Chapter 8: Alternative Sources of Finance

• Maturity transformations 


  Converting short term liabilities to long term assets
• Shadow banks 


  Non-financial institutions that carry out maturity transformations outside the regulated system
• A defining characteristic of regular banks

  They accept deposits and are therefore subject to regulatory scrutiny
• The regulatory system for regular banks

  Reserving requirements (liquid funds to make payouts). Capital requirements (specify min requirements relating to the bank's assets in excess of its liabilities), disclosure of prescribed information
• The benefits associated with regulatory requirements 


  Protection of customer deposits, economy has confidence in the banking system, reputational benefits-attract customers
• What do shadow banks do?

  Borrow short term funds in the money market and lend or invest these funds over the longer terms. Not subject to capital requirements and reserve requirements so higher returns. Not able to borrow from central banks.
• Who are the lenders in shadow banks?

  Investors from whom the bank has borrowed money in the money market
• The advantages of shadow banking over traditional banking

  Cheaper loans: avoid the costs of complying with banking regulation. Increases competition.

  Better availability: lend where banks wouldn't: no developed banking sector, or in developed markets where traditional banking is constrained by regulatory or political issues
• The risk of shadow banks in recessions

  Value of loan assets fall in a recession when borrowers are more likely to default. Investors uncertain about shadow banks longer term assets and withdraw funds, shadow banks had to sell assets to repay investors-reduced the the value of these assets, which had impacts on traditional banks. The extent of the risk wasn't clear because of the lack of info.
• Project financing 


  Finance is raised for a project not a business. Used for large infrastructure projects, often PPP (public private partnership). High risk and long term. Capital raised from a consortium of lenders from the host country and foreign lenders
• What kind of projects is project financing used in

  Development or exploitation of natural resources
• The partnership aspect of project financing

  Usual for the public sector to finance large infrastructure projects and the private sector to be contractors. This has shifted to both providing finance and sharing the projects risks and rewards (PPP)
• Features of project finance 


  Formation of a new legal entity as a SPV, non-recourse financing, off-balance sheet financing
• Special Purpose Vehicle (SPV)


  A separate legal entity needs to be created for the project. It is the borrower and subcontracts the construction and operation contracts. The shareholders are equity investors who own the company, a gov may be involved in granting permits or funds
• Non-recourse financing


  Lenders rely for repayment of the loan on the revenues from the project with the project assets as collateral. No revenue during construction period. Lenders expect higher return to compensate them for taking on additional risk. The lender is paid only from the profits of the project and assets may be insufficient
• Is recourse or non-recourse factoring cheaper

  Recourse-less risky
• Off-balance sheet financing 


  The SPV has its own accounts, project debt is not consolidated onto its balance sheet
• Crowdfunding 


  Allows a large no. of participants to support a business/product via a crowdfunding website and promoted via social media
• The attractions of crowdfunding 


  Lower associated issue costs and lower expertise-good for small businesses and entrepreneurs
• The crowdfunding website 


  Typically charges a fee-% of the money raised, May vet ventures
• Types of crowdfunding 


  Donation-based, pre-payment or reward based (receive a service or product), loan based/peer-to-peer lending (receive interest, capital repaid), investment-based (shares)
• Which has a better return between debt finance and equity type finance


  Equity type finance (investments)
• Ad and dis of rewards based funding

  Lower cost, but smaller no. of investors-who would value the reward
• Ad and dis of investment based funding 


  Longest delay before any return but at the cost of dilution of ownership and sharing future profits
• Loan based funding ad and dis

  Avoids giving away equity, but struggle to find investors with the risk appetite to want the relative security of a loan in a potentially high-risk venture
• Regulation of crowd funding

  In the UK-Financial Conduct Authority (loan and investment based)
• Risks of crowdfunding 


  Lack of secondary market (risk of being unable to cash in the investment), site collapsing, project may not go ahead, uncertainty about how long call for funds will be open
• Peer to peer lending 


  Match borrowers and lenders online. Investors don't invest in individual loans, their investment is matched with percentages of a large no of loans to reduce risk. Assess the creditworthiness of applicants and allocate them a risk rating and loan interest rate. Investors choose how to split their investment into proportions at different levels of risk. The platform collects repayments from lenders and distributing them to investors, as cash or to reinvest
• Who are peer to peer investors

  Typically individuals looking for income and willing to accept the credit risk but also some institutional investors-attractive interest rates
• Why might institutional investors do peer to peer

  Attractive returns for the risk, access to a sector and type of borrrower, diversification
• Regulation of peer to peer

  Don't accept deposits so not banks. UK: FCA, US: Securities and Exchange Commission (SEC). Not covered by the Financial Services Compensation Scheme that protects individuals savings
• Key characteristics of microloans 


  Small amounts, available to borrowers who may not have access to traditional bank loans (lack of lenders, poor credit worthiness)
• How do microloans broaden financial inclusion

  No interest, the investor has the benefit of being involved in initiating a venture. Used for start ups and small businesses and have generous repayment periods4
• The attraction of microloans to charities and donors 


  Sustainable model for benefitting a neighbourhood or community. Repaid loans may be returned to the original investor or make available to help someone else. If the charity provides the loan-also provide expertise and support (costly but increases chances of success).
• Disadvantages of microloans 


  Risk of failed business ventures and increased indebtedness of the loan recipients