In order to facilitate the growth of infrastructure investment with the help of insurance and pension funds, the Union Government of India has planned to launch a Credit Enhancement Fund of Rs.500 crores.
Credit enhancement is a method where a company tries to improve its debt or credit worthiness. It is basically a risk-reduction technique where there is an increase in the credit profile of structured financial products or transactions.
It is also used to obtain better terms for an outstanding debt. Through credit enhancement, the lender is provided reassurance that the corporate borrower will honour its obligation through additional collateral insurance or a third-party guarantee. Posting collateral and obtaining external credit enhancement such as a letter of credit (LOC) are some basic forms of credit enhancement. Firms may also increase cash reserves or take other internal measures to uphold superior solvency ratios
Credit enhancement also reduces the credit risk of debt, thus increasing the overall credit rating and lowering interest rates. For example, an issuer may use credit enhancement to improve the credit rating on its bonds. This can be done by taking a guarantee from a bank that agrees to assure a portion of the repayment of dues, which might increase the rating on the corporate bond. The bank guarantee serves as an addition to the bond issue that improves the issue’s safety of principal and interest. The issuer benefits since its cost of raising funds decreases with a higher credit rating.
Another means for the bond issuer to enhance its credit is by purchasing insurance to guarantee that interest payments and principal repayments will be made.
With the use of credit enhancement a structured financial transaction can improve the credit profile or the methods used to improve the credit profiles of any products or transactions. It is a key part of the securitization transaction in structured finance, and is important for credit rating agencies when rating a securitization.
Securitization is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations and selling their related cash flows to third party investors as securities, otherwise called bonds. Investors are repaid from the principal and interest cash flows collected from the underlying debt and redistributed through the capital structure of the new financing. Securities backed by mortgage receivables are called mortgage backed securities (MBS), while those backed by other types of receivables are asset backed securities (ABS). (Check Loans Online)
The CEF provides additional source of assurance or guarantee to the borrower who will service their loan. In this process, the borrower can raise loans at lower interest rates. The fund was first announced in our Union Budget for fiscal year 2016-17.
Credit Enhancement Fund will provide credit enhancement for infrastructure projects which will help in upgrading credit ratings of bonds issued by infrastructure companies and facilitate investment. This involves investors like pension and insurance funds.
The initial corpus of the fund, to be sponsored by India Infrastructure Finance Company (IIFCL), will be ₹500 crore, and it will operate as a non-banking finance company (NBFC)
IIFCL will hold 22.5% stake in the NBFC, while Asian Infrastructure Investment Bank (AIIB) has been offered by the Government to pick up 10% stake.
At present, only $110 billion is being invested in infrastructure in India, against the requirement of $200 billion, Hence the leading analysts classify India as infrastructure deficit country.
A majority of the present infrastructure project financing is done by the banking system. But most of these lenders are saddled with problem of non-performing assets (NPAs). So there is need to look for alternatives.
The private sector has to be more active on the infrastructure investment front. Credit Enhancement Fund plans to serve as alternative for raising of money for infrastructure projects through corporate bonds.
Some public sector banks, including SBI and Bank of Baroda have evinced interest in picking up stake in the fund. Public sector LIC, General Insurance Corporation of India (GIC) also plans to pick up stake in the credit enhancement fund.