RBI’s Proposed Framework for Project Financing

RBI’s Proposed Framework for Project Financing

Context:

The Reserve Bank of India (RBI) is set to bolster regulations surrounding the financing of projects with long gestation periods, particularly in the infrastructure, non-infrastructure, and commercial real estate sectors.

• This move is aimed at mitigating risks associated with delays and cost overruns often encountered due to land acquisition issues, environmental clearances, and changes in project scope.
• The Ministry of Statistics and Programme Implementation has underscored the prevalence of these delays and cost overruns in its reviews.

Relevance:
GS-03 (Mobilization of Resources)

Key Revisions Proposed:

1. Enhanced Provisioning Requirements:

• The RBI proposes to increase the general provisioning for projects from 0.4% to 5% during the construction phase.
• This increase will be implemented gradually to ease the transition.

2. Impact on Infrastructure Developers:

• According to CareEdge Ratings, this heightened provisioning could dampen the bidding enthusiasm among developers in the medium term.

Prudential Conditions and Guidelines:

1. Pre-requisites Before Financial Closure: Projects must secure all necessary clearances (environmental, regulatory, and legal) before financial closure, with a well-defined Date of Commencement of Commercial Operations (DCCO).

2. Progress-based Disbursals: Financial disbursements and equity infusions will be tied to the project’s completion stages, with oversight by an independent engineer or architect.
3. Net Present Value (NPV) Assessment: Projects must demonstrate a positive NPV, with annual independent re-evaluations conducted by lenders.
4. Revised Repayment Norms: The maximum repayment tenure is capped at 85% of the project’s economic life.
5. Revised Repayment Schedule Criteria: Criteria for revising the repayment schedule due to increased project costs will depend on lender reassessment and the project’s ongoing viability.
6. Standby Credit Facility: New guidelines introduce a standby credit facility to address funding shortfalls arising from project delays.

Initial Observations and Impact:

1. Impact on Non-Banking Financial Companies (NBFCs): According to ICRA, the higher provisioning requirements are likely to affect the near-term profitability of NBFCs and infrastructure financing companies.

2. Confidence from Major Banks: Major banks such as SBI, Union Bank of India, and Bank of Baroda have expressed confidence in the proposed framework, with no anticipated significant impact on their operations, as discussed in a recent earnings call.

Conclusion:

The RBI’s proposed framework for project financing represents a comprehensive effort to address the persistent challenges of delays and cost overruns in the infrastructure sector. By enhancing provisioning requirements and instituting stricter prudential conditions, the RBI aims to foster a more resilient and sustainable financing environment. While there may be near-term impacts on NBFCs and developer bidding interest, the long-term benefits of improved financial discipline and project viability are expected to outweigh these challenges.