This paper analyses the peculiar nature of credit risk in project finance by
means of a comparative econometric analysis of ex ante credit spreads for a
large cross section of international loans and bonds between 1993 and 2001 in
both industrialised and emerging countries.
Our main contribution relates to the analysis of the term
structure of credit spreads for project finance loans compared to other loans
and bonds. For both investment-grade and speculative-grade bonds used for
purposes other than project financing, we find that the term structure of credit
spreads can reasonably be approximated by a linear positive function of
maturity, once other relevant micro and macro risk factors have been controlled
for. For project finance loans, instead, we show that the term structure of
credit spreads is hump-shaped. This result applies to both industrialised as
well as emerging countries and appears robust to a large number of sensitivity
tests, controlling also for possible sample selection bias or endogeneity of
maturity choice. We emphasise a number of key features of project finance
structures that might underlie this finding. In particular, we illustrate the
mechanisms by which higher leverage, short-term liquidity concerns due to the
exclusive reliance on project cash flows as well as the sequential resolution of
risks along various project advancement stages might all alleviate the perceived
risk of longer-maturity project finance loans.
This paper offers a number of policy implications. It
provides a cross-country assessment of the riskmitigating role of explicit or
implicit guarantees from multilateral development banks and export credit
agencies in project finance. It also makes a number of suggestions for bank
regulators on how to effectively align capital requirements with the actual term
structure of credit risk in project finance. In particular, our results indicate
that a linear maturity adjustment to regulatory capital with slope inversely
related to the probability of default might not be applicable to project finance
exposures. We acknowledge, however, that introducing different maturity
adjustments for different asset classes, while improving the risk sensitivity of
capital requirements, would also add to the complexity of their implementation.
Keywords: project finance, term structure of credit spreads, political risk,
capital requirements.
JEL codes: F34, G12, G28, G32.