Determinants of bank loan spread in project finance

Abstract

PurposeThe purpose of this paper is to develop a better understanding of the pricing decisions of banks for project finance (PF) loans and the main drivers affecting the cost of debt in infrastructure deals. As infrastructure projects are typically highly leveraged, the cost of bank lending is an important driver of the overall funding costs for the project.Design/methodology/approachFirst, the paper provides a general review of the drivers of the cost of funds in PF. Second, the paper develops a regression analysis of the loan’s spread on four categories: project, loan, bank characteristics and the economic environment. By using a new data set of InfraDeals containing data on bank spreads of more than 700 infrastructure projects worldwide from 2006 to 2016.FindingsThe results show that the cost of debt is predominantly affected by the market and the business cycle, rather than the structuring of the project. This implicates that the timing when the deal is closed weighs more heavily than the specificities of the project itself.Practical implicationsThe results have important policy implications. As PF deals are often paid for by taxpayers, this paper could help policymakers to use public funds for infrastructure in the most efficient way.Originality/valueOne weakness of existing studies in PF loan pricing is that they undervalue the role of the economic environment in the cost of debt. Few studies in the literature include macroeconomic control variables in their model and the others do not seem to find significant results. This paper reveals new insights on the pricing decisions of banks for PF loans.