Alternative sources of finance-7 Flashcards
Traditional banks raise finance within the regular banking system through
maturity transformation.
Shadow banks are
non-bank financial institutions that carry out banking activity outside the regulated system.
Regular banks accept deposits, while shadow banks
borrow short-term funds and lend them long-term.
Regular banks are subject to
regulatory scrutiny, which involves reserve and capital requirements and disclosure of prescribed information.
Regular banks are subject to
regulatory scrutiny, which involves reserve and capital requirements and disclosure of prescribed information.
Benefits of regulation include
central banks providing liquid funds to regulated banks in an emergency and protection of customers’ deposits.
Shadow banks offer _______returns to lenders but are ____
Shadow banks offer higher returns to lenders but are more exposed in emergencies since they are not able to borrow from central banks.
Shadow banks may offer what benefits
cheaper loans, increase competition, and be available in countries where traditional banks are not.
The majority of a bank’s assets are
long-term loans, which can be sold on.
Putting a value on loan assets is difficult since
their value falls in a recession.
A company wishes to take out a loan. Explain the possible advantages the shadow banking sector
might have over the traditional banking sector for a company looking to borrow money.
Solution
he loan may be cheaper as shadow banks avoid the costs of complying with banking regulation.
The existence of the shadow banking sector also potentially increases the level of competition in
the sector by increasing the number of players in the market to more than just traditional banks.
The availability may also be better, for example a shadow bank may be prepared to lend in
circumstances where traditional banks wouldn’t or finance might be available in countries where
there isn’t a developed banking sector, or in developed markets where the traditional banking
sector is being constrained by other regulatory or political issues.
Question
Complying with regulatory requirements involves costs for banks. State the benefits associated
with regulation of banks
Solution
The main benefit is access to the protections of the regulatory system. For example, central
banks provide liquid funds to regulated banks in an emergency and provide protection of
customers’ deposits (possibly up to a maximum amount).
These protections provide an economy with confidence in the banking system and have
reputational benefits for the banks, eg increasing their ability to attract customers
Project financing involves
raising finance for a specific project and not for the business carrying out the project.
Project financing is used for large infrastructure projects, particularly public-private partnerships (PPP) that require
a substantial amount of capital.
______________of lenders from the host country and foreign lenders provide capital for the project
Consortium
PPP involves a partnership approach where both public and private sectors provide finance and share
the project’s risks and rewards.
Project financing is used for projects related to
the development or exploitation of natural resources.
A new legal entity called_______ is formed for the project to achieve the characteristic ring-fencing needed for project financing.
Special Purpose Vehicle (SPV)
_______________ is generally used in project financing where lenders rely on the revenues from the project for repayment of the loan with the project’s assets held as collateral.
Non-recourse financing
Non-recourse financing is different from recourse financing where lenders
can be paid from the assets or cash flows of the shareholders in case of default.
is Non-recourse financing factoring cheaper than -recourse financing
Non-recourse financing involves higher risk to the lender, making recourse financing cheaper.
Off-balance-sheet financing is used in project financing to keep the liabilities of the project
off the balance sheet of the borrowing company.
SPVs have their own accounts separate from
the accounts of the borrowing company or companies involved.
Crowdfunding
Crowdfunding allows many individuals or businesses to support a project or campaign.
Crowdfunding typically takes place through
a dedicated website and social media channels.
attractive to small businesses and entrepreneurs.
The process of crowdfunding is less formal than other sources of finance, making it
why Crowdfunding attractive to small businesses and entrepreneurs.
The process of crowdfunding is less formal than other sources of finance, making it
Crowdfunding websites charge a fee for their services and may or may not vet the projects that
are promoted on their platform.
Crowdfunding has gained popularity as a means of financing
start-up projects or new products.
Four types of crowdfunding exist:
donation-based, pre-payment or reward-based, loan-based, and investment-based.
Donation-based crowdfunding yields a
loss of the amount invested.
Pre-payment or reward-based crowdfunding yields the value of the reward given to
investors.
Loan-based crowdfunding yields
interest on the money invested and repayment of the capital over time.
Investment-based crowdfunding allows investors to
buy shares in the business and benefit if the venture succeeds.
Rewards-based crowdfunding might have lower costs but may appeal to
a smaller number of potential investors.
Investment-based crowdfunding offers potential long
delays before any return is paid to investors, and the cost of dilution of ownership and future profit sharing.
Loan-based crowdfunding avoids giving away equity but may struggle to find
investors with an appetite for risk.
Crowdfunding carries additional risks, such as lack of a
secondary market, the project may not go ahead if insufficient investors are found, and uncertainty about how long the call for funds will be open.
Microfinance provides small loans
that are faster and easier to secure than traditional loans.
Microfinance provides small loans that are faster and
that are faster and easier to secure than traditional loans.
Microloans are typically small amounts available to borrowers who may not
have access to traditional loans.
Microloans broaden
financial inclusion.
Microloans have generous repayment periods and
are used for start-ups and small businesses.
Charities involved in reducing poverty and promoting small-scale start-ups in developing countries use microfinance to
encourage funding.
Which of the following is NOT a type of crowdfunding?
A donation-based
B pre-payment
C loan-based
D non-recourse.
Answer = D
The fourth type of crowdfunding mentioned is investment-based
Which of the following statements about project finance is true?
A It entails the formation of a new legal entity.
B It is a recourse method of financing.
C It provides on-balance-sheet financing.
D It always involves the public sector. [2
Answer = A
Project finance is a non-recourse, off-balance sheet method of obtaining finance. It often involves
public-private partnerships, but does not have to involve the public sector.
Outline the similarities and differences between shadow banking and regular banking
Similarities
Both perform ‘maturity transformation’ ie the conversion of short-term liabilities to long-term
assets. [1]
Both face the risk of investors losing confidence which can create a liquidity risk. [1]
Differences
In regular banking, the liabilities are cash deposits from banking customers. Shadow banks do not
take deposits. Instead they borrow money in the money markets. [1]
Customers in regular banks may demand the return of their deposits. The bank will not hold
enough in cash to meet this demand if a large number of customers want their money at the
same time. [1]
Shadow banks may struggle to roll over their short-term borrowings, for example if investors are
concerned about the value of the shadow banks assets. [1]
Shadow banks are outside the banking regulatory system and so are not subject to the reserve
and capital requirements imposed on regular banks. [1]
Shadow banks are not able to borrow from the central bank and so are more exposed in an
emergency. [1
