Creating a bankable project is not enough to automatically mobilize financing.
ADB’s recent report Meeting Asia’s Infrastructure Needs notes that the region needs to spend $26 trillion by 2030, or $1.7 trillion per year, in order to relax infrastructure constraints to economic growth and development. To achieve this goal, the public and private sectors will have to join forces to mobilize financial resources into bankable projects.
While banks will remain a key driver of finances over the medium term, capital markets will play a bigger role in the long term. Bond markets—especially local currency bond markets—will be critical to filling Asia’s infrastructure investment gap with long-term sources of financing for infrastructure projects and also to avoid currency mismatches from borrowing in foreign currency for projects that generate revenues largely in local currency.
Getting the finances right is, thus, no trivial matter.
Many development experts are true Sayists at heart and believe that the supply of a “bankable” project—backed by a Financial and Internal Rate of Return estimate, a feasibility study, and a procurement plan—should suffice to automatically create the demand for loanable funds. In other words, money or financing is not the issue.
For a banker, on the other hand, the key elements to financing projects are credit risk, pricing, and tenor of the loan, typically captured in the project term sheet. If the return on the project can cover these costs, plus a margin and given a credible feasibility study, the project will likely push through. Even if a project appears to be unbankable, this can change with some structuring effort – including through credit enhancements, viability gap support, or by bundling of projects to improve cash flow, etc.
The important message here is that creating a bankable project is not enough to automatically mobilize financing. More starkly, there is no such thing as an infrastructure project, public or private, devoid of financiers.
Wholesale financing can fund full pipeline of projects
ADB has pioneered in South Asia what is known as the wholesale model of financing (WMF). The idea is to work in close partnership with a non-bank financial institution to leverage public-private partnership (PPP) frameworks already in place to provide two-step or financial intermediation lending for an entire pipeline of sub-projects, not single projects as ADB typically does. This doesn’t mean that ADB is signing one big blank check, as eligible sub-projects must meet upfront, objective, and transparent sub-project criteria. This is essential to scale up the development impact of ADB resources.
There are four key benefits from using the WMF approach.
First, it leverages ADB resources, creating more bang for our buck. As a financier, ADB has a critical comparative advantage in that it can provide long-term finance that is in short supply (or very costly) across ADB’s developing member countries, and cover the long gestation costs associated with infrastructure projects. This leverage is attained by limiting ADB financing to a maximum of 20-40% of total sub-project costs, with the remaining costs covered by a consortium of commercial financiers in the market. ADB loans, typically with tenors of 15-20 years, help anchor and catalyze short-term, commercial project financing.
Second, through its AAA international credit rating, ADB can raise funds at a lower cost in the market—in some instances even in local currency—and pass on these benefits to its borrowers. Blending ADB funds with commercial financing brings down the average borrowing cost, and at the margin is a very powerful funding mechanism to support project returns. This is crucial, given that public service users across developing Asia have a low ability to pay. PPP projects—with their own operational framework and sharing of risks between parties with different risk appetite and model concessional agreements, and at times supported by viability gap funding—can also help contain overall project costs.
Third, from a purely transaction cost perspective, ADB devolves or transfers the compliance operations to the partner institution once it has developed an accredited system. This frees up its own resources and creates a win-win situation for both sides. This institutional knowledge transfer is not limited to compliance requirements; it also improves financial and risk management practices that become more relevant as the partner’s portfolio expands.
Fourth, by operating through PPP projects, the WMF approach crowds in the private sector. By bringing additional long-term financial resources into a country, ADB is expanding the pool of loanable resources available for private sector financing. ADB funding thereby represents a strategic complement to available short-term financing for infrastructure projects, and doesn’t compete with the private sector for these scarce resources. Equally important is that price distortions are contained as partners do not unilaterally set the lending rate, but accept the rate set by the consortium of financiers.
WMF approach catalyzes private financing
Over the past decade, ADB’s South Asia Regional Department has provided $1.9 billion in three WMF loans to the India Infrastructure Finance Company Ltd. and $275 million in two loans to the Infrastructure Development Company Ltd., in Bangladesh.
This funding has helped complete PPP road and airport projects in India, and mostly power projects in Bangladesh. But even more important is that through the WMF approach, ADB has catalyzed 13 times its funding in India, and nearly five times in Bangladesh.
WMF has been a very effective financing model to partially address the infrastructure gap, and all the loans appraised to date are rated successful. To help Asia fund the infrastructure it needs, we should consider rolling out WMF beyond South Asia.