The emergence of shadow banking as a significant source of finance for infrastructure projects is thrown into sharp relief in a report published by Standard & Poor’s Ratings Services. Inside Credit: Shadow Banking Looks Set To Capture A Larger Share Of Project Financing In 2013 finds that in just two years, shadow banking finance for projects has risen from virtually zero to an estimated $20 billion. What’s more, such funding looks set to climb further this year to a projected $25 billion.
“Traditional project finance lenders–governments and the banks–are under severe economic pressure while demand for capital to fund projects is growing,” said Standard & Poor’s credit analyst Michael Wilkins. “Just less than $200 billion of funding came from the global loan market for projects in 2012, down from $214 billion in 2011.”
Because the shadow banking market is not transparent, it’s difficult to determine how much of the decline in bank finance is being replaced by alternative sources of funding.
However, we believe that about 10% of all project finance lending–$20 billion–last year came directly from alternative sources and institutional investors. This is nearly as much as the amount that came from the public bond markets, which in 2012 totaled $24 billion globally, according to Project Finance International.
We define shadow banking as the system of finance that exists outside regulated depositories, commercial banks, and publicly traded bonds.
Although alternative lending can in our view create opportunities for borrowers and lenders to obtain cheaper sources of capital with less onerous disclosure requirements, there are risks. First, we believe that more lenders participating in the project finance sector may create incentives for project companies to maximize debt leverage–a process that has led, and may lead again, to systemic defaults and downgrades. And second, construction risk in particular remains a specific source of anxiety for investors.
Despite the increasing contribution to project finance from shadow banking, we believe that funding sources for infrastructure projects need to diversify further. As we see it, the main factors holding back the shadow banking sector and other alternative funding sources from investing further in infrastructure are a lack of data, inexperience, and an unwillingness to take on construction risk.
However, we believe that these obstacles are not insurmountable, and that investment from alternative providers of funding will continue to grow in 2013 and beyond.