Risk provisioning

The stability of the banking system should be paramount

Draft norms on provisioning pertaining to advances for projects under implementation have stirred up a storm in the banking sector. Commercial banks, as reported by this newspaper, are planning to write to the Reserve Bank of India (RBI) to seek relaxation. The government is also reportedly studying the proposed norms, while banks’ and non-banking financial companies’ (NBFCs’) stock prices have taken a knock. The RBI last week proposed to increase the provisioning for project finance to 5 per cent from the existing level of 0.4 per cent. Commercial banks are willing to settle for 1-2 per cent. Notably, the RBI draft suggests increasing the provisioning in a phased manner — 2 per cent effective March 31, 2025, 3.5 per cent by March 2026, and 5 per cent by March 31, 2027.

The concerns among lenders are not very difficult to understand. Higher provisioning for project finance books will affect the bottom line. It is also being argued that this will push up lending rates, making some projects unviable. On a broader level, it could arguably affect capital expenditure and overall growth. The factors driving the move at this stage remain debatable on the RBI’s part, but the intention is clear. The regulator intends to ring-fence banks and NBFCs at the very beginning of the investment cycle. Although the private sector has been reluctant to increase investment in a big way, there are signs of tentative recovery. It is worth remembering that it was mainly the infrastructure and project financing that caused the twin balance sheet crisis of the last decade, which pushed up gross non-performing assets in the banking system to double digits. Evidently, the RBI doesn’t want the banking system to be in the same spot again. It has taken a lot of time, effort, and capital to rebuild the banking sector balance sheet, which is now in the best position in over a decade, and must be protected.

To be sure, the proposal is at the draft stage and the RBI is expected to take suggestions from all stakeholders. However, the final decision by the RBI should be based on two basic principles, which should be acceptable to all stakeholders. First, the stability and soundness of the banking system is paramount. There should not be a compromise on this aspect. India witnessed in the last decade what lax lending can lead to. A capital-expenditure cycle based on inappropriate lending standards and the resultant economic growth cannot be sustained. The RBI should also explain why provisioning of 5 per cent would be appropriate.

Second, there should not be a distinction between projects in the public and private sectors. It has been argued that public-sector projects should attract lower provisioning. This can put the private sector at an artificial disadvantage, which should be avoided. The norms should also not differ for private and public-sector banks. On the whole, higher provisioning could discourage some banks from lending to long-gestation projects, which are inherently riskier. It is worth noting that Indian firms are overdependent on banks and NBFCs due to the lack of a vibrant corporate debt market. It is prudent to guard banks from financing long-term projects, but policymakers must also work on creating enabling avenues for raising long-term debt finance.