NEWS – To strengthen the existing regulatory framework around long-gestation period financing for projects in infrastructure, non-infrastructure and commercial real estate sectors, the RBI issued draft regulations to administer project financing

PURPOSE OF THE FRAMEWORK

• Mitigate Financial Risks: Infrastructure projects are prone to financial non-viability due to long gestation periods and high initial costs. The framework aims to mitigate the risks of defaults and financial instability.
• Address Delays and Overruns: The Ministry of Statistics and Programme Implementation’s review highlighted frequent delays and cost overruns in infrastructure projects. By establishing clear guidelines and provisions, the framework seeks to manage these issues proactively.
• Encourage Responsible Lending: The framework is designed to ensure that banks and financial institutions account for potential risks adequately, thus promoting responsible lending practices.

KEY REVISIONS

1. Provisioning Requirements:
   • The RBI proposes increasing the general provisioning for infrastructure projects at the construction stage from 0.4% to 5%. This is intended to build a financial buffer to absorb potential losses, although it may reduce the bidding appetite of developers in the medium term.
   • The 5% provisioning would be phased in gradually to manage the impact on financial institutions.
2. Prudential Conditions:
   • Mandatory Pre-requisites: Before financial closure, all necessary environmental, regulatory, and legal clearances must be in place.
   • Monitoring Progress: Financial disbursals and equity infusion will be tied to project milestones. Independent engineers or architects must certify the progress to ensure transparency and accountability.
   • Positive NPV Requirement: Projects must demonstrate a positive Net Present Value (NPV) to secure financing. Lenders are required to re-evaluate the project NPV annually to monitor ongoing viability.
3. Repayment Norms:
   • The repayment tenure, including any moratorium period, must not exceed 85% of the project’s economic life.
   • Adjustments to the repayment schedule due to project scope and size increases must be reassessed for viability before the Date of Commencement of Commercial Operations (DCCO).
4. Standby Credit Facility:
   • A standby credit facility must be established at the time of financial closure to cover potential cost overruns due to delays, providing a financial safety net for unexpected expenses.

INITIAL OBSERVATIONS

• Impact on Profitability: Ratings agency ICRA notes that the increased provisioning requirement may impact the short-term profitability of non-banking financial companies and infrastructure financing companies.
• Bank Responses: Major banks like SBI, Union Bank of India, and Bank of Baroda have expressed confidence that the proposed framework will not have a significant adverse impact on their operations.