The end of project finance?

In March, The Royal Bank of Scotland announced the kind of decision investors in infrastructure have become well accustomed to by now: the crisis-stricken bank is ending its presence in project finance.

For nearly 20 years, RBS was a big player in this market. Now on government-sponsored life support, the humbled institution sees its future in other product lines. Many of its peers do, too.

As balance sheets shrink, the move away from project finance is a case of needs must. Banks simply do not have the capital any longer to provide long-term infrastructure funding.

To some bankers the retreat will be lamentable; others may be relieved to see the back of an activity they were never overly enamoured with. From a banker’s perspective, the trouble with project finance is that it ties up large amounts of capital for long periods, requires extensive due diligence and, worst of all, carries low margins.

While markets were booming, these drawbacks were partly offset by banks’ ability to leverage project finance relationships to win other, more attractive, business. But now that demand for highly priced banking services has fallen off a cliff, project finance has gone from being a loss leader to being an activity with great opportunity cost and no redeeming features.

So with banks abandoning the business, what substitutes for project finance will there be? Emerging markets must rely on supranational institutions such as the International Finance Corporation, as well as the export credit agencies. In mature markets, government- backed loan guarantee programmes will play a role as well. Meanwhile bankers are talking of new types of debt providers emerging, such as pension schemes and sovereign wealth funds.

These alternative sources of funding won’t fully replace project finance overnight. But in today’s new world of capital scarcity, they’re good places to start.