Impact of RBI’s draft project finance norms

Good infrastructure projects ensure good economic growth. However, building infrastructure is full of uncertainties and risks for all stakeholders.

Besides, such projects are highly capital-intensive, time-consuming and vulnerable to cost overruns due to delays at various stages.

According to the Ministry of Statistics and Programme Implementation, by December 2023, out of 1,820 infrastructure projects with investment of over ₹150 crore each, 431 reported cost overrun to the tune of ₹4.82-lakh crore.

Due to these issues, initially, the governments used to build infrastructure. However, with the government finances running into deficits over time, private entrepreneurs were invited to fund, build and run these projects either in partnership or singly. The private stakeholders raised capital (equity and debt) through several means including the capital market, and borrowings from banks/non-banks.

The infrastructure projects propelled the country’s gross fixed capital formation/gross domestic product ratio (at current prices) from 26.9 per cent in 2019-20 to 30.8 per cent in 2023-24. Similarly, the NSE-30 Infrastructure Index (closing values) zoomed from 2,360.50 (March-end 2020) to 8,336.0 (March-end 2024).

Infrastructure loans - risks

Infrastructure loans are ‘lumpy’, and the financiers (banks/non-banks) encounter several risks of which, in our view, two are important.

Asset-Liability Mismatch (ALM) Risk: Banks mobilise short- and medium-term savings (in India, maximum up to 10 years) from a multitude of savers and lend these to several potentially profitable investments (including long-term projects). Banks balance this process of ‘financial intermediation’ in such a way that their depositors, in general, can withdraw their deposits with interest ‘on demand’.

In case a bank defaults in paying off these depositors, then a liquidity crisis is most likely to emerge, which, if not managed properly, may eventually trigger a bank run. Liquidity crisis is exacerbated because such ‘lumpy’ projects are normally ‘illiquid’.

For example, the Northern Rock, a small bank in Northern England and Ireland, failed in the aftermath of 2007-09 crisis due to ALM coupled with inappropriate liquidity management.

Concentration risk: In general, the concentration risk arises from “imperfect diversification”. According to the Basle Committee on Banking Supervision, one of the two types of imperfect diversification that makes banks’ credit portfolios vulnerable to this risk, is the “sector” concentration which occurs when a bank is unable to perfectly diversify the systematic components of risk across sectoral factors.

Several banks incurred huge losses following failures of ‘lumpy’ projects like Enron, Worldcom and Parmalat. Even the systemic stability was threatened.

RBI draft framework

The RBI Draft “Prudential Framework for Income Recognition, Asset Classification and Provisioning pertaining to Advances - Projects Under Implementation”, released for comments on May 3, 2024, aims at harmonising “prudential framework for financing of projects in Infrastructure, Non-Infrastructure and Commercial Real Estate sectors by regulated entities.”

The Draft proposes to increase the provisioning requirement on standard assets to ‘up to five per cent’ by March 2027.

Other proposals include higher provisions for delayed projects, tightened exposure criteria, classification of such loan accounts, and maintaining project-specific data.

Likely implications

The guidelines are a dampener for project finance and will adversely affect credit availability to the infrastructure sector. Given the earlier experience, besides likely delinquencies, the low interest yield and tenor mismatch would make it a commercially marginal proposal.

Some view the guidelines as favourable because these will reduce the big headache of financing infrastructure projects stuffed with several risks, and to manage these banks don’t have the required skillsets and technical capabilities. They are happy with the pure ‘financial intermediation’ function of banks.

However, the worried lot is the entrepreneurs including the government sector for whom the cost of borrowing will increase. Still, the interest rate for infrastructure loans will likely remain below that for agriculture, large industries and Micro, Small & Medium Enterprises.

The Date of Commencement of Commercial Operations is emphasised in order to motivate the entrepreneurs to reduce delay in starting operation and cost overruns.

Is ALM lurking?

As mentioned earlier, the crucial ALM risk undermines the core function of banks. But the question is: has there been an ALM ‘event’ at the system level in the recent years, especially favouring long-term projects?

Since bank balance sheets don’t disclose maturity bucket-wise distribution of their deposits and loans over five years, it is conjectured that perhaps the draft guidelines are a proactive measure against the possibility of any ALM risk in the near future.

However, based on the March-end 2023 data on concentration of loans in the top 20 borrowers in 21 banks (12 public and nine private), it was observed that the concentration per borrower was as high as ₹5,085 crore, implying inclusion of some project/infrastructure loans. In aggregate, such borrowers constituted 12.5 per cent of the total outstanding loans of 21 banks.

Some proposals

Will the National Bank for Financing Infrastructure and Development along with the National Investment and Infrastructure Fund, the country’s first sovereign wealth fund, be able to meet the humongous demand for infrastructure loans?

It is felt that perhaps the government may have to revive the ‘Development Financial Institutions’ concept which existed earlier, and these institutions (e.g., Industrial Development Bank of India, and Industrial Credit and Investment Corporation of India) had access to assured sources of long-term and low-cost funds. These institutions were converted into universal banks following the S H Khan Committee Report (1998).

The commercial banks can help provided they are allowed to mobilise long-term deposits, say, for over 10 years’ maturity.

The hurdle is how to determine rates of interest for ‘over 10 years’ deposits? This can be mitigated by the increasing availability of data and advanced econometric models now.

Another proposal is to allow the Domestic – Systemically Important Banks as well as select big banks (may be after another round of mergers) to enter into infrastructure projects.

Banks should have their own project appraisal, monitoring and evaluation specialists from various disciplines depending on projects they are financing. Outsourcing these functions, instead of doing in-house, is vulnerable to window-dressing.

Finally, banks should disclose the maturity pattern of their assets and liabilities for ‘over five years’ too.

The writer is a former senior economist, SBI. Views expressed are personal