RBI's draft provisions create a flutter

The new provisioning norms for infrastructure financing have set the cat amongst the pigeons

The infrastructure financing world is abuzz with the Reserve Bank of India’s (RBI) draft provisions for infrastructure lending.

Even before the dust has settled, State Bank of India (SBI) has started altering its future loan agreements to cope with the potential impact of the RBI’s proposed guidelines on project financing. SBI has introduced a new clause allowing it to “pass-through” any additional costs from increased provisioning directly to the borrower —possibly signalling an expectation that the RBI may not significantly relax these norms.

Meanwhile, the Ministry of Road Transport and Highways is advocating the status quo on current project finance formats and consequent lending rates. It is opposing any norm changes that could increase lending rates, and urges the central bank to ensure infrastructure financing costs, and therefore progress, are left unaffected in the national interest. The National Highways Authority of India  has started consultations with the National Highways Builders Federation , which fears a significant increase in the financial burden if the RBI’s draft proposals become a reality.

But what exactly are these new requirements?

In early May, the RBI released draft guidelines aimed at tightening the prudential framework for project financing. These guidelines propose that banks must set aside 5 per cent of the loan value as provisions for infrastructure and commercial real estate projects that are under construction. This is significantly higher than the current rates, which stand at 1 per cent for commercial real estate loans, 0.75 per cent for residential projects, and 0.40 per cent for other types of loans, including those for project finance. As projects move to operational status, provisions can be scaled down to 2.5 per cent of the funded outstanding, with further reductions to 1 per cent under specific conditions. Moreover, banks are now mandated to classify loans as “non-performing” if projects exceed a six-month delay of completion from the original deadline.

Bankers are voicing grave concerns regarding the negative impacts of the suggested 5 per cent provisioning rule, and are worried that it could significantly dampen lending enthusiasm by cascading into higher interest rates. Such higher interest rates could inflate project costs and render many ventures financially unsustainable. Meanwhile, the blanket six-month moratorium on all projects is drawing criticism for its extremely stringent stance. Amidst all these apprehensions, there is an overarching worry about stifling infrastructure investment growth just as the capex cycle is gaining momentum.

Developers are struggling with their own set of worries regarding funding sustainability. Analysts anticipate a domino effect across the sector due to these heightened provisioning requirements during both construction and operational phases of projects. This could lead to increased construction finance costs for developers, eventually trickling down to buyers. Tier II and III developers, who heavily rely on external financing, may face greater challenges compared to larger developers.

Nevertheless, it would be useful to try and understand the RBI’s concerns. The spectre of non-performing assets (NPAs) over the last two decades has loomed large, casting a shadow over the financial health of both lenders and borrowers.

Delving into India’s NPA trends unveils a narrative marked by distinct phases. Following a decline in NPAs during 1992-2009, a period coinciding with the initiation of financial sector reforms, the country witnessed a serious rise in NPAs post-2008 due to widespread defaults on infrastructure projects. This debilitating uptrend, exacerbated by the well-documented “Twin Balance Sheet Problem,” wherein both banks and companies grappled with financial stress, posed a historic challenge to India’s banking ecosystem. The RBI is clear that it does not want a repeat of this. Thus, strict monitoring of NPA trends remains paramount to safeguarding the stability and integrity of India’s banking system. The RBI’s draft provisioning guidelines, therefore, emerge from this concern.

Finance Minister Nirmala Sitharaman added her perspective to these discussions by emphasising the importance of thorough discussion and consideration of all viewpoints before deciding on the draft guidelines.

Bank leaders, including the chairman of State Bank of India, managing director & chief executive officer of Union Bank of India, and Canara bank, have provided insights into their institutions’ readiness, or otherwise, to absorb the impact of the proposed changes. The Power Finance Corporation, after examining the draft norms, has suggested that these would have no impact on profitability. Meanwhile, Punjab National Bank is seeking clarifications on the applicability of the changed provisioning rules to various categories of infrastructure financing. The Finance Industry Development Council, representing non-banking financial companies, has raised issues with the draft guidelines and plans to write a strong letter to the RBI. A top public sector bank official has argued against the need for such revised provisioning requirements, highlighting that it is the government that is the counterparty in most projects. The official emphasised that a one-size-fits-all approach to project financing is not appropriate.

The Department of Economic Affairs in the finance ministry is facilitating the collection of feedback from banks and infrastructure lenders on the draft guidelines. Following this consultation, senior officials are poised to engage with the RBI to convey the government’s stance on the matter. With stakeholder comments due by June 15, the stage is set for further deliberations and potential revisions to shape the future of project financing regulations.

As the RBI ponders over the feedback on its draft guidelines, it will have to strike a delicate balance between safeguarding the financial health of the banking system and fostering an environment conducive to sustainable growth. As of now, the general perception appears to be that the RBI is proposing to use a sledgehammer to swat flies; and that a bespoke approach is preferable instead of this general tightening of provisioning norms.

After all, it is well-acknowledged that infrastructure investments have been, and will continue to be, the pump primer for economic growth.

The writer is an infrastructure expert. He is also the founder and managing trustee of The Infravision Foundation. (Research inputs from Vrinda Singh)