What is take-out financing?

Take-out financing is a method of providing finance for longer duration projects of about 15 years by banks sanctioning medium-term loans for 5-7 years. It is given that the loan will be taken out of books of the financing bank within pre-fixed period by another institution, thus preventing any possible asset-liability mismatch. After taking out the loan from banks, the institution could offload them to another bank or keep it.

Though internationally this kind of lending has been in existence for many years, it came to India only in the late 90s. These long-tenure loans were primarily introduced to incentivise banks to lend to the infrastructure sector as banks back then had very little exposure to long-term loans, and also because they did not have adequate resources of similar tenure to create such long-term assets. What does the Reserve Bank rule say? Banks/FIs are free to finance technically feasible, financially-viable and bankable projects undertaken by both public sector and private sector undertakings, provided the amount sanctioned is within the overall ceiling of the prudential exposure norms prescribed by RBI for infrastructure financing. They should also have the requisite expertise for appraising technical feasibility, financial viability and bankability of projects. Which institutions, besides banks, are engaged in this practice? The government promoted Infrastructure Development Finance Corporation, by setting aside a corpus from the union budget, with a primary mandate to promote infrastructure funding. Later, India Infrastructure Finance Company also came up essentially to refinance infrastructure loans of commercial banks. What are the problems with take-out financing? Though take-out financing is a permissible practice in India, the concept has not taken off in a big way. Though the concept in a way addresses the asset-liability issue, regulators still want banks to set aside higher capital for their exposure. Besides, banks are also wary of taking risks such as construction risks, which may delay the project as well as increase its cost.

IIFCL to pick up infrastructure loans from banks' books

Take-out financing', an old hat in advanced markets and a subject of academic discussion for years among local bankers, will be tried out to fund Indian infrastructure projects deals which very few lenders are willing to touch. To make things work, the state-owned vehicle, India Infrastructure Finance Company (IIFCL), will pick up infrastructure loans from banks' books. The transaction to buy out loans after a few years of disbursement is called take-out financing. Banks shun infrastructure loans, which have a long repayment period. The average tenure of bank deposits is 3-5 years, while most infrastructure projects span over 7-15 years. A bank funding such long-term projects with short-term money runs the risk of having serious mismatches on their books. Banks badly need another agency to take over such loans. This is where take-out financing comes in. Here, a term-lending institution takes over the loans after a few years of the bank disbursing them. This not only minimises the bank's asset-liability mismatches, but also frees up its capital.
Besides take-out funding, IIFCL will refinance 60% of commercial bank loans for PPP projects in critical sectors over the next 15-18 months. "IIFCL will provide refinance at 7.85%, which banks can on-lend at 10.35%," said Mr Kohli. Bankers said IIFCL should be given more freedom on financing. Currently, IIFCL can neither finance telecom projects nor refinance power projects. Furthermore, the Rs 10,000 crore of capital that the company raised last year against government guarantee can be used for financing road and ports only. "We are going to seek clarification from the government to address these issues," pointed out Mr Kohli.

What is viability gap funding? There are many projects with high economic returns, but the financial returns may not be adequate for a profit-seeking investor. For instance, a rural road connecting several villages to the nearby town. This would yield huge economic benefits by integrating these villages with the market economy, but because of low incomes it may not be possible to charge user fee. In such a situation, the project is unlikely to get private investment. In such cases, the government can pitch in and meet a portion of the cost, making the project viable. This method is known as viability gap funding. Ads by Google

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How does the scheme work?

VGF is typically provided in competitively bid projects. Under VGF, the central government meets up to 20% of capital cost of a project being implemented in public private partnership (PPP) mode by a central ministry, state government, statutory entity or a local body. The state government, sponsoring ministry or the project authority can pitch in with another 20% of the project cost to make the projects even more attractive for the investors. Potential investors bid for these projects on the basis of VGF needed. Those needing the least VGF sup-port will be awarded the project. The scheme is administered by the ministry of finance. Which are the eligible sectors? Projects in a number of sectors such as roads, ports, airports, railways, inland waterways, urban transport, power, water supply, other physi-cal infrastructure in urban areas, infrastructure projects in special eco-nomic zones, tourism infrastructure projects are generally eligible for viability gap funding. The government now proposes to add social sectors such as education and health to the list. How does the government benefit? The government has limited resources. It can use those funds to build everything on its own, but such public funding will take years to cre-ate the infrastructure that is needed to achieve higher growth. Through viability gap funding, the same amount of funds can be used to execute many more projects through private participation. VGF is in that sense a force multiplier, enabling government to leverage its re-sources more effectively.