Project Finance Concepts, how it works and risks associated

1. OverviewProject finance1 is a rapidly expanding field, with almost USD 200bn lent to companies to finance particular projects in 2004. While project finance has its origins in the natural resource and infrastructure sectors, the current demand for infrastructure and capital investments is primarily fuelled by deregulation in the power, telecommunications, and transportation sectors; by the globalisation of product; and by the privatisation of governmentowned entities in developed and developing countries. The long-term prospects are strong, as countries with limited government resources try to meet the growing demand for infrastructure assets.

Given the right applications and structures, the benefits of project finance can more than offset the higher transaction costs, increased time commitments, and higher debt rates typically associated with project financings.

However, project finance may result in unsustainable practices because banksand project sponsors (bank clients) often do not carry out adequate environmental and social impact assessments of the projects they are financing.

English: Metropolitan Life Bldg., Manhattan, New Y...

ABN AMRO headquarters in Amsterdam.

ABN Amro Bank in Dubai

In addition, financiers oftentake inadequate steps to address the issue of sustainability, as environmental and social regulations in some host countries can be weak. This is especially true in developing countries.

As a result of the adverse consequences big infrastructure projects may have, civil society has increasingly targeted the financiers involved in the projects to act more responsibly.

This briefing seeks to identify the areas of potential risk associated with project finance, and the ways in which these may materialise in the short and medium term for financial institutions.

The briefing then examines the policies and strategies adopted by nine of the largest financial institutions involved in project finance in mitigating those risks, against a set of indicators devised by EIRIS. Finally the paper discusses how financial institutions could further decrease their risk exposure while investing in largeand often controversial projects, as well as looking at best...