RBI’s proposed framework to administer project financing | Explained

RBI's new draft regulations aim to strengthen project financing frameworks, with a focus on risk mitigation. We explore.

The story so far: To strengthen the existing regulatory framework for long gestation period financing for projects such as infrastructure, non-infrastructure and commercial real estate sectors, the Reserve Bank of India (RBI) issued draft regulations for consultation earlier this month. The regulations endeavour to provide a “harmonised prudential framework” for financing projects. It also proposes to revise the criteria for changing the date of commencement of commercial operations (DCCO) of such projects. As per the banking regulator, this is in light of a review of the extant instructions and analysis of the risks inherent in such financing. Comments on the draft direction are solicited until June 15.  

Infrastructure projects usually have a long gestation period, with a higher probability of not being financially viable. It may not always be possible to meet investment requirements of the projects fully from the budgetary resources of the government. This opens up two financing avenues: public private partnerships and project financing from domestic financial institutions. The latter is particularly crucial for certain projects with longer payback periods. Depending on scale and technology, these projects may also require a loan with a longer tenure. 

Such projects may face multiple obstacles leading to delays or cost-overruns. For perspective, the Ministry of Statistics and Programme Implementation’s March review of 1,837 projects observed that 779 of them were delayed and 449 faced cost overruns. Cost overruns stood at ₹5.01 lakh crores when compared with their original cost. The review attributed the delay to land acquisition, obtaining forest/environment clearances, changes in scope (and size), and delays in tendering, ordering and obtaining equipment, among other things. Cost overruns were primarily due to under-estimation of original cost, high cost of environmental safeguards and rehabilitation measures for those displaced and spiralling land acquisition costs.  

These factors are dampeners for banks, which would have priced the risks associated with the project in a certain way on their books. As explained by the then Deputy Governor of RBI, Harun R. Khan (2012), “The added uncertainty due to these factors (legal and procedural) affects the risk appetite of investors as well as banks to extend funds for the development of infrastructure.”  

RBI’s focus is on mitigating a ‘credit event,’ that is, a default or a need to extend the original DCCO or infuse additional debt, and/or diminution in the net present value (NPV) of the project.  

One of the more important revisions concerns ‘provisioning,’ that is, setting aside some money ahead of time to compensate for a potential loss. The proposed framework recommends that, at the construction stage (that is, when the financial assessment is finalised and before commencement), a general provision of 5% is to be maintained on all existing and fresh exposures. This is a revision from the erstwhile 0.4%. Concerns have emerged about the impact on the cost of debt. According to CareEdge Ratings, this would “dampen the bidding appetite from infrastructure developers in the medium term.” This 5% provisioning would be implemented in a phased manner, that is, 2% for FY25, 3.5% for the next financial year and eventually 5% in FY27. 

The framework stipulates that the provisioning can be reduced to 2.5% and 1% at the operational phase (that is, commencement of commercial operations). For the latter, the project must have a positive net operating cash flow to cover all repayment obligations and total long-term debt must have declined by at least 20% from the outstanding when the DCCO is achieved.