Why in News?

The RBI's recent draft guidelines on project financing - Draft Prudential Framework for Income Recognition, Asset Classification and Provisioning pertaining to Advances - Projects Under Implementation, Directions, 2024 - have caused much anxiety among lenders.

What’s in Today’s Article?

• Need for the Project Financing Framework
• What Causes Time and Cost Overruns and How do it Affect Lenders?
• What are the New RBI Rules on Project Finance?
• Why are these Draft Rules Opposed?

Need for the Project Financing Framework:

• Long gestation periods of infrastructure projects:
  • Hence, there is a higher probability of these projects not being financially viable.
  • The government's budgetary resources might not always be sufficient to cover all of the projects' investment requirements.
• These projects require a loan with a longer tenure:
  • Public-private partnerships (PPP) and project funding from domestic financial institutions become viable options as a result.
  • For some projects with longer payback periods, the latter is especially important.
• Time/ cost-overruns in the implementation of these projects: For example,
  • As per the Ministry of Statistics and Programme Implementation’s March review of 1,837 projects, 779 of them were delayed and 449 faced cost overruns.
  • Cost overruns stood at ₹5.01 lakh crores when compared with their original cost.

What Causes Time and Cost Overruns and How do it Affect Lenders?

• The reasons for the time overruns include delays in land acquisition; obtaining forest/environment clearances; changes in scope (and size); and delays in tendering, ordering and obtaining equipment; etc.
• The main causes of cost overruns are under-estimation of original cost, high cost of environmental safeguards and rehabilitation measures for those displaced and spiralling land acquisition costs.
• These factors operate as deterrents for banks, who would have recorded the project's risks at a particular cost on their records.
• The increased uncertainty brought about by these procedural and legal variables influences banks' and investors' risk appetite to fund for infrastructure development.
• Hence, to strengthen the existing regulatory framework for long gestation period financing, the Reserve Bank of India (RBI) issued draft regulations for consultation.
  • The regulations endeavour to provide a “harmonised prudential framework” for financing projects.

What are the New RBI Rules on Project Finance?

• It pertains to the prudential framework for financing projects in the infrastructure, non-infrastructure and commercial real estate sectors.
• It provides for higher provisioning, which means setting aside or providing funds as a percentage of a loan.
  • The central bank aims to increase standard asset provisioning to 1-5% of loans from the current 0.4%, in a phased manner.
  • A bank has to set aside a much higher 5% 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% of the funded outstanding and then further down to 1% if certain conditions are met.
  • This is a protection against possible accounting shocks in case the loan turns bad.
• The framework requires that before a financial statement is finalised, all necessary prerequisites (environmental, regulatory and legal clearances relevant to the project) must be met.
• It also proposes to revise the criteria for changing the date of commencement of commercial operations (DCCO) of such projects, so that the DCCO must be clearly spelt out.
• The 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.
• 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.
• The RBI also proposed that the original or revised repayment tenor should not exceed 85% of the economic life of the project.

Why are these Draft Rules Opposed?

• Many think the higher provisioning for standard assets will hit the business of banks and NBFCs as well as the viability and health of infrastructural projects.
• Banks and NBFCs might transfer part of the heightened costs to borrowers through increased interest rates and thus derailing capital expenditure momentum India has built over the past several years.
• Sectors such as renewable energy that operate at slim margins will be hit the hardest if interest rates rise.