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Project financing

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An introduction on project financing of Bangladesh showing that it is a political issue in Bangladesh..

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Project financing

  1. 1. Page | 1 Project Finance Project finance is defined slightly different by different authors. Esty (2004) defines it as: “Project finance involves the creation of a legally independent project company financed with equity from one or more sponsor firms and non-recourse debt for the purpose of investing in a capital asset” (Esty, 2004 pp.25), while Finnery (2007) says: “Project finance is raising funds on a limited-recourse or non-recourse basis to finance an economically separable capital investment project in which the providers of the funds look primarily to the cash flow from the project as the source of funds to service their loans and provide the return of and the return on their equity invested in the project” (Finnery, 2007 pp.1). Finally, Yescombe (2002) defines it in the following manner: “Project finance is a method of raising long-term debt financing for major projects through “financial engineering”, based on lending against the cash flows generated by the project alone; it depends on a detailed evaluation of a project’s construction, operating and revenue risks and their allocation between investors, lenders and other parties through contractual and other arrangements” (Yescombe, 2002 pp.1). Project Finance Structure Project financing can be done by: 1. A single bank, or 2. Through loan syndication(arranging loan from a number of banks/ financial institutions) In both cases, credit appraisal remains identical with focus being the same: determining cash flow generating capacity of the project. However, syndication is generally preferred when loan size is large (e.g. say, exceeds Tk. 30.0 crore), and the borrower has strong operational and financial track record so that it is possible to raise fund from the market.
  2. 2. Page | 2 Project Financing in Bangladesh  A report noted that capital market intermediaries and insurance companies face significant challenges, both in terms of financial health and technical capacity. Access to finance in Bangladesh is tight and a study of firms nationwide suggested that more than 40 percent of firms found access to finance to be a major or severe obstacle to business, a higher percentage than the average for low and lower-income countries, and the highest in the region after Pakistan.  In addition, 69 percent of lending has a maturity of less than three years. A little less than half of the loans have maturity dates of one year. As a result, long-term financing is typically procured through accumulated earnings, and firms tend to under- invest. Companies often resort to financing long-term asset purchases with short-term financing causing asset-liability mismatches and sub-optimal capital structures increasing financial risk. Some companies rollover existing loans, which can be destabilizing to the financial system. According to the ADB, the Private Equity industry (including venture capital) in Bangladesh is still largely at a nascent stage with only about $150 to $200 million committed capital from Bangladesh focused private equity and venture capital funds.  Prior to 2008, the majority of private equity activity had originated in a much more limited way from the three major developmental finance agencies, namely, the International Finance Corporation (IFC) (part of World Bank Group), the UK’s CDC Group (formerly the Commonwealth Development Corporation) and the German Investment and Development Corporation (DEG).  There were direct investments in the power and infrastructure sector, the financial sector, and selectively in the textile sector. More recent examples of project finance listed in the International Comparative Legal Guide include: A $210 million loan for setting up a 341 megawatt (MW) combined-cycle gas-fired power plant project near Bibiyana. The loan was extended by the ADB, IFC, and the Islamic Development Bank. In the telecommunication sector, Robi received a $99 million IFC loan to expand its 3G network in Bangladesh. The loan has been received at LIBOR plus 2% with a tenor of seven years. In the shipping sector, Summit Alliance Port Limited received $30.51 million from Nederland’s Financierings-Maatschappij voor Ontwikkelingslanden N.V. and Infrastructure Development Company Ltd. for the development of an inland container depot, including the construction, operation and maintenance of a quay/container berth, acquisition and installation of necessary cargo handling equipment, and acquisition of vessels.  The study goes on to explain that, given the relatively new status of private equity investment in Bangladesh, corporations still largely view private equity as simply an alternative source to debt financing rather than as a true partnership providing broader benefits such as improved corporate governance, strategic direction, access to broader ranges of financing, optimization of capital structure, market access and improved valuation of businesses.  Multilateral Development Banks: The Commercial Service maintains Commercial Liaison Offices in each of the main Multilateral Development Banks, including the Asian
  3. 3. Page | 3 Development Bank and the World Bank. These institutions lend billions of dollars in developing countries on projects aimed at accelerating economic growth and social development by reducing poverty and inequality, improving health and education, and advancing infrastructure development. The Commercial Liaison Offices help American businesses learn how to get involved in bank-funded projects, and advocate on behalf of American bidders. Learn more by contacting the Commercial Liaison Offices to the Asian Development Bank and the World Bank. Project Financing As Highly Political Issue Finnerty (2007) writes: “Political risk involves the possibility that political authorities in the host political jurisdiction might interfere with the timely development and/orlong-term economic viability of the project” (Finnerty, 2007 pp.82). This means, that political risk is considered any action by the host government that can affect the project negatively either by postponing the capital inflows or by directly affecting the profitability of the project. This definition is in line with Howell & Chaddick (1994) who states that “"Political risk" is the possibility that political decisions, events, or conditions in a country, including those that might be referred to as social, will affect the business environment such that investors will lose money or have a reduced profit margin” (Howell & Chaddick, 1994 pp.71). There seems to be some correlation between the use of project finance and the level of political risk in a country according to the previous discussions. However, in order to test this relationship one must find appropriate ways of measuring political risk. This is not an easy task. Many academics have discussed what measures to use when testing the importance of political risk upon economic growth or investment. This section will therefore try to establish which measures to use based upon previous findings in the literature on which measures to use when reflecting the political risk that an investor faces when investing domestic or foreign. Main political issues working behind a project financing in Bangladesh are: 1. Democracy: The first category is democracy, which was used in the earliest literature as a measure of political risk. The main reason given for the use of democracy as a determinant of economic growth in Bangladesh have democracy and have been unsuccessful in supporting growth. Democracy is often measured using the Gastil index for civil liberties and political rights where the latter mainly concentrates on the election process and whether these are subject to fair, competitive and clear procedure (Brunetti and Weder 1995). Brunetti (1997) finds that the explanatory power of democracy is very low in cross country growth studies. A democracy may have unpredictable rules as can a state with political stability (Brunetti and Weder, 1995) which is a risk to project financing in national or international projects. 2. Government stability & Political Violence: The second category, Government stability, refers to the number of or probability of changes in government, keeping in mind that the changes must be fundamental and thus lead to possible change or reversal of the rules and decisions set in place by the former government. This is theoretically thought to affect growth and investment through the fact that less stability will lead investors to invest in
  4. 4. Page | 4 short-term assets. These are more liquid and thus easier to divest in case the government should change and make changes that affect the investment. This will lead to less accumulation of physical capital and hence less growth (Feng, 2001). In Brunetti and Weder’s article from 1995, it is concluded that “the political variables used in these studies i.e. democracy and political instability, do adequately reflect the “investors problem”” (Brunetti and Weder, 1995 pp.125). This should be noted that, it is one of the major issue for project financing in Bangladesh. 3. Policy Stability: A fourth option is to identify political risk as the uncertainty of policies. It captures more of the issues relevant to an investor, as it is a proxy for the amount of uncertainty that is created by government-controlled policies (Brunetti, 1997). This would be the predictability and credibility of the rules created as it is measured as the volatility of monetary and fiscal policies. In this instant, the results in the growth analysis’ seems more clear towards a negative relationship meaning that higher volatility will lead to a lower growth although the statistical significance frequently depends on the specifications of the models when the specifications are richer (Brunetti, 1997). Feng (2001) measure of policy uncertainty is measured as variability of government capacity. As Feng (2001) states in his paper “The fluctuation of government capacity indicates that the government lacks consistency in its power to get a job done. Uncertainty about government effectiveness can be more adverse than the policy itself by deterring investors from committing their assets. Given a bad policy with certainty about its execution the investor can still find ways to make money” (Feng, 2001 pp.276). 4. Subjective perception of politics: The latest part of literature on cross-country growth analysis’ that Brunetti (1997) have summarized, being category five, have focused on using more subjective perceptions of politics. This is another political issue for project financing in Bangladesh. 5. Instability of Law & its Implementation: This is an important political issue of project financing in Bangladesh. There are a lot instabilities in laws in Bangladesh especially for the national & international projects which indicates risk to project financing. After discussing above points, it is clear that project financing is a highly political issue in the perspective of Bangladesh. Loan Policy in Bangladesh: Funding of National & International Projects 75% 13% 7% 5% Types of Bank in Bangladesh Government Bank SCB Others Other Foreign banks
  5. 5. Page | 5 Some types of loans in Bangladesh are:  Full Recourse Loan: A loan in which the lender can claim more than the collateral as repayment in the event that the loan is enforced. Thus a full recourse loan places the Sponsor’s assets at risk.  Nonrecourse Loan: A loan in which the lender cannot claim more than the collateral as repayment in the event that the loan is enforced.  Limited Recourse Loan: A loan in which the lender can claim more than the collateral, subject to some restrictions, as repayment in the event that the loan is enforced.  Continuous Loan: The loan Accounts in which transactions may be made within certain limit and have an expiry date for full adjustment will be treated as Continuous Loans. Examples are: CC, OD etc.  Demand Loan: The loans that become repayable on demand by the bank will be treated as Demand Loans. If any contingent or any other liabilities are turned to forced loans (i.e. without any prior approval as regular loan) those too will be treated as Demand Loans. Such as: Forced LIM, PAD, FBP, and IBP etc.  Fixed Term Loan: The loans, which are repayable within a specific time period under a specific repayment schedule will be treated as Fixed Term Loans.  Short-term Agricultural Credit will include the short-term credits as listed under the Annual Credit Program issued by the Agricultural Credit Department of Bangladesh Bank. Credits in the agricultural sector repayable within less than 12 months will also be included herein. Short-term Micro-Credits will include any micro-credits for less than Tk.50, 000/= and repayable within less than 12 months, be those termed in any names such as Non-agricultural credit, Self-reliant Credit. Loan Policies in Bangladesh (Bangladesh Bank & World Bank): Loan cycle of World Bank is given below for financing different types of nation & international projects: Stage Description Preparation Comprises identification and concept review. This stage involves identifying programs/projects that support the Country Partnership Framework, the government agency responsible for preparation, key stakeholders, and target beneficiaries. Following this stage, a concept note is created; the design is determined; economic, technical, social, and environmental feasibility are assessed; and potential risks and safeguard issues are identified. Appraisal Involves confirming the expected outcomes of the program/project; reviewing economic, technical, environmental, social, and fiduciary aspects; and agreeing on the institutional arrangements to implement the program/project and timelines. The program/project appraisal document and draft financing agreements are prepared. Negotiation Involves resolution of any outstanding issues from the appraisal stage, agreement on the procurement strategy and procurement plan for Investment Project Financing (IPF), financing and disbursement
  6. 6. Page | 6 arrangements (including disbursement letter for IPF), and terms and conditions. Approval Involves review and approval of program/project and financing documents by the Bank’s Board of Executive Directors or by the management. Signing Involves signing of legal financing agreements by the Bank and client representatives. Effectiveness Involves determination by Bank officials that predetermined and agreed conditions have been met to begin disbursements. Disbursements, restructuring, refunds, cancellations, and loan closing Involves disbursements to borrowers based on valid withdrawal applications for program financing and eligible expenditures related to program/project activities up to the closing date. Refunds of ineligible expenditures and unused advances, cancellations initiated by the Bank or the client, final disbursements, and loan closure are handled at this stage. Billing receipts and overdue management Involves support to borrowers for debt service, by means of billing statements after signing in certain cases and after effectiveness in all cases (loans, credits, and guarantees). Debt service of charges by borrowers starts once disbursements are made under the loan or credit. In certain cases, debt service of charges begins after the signing date of the agreement. Principal repayments start after the agreed grace period ends. Applying borrowers’ debt service payments to dues and following up on overdue cases, according to Bank policies and procedures, are the other activities carried out at this stage. Final maturity Represents the final repayment date as specified in the financing agreement. Loan Policies in Bangladesh Bank:  Two Step Loan: The Two Step Loan (TSL) fund of JICA assisted FSPDSME project is providing medium and long term loans to micro, small and medium enterprises for their productive investment. The Operating Guidelines of the FSPDSME project allow providing refinance or pre-finance of maximum 83% of the sub-loan or maximum 75% of the sub- project. Additionally, the Operating Guidelines does not allow financing to women led enterprise at preferential interest rates like other refinancing schemes of BB. It is, therefore, observed that women entrepreneurs do not show much interest to take financing under this project. In order to motivate women entrepreneurs in productive investments, the Steering Committee of the project in its 5th meeting held on 06 January 2016 decided to allow providing 100% refinance/ pre-finance at preferential interest rate [ bank rate + maximum 5% spread] in line with prevailing women entrepreneurship development strategy of BB. The FSPDSME project was successfully closed on 31 March 2016. Refinancing and pre- financing to participating financial institutions (PFIs), however, is being continued from the revolving fund account of the project.  Loan Rescheduling: Bangladesh Bank recognizes that in some cases, a legitimate banking practice may allow for the renewal of a continuous loan or line of credit. Occasionally, even
  7. 7. Page | 7 a term loan is renewed or extended under unfortunate circumstances that are beyond the control of the borrower and do not signify that the borrower's willingness or ability to repay has deteriorated the loan. However, Bangladesh Bank is concerned that rescheduling (also known as “prolongation” or “ever greening”) may sometimes result in an overstatement of capital, when loans that have a low probability of repayment are carried at full value on banks' balance sheets. Bangladesh Bank is hereby issuing this circular in order to communicate its policy stance that rescheduling should be done only in limited circumstances and under restrictions. Rescheduling differs from different types of loans. Although loan classifications & policies are important parts of financing in Bangladesh for projects, business, agriculture etc. but this is a reason for confliction, problems in banking sectors.