The Reserve Bank of India (RBI) last week released draft guidelines to prevent the deterioration of asset quality by implementing stringent provisioning norms and resolution mechanisms.
“ A general provision of 5 per cent of the funded outstanding shall be maintained on all existing as well as fresh exposures on a portfolio basis,” the RBI stated. Earlier, the provisioning requirement used to be 0.40 per cent for financial institutions.
For accounts which have availed Date of Commencement of Commercial Operations (DCCO) deferment from the above-mentioned provision and are classified as ‘standard’, and wherein the cumulative deferments are more than two years and one year for infrastructure and non-infrastructure projects respectively, lenders shall maintain additional specific provisions of 2.5 per cent over and above the applicable standard asset provision as the construction phase. This additional provision of 2.5 per cent shall be reversed on the commencement of commercial operation.
Once the project reaches the ‘Operational phase’, the above provisions of 5 per cent can be reduced to 2.5 per cent of the funded outstanding. This can be further reduced to 1 per cent of the funded outstanding provided that the project has 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).
“Increased provisioning requirements on under-construction projects would have an adverse impact on the profitability and capital ratios of the lenders on day one. Only after the project becomes operational, the provisioning requirement would be reduced, however, the same would still be higher than the current norms for the standard projects,” said Sachin Sachdeva, Vice President, Sector Head - of Financial Sector Ratings, Icra.
“The harmonised approach in relation to resolution of stress, restructuring, extension of DCCO and classification of accounts coupled with the flexibility granted to lenders including on account of exogenous and endogenous risks and the expectations in relation to reporting and disclosures will bring about stability and discipline in dealing with project related difficulties,” said Smriti Mehta, Partner, Desai & Diwanji.
The draft circular outlines Exogenous Risks, which are risks beyond the control of a particular project and may negatively affect some or most of the entities in the economy, sector, or geographic region. These risks may arise from natural disasters, pandemics, changes in government policies, regulations, or laws, and can result in cost overruns and/or delays.
Endogenous risks are risks that arise within a project due to deficiencies in the planning or execution capabilities of the project sponsor or concessionaire. These risks may lead to cost overruns, time delays, change of ownership, and other issues.
Allowable deferment of DCCO from the DCCO originally envisaged in the financing agreement is up to one year including commercial real estate (CRE) projects in case of exogenous risks. In case of endogenous risks the allowable deferment up to two years for infrastructure projects and up to one year for non-infrastructure Projects (excluding CRE projects).
However, the experts also highlight that the higher provisioning norms under the draft framework may impact the profitability of the lenders which may in-turn increase the cost of financing due to increased interest rates.
“This may encourage the borrowers to be cautious in raising project loans and bolster private credit and other sources of financing for projects,” Smriti from Desai & Diwanji added.
Along similar lines, K Satyanarayana Raju, managing director (MD) and chief executive officer (CEO), of Canara Bank has said, “We ourselves have already started internally from the last six months whenever there is some process to do the date of commencement extension, we will be going to charge an additional interest rate. We are already passing on the burden to the borrowers.”
Sachdeva from Icra also stated that the lenders will have to increase the lending rates to account for the increased provisions, thereby impacting the projects' viability.
“On the other hand, other funding structures such as debt capital markets, InvITs or Infrastructure debt funds would become more attractive to borrowers compared to project term loans,” Sachdeva added.
In order for a project to be financed by lenders, it must have a positive net present value (NPV). If there is any reduction in NPV during the construction phase, whether it is due to changes in projected cash flows, the project's lifespan, or any other relevant factor that could lead to credit impairment, this will be considered a credit event. As a result, lenders will have the project's NPV re-evaluated annually by an independent evaluator.
“In addition, the capital requirement of infrastructure financing companies would increase, the majority of which are government-owned like NabFid, IIFCL, PFC and REC etc. In the absence of which the overall funds flow to the infrastructure sector may witness a slowdown," Sachdeva from Icra emphasised.
