Commercial banks for 1-2% project finance provisioning; RBI proposed 5%

Industry sees short-term pain

Commercial banks are planning to write to the Reserve Bank of India (RBI), seeking a lower provision rate of 1-2 per cent as compared to the 5 per cent proposed in the recent draft norms on project finance. These draft norms propose to increase standard asset provision to 5 per cent, even for existing loans, from 0.4 per cent currently.

Such an  increase in provisioning requirements could push the financing cost of projects, potentially rendering them unviable, argue bankers and experts. According to industry executives, lenders would suggest a 1 per cent standard asset provision for government or public sector projects, given the lower risk involved. For other projects, they would propose a 2 per cent provision.

The RBI recently released draft norms on the ‘Prudential Framework for Income Recognition, Asset Classification and Provisioning pertaining to Advances — Projects Under Implementation’. These guidelines propose a phased 5 per cent standard asset provision during the construction phase.

A senior banker from a large public sector bank expressed concerns, saying: “For existing proposals, which are under construction and for which financing has already happened, if the provisioning is increased to 5 per cent, the economics of the project could be doubtful. One does not know if the project will still be viable.”

The official further said the sudden increase in provision to 5 per cent of the loan amount could “threaten the viability of existing cases”, which have been assessed based on certain presumptions.

Bankers plan to request the Indian Banks’ Association (IBA) to ask all lenders to conduct an impact assessment on their current portfolio and future projects. “When we meet the RBI, we should be able to present before it the real picture of the expected impact on us (due to the proposed increase in provisioning),” said the executive.

 

The executive suggested different treatment for government-owned entities or the public sector due to the implied sovereign backing. In such cases, the provisioning could be 1 per cent. For others, it could be 2 per cent. If a project is facing delays, the provisioning could be increased.

Banks acknowledge that some lenders may offer lower rates for infrastructure projects by linking such loans to short-term rates like the repo rate. However, if that were the case, the RBI would have mandated linking project loans to longer-term rates like the marginal cost of fund-based lending (MCLR), rather than imposing blanket provision requirements.

Shanti Lal Jain, managing director and chief executive officer of Indian Bank, said: “Your balance sheet should be strong enough to take that kind of a risk... These are draft guidelines, so we will discuss them within the bank and the IBA and will give our request to the RBI to consider it.” He stressed that Indian Bank would be least impacted as 63 per cent of its loan book is towards retail, MSME, and agriculture.

One reason for the sharp increase in provision norms is the rise in non-performing assets (NPAs) in the past decade, primarily due to many infrastructure loans turning bad. Gross NPAs hit 11.8 per cent of gross advances by March 2018, but have fallen over the past five years to 3.2 per cent as of September 2023.

Bankers claim to have learned from past mistakes, with loans going bad due to issues concerning environmental clearance, land acquisition, and others. “Now, no bank disburses unless a minimum of 90 per cent of land is acquired, and all permissions are in place before disbursements,” said another banker. 

Following the release of the RBI’s draft guidelines, banking sector stocks, particularly public sector banks, have fallen. Over two trading sessions, including Tuesday’s 2.3 per cent fall, the Nifty PSU Bank index is down nearly 6 per cent.

Infra sector: Analysts see short-term pain

Rating industry experts and infra sector representatives predict short-term pain but believe the move is positive from a longer-term perspective.

Rajashree Murkute, senior director at CareEdge Ratings, said: “The draft guidelines for project financing proposed by the RBI, if implemented, are expected to present funding challenges for both under-construction and operational infrastructure projects.”

The rating agency said the change in provisioning standards will directly impact the cost of debt, potentially dampening the bidding appetite from infrastructure developers in the medium term.

“Projects with stable cash flows, such as road annuities, transmission, and commercial real estate, typically see an improvement in credit profile within one year of establishing a payment track record from the counterparty. Therefore, the mandate to reduce debt by 20 per cent to lower provisioning could delay the realisation of interest rate benefits for such operational projects, despite an enhanced credit profile,” said Murkute.

A mandatory tail period accounting for 15 per cent of a project’s economic life will restrict the ability of infrastructure projects to secure additional top-up loans, CareEdge Ratings said.  It will necessitate an 8-10 per cent increase in equity requirements for the hybrid-annuity model (HAM)-based road projects to align the loan tenure with 85 per cent of the economic life for concessions lasting 15 years, noted Murkute.

ICRA, too, echoed concerns regarding HAM road projects of National Highways Authority of India (NHAI). Vinay Kumar G, vice-president and sector head-corporate ratings, ICRA, highlighted practical challenges in implementing the proposed RBI regulations. “For a HAM road project of NHAI, the annuity becomes due for payment after 180 days of COD (commercial operations date), and the authority (NHAI) has 15 days for making the annuity payment as per the concession agreement. To address these timelines, HAM project sanctions generally have seven months (or higher) repayment moratorium from the COD date which provides a cushion of more than one month in case of administrative delays in annuity receipt, if any. However, the proposed RBI regulations will have practical challenges in implementing as the maximum moratorium period allowed is six months, thereby providing no headroom in case of delays in annuity receipt.”

But industry veteran Vinayak Chatterjee suggested that concerns might not be as profound as they seem. He said: “Apprehensions are being expressed on the RBI’s draft resetting some conditionality for bank lending to infra & realty (projects). The intensity of concerns is misplaced. Learning from the infirmities of the last credit cycle, the RBI is attempting to capture some implementation realities,” he said.
 

Murkute, too, said that a 20 per cent debt reduction to achieve lower provisioning is positive, as it mitigates back-ended repayment risks.

For the power sector, too, experts feel the draft guidelines to be net positive in the long term. A K Khurana, director general, Association of Power Producers, said that the sector has consolidated and only serious players remain – they are in favour of strong financing. “No one wants a repeat of the last decade when the Indian financial sector faced Rs 10 trillion worth of power project NPAs," he said. 

Assessing the impact of the RBI’s move on India's capex cycle, Bernstein analysts led by Nikhil Nigania and Venugopal Garre, in a report said that they do not believe that there will be a major impact due to the RBI’s proposal. They noted that even considering a Rs 30 basis points impact on borrowing cost of such a regulation, they don’t see any major impact on India’s capex cycle. “If anything, it plays to the advantage of the likes of NTPC and Power Grid, which can borrow directly by issuing long duration rupee bonds where such regulations have no impact (whereas most of their competitors would have to rely largely on NBFCs/banks charging Rs 30 basis points more than earlier). Even for L&T, such an event should not dent order inflow growth expectations,” they noted.

(With Dhruvaksh Saha, Shreya Jai & Abhijit Lele)