Project Financing in India: Sources, Institutions, and Key Features

Fintaxman August 24, 2025

Project Financing in India

Project financing refers to the process of raising funds required to finance an economically separable capital investment proposal, where lenders primarily rely on the estimated cash flow generated by the project to service their loans.


    Difference Between Project Financing and Conventional Financing

    Project financing differs significantly from conventional financing in several ways:
    1. Cash Flow Consideration:
      • Conventional financing considers combined cash flows from all assets and businesses.
      • Project financing focuses solely on cash flows from project-related assets to assess repayment capacity.
    2. End-Use of Funds:
      • In conventional financing, lenders do not strictly monitor the end use of borrowed funds.
      • In project financing, creditors ensure proper utilization of funds and creation of assets as outlined in the project proposal.
    3. Monitoring of Performance:
      • Conventional financiers mainly ensure loan repayment without closely monitoring business performance.
      • Project financiers actively monitor project performance and may suggest or enforce corrective measures to ensure debt repayment.

    Sources of Project Finance

    Once the project cost is estimated, the sources of finance must be analyzed, and a suitable mix chosen. Broadly, financing sources fall under equity capital and debt capital:
    • Equity Capital: Permanent capital without repayment obligations, acting as a cushion during unfavorable conditions.
    • Debt Capital: Borrowed funds requiring repayment of principal and interest within a fixed period.

    The key sources of project finance include:

    1. Ordinary Shares (Equity):

    Equity shareholders are owners of the company, bearing ownership risks. Dividends are payable only after meeting obligations toward creditors and preference shareholders.

    2. Preference Shares:

    Carry a predetermined dividend rate and priority over equity in dividend payments. Unpaid dividends in loss years are carried forward to future profitable years.

    3. Debentures:

    Long-term debt instruments requiring fixed interest and principal repayment. Convertible debentures can be converted into equity shares at the option of the holder.

    4. Bonds:

    Similar to debentures, though in India the term “bond” is commonly used for public debt securities issued by the government and public sector enterprises.

    5. Bridge Finance:

    Short-term loans provided by banks and financial institutions to avoid project delays during implementation.

    6. Deferred Credit:

    Credit facility offered by machinery suppliers, often backed by a bank guarantee from the project promoter.

    7. Unsecured Loans:

    Loans from friends, relatives, or well-wishers to cover shortfalls. These loans are unsecured, meaning lenders have no claim over company assets.

    8. Term Loans:

    Long-term loans (5–10 years) offered by institutions like LIC, IDBI, UTI, and ICICI. Such loans usually require promoters to contribute a minimum equity share toward project costs.

    Role of Financial Institutions in Project Financing

    Large-scale projects are typically financed through a mix of equity and debt, as relying entirely on equity is often impractical. Financial institutions usually require promoters to mobilize equity capital before disbursing loan funds.
    In India, project financing is primarily undertaken by:
    1. All-India financial institutions (IDBI, ICICI, IFCI)
    2. State financial corporations
    3. Banks
    Non-Banking Financial Companies (NBFCs) also participate, though their share is relatively small.
    These institutions, often referred to as development bankers, play a crucial role in promoting industrial development, particularly by supporting new and first-generation entrepreneurs. Banks, being custodians of public funds, act as trustees and lend only after careful evaluation.

    Lending Criteria

    The decision to finance a project is governed by three primary conditions:

    1. Repayment Capacity:

    The project must generate sufficient cash flows to service debt obligations.

    2. Security Value:

    Adequate collateral must be provided to safeguard lenders’ interests.

    3. Borrower Integrity:

    The credibility, commitment, and repayment willingness of the borrower are assessed.

    Above all, the project must be self-sustaining, capable of repaying obligations from its own cash flows. When this condition is met, other objectives such as wealth creation, resource utilization, and employment generation can also be successfully achieved.

    FAQ's

    What is project financing?

    Project financing is a method of funding large-scale projects where repayment depends primarily on the project’s future cash flows rather than the overall financial health of the promoters.

    How does project financing differ from conventional financing?

    Unlike conventional financing, project financing focuses only on the cash flows of the specific project, involves strict monitoring of fund usage, and requires lenders to closely track project performance.

    What are the main sources of project finance in India?

    The main sources include equity shares, preference shares, debentures, bonds, bridge finance, deferred credits, unsecured loans, and long-term term loans from institutions.

    Which institutions provide project financing in India?

    All-India financial institutions like IDBI, ICICI, IFCI, state financial corporations, banks, and to a limited extent NBFCs, provide project financing.

    What are the key factors lenders consider before financing a project?

    Lenders evaluate repayment capacity from project cash flows, adequacy of security/collateral, and the integrity and commitment of the borrower.



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