a n s w e r s t o t he s e questions. Definition of project finance

P r o j e c t f i n a n c e i s t yp i c a l l y d e f i n e d a s l i m i t e d o r no n- r e c o u r s e f i n a n c i n g o f a n e w project through separate incorporation of vehicle or Project Company. Project financinginvolves non-recourse financing of the development and construction of a particular project in which t he lender looks principally to the revenues expected to be generated by the project for the repayment of its loan and to the assets of the project as collateralfor its loan rather than to the general credit of the project sponsor.In other words the lenders finance the project looking at the creditworthiness of the project, not the creditworthiness of the borrowing part y. Project Financing disciplineincludes understanding the rationale for project financing, how to prepare the financial plan, assess the risk, design the financing mix, and raise the funds.A k no w l e d g e ba s e i s r e q u ir e d r e g a r d i n g t he d e s i g n o f c o nt r a c t u a l a r r a ng e m e nt s t o s u p p o r t p r o j e c t f i n a n c i n g ; i s s u e s f io r t he ho s t g o ve r n m e nt le g i s l a t i v e p r o v i s io n s , public/private infrastructure partnerships, public/private financing structures; creditrequirements of lenders, and how to determine the projects borrowing capacity; how to prepare cash flow projections and use them to measure expected rates of return; tax andaccounting considerations; and analytical techniques to validate the projects feasibility. Comparison between corporate finance and project finance Tradit ional finance is corporate finance, where the primary source of repayment for investor and creditors is the sponsoring company, backed by its entire balance sheet, notthe project alone. Alt hough creditors will usually st ill seek to assure themselves of economic viability of the project being financed so that it is not a drain on the corporatesponsors exist ing pool of assets, an important influence on their credit decisio n is t heoverall strength of the sponsors balance sheet, as well as their business reputation. If the project fails, lenders do not necessarily suffer, as long as the company owning the project remains financially viable

Demerits 1. Co mp le x it y o f r is k a llo cat io n: pr o je ct fina nc ing is co mp le x t r a n s a c t i o n i n vo l v i n g m a n y p a r t ic i p a n t s w it h d i v e r s e i n t e r e s t . I f a p r o je c t i s t o b e successful risk must be allocated among the participants in an economicallyefficient way. However, there is necessary tension between the participants.For e.g between the lender and the sponsor regarding the degree of recourse, between the sponsor and contractor regarding the nature of guarantees., etcwhich may slow down the realization of the project.2 . I nc r e a s e t r a n s a c t io n c o s t : it i n vo l v e s h i g h e r t r a n s a c t io n c o s t s c o mp a r e d t o o t he r t yp e s o f t r a n s a c t io n s , be c a u s e it r e q u i r e s a n e xp e n s i v e a nd t ime-c o n s u m i n g d u e d i l i g e n c e c o n d u c t e d b y t h e l e n d e r s l a w y e r , t h e independent engineers etc., since the documentation is usually complex andlengthy.3 . h i g h e r i nt e r e s t r a t e s a nd f e e s : t he i nt e r e s t r a t e s a nd f e e s c h a r g e d i n p r o j e c t financing are higher than on direct loan made to the project sponsor since thelender takes on more risk.4 . l e n d e r s u p e r v i s i o n : i n a c c o r d a n c e w i t h a h i g h e r r i s k t a k e n i n p r o j e c t f i n a n c i n g t h e l e nd e r i mp o s e s a g r e a t e r s u p e r v io n o n t he m a n g e m e nt a nd operation of the project to make sure that the project success is not impaired.The degree of lender supervision will usually result into higher costs whichwill typically have to be borne by the sponsor.

Importance of project finance Whether expanding manufacturing facilities, implementing new processing capabilities,or leveraging existing assets in new markets, innovative financing is often at the core of lo n g t e r m p r o je c t s t o t r a ns fo r m a c o m p a n y s o p e r a t io n s . Ak i n t o t he u n d e r l y i n g corporate transformat ion, the challenge wit h innovat ive financial structures such as project finance is that the investment is made upfront while the anticipated benefits of the initiative are realized years later.There has been a rise in number of companies that need innovative financing to satisfytheir capital needs, in a significant number of instances they have viable goals but findt h a t t r a d it io n a l le n d e r s a r e u n a b l e t o u nd e r s t a n d t h e i r i n it i a t i v e s . A n d s o t he n e e d emerged for project finance.P r o j e c t f i n a n c i n g is a spe c ia liz e d fo r m o f fina nc ing t hat ma y o ffer so me co st ad va nt ag e s w he n ver y lar ge a mo unt s o f ca p it a l ar e invo lve d I t c a n b e t r i c k y t o s t r u c t u r e , a nd i s u s u a l l y l i m i t e d t o p r o je c t s w h e r e a g o o d c a s h f l o w i s a nt i c i p a t e d . Project finance can be defined as: financing o f an industrial (or infrastructure) projectwith myriad capitalneeds, usually based on nonrecourse or limited recourse structures, where project debtand equit y (and potentially leases) used to finance the project are paid back from thecash flow generated by the project, with the project's assets, rights and interests held ascollateral. In other words, its an incredibly flexible and comprehensive financingsolution that demands a long-term lending approach not typical in todays market place.Whether expanding manufacturing facilities, implementing new processing capabilities,or leveraging existing assets in new markets, innovative financing is often at the core of lo n g - t e r m p r o j e c t s t o t r a n s fo r m a c o mp a n y s o p e r a t io n s . Ak i n t o t he u n d e r l y i n g corporate transformat ion, the challenge wit h innovat ive financial structures such as project finance is that the investment is made upfront while the anticipated benefits of the initiative are realized years later. Infrastructure is t he backbo ne o f any econo my and the key to a c h i e v i n g r a p i d sustainable rate of economic development and compet it ive advantage. Realizing itsi m p o r t a n c e g o v e r n m e n t s c o m m i t s u b s t a n t i a l p o r t i o n s o f t h e i r r e s o u r c e s f o r d e v e lo p m e nt o f t h e i n f r a s t r u c t u r e s e c t o r . As mo r e p r o j e c t s e m e r g e g e t t i n g t he m financed will continue to require a balance between equity and debt. With infrastructurestocks and bonds being traded in the markets around the world, the tradit ionalist facechange. A country on the crest of change is India. Unlike many developing countriesIndia has developed judicial framework of trust laws, company laws and contract lawsnecessary for project finance to flourish