The unanticipated contest between the Great Indian Bustard and the solar energy companies in vast tracts of area around Rajasthan and Gujarat exposed the vulnerable spot of project financing. But surely this unusual instance could not have influenced the Reserve Bank of India (RBI) to come out with new draft guidelines which is set to sharply increase the provisioning requirements of infrastructure loans sanctioned by banks.

Why RBI wants stiffer norms

The regulator has many reasons to feel that project financing is fraught with risks that can trigger loans to turn sour. Besides environmental issues and climate change, there are many predictable and unpredictable influencers that can spoil project loans.

The RBI’s proposals are taken keeping these factors in mind, including concerns about the right pricing of the risk by some of the lenders. The basic principle is that if there are more risks, there should be more provisions.

 As per the draft guidelines on project financing, issued on 3 May, banks have to set aside a provision of 5% of the loan amount during the construction phase. At present, lenders are required to have a provision of 0.4% on project loans that are not overdue or stressed.

Senior bank officials say on condition of anonymity that the draft rules on project financing are “hurriedly sewn” and “visualise an imaginary stockpile of non-performing loans without a thought on operational difficulties”. 

Why banks worry

The worry is that prices would go up all around if the draft guidelines are implemented in its current form. A higher provisioning requirement would lead to repricing of loans as top bank executives have said that lenders would pass on the additional burden to borrowers. Project costs in turn would rise and there is also a possibility that some of them would even get stalled. 

Since the proposed rules will also be applicable for existing projects, any hike in lending rates midway can upset the original cost estimates made by the borrower. This can impact the viability of a project which has already gone under the construction phase.

As per the draft rules, the RBI has classified projects under three stages – design, construction and operational phase. A bank has to set aside 5% of the exposure during the construction phase. For projects reaching the operational phase, the provisions can be reduced to 2.5% of the funded outstanding and then further brought down to 1% if certain conditions are met.

Guidelines versus Growth

The draft norms are coming at a questionable time when the Indian economy is beginning to look up and green shoots of growth are visible in multiple sectors, senior bank officials say. Loan demand is coming from iron & steel, cement, aviation, semi-conductor and many other sectors. For private companies, the capex cycle is also starting to pick up.

According to some analysts, additional provisioning can hurt capex and overall loan growth. For companies investing in new capex, each incremental loan will come with a 5% burden for at least three years as that is the time taken to construct any basic project. The concern is that these loans may be loss-making or turn out to be very costly for at least three years.

“If the government is pushing for growth and providing incentives for it, the draft guidelines run contrary to that,” said a senior official who is readying the bank’s feedback to the regulator. 

The RBI has asked lenders to submit their comments on the draft proposals by 15 June. 

The price pinch, industry experts say, will also be felt by consumers as interest costs rise for infrastructure companies. In case of real estate projects, the price of housing units will increase as developers decide to pass on the higher interest cost burden.

The RBI’s proposed guidelines cover infrastructure, non-infrastructure and commercial real estate sectors.

Profitability to be hurt

Banks also fear that their profitability will be hurt as intense competition amongst them will not allow them to entirely pass on the proposed increase in project loan provisions to their large borrowers. The mispricing of loans without factoring in the risk premium is what probably is disturbing the RBI.

Besides sending their views to the regulator, banks are also requesting the government to look into the matter.

Senior executives from non-banking financial companies (NBFCs) and lenders including State Bank of India and Punjab National Bank met top finance ministry officials, expressing their concern that the cost of loans for infrastructure projects would go up and eat into the profit of banks.

The government has yet to take a definite stance but is closely examining the draft. “We are studying the draft regulations of RBI on project finance and will send our response if required,” Department of Financial Services (DFS) Secretary Vivek Joshi said at a CII event on 17 May.

Case of the Great Indian Bustard

While the debate goes on between the RBI’s proposed tightening of project financing and its impact on cost overruns and growth, one is tempted to go back to the Great Indian Bustard (GIB) case as an extreme example. In areas of Rajasthan and Gujarat which receive long hours of sunlight and speedy wind but also happen to be the natural habitat of the GIB, renewable energy companies started setting up power plants and transmission towers.

Banks, lending to renewable energy companies, never anticipated that the transmission lines would come in the path of the endangered bird, whose numbers are now reduced to under 200 in India. The 4-feet tall, stocky bird cannot fly too high and its vision is not too sharp to dodge the high-tension transmission lines. They run the risk of colliding with these wires, getting electrocuted and dying. 

Responding to a public interest litigation (PIL) filed in 2019 by wildlife activists, the Supreme Court in 2021 ordered power firms to lay underground wiring and install diverters on existing lines in the region. The overhead wiring in this belt was banned to protect the GIBs.

Other contentious issues

There are other issues in the draft which are contentious. On the 10% exposure clause for individual lenders, bankers say the smaller banks may find it difficult to participate in the consortium loan for the project. 

The RBI’s draft states that for projects financed under consortium arrangements where the aggregate exposure of lenders is up to Rs 1,500 crore, no individual shall have an exposure which is less than 10%. For projects where aggregate exposure of lenders is more than Rs 1,500 crore, the individual exposure floor shall be 5% or Rs 150 crore, whichever is higher.

Bank executives want more clarity from the RBI on several issues, including floor cost for the size of projects. “For some of our SME clients, we have given project loans worth only a few crores of rupees. We want to know whether this will also qualify for additional provisions under the new draft guidelines,” said the chief of a mid-sized public sector bank.

The other requirement under the draft guidelines is to calculate the net present value (NPV)of the project. If the value goes up due to cost overruns or other reasons (one of which could be interest rates going up), then it has to be considered as an event of default and the promoter would be required to bring in more equity. 

“Isn't it better  to put a resolution plan so that the project can continue under slightly relaxed parameters? This is in case there are genuine difficulties like unanticipated rise in coal prices, inventory cost or just about anything which was not in the control of the promoter or the lenders,” said a senior banker.

A positive NPV is a prerequisite for any project financed by lenders. “Any subsequent diminution in NPV during the construction phase, either due to changes in projected cash flows, project life-period or any other relevant factor which may lead to credit impairment, shall be construed as a credit event. Accordingly, lenders shall get the project NPV independently re-evaluated every year,” the RBI draft guidelines stated.

The regulator, bankers say, should not think that provisioning is the only method to cushion the banking system from losses. The bond market should be deepened and widened so that there are more participants, the secondary market thrives and the project financing burden on banks is reduced.

What have Bank Chiefs said

SBI Chairman Dinesh Khara

The intent seems to be that the RBI has got some concerns about the right pricing of the risk by some of the lenders. So, when you know that lenders start pricing a 15-year term loan with T-bill, it will naturally concern the regulator.

Whatever be the additional provision requirement, we can absorb it in no time. We still have got almost about Rs 32,000 crore worth of non-NPA provisions holding in our book.

Our project loan size is only about Rs 1.21 trillion. We are not worried. If at all the RBI’s draft on project financing gets implemented in the current form, we will revisit the pricing, if need be.

Based on the broad assessment the bank has done, the incremental provisions required for ongoing infra projects will not be very significant. We will be able to absorb those additional provisions without much disruption.

My sense is that there will certainly be some middle path. I am quite confident about that. The RBI has been quite receptive about various regulatory provisions. I am hoping for that. But even, in the worst situation, we're quite comfortable.

Punjab National Bank MD & CEO Atul Kumar Goel

I think we should not panic. The regulator is thinking that if there is more risk, there should be more provisions and they are trying to bring in the discipline. 

On whether it should be 5% or not, this is a consultative process and the RBI has given us time until 15 June to send our views. So, we will discuss this matter regarding the provisioning requirement. 

We need clarifications on many things. We have given so many loans which we have classified under infra. Let us take the example of InvIT. We have given this loan to many and they are operational projects. I think we should wait for more clarity before we can comment.  

As on date, the bank has a very healthy balance sheet and provision is normally required when the position is healthy. So, I think from the regulator’s point of view, it is an appropriate guideline. We have not panicked. Even if we are required to provide, we are very comfortable and we will easily be in a position to do so.

Even in the NBFC case, whatever additional pricing was required we passed it on. I think more than 80-90% of borrowers agreed. So, even in this case, if there is some need of increase in loan pricing, we will pass that on.

Canara Bank MD & CEO K Satyanarayana Raju

RBI draft guidelines is still at a premature stage. We have made a preliminary assessment but have several doubts on that. The draft has not spoken about what the floor limit is for that project. Whether it’s a project cost we have to take into account or the loan amount sanctioned? That clarity is not there. We have doubts and are seeking clarification from the regulator.

At this moment, we expect that our exposures are in and around Rs 1 lakh crore, if you take everything. But let the clarification come. Without that, it will be difficult for us to assess the impact it will have on us. 

Whatever be the guidelines, we are well prepared to face that. Because you know that last time when the risk weight came on the NBFC (non-banking finance company) exposure, we were the first bank to have partly shared it with our borrowers. That is why we could maintain our NIM (net interest margin) at 3.07% and have shown an improvement in the yield on advances in the fiscal fourth quarter ended 31 March 2024.

In this case, we will do a similar exercise. If provisioning norms are increased, we will recalculate. Part of that we will share with our borrowers and the remaining we will absorb. I don't see too much pressure on our bottom line or even on the capital side. I don't think there is a need to panic too much. We have ample cushion in our balance sheet. 

Union Bank of India MD & CEO A Manimekhalai

As per the RBI draft guidelines, we are not seeing much impact. But there is a lot of clarity that needs to come and we are still calculating the numbers. 

The total corporate loan book of the bank is about Rs 4.07 lakh crore. Out of this, about 28% is project loans. And of this, 68% is already completed projects. The remaining is in various stages of implementation. 

We will be able to manage the situation, as we did in the case of NBFCs when the RBI introduced higher provisioning norms. We engaged with all the NBFCs and improved the pricing. We will be closely associating with the corporates and negotiating on loan pricing.