How does bank financing to infrastructure companies work? Most infrastructure (infra) projects take 10-15 years for completion while average bank deposits are of a shorter duration (anywhere between 1 month - 5 years).
Here long term assets (infra-loans) are funded by short term liabilities (bank deposits). This scenario creates an (ALM) asset liability management mismatch. While depositors can demand funds early, the funds may remain locked up either in an unfinished road or a power project.
While fixed deposits are very popular amongst Indians, the participation in equity investments in India is low. Only around 1% of the population has demat accounts. Most of India’s large saving class thus invests their surplus funds into banks. These are considered safe investments by the conservative Indians. With such enormous funds available to deploy, banks could deploy them profitably in the infra space. But, how do these banks lend to the sector despite the ALM?
Source: IDFC FY10 annual report
Note: Does not include debt financing from NBFCs, insurance companies & ECBs
One method which we will discuss in this article is called take-out financing.
It is a method of providing bank finance for longer duration projects (10-15 years) by sanctioning medium term loans (say 5-7 years). This is how it works out. Banks enter into an understanding with an institution, (IIFCL, IDFC
etc), that the long-term loan will be taken out of their books within a pre-determined period (e.g. 5 years). This helps prevent any possible asset-liability mismatch. After these loans are taken out of the banks’ books, the institution can sell these loans to other banks or keep it on their own books. The bank which disbursed the loan will be paid off by the institution or the second bank after the initial 5 years. A consortium of banks can also enter this type of financing, with 3 banks each lending funds for 5 years for a 15 year project.
This take-out of loans can be on a conditional or an unconditional basis:
Unconditional: This method of take out finance involves the assumption of partial or full credit risk by the institution (IDFC, IIFCL). They agree to take over the finance from the original lender (bank) after the initial period.
Conditional: In this case, the taking over institution (IDFC, IIFCL) would have certain conditions which need to be satisfied by the borrower before it is taken over from the lending institution (bank). These may include that a certain percentage of the project should have been completed, etc. before the loan is taken over.
According to new RBI guidelines, takeout financing can also now be done over the external commercial borrowings (ECB) route. This means that domestic rupee loans can be refinanced though cheaper forex-loans after a certain period. This is applicable to companies involved in seaport, airport, road and power sectors.
Takeout financing helps banks to manage their asset-liabilities mismatch better. It also helps free up the balance sheets of banks after a certain period, thus helping them to bankroll more projects in the infra space. Government backed institutions such as IIFCL and IDFC take over the loans after a certain period, thus credit risk is transferred. However, certain criterions need to be fulfilled in order for the loans to be taken off the banks books after the initial period. Thus banks have to become more careful and lend only to viable projects which are estimated to have strong positive cash flows.
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