RBI’s Proposed Infra Financing Guidelines Could Force Banks To Stick To Only Short-Term Loans

The Reserve Bank of India’s (RBI’s) recently released draft guidelines on infrastructure financing seem to have added to the worries of Indian banks. The RBI suggested that banks allocate a provision of 5% of the loan amount given out for an infrastructure project during the construction phase. The plan is to increase the provision rate in a phased manner from the current 0.4%, a significant shift.

This provision can be decreased to 2.5% once the project becomes operational and be further reduced to 1% once the project starts generating enough cash to meet the repayment obligations to lenders.

India is expected to spend Rs 143 lakh crore on infrastructure projects in the next seven fiscal years through 2030, more than twice the Rs 67 lakh crore spent in the previous seven starting fiscal 2017, credit rating agency CRISIL said in its report released in October 2023.

The proposed rules will apply to banks and non-banking financial companies (NBFCs) and come at a time when infrastructure lending has put pressure on banks. Banks aren’t happy with the announcement as it would increase the cost of lending for infrastructure financing.

“This prescription is a little too high for the Indian banks,” said BN Mishra, former chief general manager of the Punjab National Bank. Mishra believes that while the RBI has good reason to propose these guidelines, Indian banks are likely not in a comfortable position to implement them.

India’s banks have been struggling with liquidity issues in the last few quarters and increasing the provisioning for infra loans will lead to further pressures on liquidity. This could also lead to an asset-liability mismatch. For now, banks don’t have a quick solution to address the liquidity problem. One of the effects of the guidelines, if implemented, could mean that banks only cater to short-term project loans as financing long-term infra loans demands more availability of funds.

Banks Aren’t Great At Assessing Infra Risks

Infrastructure projects come with varied risks. The political situation of an area, ecological sustainability and social influences are among factors that need to be considered to see an infrastructure project to completion. Industry experts believe banks often fail to assess risks and get a correct valuation.

“Scheduled commercial banks have never been very good at project financing due to the lack of expertise in the risk assessment process. Indian banks suffered in 2015 for this,” Mishra said.

Background checks by banks’ risk management teams have also been a pain point, leaving banks exposed to bad loans.

“There have been instances when the bank financed a project and after a few years, there was an issue with land acquisition. Ninety-five percent of the land was allotted for the project but for the remaining 5% the project had to be ceased midway,” said Naresh Malhotra, banking consultant and director at consultancy firm JCR & Co. LLP.

In 2015, Indian banks, especially public service banks (PSBs), were on the verge of a financial meltdown because of the growing burden of bad loans. RBI data shows that gross bad loans of scheduled banks rose to 5.1% of gross advances between March and September 2015. The RBI’s Financial Stability Report from December 2014 indicated that by June 2014, the infrastructure, iron and steel, mining, textiles, and aviation sectors were responsible for 52% of bad loans and restructured loans in scheduled banks.

“Unfortunately, most banks fail to do the project appraisal properly. Often the projects need to be re-appraised. Banks need to gear up and gain proper expertise for project financing,” said a former MD of a public service bank, requesting anonymity.

According to the latest report for April 2024, by the Infrastructure and Project Monitoring Division, 792 projects were delayed with respect to their original completion date and 514 projects were behind schedule even after being granted extensions. On average, projects have been delayed by more than 35 months.

The proposed guidelines require lenders to maintain project data and update them whenever there is a change in the parameters of a project, within 15 days.

Struggle With Capital

The increase in risk weights for personal loans and loans to non-banking financial companies (NBFCs) may lead to a decline in the capital adequacy ratio of 71 basis points (bps) of the banking system, suggested the Financial Stability Report released by the RBI in December 2023. At a time when banks are struggling with capital adequacy, increasing the provisions for infra loans will add more pressure.

The RBI suspects that the banks may have an asset-liability mismatch going forward if no checks and balances are implemented. “Banks fail to attract investments from the public for longer tenure. Most of the investments in the form of deposits coming to the banks are of shorter tenure of two to five years. Unlike NaBFID (National Bank for Financing Infrastructure and Development), banks don’t issue infrastructure bonds,” said Debabrata Sarkar, former chairperson and managing director of Union Bank of India.

If the RBI increases the provisions for infrastructure loans, banks won’t be able to finance longer-term loans and the tenure of loans for infrastructure projects will likely reduce. Banks’ access to deposits has drastically reduced as investors are choosing equity-linked investments over bank deposits.

“Commercial banks accept deposits from the public for a maximum period of ten years. People hardly invest for ten years, they usually go for a tenure of five years for investments in banks. While the gestation period for infrastructure is much higher, usually 15-20 years,” said Mishra. In such a situation, banks can consider those projects that can generate revenue within four to five years. But projects with a tenure of ten years or more could prove to be risky for banks, in terms of maintaining the liquidity. Bankers fear that disbursing short-term infra loans might have some repercussions in the banking system.

"Decreasing the number of long-term infra loans will have some impact on the credit growth, as short-term infra loans are not major projects. For, if a bank is financing a highway project, then the borrower will only be able to repay once the highway gets functional and they could collect tolls," said a former senior banker of Bank of Baroda, who doesn't wish to be named. Thus, the only alternative for the banks will be to focus more on the retail loans to have a sustained credit growth.

“Banks are not in a position to raise the resources for long-term infra financing,” said Sarkar.

What Do Banks Do?

Banks could continue to give out longer-term loans to these projects if they could turn to viable resources for liquidity. Two options are the bond market and offshore borrowings.

According to ICRA's forecast, the growth of new loans (incremental credit flow) in the Indian economy is anticipated to decelerate in the financial year 2025 (FY2025). Meanwhile, bond issuances are projected to increase to Rs 10.6 trillion in FY2025, up from Rs 10.2 trillion in FY2024. However, the ground reality isn’t as rosy.

“Unlike countries like the US, the bond market is not vibrant in India. There is barely any interest for retail bonds in Indian markets. And without getting into the retail bond market, it will be difficult to manage resources for infra financing,” said Sarkar. Sarkar said that banks often get resources from the bond market but they fail to allocate the funds properly in project financing. So, there is no point in getting such funds from the bond market, unless they have a plan on where they can use the funds.

Apart from tapping the bond market, the only possible alternatives for the banks are to either pass on the cost to the borrowers or get into a tie-up with the NBFC-IHCs. “If the RBI implements the proposed guidelines, the interest rate will be increased by around 100 bps,” said Pawan K Kumar, director at the Indian Infrastructure Finance Company Ltd, a government of India undertaking company.

Unlike banks, IHCs don’t have the pressure of maintaining liquidity making it easier for them to fund long-term infra projects. A co-lending model with IHCs or with the National Bank for Financing Infrastructure and Development (NaBFID), where banks will have lesser credit exposure to the projects and the latter will be the majority stakeholder of the loan.

NaBFID was set up in 2021 as a dedicated and specialised institution focused on addressing the long-term financing needs of the infrastructure sector in India. However, numbers show it has failed to meet the needs. NaBFID has made cumulative sanctions and disbursements of around Rs 71,000 crore and Rs 21,500 crore, respectively, till January 2024. On the other hand, the total construction and infrastructure loans of banks was at Rs 14.6 lakh crore till March 2024 this year which was at Rs 10.8 lakh crore in January 2019. Thus it has gone up by more than 25% in five years.

"NaBFID is still at a very early stage and they are yet to finalise their working mechanism. They don't even have their logo finalised yet. So, in a way, borrowers still have faith in banks in terms of project financing. Thus, even after NabFID was introduced, there was merely any change in the amount of loan disbursement for infra financing," Mishra said

For now, banks plan to approach the Department of Economic Affairs (DEA) with their concerns over the guidelines. While the DEA has promised to take feedback, banks have found little solace.