RBI cools down infra lending
Tighter lending rules for infrastructure projects in India will hurt the profitability of lenders and dent their appetite for construction projects, bankers and analysts said.
In a draft circular on May 3, the Reserve Bank of India proposed that lenders set aside a provision of 5% of the loan amount during the construction phase of a project, a steep increase from the current provision of 0.4%. The higher requirement will be introduced progressively – 2% in March 2025, 3.5% in March 2026 and 5% in March 2027.
The proposed rules stand in contrast to the government's strong support for infrastructure spending. The federal budget for the current fiscal year, which began on April 1, includes an 11% increase in capex to a record Rs11.1trn (US$131.76bn) to build ports, airports and highways.
However, India saw a series of defaults in the infrastructure sector in the past decade on the back of exuberant lending, causing stress in the financial system and encouraging the central bank to act to prevent a repeat.
"RBI is trying to take proactive measures this time around, as capex spending is at a four-year high, to avoid the pain seen in the last bad loan cycle which began in April 2013 mostly on account of infrastructure," said Soumyajit Niyogi, director at India Ratings & Research.
Onerous rules
Still, market participants said the draft rules are onerous as the banking sector's exposure to infrastructure is substantial.
"If a lender is going to fund an under-construction project, there will be an impact on the profitability and the capital on day one for the lender, till the time the project becomes operational," said Anil Gupta, senior vice president of financial sector ratings at Icra.
"It will become costlier for us to lend to under-construction projects if the provisions increase sharply," said the managing director of an infrastructure financing company.
RBI's draft rules come as infrastructure lending has picked up in the country. Banks have disbursed an estimated Rs1.2trn towards project loans for capex in the fiscal year that ended in March, according to Nomura.
Some analysts feel that higher provisioning will affect loan growth.
The higher provisioning requirements towards incremental and existing project lending, if implemented, could "significantly impair the long-term banking sector loan growth outlook," Nomura said in a note on May 6.
The RBI said that once a project reaches the operational phase, provisions can be reduced to 2.5% of the funded outstanding, which can be further reduced to 1% once it generates cashflows and the long-term debt of the project declines by at least 20% from the start of operation.
Even with the phased reduction in provisions, the new regime is expected to affect the appetite of lenders for project finance.
The proposed 2.5% provisions once the project becomes operational "will block the capital for lenders, thereby, pushing up the funding costs for the borrowers," said Gupta at Icra. "In such a scenario, the lenders may lose [their] competitive edge over other funding structures such as debt capital market, InvITs [infrastructure investment trusts] or infrastructure debt funds."
The cost of funding will also increase for infrastructure companies.
"If these draft rules are enforced 'as-is' then lenders will pass through these additional provisions by charging higher interest rates," said Jayen Shah, founder at Mavuca Capital Advisors. "Project sponsors will go back to their drawing board for revalidation of project equity IRRs [internal rate of return], so this action, when capex growth is just picking up, may end up being counter-productive."
As the cost of debt increases, "consequently, this will dampen the bidding appetite from infrastructure developers in the medium term," said Care in a note on May 7.
Sharp market reaction
The shares of infrastructure financiers such as REC, Power Finance Corp and Indian Renewable Energy Agency plunged 9% to 13.3% since the announcement on May 3, while shares of state-owned banks like State Bank of India, Punjab National Bank and Bank of Baroda declined 1% to 10% as credit costs and provisions will increase sharply for these companies.
The incremental credit costs should rise by 10bp–15bp from March 2025 to March 2027 for the majority of public sector banks, Avendus Spark Institutional Equities said in a note on May 6.
IIFL Securities estimates additional provisioning at around 0.5%–3% of banks' net worth, eating up 7bp–30bp of their Common equity Tier 1 ratios, and this could be even higher for public sector banks, according to a note on May 6.
Dinesh Khara, chairman of the country's largest public sector lender State Bank of India, said during the bank's Q4 results briefing on Thursday that SBI will submit comments and feedback on the proposed rules. Its early assessment suggests that additional provisions for project finance rules, if implemented, "can be easily absorbed", but that the pricing of infrastructure loans may have to be revised.
The Tier 1 ratios of non-bank lenders from the infrastructure sector such as REC, PFC and IREDA could see a potential hit of 200bp–300bp, according to IIFL Securities.
Since REC, PFC, IREDA and some other infrastructure finance providers like the National Bank for Financing Infrastructure and Development and India Infrastructure Finance Company are wholly or partly owned by the government, their need for more capital is likely to affect the national infrastructure programme, said Gupta at Icra.
The RBI's draft rules also state that for infrastructure projects financed by a consortium of banks, individual lenders should have at least 10% exposure to the project if the total exposure of the lenders is up to Rs15bn (US$180m). If the total exposure is more than Rs15bn, the individual exposure floor should be at least 5%.
"We believe, minimum 10% exposure requirement will limit the opportunities for small players," IIFL Securities said in a note.
The central bank said that lenders are expected "to monitor the build-up of stress in a project on an ongoing basis and initiate a resolution plan well in advance." If the project is delayed by three years, the lenders should classify the loan as stressed, RBI proposes.
Earlier the permissible limit for delay for commencement of commercial operation of project was four years and some analysts find the three-year rule stringent as litigation cases in India take a long time resolve.
The proposals are open for consultation until June 15, with lenders expected to take a strong stand against them. The RBI says the changes are necessary to rationalise and harmonise the prudential rules governing project finance for all regulated entities.