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Asset class under assault: Project finance battles risk misconception

Project finance has been hampered by misperceptions of its riskiness — among bankers and regulators alike. Although its risk-return profile is better than vanilla corporate lending, the Basle II risk proposals could weaken the market further. Paul Ashley of Oliver, Wyman looks at the threat and possible solutions.

Project finance is facing its greatest external threat for many years. Despite being less risky than lending to corporates it is penalized by the new Basle capital accord (Basle II). As it stands, Basle II will fundamentally alter the structure of the market. A greater polarization will occur between price makers and price takers, and non-bank players will grow at the expense of banks unable to qualify for advanced status. Over the long term, the project finance market has the potential to grow disproportionately when compared with commercial banking as a whole and in theory should represent an attractive proposition for banks looking for balance sheet income.

Demand is set to greatly outstrip supply. The vast market for infrastructure projects in the emerging markets, huge growth in renewable energy, and the expansion of the private finance initiative concept in the developed economies - for everything from toll roads to airports and from schools to hospitals - show no signs of slowdown.

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