The Reserve Bank of India’s (RBI) proposed norms to tighten project financing, which has recommended an increased standard asset provisioning of up to 5 per cent on loans, is likely to result in an additional provisioning of 0.5-3 per cent of banks net worth.
Last week, the RBI released a draft framework for lenders who undertake project finance. The framework proposed to tighten monitoring and guidelines for restructuring and to maintain a general provision of 5 per cent of the funded outstanding on all existing as well as fresh exposures on a portfolio basis. At present, the standard asset provisioning is 0.4 per cent for project finance.
“We estimate additional provisioning requirements to be 0.5-3 per cent of banks’ net worth and hurt CET1 (Common Equity Tier 1) ratio by 7-30 basis points (bps),’’ IIFL Securities said in a report.
CET 1 ratio is a measurement of a bank’s core equity capital, compared with its risk-weighted assets. It shows a bank’s ability to withstand any financial stress. One basis point is one-hundredth of a percentage point.
Project finance refers to the method of funding in which the lender looks primarily to the revenues generated by a single project, both as the source of repayment and as a security for the loan. This type of financing is usually for large, complex and expensive installations such as power plants, chemical processing plants, mines, transportation infrastructure, environment, telecoms etc.
A significant increase in provisioning requirement will result in lower returns for lenders in project finance and reduce incremental appetite for such exposures, if implemented in current form, a report by JM Financial said in a report. The draft guidelines have suggested that once the project reaches the operational phase, the 5 per cent provisions can be reduced to 2.5 per cent of the funded outstanding. It can be further reduced to 1 per cent of the funded outstanding provided that the project has a positive net operating cash flow that is sufficient to cover current repayment obligation to all lenders, and total long-term debt of the project with the lenders has declined by at least 20 per cent from the outstanding at the time of achieving DCCO.
DCCO (Date of Commencement of Commercial Operations) is the date by which the project is expected to be put to commercial use and completion certificate/provisional completion certificate is issued to the concessionaire.
For non-banking finance companies (NBFCs), additional provisions will not be routed through P&L (profit & loss), but instead will be apportioned to the impairment reserve. Therefore, NBFCs will not have an impact on RoE (return on equity), IIFL Securities said.
It said infrastructure-focused NBFCs such as REC Ltd, Power Finance Corporation (PFC) and IREDA (Indian Renewable Energy Development Agency Limited) can see a potential hit of 200-300bps to their capital ratio. Valuation of these NBFCs can also be potentially impacted as the adjusted net worth will be 8-13 per cent lower.
On Monday, the share prices of REC Ltd, PFC and IREDA dropped by 7.35 per cent, 8.93 per cent and 4.06 per cent, respectively. Even shares of Punjab National Bank (PNB) tumbled 6.41 per cent, Canara Bank plunged 5.42 per cent, Bank of Baroda tanked 3.71 per cent and Union Bank of India declined 3.12 per cent on the BSE. The stock of State Bank of India dropped 2.86 per cent and Bank of India dipped 2.57 per cent.
“Profit After Tax (PAT) is expected to be largely unaffected, while there may be marginal impacts on Net Worth and Capital Adequacy Ratio (CRAR). However, with our currently healthy CRAR (capital to risk (weighted) assets ratio) levels, any marginal impact can be accommodated accordingly,” said Pradip Kumar Das, Chairman & Managing Director, IREDA. The draft norms said in projects financed under consortium arrangements, where the aggregate exposure of the participant lenders to the project is up to Rs 1,500 crore, no individual lender shall have an exposure which is less than 10 per cent of the aggregate exposure. For projects where aggregate exposure of lenders is more than Rs 1,500 crore, this individual exposure floor shall be 5 per cent or Rs 150 crore, whichever is higher.