Non-recourse finance is a method of getting funding through a loan secured by either an asset or cash flow from a project. The collateral may be pursued by the lender in case the borrower defaults on payback obligations, but the lender cannot pursue any other assets from the borrower. Since much of the risk is assumed by the lender in a non-recourse finance agreement, the loan usually includes high interest rates and may not be for the full amount of the secured asset. This type of financing is often used to finance major business projects and must be counted as debt by the company doing the borrowing on its balance sheet.
It is common for both individuals and companies to use loans as a method of financing major expenditures. These borrowers may turn to banks or institutional lenders to proceed with the purchases or expenditures they need to make. With many loans, the lender has the ability to recoup the losses of a defaulted loan by taking whatever assets the borrower might have that would cover the amount owed. A different type of loan agreement, known as non-recourse finance, protects the borrower from something like that happening.
As an example of how non-recourse finance works, imagine that a man takes out a non-recourse loan to purchase a new car. A bank fronts him the majority of the money needed to buy the car, with the expectation that the man will pay back the loan amount along with specified interest. If the man doesn't make the necessary payments, the bank can take possession of the car. It cannot, however, take any other assets away from the man, even if the value of the car is now less than the amount originally loaned.
That example shows how non-recourse finance puts more risk on the lender. As a result, banks or other lenders that agree to such loans often do so with high interest rates attached. In that way, it can compensate for the potential damage done by a default.
Many companies use non-recourse finance as a way of funding large projects. In cases like that, the lenders are often able to go after any cash flows generated by the project if there is some sort of default. Most of these types of loans must be included on the borrowing company's balance sheet as debt. Otherwise, off-balance sheet financing, which can deceive shareholders and financial watchdogs, may lead to negative ramifications down the road.