The Jordanian Banking Experience in Project Financing

With Special Reference to Water Projects

Banking in Jordan is one of the most advanced and dynamic sectors of the economy.  It continues to achieve impressive growth in terms of assets and quality of services, while providing the Kingdom’s growing economy with financing and intermediation services.

Banks in Jordan have been playing a vital role in providing both the private and public sectors with various modes of finance of both short and medium term maturities.

This short paper explores the outlook of the Jordanian banking system and its role in financing major projects.  It sheds some light on the banks’ lending philosophy and touches on major water projects in Jordan and the expected role that banks can play in providing finance needed for these projects.

The Jordanian Economy: Background: 

Jordan has made significant progress over the past eight years in the fields of macroeconomic stabilization and transformation of its economic structure.  This success was a direct outcome of the Kingdom’s firm commitment to a structural readjustment program initiated back in 1989.  Among the real achievements are structural reforms in the areas of energy, agriculture, water and telecommunications and major changes in the regulatory framework to encourage private sector involvement and promote investment.

This investment-promoting environment has in fact encouraged the private sector to increase investment in infrastructure projects, such as transportation, electricity and water.

The Role of the Banking System:

Through the years, the banking system in Jordan managed to, efficiently, pool the resources to provide short and medium term finance to the Jordanian businesses. 

With the current level of sophistication, the Jordanian banks alone will not be able to meet the demands for long term financing needs.  Banks need to be more innovative in creating additional sources and tools of finance.  They, also, must strengthen their relations with the Arab as well as the international multilateral financial institutions, whose strong capital bases have not been fully utilized.

I believe that the growing financial needs could be best addressed through cooperation among commercial banks and credit institutions as well as utilization of the local, regional and international financial markets.  This broader resource pool could effectively meet a significant part of the Kingdom’s need for longer-term financing.  Within this context, large projects, i.e., Privatization of the telecommunication sector, Aqaba Railway, Amman-Zarqa link, the consortium of Nork Hydro & Jordan Phosphate Mines Co., Jordan Magnesia, Bromine, Dissi Water … etc. are all projects currently looking for outside financial sources to meet with their long term financing requirements.

At present, commercial banks are still the major source of finance for small and medium size projects in the Jordanian market.  They normally provide construction loans, term loans, bridge loan facilities and working capital financing.  In these loans, commercial banks tend to limit their commitment to a period of 5 – 10 years with floating interest rates. 

However, for longer maturities, other sources of financing are need to be sought and considered:

Ø                      Suppliers’ credit.

Ø                      Export credit.

Ø                      Buyers’ credit supported by export credit agency.

Ø                      National and international development banks.

Ø                      Co-financing.

Ø                      Bond issues.

Ø                      Production and payment loans.

Ø                      Leasing. 

Jordanian Banking Sector: Historical Background:

Jordan banks have been remarkably successful in sustaining economic growth through their role as intermediaries.  They facilitate pooling domestic savings and attracting foreign investment and channeling them to viable projects in all sectors of the economy. The Jordanian banking system has been able, at least partially, to bridge the financial gap in major projects in Jordan through lending operations and direct equity participation.

The Jordanian banking sector has been successful in the fields of assets growth and branching while improving the quality of services.  The banking system contributes up to 7.5% of Jordan’s GDP.

Today, the Jordanian banking sector consists of 14 commercial banks, 5 investment banks, 5 specialized lending institutions and two Islamic banks.  Through a network totaling more than 460 branches, commercial banks conduct all types of lending activities including short and medium-term financing for all purposes, including the financing of seasonal and working capital requirements and acquisition of fixed assets.

Commercial banks continue to dominate other financial institutions in Jordan in terms of size of deposits and total assets.  They are the main source of credit in the market due to the absence of competition from other institutions or lenders. 

The following figures illustrate the size of the banking sector in Jordan and its development over the past four decades:

(In JD Million)

Among the commercial banks operating in Jordan, Arab Bank is the largest with a market share of around 35% in terms of total deposits.  It is the only bank, which has, in addition to its strong local standing, a solid regional and international presence.  This enables Arab Bank to exercise a pivotal role in commercial finance and in project finance.

Although the banking system is more advanced than 10 years ago, it continues to be dominated by a small number of domestic banks.  Those banks offer a limited variety of financial product and instruments to lenders and borrowers.  In addition to the need to diversify their product, they face the challenge of globalization and integration with the international markets. 

The Lending Philosophy of Jordanian Banks:

In its beginnings, the Jordanian banking sector suffered from limited sources of funding, shortage of human resources, weak investment in technology, lack of efficient means of communication and the absence of a central bank.  Due to these constraints, the lending practices were conservative, and the lending philosophy was based on collateral and the individual net worth and trustworthiness (name lending).

Until the early 1970s, the lending policies of the Jordanian banks were limited to traditional short term financing extended, primarily to the commercial sector, either through discounting short-term commercial papers or through overdraft accounts contracted to finance working capital requirements.  This was the result of the short-term nature of the funding and the absence of a central bank and specialized credit institutions.  However, the absence of the supply was not noticed due to a lack of demand for long term lending. 

However, after the foundation of the Central Bank of Jordan (CBJ) and some other specialized credit institutions, the initiation of economic development planning, and the resultant increase in the demand for longer term financing, banks in Jordan became more daring and aggressive in extending medium term loans to their customers.  This trend was further enhanced by the changing deposit structure, which showed relatively longer maturities, enabling the Jordanian banks to further extend their loan maturities.

During the last couple of decades, the Jordanian banking sector has gone through many changes and developments in terms of its lending and investment philosophy.  In this regard, banks in Jordan have courageously started to venture into the field of relatively longer term financing.  For that purpose, many banks in the Kingdom have incorporated special investment departments within their head offices in order to identify potential investment opportunities and conduct the necessary feasibility and technical studies.

However, long term commercial financing of maturities that exceed 7 – 8 years remain unavailable within the Jordanian financial market, and short and medium term loans prevail and remain the only means of finance available to borrowers.

In addition, the Jordanian banks become keen to directly participate, as major shareholders, in the equities of newly established companies.  This new role has been perceived as an abandonment of the traditional role of banks, which mainly concentrated on the financing of working capital requirements.  This trend resembles the German banking philosophy, which gave the German industries the momentum needed to catch up with the industrial revolution first initiated in England.       

Project Financing versus Traditional Lending:

Project financing is relatively a new financial tool that has been developed within the global financial markets during the past couple of decades, in order to provide necessary financing for projects of relatively large financing requirements.  While the philosophy behind traditional commercial lending concentrates on the borrower himself (character, reputation, collateral, credit worthiness, and sources of income and repayment), project financing is based upon the project itself and its ability to generate enough cash to service its debt.

How is project financing different from other traditional types of financing?  In project finance, the lender evaluates the project in terms of its cash flow as the main source of repayment and its assets as the major collateral for the required loan (second way out).

In project finance, the project, its contracts, its economics and cash flow are looked at in isolation of the project’s sponsors when conducting a credit appraisal and eventually extending a loan to the project.  The quality of the sponsor is relevant when evaluating the ability of the sponsor to operate the project and to inject additional equity in case of a cost overrun.

The key to successful project financing lies in structuring the financing with minimum recourse to the sponsors, while, at the same time, providing sufficient credit support through suitable guarantees or undertakings of the sponsors or a third party, so that the lenders are satisfied with the possible credit risks.

On the other hand, only experienced banks, with knowledgeable personnel undertake project finance because of the numerous risks inherent in project finance. To understand these risks, the bank will need to rely of the expertise of financial analysts, engineers, lawyers, industry and insurance experts.  Some of those tasks can be outsourced, other cannot.

In this regard, the following are just a few of the risks usually associated with project financing:

Ø                      Financial risks (interest, inflation and currency exchange risks).

Ø                      Construction (reserves, capacity and cost overrun).

Ø                      Credit risk (borrower, contractor, sponsors, suppliers and operator).

Ø                      Appraisal.

Ø                      Permits and licenses.

Ø                      Operation performance.

Ø                      The price of products.

Ø                      The price (cost) of raw materials.

Ø                      Competition.

Ø                      Legal risks (enforceability of security, and dispute resolution).

Ø                      Insurance risks.

Ø                      Environmental risks.

When dealing with water projects specifically, additional risks can be identified and must be addressed.   The producers cannot stop supplying water for any reason.  In such projects, it is sometimes extremely difficult to change prices.  This necessitates governmental support at the time of construction in order to enable producers to price the product reasonably.  The support may take the form of a purchase agreement guaranteeing the cash flow needed to service the debt and generate the desired return to the sponsors.

Project Finance in Jordan:

The Jordanian banks’ experience in the field of project financing is limited.  It was only after mid 1980s that the expansion in the Jordanian economy in general and the industrial sector in particular drove the demand for this type of finance.  Banks in Jordan were able to provide sizeable loans to various projects through means of short and medium term financing in most cases.  The loans were undertaken in the form of syndicated loans in case of projects of larger financing needs with slightly longer tenors.

The major obstacle to the development of project finance within the Jordanian market is the capital market, which is not well developed.  The capital market is almost exclusively limited to the shares of companies listed on the Amman Financial Market (AFM).  The bonds market is still in its infancy.  The size of issues is limited and secondary market trading is virtually non-existent, which can be attributed to the absence of credit rating institutions and underwriters in the market.  The weakness of the Jordanian capital market makes it extremely difficult to raise finance with maturities exceeding 8 years.  

Recently, there has been an increasing awareness of the importance of project finance as a major tool for financing larger projects in Jordan as well as other countries within the region.  During 1990s, two major developments further stirred up and brought to the surface the need for longer-term financing in Jordan.  First, the peace process, which gave rise to huge regional projects within the area.  Various projects of concern to all parties within the region, including Jordan, have been the core of intensive studies and subject to serious consideration.

The second development that highlighted the need for project finance was the privatization program adopted by the Jordanian government.  Privatization allows private investors to undertake major projects that were normally reserved for government entities. Project finance is the likely vehicle to raise the resources needed to undertake such projects.  The advent of these two developments creates an opportunity and a challenge to the Jordanian banking sector to participate in financing these projects (subject to their viability.

So far, Jordanian commercial banks have managed to provide a significant portion of the financial requirements for a few projects within the Kingdom. Two examples of such financings are the mixed finance packages put together for the US$ 170 million dollar Indo-Jordan Phosphoric Acid Plant project and the US$ 85 million dollar Nippon-Jordan Fertilizer project.  In both cases, local banks pooled resources with international agencies (IFC), foreign export credit agencies, and a group of international banks to get these projects off the ground.

Water Sector and the Financing Needs:

Jordan, among other countries of the regions, has been suffering a water scarcity problem, which intensified during the past decade due to unfair regional distribution of water resources, high rates of population growth and the increasing demand of its industrial sector.  For this purpose, water has been a core issue during the peace negotiations.  Regional cooperation vis-a-vis the water crisis has been highlighted and stressed giving rise to various projects proposed within this area.

In Jordan, the water problem is severe and critical.  Jordan has been trying to locate possible sources of water in order to satisfy the growing demand.  Among the alternatives being studied are several projects, including the building of several dams and water conveyers connecting Amman with the sources of underground water.  The following are some of the projects being evaluated:

Ø                      Disi-Amman Water Project                                                          US$ 730 mm.

Ø                      Mujeb Dam Works                                                                     US$ 71 mm.

Ø                      Restructuring of Amman Water Network                                      US$ 200 mm.

Ø                      Yarmouk River Dam (Wihdah Dam)                                              US$ 150 mm.

Ø                      Lijun Water Aquifer                                                                    US$ 10 mm.

Ø                      Hisban Water Desalination Project                                               US$ 30 mm.

Ø                      Water Corridor Project                                                               US$ 15 mm.

Ø                      Great Amman & Zarka Basin-Waste Water                                   US$ 200 mm.

All of the projects above, which total US$ 1.4 billion, are considered top priority due to the chronic deficit in the water supply in Jordan.  Jordan, like other countries in the region, face increasing demand for water from limited supplies.  Financing these projects is a top national priority for Jordan.  

The Potential Role of Jordanian Banks:

It is evident that the resources of the Jordanian banking system have not been fully exploited.  While the industry has made efficient use of its deposits denominated in local currency, it still holds a large surplus of foreign deposits, estimated at US $ 3 billion of semi-idle funds, awaiting investment through proper channels.

The Jordanian banking industry, with all its significant achievements, has yet to handle the financing requirements of the new era of development.  The needs of this ear are characterized by different purpose, volume, maturity structure, risk and collateral of financing.

The Jordanian banks’ financing of some projects within the fields of electricity, water, transportation, and mining has been mainly carried out by means of syndicated loans, and not by well structured project financing means.

Again, in the case of the fertilizer project (Indo-Jordan project), which can be signified as an advanced step towards proper project financing, we had to develop a mixed financing package, comprising long-term loans from a multilateral institution (IFC) and medium-and short-term financing from local commercial banks and the French export finance agency (COFACE).  The only guarantee for all of these loans was the project's viability.

To be able to play a meaningful role in this area, banks must undertake the following essential structural changes:

ØDevelop the human resources with advanced knowledge in new financing techniques (e.g. corporate finance, project finance, etc.)

ØDevelop new financial tools.

ØDevelop long term capital market tools and instruments.

ØBanks have to restructure the liability side of their balance sheets towards longer duration and maturities.

ØDevelop the secondary market in order to enhance the liquidity of all market instruments.

ØBanks should move towards long term financing, underwriting and placement of issues.

ØCreate larger banking units in order to enhance efficiency.

Concluding Remarks:

Although project financing is not an advanced and customary activity within the Jordanian market, commercial banks have shouldered a great deal of the responsibility to meet the financial requirements of major projects within various sectors of the economy.  Commercial banks were able to provide loans of sizeable volumes to many projects through means of short and medium term financing in most cases, and syndicated loans in case of projects of larger financing needs with slightly longer tenors.

The absence of long term financing (of tenors up to 15 years) is attributed to the short-term nature of banks’ liabilities, the lack of a well-developed capital market and the short experience in this field.  Still, banks in Jordan have been successfully contributing to the financing of major projects in the fields of electricity, water, transportation and mining by means of extending construction loans, term loans, bridge loan facilities and working capital financing for tenors that could reach up to ten years. 

Recently, the rise of huge regional development projects and the launching of a comprehensive privatization program have crystallized the need for project finance in Jordan.  The water projects being considered would be a prime example of such undertakings.