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Thursday, February 16, 2012

Debt financing with equity risks-infrastructure finance, film funding, SME lending

One may be surprised how can debt financing carry equity risks. But in each of the examples mentioned above, even debt financing is quasi equity as explained below
  1. Infrastructure finance:-The RBI Deputy Governor Harun R Khan delivered a speech on  'Infrastructure financing-progress and prospects'  at the  Diamond Jubilee International Conference on Frontiers of Infrastructure Finance 2011, held at IIT Kharagpur. In that speech(http://rbi.org.in/scripts/BS_SpeechesView.aspx?Id=655), he pointed out the manifold risks ranging from financial closure to operating/political risk. Not all these risks are random, thus making it difficult to trade them off against return. For instance, political risks/legal force majure/land title etc are risks which are quasi equity and yet lenders are heavily exposed to it in the infra space
  2. Film Funding:-As I understanding during the 2nd year elective on 'Contemporary Film Industry' taught by Kandaswamy Bharathan, film funding is fully backed by intangible assets, and the market for the final product is not clear. Even with the promoter having skin in the game, that does not ensure a success. While the no-guarantee of success argument holds even in other fields, it may so happen that even big budget productions with stars and no cost overruns, still come up dud at the box office. Unlike other areas of business, 'professionalizing' the process does not increase the success unless creative talent is not impaired in the process. 
  3. SME lending:-To meet the public policy requirement of inclusive growth, SMEs are classed under the priority sector, eligible for collateral-light loans, directed lending and interest rate subvention. Yet, smaller enterprises do have a higher failure rate, and the banks are often not comfortable with the accounts/audit/governance-even appointing auditors does not remove that problem totally. Hence, banks can legitimately grouse about unsecured lending to SMEs, where they are exposed to risks like PEs are, but without the manifold upside.
The above post was just a humble effort at connecting the dots, comments welcome.

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