CORPORATE & PROJECT FINANCE ASSIGNMENT 2017-18

Dr. SHAKUNTALA MISRA NATIONAL REHABILITATION UNIVERSITY, LUCKNOW

AN ASSIGNMENT

ON

BANKING SUPERVISION IN PROJECT FINANCE

UNDER THE SUPERVISION OF

Mr. SHAIL SHAKYA

SUBMITTED TO SUBMITTED BY

Mr. SHAIL SHAKA DEVANAND PANDEY

ASSISTANT PROFESSOR B.COM.LLB (Hons.)
FACULTY OF LAW 8TH SEMESTER (2017-18)
D.S.M.N.R.U D.S.M.N.R.U

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ACKNOWLEDGEMENT

I would like to thank my Assistant Professor Mr. Shail Shakya for providing me this great
opportunity to learn from the topic “Banking Supervision in Project Finance”.

I would also like to thank my friends and well-wishers for their kind support and help during
the making of this assignment.

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TABLE OF CONTENTS

1) INTRODUCTION…………………………………………………………………………...4-5
2) BANK LENDING AND CREDIT RISK ASSESSMENT IN PROJECT FINANCE..……….6
3) CHANGINF STRUCTURE OF FINANCIAL SYSTEM..……………………………………7
4) CREDIT RISK IN PROJECT FINANCE…………………..…………………………………8
5) CONCLUSION………………………………………………………………………………...9
6) BIBLIOGRAPHY…………………………………………….………………………………10

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INTRODUCTION

Project finance is typically defined as limited or non-recourse financing of a new project

through separate incorporation of vehicle or Project Company. Project financing involves
non-recourse financing of the development and construction of a particular project in which
the 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 collateral for 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 party. Project Financing discipline includes
understanding the rationale for project financing, how to prepare the financial plan, assess the
risk, design the financing mix, and raise the funds.

A knowledge base is required regarding the design of contractual arrangements to support

project financing; issues fior the host government legislative provisions, public/private
infrastructure partnerships, public/private financing structures; credit requirements 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 and accounting considerations; and
analytical techniques to validate the projects feasibility.

Usually, the birth of the project finance goes back to the previous century in the United States
and, in particular, in the energy and oil extraction. At the international level project finance
has been established especially after the Second World War. The application of project
finance in the industry and infrastructure sector is more recent (ports, airports, railway works,
high speed rail, hospitals, prisons, subways, bridges, roads, environment projects,
telecommunication networks, alternative energy plants, power generations plants, chemical
processing plants, mines, etc.). This success was due to the privatization process that affected
the European countries and the increasingly constraints on public spending that has increased
the need for private financial resources 1.

In addition, there are agreements with local governments and administrative measures
(licenses, permits, concessions, etc). Project finance cannot therefore be regarded as a single
multilateral contract but as a set of typical contracts which are closely linked. Even though

1
http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.877.7281&rep=rep1&type=pdf (Last Accessed on
14/04/2018 at 6:47pm.)

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project finance has certain common elements, every project finance operation has unique
characteristics that distinguish one from each other. So, it is very difficult to give a general
definition, since it has been adapting not only to the objectives of parties involved but also to
technical, financial, and economic aspects of the investment projects.

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BANK LENDING AND CREDIT RISK ASSESSMENT IN PROJECT FINANCE

The de-specialization of banks has led to a greater integration between different segments of
financial intermediation: loans, securities and insurance. This was possible thanks to the
development of “universal” banks which are able to offer many kinds of services. In the
project finance business banks may offer two kind of services: advisory services and
financing services. As regards the role of financial advisor banks may assist public or private
parties to promote projects. The following financial services might be provided by banks in
the project finance business:

a) Analysis of Technical Aspects of the Project

b) Analysis of Regulatory and Legal Aspects
c) Due Diligence
d) Risk Sharing Package
e) Preparation of Business Plan and Sensitivity Plan

The project finance has two sources of funds: debt and equity. Debt capital is usually
provided by commercial banks and international investment banks. Equity capital is usually
provided by project sponsors and outside equity investors, such as commercial banks,
investment funds specializing in project finance equity, venture capital and private equity
vehicles. Banks are the largest providers of debt capital in project finance and the financial
structure of the project (leverage ratio) is very important in convincing bankers to provide
capital. It implies that banks must pay particular attention to the evaluation of the credit risk
of the project. The failure of the project, and the subsequent borrowers’ insolvency, may
damage lenders heavily.

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CHANGING STRUCTURE OF THE FINANCIAL SYSYTEM

In addition, there are agreements with local governments and administrative measures
(licenses, permits, concessions, etc). Project finance cannot therefore be regarded as a single
multilateral contract but as a set of typical contracts which are closely linked (Figure 1). Even
though project finance has certain common elements, every project finance operation has
unique characteristics that distinguish one from each other. So, it is very difficult to give a
general definition, since it has been adapting not only to the objectives of parties involved but
also to technical, financial, and economic aspects of the investment projects.

In the project finance the procedure for granting a loan is reversed. In the corporate finance a
bank evaluates the possibility to loan money based on the credit standing of the firm. In the
project finance a bank decides to fund a project by agreeing that cash flows to service debts
are associated with revenues generated from the project, and the guarantees are only
represented by the assets of the project and not by all firm's assets. The project lies at the
center of all the contractual and financial relationships in the financing scheme 2.

2
http://group30.org/images/uploads/publications/G30_BankingSupervisionFinancialStability.pdf (Last
Accessed 15/04/2018 at 7:45pm)

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CREDIT RISK IN PROJECT FINANCE

The first operation that a bank must take to implement the New Basel Capital Accord is the
classification of the credit exposure. In the project finance class, the main determinant of the
credit risk is the variability of cash flows. The PD and LGD are therefore interconnected and
depend on the revenues generated by the financed assets (Gatti, 2008; Marchetti, 2009;
Sorge, 2004). The character of project finance is primarily related to the future revenues of
the project.

In the “standardized approach” banks must continue to assimilate project finance exposures
to corporate exposures: project finance is considered as a normal financing transaction. Banks
must use a coefficient related to the external rating assigned to the SPV, otherwise a
coefficient equal to 100%. It means that when project finance loans are unrated banks have to
use 100% risk weight. The bank’s supervisory authority, however, can classify the project
finance loans as “category at higher risk”, for which is defined a coefficient higher than that
required for corporate finance. It assumes that in some cases project finance loans could be
riskier than corporate loans. This implies an higher capital requirement in the project finance
lending business3.

Within the internal rating-based approach (IRB), however, project finance exposures must be
classified in specialized lending portfolio and partly within the corporate portfolio. Banks
may classify their loans into risk categories using their own internal data. In general, to
calculate capital requirements to cover expected and unexpected losses for specialized
lending exposures, banks must apply the same rules established for corporate exposures. The
derivation of risk-weighted assets depends on estimates of PD, LGD, EAD and, in some
cases, effective maturity, for a given exposure. With the IRB approach for project finance
loans banks may incorporate specific risk profiles into capital requirements standards.

3
http://fessud.eu/wp-content/uploads/2015/03/CENTRAL-BANKS-AND-FINANCIAL-SUPERVISION-NEW-
TENDENCIES-Working-Paper-134.pdf (Last Accessed on 15/04/2018 at 8:45pm)

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CONCLUSION

Project finance is an innovative model of financing projects. It is a useful technique for

financing large and long-term projects with relatively predictable cash flows. Project finance has
typically an high leveraged financial scheme. Cash flow and risk analysis are the two main
crucial aspects of every project finance transaction. Banks have increased the use of
quantitative models to analyze default risks and loan losses in project finance lending. Banks
must be able of evaluating risk factors of the project, and the assumptions used in the
prediction of the future cash flows. In the project finance lending practices look primarily to
the expected income stream of the project.

The paper highlights the features of credit risk assessment in project finance lending, and
how the bank regulatory framework affects it. Project finance involves a higher degree of
sophistication in credit risk analysis than normal loans. This consideration suggested a
tentative conclusion regarding the regulatory implications of the project finance in the
banking business. The new bank regulatory capital requirement framework recognizes such
important differences between corporate and project finance lending.

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BIBLIOGRAPHY

PRIMARY SOURCES

1. Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012

SECONDARY SOURCES

Websites

1. www.awwwards.com

2. www.vandelaydesign.com

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