The Reserve Bank of India (RBI) has unveiled a draft framework aimed at tightening project financing norms, which proposes a significant increase in standard asset provisioning requirements. The new guidelines could substantially impact the financial health of banks and non-banking finance companies (NBFCs) involved in project finance.
Key Aspects of the Proposed Framework
Increased Standard Asset Provisioning
- The RBI’s draft framework suggests raising the general provisioning requirement to 5% of the funded outstanding for all project finance loans. This is a significant increase from the current standard provisioning of 0.4%.
- For projects in the operational phase, the provision can be reduced to 2.5% if the project meets certain criteria, such as having a positive net operating cash flow and a reduction in long-term debt by at least 20% from the outstanding amount at the Date of Commencement of Commercial Operations (DCCO).
Impact on Financial Ratios
- Capital Adequacy: The increased provisioning is expected to reduce the Common Equity Tier 1 (CET1) ratio by 7-30 basis points, according to estimates by IIFL Securities.
- Non-Banking Finance Companies (NBFCs): For NBFCs, the additional provisions will not affect the Profit & Loss (P&L) statement but will be allocated to an impairment reserve. This means that their Return on Equity (RoE) will remain unaffected, though infrastructure-focused NBFCs like REC Ltd, Power Finance Corporation (PFC), and IREDA could see a potential 200-300 basis points impact on their capital ratios.
Market Reactions
- Following the announcement, shares of infrastructure-focused NBFCs and several major banks experienced declines. For instance, REC Ltd, PFC, and IREDA saw their stock prices drop by 7.35%, 8.93%, and 4.06%, respectively. Similarly, major banks such as Punjab National Bank, Canara Bank, and State Bank of India also saw declines in their share prices.
Sectoral Impact
- The proposed norms are likely to lower returns for lenders in project finance and could dampen their willingness to engage in such financing. JM Financial indicated that the higher provisioning requirements could reduce incremental appetite for project finance exposures.
Regulatory Adjustments for Consortium Financing
- For projects financed through consortium arrangements, the draft guidelines stipulate that no individual lender should have an exposure less than 10% of the aggregate exposure if the total is up to ₹1,500 crore. For larger projects, the individual exposure floor is set at 5% or ₹150 crore, whichever is higher.
Industry Reactions
- Industry stakeholders, including IREDA’s Chairman & Managing Director Pradip Kumar Das, noted that while the Profit After Tax (PAT) might remain largely unaffected, there would be marginal impacts on Net Worth and Capital Adequacy Ratios (CRAR). Das highlighted that the healthy CRAR levels would help accommodate these impacts.
Conclusion
The RBI's proposed norms represent a major shift in the regulatory landscape for project financing. By significantly increasing provisioning requirements, the RBI aims to enhance the resilience of financial institutions against potential project-related risks. However, the immediate impact on financial ratios and market valuations underscores the challenges banks and NBFCs will face in adjusting to these new regulations. As the framework moves forward, stakeholders will need to carefully navigate these changes to mitigate their financial impact and align with the new regulatory expectations.