RBI’s Draft Regulations On Projects Finance To Have Minimal Impact On Banks & NBFCs: CareEdge Ratings

For public sector banks, the impact of draft regulations of projects under implementation incremental provisioning would be up to 20 basis points (in terms of credit cost to net advances) for each of the next three years whereas for private sector banks’ incremental provisioning would be up to 10 bps for each of years of the fiscal year 2024-25 (FY25) to FY27, highlighted the latest report by CareEdge Ratings.

Banks are also likely to be preparing themselves for the adoption of the external credit loss (ECL) framework over the period. Care Edge is of the view that the implementation of ECL provisioning could overlap with the implementation of these provisioning norms. 

The implementation of the draft guidelines, if carried out in its current form, is anticipated to have limited impact on NBFCs excluding NBFC-IFCs as Tier 1 Capital is expected to reduce by up to 83 bps over 3 years. 

For NBFC-IFCs, the Tier 1 Capital is expected to reduce up to 120 bps (as loans guaranteed by the centre/ state government are expected to be outside its preview). 

The Reserve Bank of India (RBI) released a draft guideline on Income Recognition, Asset Classification and Provisioning pertaining to Advances - Projects Under Implementation on 3 May 2024. 

Banks are required to follow IRAC (Income Recognition and Asset Classification) Norms for provisioning requirements, under which they need to maintain 0.75 per cent for CRE (Commercial Real Estate)- residential housing projects, 1.0 per cent for non-residential housing CRE and 0.4 per cent for all remaining loans, in standard category, irrespective of phase.

Under the new guidelines, credit costs will increase, thereby impacting the Profit and loss accounts of the banks.  If the draft guidelines are implemented in their existing form, for public sector banks, the impact of incremental provisioning would be up to 20 bps (in terms of credit cost to net advances) for each of the next three years whereas for private sector banks’ incremental provisioning would be upto 10 bps for each of the years between FY25 to FY27. Banks are also preparing themselves for the adoption of ECL framework as required by RBI.

Care Edge is of the view that the implementation of ECL provisioning would overlap with the implementation of these provisioning norms. Currently, banks in India are in a strong position with high capital adequacy ratios, strong profitability and a strong ability to raise capital from the equity markets.

The reduction in Tier 1 CAR is unlikely to have a significant impact on the capital adequacy position of the banks,  However, since the banks are currently under IRAC norms if the higher charge on the existing stock of funded projects is to be made by additional provisioning in the profit and loss account, the profits of the concerned banks could be impacted by up to 11 per cent in public Banks and 4% in private banks in these three years (assuming ECL norms are not implemented).

The proposed requirements of additional provisions by the RBI to cover the funding of projects under implementation consists of a combination of a one-time regulatory charge on the current stock of such exposures of the Banks plus an incremental positive/negative additional charge on the marginal increase or decrease over the opening stock of such exposures for each period.

So long as the lenders can maintain stable asset quality, these provisions will lead to reasonable strengthening of the balance sheet of these lenders. Higher provisions during initial project periods will get reversed once the projects get completed and generate cash flows as was originally scheduled. Over a period, as banks move to Ind As, the pricing structure is expected to move to cover actual credit losses.  Hence, the impact is likely to be limited.