For quite some time, the Reserve Bank of India (RBI) has been warning against incipient risks in banking. Its hard-hitting actions against HDFC, Paytm, Bajaj Finance and recently against Kotak Mahindra Bank for various non-compliances and regulatory laxities have surprised many who think those were disproportionately harsh. But the RBI has sent the message that it is not willing to take chances even if all seems well.
After chastising several entities over breaches and non-compliance in the past two years, now the RBI has sent a scare through the world of infrastructural finance, which has triggered a tumbling of stocks of many PSU banks and key infrastructure NBFCs such as Power Finance Corp, REC and Indian Renewable Energy Development Agency (IREDA).
China's huge banking system becoming vulnerable to its real estate meltdown must have alerted the central bank to risks that can grow silently and invisibly over a long period of time. Indian banking has come back from a precipitous moment. Nearly a decade ago, bad loans of Indian banks soared to 11% of advances and nearly a dozen banks were put under the Prompt Corrective Action framework, curbing their ability to disburse funds.
Infrastructure topped the list of sectors such as iron and steel, mining, textiles and aviation which had 52% of total stressed advances (NPAs and restructured loans) of all scheduled banks, the RBI's Fiscal Stability Report of December 2014 had pointed out. Within infrastructure, electricity, oil and gas constituted around 58%, transport 21% and telecommunications around 10%. Long delays in implementing projects and exuberant revenue projections led to large defaults and made lenders averse averse to the infrastructure sector. Infrastructure Leasing & Financial Services (IL&FS), meanwhile, blew up, with more than Rs 1 lakh crore owed to creditors.
India's financial system has come a long way since, with bad loans at a decadal low of about 3% and all banks meeting capital norms, and India's infrastructure sector racing ahead at a scorching pace in recent years. But the RBI is not peeling its eyes away.
The RBI has now proposed new tighter rules to govern lending to projects under implementation. The chief among the central bank's draft rules which has scared the banks is higher provisioning of up to 5 per cent during the construction phase, even if the asset is standard. A standard asset is one which does not disclose any problems and which does not carry more than normal risk attached to the business.
With tighter norms, the RBI aims to further control risks in project finance which has been notoriously susceptible in the past to delays and defaults. Project finance refers to the method of funding in which the lender looks primarily to the revenues generated by a single project, both as the source of repayment and as a security for the loan. This type of financing is usually for large, complex and expensive installations such as power plants, chemical processing plants, mines, Transportation infrastructure, environment, telecoms etc. Project finance may take the form of financing the construction of a new capital installation, or refinancing of an existing installation, with or without improvements. Last year, the RBI had remarked that project finance is generally characterized by various complexities including long gestation periods and it would prepare stricter norms to strengthen the existing regulatory framework governing the project finance and to harmonise the instructions across all regulated entities (banks, NBFCs, etc.). It has now issued the detailed draft guidelines which have upset the banks because these tighter rules will hit their business.
What are the new RBI rules on project finance?
The new norms by the RBI are the draft guidelines pertaining to the prudential framework for financing projects in the infrastructure, non-infrastructure and commercial real estate sectors. One norm under his framework which has created a stir among banks is about higher provisioning, which means setting aside, or 'providing', funds as a percentage of a loan. This is a protection against possible accounting shocks in case the loan turns bad.
The central bank aims to increase standard asset provisioning to 1-5% of loans from the current 0.4%, in a phased manner. The new draft rule says that a bank has to set aside a much higher 5 per cent of the loan exposure during the construction phase, which goes down as the project becomes operational.
Once the project reaches the 'operational phase', the provisions can be reduced to 2.5 per cent of the funded outstanding and then further down to 1 per cent if certain conditions are met. These include the project having a positive net operating cash flow that is sufficient to cover current repayment obligation to all lenders, and the total long-term debt of the project with the lenders has declined by at least 20 per cent from the outstanding at the time of achieving Date of Commencement of Commercial Operations (DCCO).
The norms also say that banks will have to classify a loan as non-performing if the project is delayed beyond six months of the original stipulated deadline or date of commencement of commercial operations. In the past, many project loans were classified as standard assets even after some of them were delayed by as much as six years from the scheduled deadline of completion, without generating cashflow.
The proposed guidelines also spell out details on stress resolution, specify the criteria for upgrading accounts, and invoke recognition. It expects lenders to maintain project-specific data in an electronic and easily accessible format. Lenders will update any change in the parameters of a project finance loan at the earliest but not later than 15 days from such change.
The RBI has also stipulated minimum exposure of banks in consortium lending. In the case of projects financed under consortium arrangements, where the aggregate exposure borrowing is up to Rs 1,500 crore, each lender should have a minimum exposure of 10%. If the aggregate exposure is more than Rs 1,500 crore, individual exposure should not be less than 5% or Rs 150 crore, whichever is higher. However, after the DCCO, lenders may acquire from or sell exposures to other lenders – new or existing –in the multiple banking or consortium arrangements.
The RBI also proposed that the original or revised repayment tenor, including the moratorium period, if any, should not exceed 85% of the economic life of the project.
The public has been given time till June 15 to respond to these and a few other proposals in the draft guidelines.
Why the rules are being opposed
Many think the higher provisioning for standard assets as well as other rules in the new draft guidelines will hit the business of banks and NBFCs as well as the viability and health of infrastructural projects . These could potentially hurt balance sheets of banks and NBFCs and exert pressure on their valuation multiples, many analysts and economists have said.
"The difference in provisioning requirement will be routed through profit and loss account, and impact 0.4-0.8% net worth impact for larger private banks, but higher - at 1.5-3% - for PSU banks," said Rikin Shah, analyst at IIFL Securities.
Banks and NBFCs might transfer part of the heightened costs to borrowers through increased interest rates. The new norms can impede the growth in the capital-intensive infrastructure sector by leading to a rise in interest rates and thus derailing capital expenditure momentum India has built over the past several years.
The new norms could lead to a 1-1.5 percentage point increase in interest rate for project finance loans, a senior banker at an infrastructure finance institution has told ET. Sectors such as renewable energy that operate at slim margins will be hit the hardest if interest rates rise."We believe this is a significant increase in provisioning requirements," Sameer Bhise, an analyst at JM Financial Services, has told ET. "(It) will result in lower returns for lenders in project finance and reduce incremental appetite for such exposures if implemented in current form."
Many think higher provisions will dent profitability on project loans and deter such lending.Banks are set to lobby with the central bank against the sharp increase in provisions, arguing that it may stall the momentum that's made India the fastest-growing major economy amid a climate of global uncertainty, ET has reported. The lenders will also likely make their views against the proposals known through the Indian Banks' Association (IBA), senior bankers have told ET. They will argue that applying higher provisions for ongoing projects could impact their viability, with costs going up, possibly leading to delays and stressed loans.
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