Risks
1. New markets/market penetration: Projects based on entering new markets are risky, but can result in a greater positive development impact. A flexible and more conservative debt-equity structure can help to mitigate the risk of a longer than assumed ramp-up. In addition, capital intensive projects must be adequately capitalized to allow for market penetration risk.
2. Foreign exchange: Projects which rely on domestic sales to repay foreign currency debt face foreign exchange risk. This problem can be addressed by:
- exploring options for providing local currency loan or guarantees;
- encouraging sponsors to enter into hedge agreements; or
- structuring the project conservatively, for a high debt service coverage ratio.
3.
Country risk: If a country is undergoing a structural adjustment/liberalization program, the project's market and price projections should be very conservative. IFC should only finance companies which are likely to succeed regardless of the outcome of the stabilization program.
4.
Projects with high risk profiles: In high risk projects (i.e. uncertain geological condition, start-up ventures, new and relatively inexperienced management) and where there are early reports of unexpected production problems, an IFC technical specialist should visit the field as soon as possible. IFC should also obtain strong completion commitments from the sponsors, and structure financing to protect its interests.
5.
Pre-payment risk: IFC should structure investments to protect itself against pre-payment risk. A loan cancellation fee may not always be a deterrent and may not be legally enforceable. Other suggestions to minimize the consequences of such a risk include (where there is a loan and equity):
- a pro-rata disbursement of the equity and loan; and
- a prepayment-linked activation of the put option.
6.
Inflation risk: IFC's analysis for companies operating in an inflationary environment should consider the risks to sustained profitability as well as the impact of currency devaluation, particularly when financing is in foreign currency.
| Other risks | Mitigating action |
| Inadequately prepared financial intermediary, leading to implementation difficulties | Provide training and technical assistance |
| Market risks for resort hotel | Market through multiple tour operators |
| Less than arm's length business transactions | Structure financing and security to mitigate |
| Use of second-hand equipment | Address start-up and production build up risks |
| Hydrology risks | Seek independent hydrology potential estimates |
| Client has insufficient knowledge of how to hedge operations against risks | IFC should educate and assist |
| Risk of sub-project default in financial market projects | - Enforce exposure limits
- Prudent portfolio management |
| Debt service risk with back-end loaded loans | Insist on mechanisms such as dividend clawback or maturity acceleration |
The above lessons are based on 55 lessons from past IFC investments.
Last updated February 1999.
