On 3 May 2024, the Reserve Bank of India (RBI) released a draft prudential framework for lenders involved in project finance and comments on the draft Direction had been invited from stakeholders by 15 June 2024.
The proposal suggests an increase in standard asset provisioning for project loans that are not overdue or stressed, from the current rate of 0.4 per cent to a range of one to five per cent. This increase would be implemented in a phased manner.
According to the draft rules, lenders must allocate a provision of five per cent of the loan amount during the construction phase of a project. Once the project is operational, this percentage will be reduced to 2.5 per cent. Eventually, it will drop to one per cent when the project generates enough cash flow to pay off its obligations.
While addressing the media, Atul Kumar Goel, managing director (MD) and chief executive officer (CEO) of Punjab National Bank said, “There is a lot of clarification that is still required. Until now, these draft guidelines are applicable to infra loans, non-infra loans and even for small amounts of loans. Therefore, we will discuss whether there should be a limit for which these rules will be applicable.”
Goel further added that the banks have healthy balance sheets and even if the bank is required to provide something, it is comfortable with it.
“We are in a position to fulfil whatever the requirements of the regulator are,” mentioned Goel.
Financial experts suggest that new provisioning norms are likely to result in improved decision-making and reduced exposure to risky projects.
Mukesh Chand, Senior Counsel at Economic Laws Practice (ELP) said, “With the focus on mandatory prerequisites and project viability assessments, lenders will have to conduct more thorough due diligence before extending project finance and all mandatory prerequisites must be met before financial closure, including encumbrance-free land, environmental clearances, and legal approvals.”
Earlier, the existing framework for resolving stressed assets was lenient on loan restructuring for projects undergoing development due to delays in commencing commercial operations.
“However, following a thorough review of regulatory norms and considering the experiences of banks in financing project loans, the RBI has decided to streamline and unify the guidelines applicable to all regulated entities involved in project finance,” said Anoop Bhargava, CEO and Director of Empire Centrum.
Land Availability Requirements for PPP Infrastructure Projects
The draft guidelines mention providing an indicative list of prerequisites including availability of encumbrance-free land and/or right of way, environmental clearance, legal clearance, regulatory clearances, etc., as applicable for the project. However, for infrastructure projects under the public-private partnership (PPP) model, land availability to the extent of 50 per cent or more can be considered sufficient by lenders to achieve financial closure.
“For PPP infrastructure projects, 50 per cent of land availability suffices for financial closure. This could lead to better decision-making and reduced exposure to risky projects,” Chand from ELP mentioned.
Positive Net Present Value
In order for a project to be financed by lenders, it must have a positive net present value (NPV). If the projected cash flows, project life period, or any other factors change during the construction phase and result in a decrease in NPV, it will be considered a default and may lead to credit impairment.
Regarding the impact on small and medium enterprises (SMEs), Chand said, “SMEs, may face challenges in meeting the stringent prerequisites and compliance requirements outlined in the guidelines. This could impact their access to credit and growth prospects.”
Reporting and Exposure Requirements for Credit Events
A credit event occurs if there is a default, extension of the commencement date of commercial operations, infusion of additional debt, or a reduction in the project's net present value. Such events must be reported to the Central Repository of Information on Large Credit by lenders in compliance with instructions. Lender(s) in a consortium shall also report the occurrence to all other members.
“RBI's prescription of a minimum of 10 per cent exposure for each lender for smaller projects and a minimum exposure of 5 per cent (not less than Rs 150 crores) for larger projects is interesting. Besides keeping out small lenders, it will also restrict the number of lenders till DCCO is achieved. This may be with an intention of only having large lenders with sophisticated project assessment abilities doing project financing,” said Jayesh H, Co-founder, of Juris Corp Advocates and Solicitors.
Jayesh further added this itself can have many implications. While this is as regards consortium financing, the restructuring benefits are sought to be limited for all practical purposes, only to consortium financing, he mentioned.
Financial experts generally believe that the new regulations will have a positive impact in the long term. Although they may cause some disruption, they are expected to encourage the emergence of specialised project financing firms, similar to those that existed several decades ago.
Bankers are optimistic that they can fulfil the conditions of the new draft guidelines and are in discussions for clarifications.
"This is still the draft guidelines and we are seeking clarifications from the regulator like what is the bottom line for this, like what is the minimum funding etc," said K Satyanarayana Raju, managing director (MD) and chief executive officer (CEO), of Canara Bank.
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