Assessment and mitigation of credit risks in project financing

Svitlana Naumenkova,Viktor Ivanov,Volodymyr Mishchenko,Ievgen Tishchenko,Svitlana Mishchenko

doi:10.21511/bbs.15(1).2020.08

Abstract

Lending to long-term investment projects in fragile countries requires additional financial instruments to control the sustainability of project cash flows and to increase the borrower’s financial discipline in debt servicing. This paper analyzes the special aspects of using financial covenants as credit risk mitigation instruments in project financing in Ukraine. It also argues that regulatory requirements to maintain financial strength indicators at the appropriate level have an indirect impact on the change in project finance loan rates. The study primarily aims at developing approaches to defining a credit rate corridor for an investment project, depending on changes in the values of financial sustainability indicators. The implementation of the proposed approach allows increasing the validity of credit risk components for investors and optimizing capital value for borrowers.As required by international practice, violation of covenant terms is the trigger for satisfying the creditors’ claims. According to the authors’ conclusions, the use of financial covenants as a tool for protecting the creditors’ interests should not be an instrument of unreasonable financial pressure on borrowers. The study reveals benefits and drawbacks of using financial covenants to mitigate credit risk and reduce the probability of a borrower default in the field of project financing in Ukraine.

Highlights

The need to intensify investment activities in order to stimulate the development of the real sector, industrial and social infrastructure is an urgent task at the current stage of economic development in Ukraine
The results indicate that the regent covariance conditions were calculated. quirement strengthening for the project financial strength leads to a significant increase in the cost
The findings confirm that requirements to maintain ing, which varies depending on the borrower class the desired level of financial soundness of an invest- and the target values of financial strength ratios ment project while meeting the set values of DSCRі, (Figure 4)

Summary

INTRODUCTION

The need to intensify investment activities in order to stimulate the development of the real sector, industrial and social infrastructure is an urgent task at the current stage of economic development in Ukraine. Project financing is a complex investment activity involving a number of risks, most of which have specific manifestations; this requires appropriate techniques to manage them. Credit risk assessment is one of the most important components of a project risk management system and, requires special attention. An investment project loan is defined as a long-term loan, which is aimed at financing the construction of enterprises, industrial and social infrastructure (NBU, 2016). To evaluate the financial impact of certain events, monitor the sustainability of project cash flow, and enhance the borrower’s financial discipline in terms of servicing project debt over a specified period, lenders may represent the need to meet certain conditions in credit agreements, including maintaining the values of specific financial ratios at the appropriate level. The mechanism for using this tool in regulatory practice in Ukraine needs more scrutiny, given the need to standardize supervisory requirements to international practice and to harmonize the mechanism of dispute settlement between creditors and borrowers

LITERATURE REVIEW

DATA AND METHODS

RESULTS

DISCUSSION

Findings

CONCLUSION