Developing countries face unique challenges when seeking development finance. The challenges are so acute that countries are often in a race to ensure that they have the financial resources to develop as quickly as possible. In addition, there is a focus on the need to promote effective use of the finance and how that needs to be in line with the country’s development objectives.
As a result, governments are increasingly turning to short term bridging finance, a form of development finance that helps to reduce risks associated with long-term financing. Developing countries often need bridging finance to ensure that the process of getting funding from banks and other sources does not have the effect of eroding the viability of their development objectives. In the case of private sources of finance, there is an urgent need to reduce risks to enhance the risk profile associated with development financing.
However, there are substantial differences between government and development finance. Development finance usually comes in the form of a loan or an extended facility, such as the EB-XII. In this type of finance, the lending party will pledge the ability to repay and will also carry out a feasibility study to see whether the debt will be sustainable in the long term. This type of borrowing is also seen as offering greater flexibility, as it allows the lending party to set the terms of repayment.
However, development finance is not usually free. There is usually a period of time in which the loan is expected to be repaid before any capital is required by the lending party. The borrower will usually take up the default position, which allows them to get out of the debt at the earliest opportunity.
If this happens and the loan has not been repaid within the period of the agreement, the borrower can choose to take certain special measures. These can range from extending the loan terms or obtaining different types of financing to help re-establish the viability of the projects being undertaken.
As well as its flexibility, development finance offers advantages to the lender. It allows for debt consolidation, as the cost of interest will be less than the cost of new capital. It also allows for repayment earlier and reduces the number of individual projects and therefore the risk of a failure.
Another benefit is the provision of debt-management plans, which are written by an expert to help businesses plan and manage the costs of their existing and future loans. Often, a business will approach the issuing entity for bridging finance and be surprised to find that the lending party has already carried out this aspect of their planning. By using the plans, the businesses can restructure their debt based on what they currently have.
Another area of development finance that governments use is corporate restructuring. This allows businesses to restructure their debt and raise the capital they need to complete their projects. Corporates are commonly able to access these funds through the establishment of a new entity that will be looking after its interests.
More formal development finance comes in the form of bonding arrangements. This takes a long-term loan from a lending party and puts up as security the equity of the business. Bonds are secured against the collateral, such as land or some kind of asset.
Government bonds are viewed as the cheapest option and also offer the greatest level of protection from risks. They are also seen as offering the greatest assurance of return. However, as with any other form of financing, risks do exist.
Finally, because commercial loans are considered as riskier than conventional loans, there is an added level of scrutiny as it relates to where the risk comes from. One of the most common reasons for seeking development finance is a failure to meet investment targets, which can affect the confidence of the domestic market.
Bridging finance provides the risk mitigation benefits of development finance but without the risks associated with those same benefits. Countries benefit from bridging finance by gaining a more realistic chance of achieving their development objectives.