Project Finance Default in India: Implications for Bank Loans to the Infrastructure Sector

Abstract

For large, capital-intensive infrastructure projects, project finance is an attractive financing alternative. The project finance structure attracts high leverage and allows for optimal sharing, allocation, and mitigation of risk among the project parties, equity providers, and financiers. In an ideal situation, the contractual bundle quarantines the developers and financiers. In India, because of a lack of other long-term sources of debt, it is bank credit that funds infrastructure projects. These projects have a higher marginal default rate in the construction period. In India, it is difficult to mitigate regulatory and political risks, particularly risks related to land acquisition and environmental clearances for a project to start. These risks compound the problems of early default and lead to deterioration of asset quality on the books of the banks. Thus, banks have to bear higher capital charges to comply with Basel II norms. This article argues that in uncertain regulatory/political/legal macro-environments, where optimally priced risk mitigants are not available, the use of project finance bank loans to fund highly leveraged infrastructure assets must be reconsidered. <b>TOPICS:</b>Project finance, other real assets, legal/regulatory/public policy, risk management