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RBI’s Proposed Framework to Administer Project Financing

Context:

To enhance the current regulatory framework governing long-gestation period financing for infrastructure, non-infrastructure, and commercial real estate projects, the RBI released draft regulations for public consultation earlier this month. Feedback on the draft regulations is invited until June 15.

Relevance:

GS3-

  • Government Policies and Interventions
  • Growth and Development
  • Infrastructure

Mains Question:

Infrastructure projects typically have extended gestation periods, increasing the likelihood of not being financially viable. Discuss how does the RBI’s proposed framework on project financing aims to address this effectively. (10 Marks, 150 Words).

What is the Purpose of the Framework?

  • Infrastructure projects typically have extended gestation periods, increasing the likelihood of not being financially viable.
  • These projects, depending on their scale and technology, often require long-term loans. They also face numerous challenges, such as delays and cost overruns.
  • According to the Ministry of Statistics and Programme Implementation’s review in March, out of 1,837 projects, 779 were delayed, and 449 experienced cost overruns.
  • The delays were primarily due to issues like land acquisition, securing forest/environment clearances, and changes in project scope and size.
  • These factors deter banks, as they impact the risk assessment and pricing of such projects on their financial books.

What are the Key Revisions?

  • The RBI aims to prevent credit events, such as defaults, extensions of the original Date of Commencement of Commercial Operations (DCCO), the need for additional debt, or a reduction in the project’s Net Present Value (NPV).
  • One significant revision involves ‘provisioning,’ which means setting aside funds in advance to cover potential losses.
  • The new framework suggests that during the construction phase (before DCCO), a general provision of 5% should be maintained on all existing and new exposures, an increase from the previous 0.4%.
  • According to CareEdge Ratings, this higher provisioning requirement could reduce the bidding interest from infrastructure developers in the medium term. This 5% provisioning will be implemented gradually.

What about Prudential Conditions?

  • The framework requires all mandatory pre-requisites to be in place before financial closure (the finalization of financial conditions).
  • This includes environmental, regulatory, and legal clearances relevant to the project. The DCCO must be clearly defined.
  • Financial disbursements will be made, and progress in equity infusion agreed upon, based on stages of project completion.
  • Banks must appoint an independent engineer or architect to certify the project’s progress.

Can Repayment Norms be Revised?

  • Yes, the framework allows for revising repayment norms. However, it stipulates that the original or revised repayment tenure, including the moratorium period, must not exceed 85% of the project’s economic life.
  • The proposed framework also sets criteria for evaluating changes in the repayment schedule due to an increase in project outlay resulting from an expanded scope and size of the project.
  • Such revisions must occur before the DCCO, after lenders have satisfactorily reassessed the project’s viability, and if the risk in project cost, excluding any cost overrun, is 25% or more of the original outlay.
  • Additionally, the framework introduces guidelines for triggering a standby credit facility, to be sanctioned at financial closure to cover cost overruns caused by delays.

Conclusion:

Ratings agency ICRA noted that the higher provisioning requirements for projects under implementation could affect the near-term profitability of non-banking financial companies and infrastructure financing companies. However, in their recent earnings calls, the State Bank of India (SBI), Union Bank of India, and Bank of Baroda expressed confidence that the proposal would not have any significant impact on them.


June 2024
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