Wang, X; Shi, L; Wang, B and Kan, M (2020) A method to evaluate credit risk for banks under PPP project finance. Engineering, Construction and Architectural Management, 27(2), pp. 483-501. ISSN 0969-9988
Abstract
Purpose: The purpose of this paper is to provide a method that can better evaluate the credit risk (CR) under PPP project finance. Design/methodology/approach: The principle to evaluate the CR of PPP projects is to calculate three critical indicators: the default probability (DP), the recovery rate (RR) and the exposure at default (EAD). The RR is determined by qualitative analysis according to Standard & Poor’s Recovery Scale, and the EAD is estimated by NPV analysis. The estimation of the DP is the focus of CR assessment because the future cash flow is not certain, and there are no trading records and market data that can be used to evaluate the credit condition of PPP projects before financial close. The modified CreditMetrics model and Monte Carlo simulation are applied to evaluate the DP, and the application is illustrated by a PPP project finance case. Findings: First, the proposed method can evaluate the influence of the project’s cash flow uncertainty on the potential loss of the bank. Second, instead of outputting a certain default loss value, the method can derive an interval of the potential loss for the bank. Third, the method can effectively analyze how different repayment schedules and risk preference of banks influence the evaluating result. Originality/value: The proposed method offers an approach for the bank to value the CR under PPP project finance. The method took into consideration of the uncertainty and other characteristics of PPP project finance, adopted and improved the CreditMetrics model, and provided a possible loss range under different project cash flow volatilities through interval estimation under certain confident level. In addition, the bank’s risk preference is considered in the CR evaluating method proposed in this study where the bank’s risk preference is first investigated in the CR evaluating process of PPP project finance.
| Item Type: | Article |
|---|---|
| Uncontrolled Keywords: | engineering; estimating; optimization; risk management; simulation |
| Index terms: | risk management, recovery, estimation, Monte Carlo simulation, qualitative analysis, methodology, project finance, estimating, exposure, preference, default, cash flow |
| Subjects: | risk assessment, research design and methodology, dispute resolution, modelling and simulation, operations management, financial and cost management, financial management, research methods, public and environmental health, decision-making and reasoning |
| Topics: | Legal Issues, Risk Management, Project Management, Research Practice, Cost Management, Health and Safety |
| Descriptive scope: | 4 PCTA |
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