5.

0 DISCUSSION
Generally, a developer obtains the project finance either from internal or external
sources. The internal sources of finance, also known as equity capital, is risky as the developer
or investor does not have security that will recover the returns of investment. However, if an
external source of financing is made, the loan needs to be paid according to a fixed programme
and duration.

Structure of Finance
Financial structure refers to the mix of debt and equity that a company uses to finance
its operations. This composition directly affects the risk and value of the associated business.
The financial managers of the business have the responsibility of deciding the best mixture of
debt and equity for optimizing the financial structure.

1. Equity and Debt

A business organisation is able to finance its activities by:

 Obtaining additional finance from the owner.

 Generating internal finance by producing and retaining profits.
 Borrowing from other sources.

The first two finances are known as equity. In the case of a company, it is known as
shareholders’ funds or share capital. External borrowing can be obtained from:

 Banks, Building Society or Similar Institutions

 Capital Market
 Client
Developers of development are more inclined to borrow via external sources. This is
because it is more costly and difficult to finance a development by raising equity. By
borrowing, also, the developer is able to transfer more of the development risk to the
lender.

2. Equity Finance
This may be provided by installation like insurance companies and pension funds via
two ways:

 Forward funding
With this method the institution purchases the site and provides funds for the
construction of building.

 Forward sale
In this case the institution initiates an early commitment to purchase the
development upon its completion.
3. Bank Finance

Bank loans for development finance can be done in three forms:

 The interest rate charged may be fixed or otherwise, normally not fixed.

 The interest rate of the loan can either be paid on an ongoing basis over the
period of implementation, or after project completion or when the project is
ready to be rented out.

 The loans can be secured on the project itself or normally by utilising fixed
assets.

4. Market Debt

A loan from the market can be secured by a charge on the business’s asset.
The charge can be in the form of security like debenture or other types loan stock. The
use of bonds and stocks are more common whereby a fixed return on the capital will
be paid to the lender at the end of the loan duration.
Duration of Finance
The duration of project construction varies depending highly on the type and size of
construction. It is easier to differentiate the duration of the finance based on the duration
required for it. The sources of finance in the construction industry are influenced by finance
duration. A development company probably needs short term, medium or long-term
finance. The short-term finance is the most frequently required for a period ranging from a
few months to a maximum of two/three years. The medium-term loan refers to a period of
two to five years while the long-term loan has a duration exceeding five years.
A summary of the duration of finance and its uses are as follows:

Finance Short-term Medium-term Long-term

Duration From a few months 2-5 years Exceeding 5
to 2/3 years years

Uses To finance To finance For investment

operation of expansion of and purchase of
company, purchase company, purchase assets
of land etc pf equipment etc

In Malaysia, there are only two categories of duration of finance commonly adopted
that is a short-term and long-term, depending on the duration of loan repayment. The short-
term is for a period ranging from several months to 2/3 years or until the completion of a
construction. While the long-term is for period of up to 30/35 years or until the borrower
reaches the age of 60/65 years.
Sources of Finance
The sources of finance are according to the types of developer involved in construction
industry: public and private. The public sources of finance are mostly subjected to government
policies and current economic conditions. Private sources of finance seem to be more critical
and therefore, the sources of external finance to companies will be emphasised here. These
are actually the most common sources used by developer and buyers of development.

DEVELOPER

PUBLIC PRIVATE

INTERNAL EXTERNAL INTERNAL EXTERNAL

Commercial Bank

Commercial Bank is the biggest and most important financial source in Malaysia. There
are two basic services provided by commercial banks; as a new place where individuals and
companies deposit and withdraw their money whenever needed and as a place that provides
credit facilities for customers. This bank offers hassle-free financing for construction activities
by charging a competitive interest rate. As such, it has also been regarded as the cheapest
loan provider.
Commercial banks provide facilities like overdrafts, long-term loan, bridging finances
and performance bond and in new cases these banks also invest in government securities.
Some commercial banks in fact, provide mortgage loan services for housing loans.
The loan from commercial banks has generally been regarded as the cheapest source
of finance for clients. However, if a client intends to take a large scale loan, or as and when a
loan is needed for riskier projects, he may well have to apply for financing from other banking
sectors.
It has been a practice that commercial banks will advance loans on overdraft
depending on the borrower’s financial standing and type of collateral security offered. The
interest rate changed will normally very depending on the bank’s current interest rate which
fluctuates. In certain case nonetheless, the interest rate can be fixed throughout the loan
duration. In view of banks being desirous of maintaining their liquidity ratios, they will normally
limit loans for long periods.

1. Affin Bank Berhad

2. Alliance Bank Malaysia Berhad
3. AmBank (M) Berhad
4. Bangkok Bank Berhad
5. Bank of America Malaysia Berhad
6. Bank of China (Malaysia) Berhad
7. Bank of Tokyo-Mitsubishi UFJ (Malaysia) Berhad
8. CIMB Bank Berhad
9. Citibank Berhad
10. Deutsche Bank (Malaysia) Berhad
11. EON Bank Berhad
12. Hong Leong Bank Berhad
13. HSBC Bank Malaysia Berhad
14. Industrial and Commercial Bank of China (Malaysia) Berhad
15. J.P. Morgan Chase Bank Berhad
16. Malayan Banking Berhad
17. OCBC Bank (Malaysia) Berhad
18. Public Bank Berhad
19. RHB Bank Berhad
20. Standard Chartered Bank Malaysia Berhad
21. Sumitomo Mitsui Banking Corporation Malaysia Berhad
22. The Bank of Nova Scotia Berhad
23. The Royal Bank of Scotland Berhad
24. United Overseas Bank (Malaysia) Bhd.
Method of Finance

1. Overdraft
Overdraft can be defined as acquisition or withdrawal of money from a bank which exceeds
one’s savings. A bank overdraft allows the borrower to withdraw money up to a fixed maximum
amount from his current account, but there is no necessity to observe the fixed repayment
period. All the borrower needs to do is to pay the amount withdrawn from the account and the
interest charged on it, and not upon the face value of the credit facility allowed.
Only those with current accounts with the bank are allowed to make an overdraft and these
accounts must be active for at least six months. The interest rate for overdraft is calculated on
daily basis and it is normally based on BLR + (2-3%). The credit limit allowed depends on the
clients’ credit worthiness, nature of project, estimate current cash or when the project
completed, management experience, project risk and other factors that vary between banks.
Overdraft therefore is a short-term loan and the borrower is normally allowed up to a year to
balance his account.

2. Term Loan
Term loan is a short and medium duration loan, between one to seven years. The interest
rate is fixed once the loan has been granted and it is normally higher than the overdraft interest
rate, as the bank to bear added risk since the loan is not redeemable. The credit time and limit
imposed can be negotiated and prolonged should the project delayed and if it encounters
problem. Interest is usually paid on a monthly basis on the total sum issued regardless of the
decreasing balance. In addition to the interest, banks often charge a set up fee which can
amount to 0.5% of the sum lent.

3. Trade Credit
Most construction companies use trade credit which enable them to purchase the
materials and services first and pay for them later. The credit terms normally depend on the
company’s credit worthiness and the current practice. If the time difference between the
purchase of raw materials and sale of construction product is long, the supplier is normally
prepared to grant a long-term credit. It is quite common that a supplier offers some discount
to the companies as incentive for early payment.

4. Hire Purchase
This is widely used by the construction companies as a way to provide project finance and
it gives additional benefits in the forms of low deposits and competitive interest rates. The
interest rate charged varies and more competitive rate is negotiable between the companies
offering hire-purchase and one or more finance companies. The charge imposed takes into
consideration the finance company’s base rate which can be as low as 1%.
5. Bank Guarantee
Bank guarantee is also known by various names depending on the specific
requirement and purpose of each type of guarantee. Among the names used are the banker’s
guarantee, commercial guarantee, letter of guarantee, letter of guarantee, performance
guarantee, security deposit guarantee, credit guarantee depending on its specific requirement
and purpose. A bank guarantee is basically a legal undertaking issued by a bank on behalf of
a third party (for example, a contractor) in which it guarantees the payment of a certain sum
of money or up to a certain limit to a creditor should be contractor fail to settle his debt or
adhere to his legal obligation.
Banks normally will issue a few types of guarantee according to the demand of the
construction company. There are various considerations before offering the guarantee such
as liability level, duration and expired date, purpose and procedure of the claimant. The
interest rate is usually 1% per annum. Guarantee is offered by banks to construction
companies for the following reasons:

 Guarantee may be offered for the payment of money (based on a certain limit) for the
supply of goods and services on credit to construction companies. The goods and
services should be supplied only on credit to companies and these companies will only
make payment when the credit limit expires, which is a normally 60 days.

 When a tenderer is called for a certain project, he is actually required to place a certain
deposit, known as tender deposit. Instead of depositing cash, the tenderer can also
apply to the bank to issue a guarantee (tender guarantee). If the tenderer fails, the
client must return the guarantee to the bank for cancellation.

 If the tenderer is successful in securing a contract, more conditions are required to be

fulfilled. One of the conditions is the requirement to surrender a certain amount of
money as security deposit for the contract performance. This amount is normally in the
form of a bank guarantee. The tenderer is allowed to deal with any banks or banks that
are listed for public projects in acquiring performance guarantee or contract
performance bond.