Introduction
The Reserve Bank of India (‘RBI’) announced on 06.10.2023, that it plans to update the rules for financing project loans to make them stronger and more consistent across all regulated entities (‘REs’). In furtherance of this, the RBI on 03.05.2024 has released a draft[i] titled Prudential Framework for Income Recognition, Asset Classification and Provisioning pertaining to Advances – Projects under Implementation, Directions, 2024 (‘Directions’), applicable to financing of project loans and is inviting feedback from the public and stakeholders until 15.06.2024. These revised guidelines aim to create a supportive framework for REs to finance project loans while mitigating the associated risks.
Background
Before delving into the draft released by the RBI, it is pertinent to have brief information about the background. The Directions laid out by the RBI, harmonize guidelines across all REs involved in project finance, aiming for a unified regulatory approach. They provide a comprehensive framework aimed at ensuring the structured and risk-mitigated financing of projects, with a particular focus on detailed monitoring and compliance with clearly defined phases and conditions. Accordingly, the Directions aim to enhance monitoring, provide clarity on resolving project stress and ensure financial stability and viability of project finance accounts.
The RBI has worked to establish a principle-based regime for early recognition and resolution of stressed assets, as seen in the Prudential Framework for Resolution of Stressed Assets (‘PFRSA’) issued on 07.06.2019. However, restructuring of exposures relating to projects under implementation on account of change in the date of commencement of commercial operations (‘DCCO’) was excluded from the ambit of the PFSRA, pending further review. After reviewing regulatory norms and banking experiences in project financing, Directions have been issued to address this gap by including specific provisions for such projects. The Directions, issued under various acts, including the Banking Regulation Act, 1949; the RBI Act, 1934; the National Housing Bank Act, 1987; and the Factoring Regulation Act, 2011, allow for modification of the DCCO in public-private partnership (‘PPP’) projects, which was not specified in previous frameworks; provides for enhanced reporting to Central Repository of Information on Large Credit (‘CRILC’) and within consortiums; and introduces new conditions for DCCO extension and continued ‘standard’ classification based on risk categories and project changes.
What do the Directions say?
The Directions are divided into 4 chapters accompanied by 4 annexures that outline several essential provisions, a few of which are as follows: -
Providing a prudential framework for financing projects in infrastructure, non-infrastructure and commercial real estate (‘CRE’) sectors by REs, the Directions come into force with immediate effect and apply to scheduled commercial banks, non-banking finance companies (‘NBFCs’), primary (urban) cooperative banks and All India Financial Institutions, collectively referred to as ‘Lenders’.
It provides for various definitions of terms such as CRE, credit event, DCCO, default, endogenous and exogenous risks, interest during construction (‘IDC’), project and project finance, restructuring, resolution plan (‘RP’), and standby credit facility.
The Directions divides projects into 3 phases for application of the prudential guidelines such as the design phase, construction phase, and the operational phase and mandates lenders to have a board-approved policy for resolving stress triggered by credit events. It further specifies mandatory prerequisites before financial closure including encumbrance-free land, and environmental, legal, and regulatory clearances.
It further lays down the conditions before fund disbursement. Lenders are mandated to engage the lender’s independent engineer (‘LIE’) to conduct a techno-economic viability (‘TEV’) study. This study should assess the estimated expenditure, economic viability, and bankability of PPP projects. The Directions state that lenders in consortium projects must comply with exposure limits. For projects with aggregate exposure up to Rs. 1,500 crores, no lender should have exposure less than 10% of the aggregate exposure. For projects with exposure exceeding Rs. 1,500 crores, this floor should be 5% or Rs. 150 crores, whichever is higher.
It is stated that post-DCCO, lenders can acquire from or sell exposures to other lenders in multiple banking/consortium arrangements, while further clarifying provisions for moratorium on repayments and repayment tenor limits. All financed projects must maintain a positive net present value (‘NPV’). If there is a subsequent decrease in NPV during construction, leading to credit impairment, an annual re-evaluation is warranted to ensure financial health.
The Directions state that lenders must continuously monitor project stress and initiate an RP pre-emptively. Under the PFRSA, any credit event mandates a collective resolution effort. These events must be reported weekly to CRILC. Within 30 days of a credit event, the lenders must review debtor accounts. Projects can maintain a ‘standard’ classification if the DCCO adjustments stay within specified limits, RPs must be implemented within 180 days after the review period, or accounts will be downgraded to non-performing assets (‘NPA’). Upgradation of NPAs is possible after 360 days if conditions are met.
Lenders must now capture and maintain project-specific data electronically, updating any changes within 15 days. A compliance system is required within 3 months. Quarterly returns on project finance loans must be submitted to the Department of Supervision within 15 days of each quarter’s end, with disclosure formats to be notified. Financial statements must include RP implementation disclosures. The 5% provisioning for standard assets during the construction phase will be phased in: 2% by March 2025, 3.5% by March 2026, and 5% by March 2027. Non-compliance will result in enforcement actions.
Our Analysis
The Directions issued by the RBI represent a comprehensive approach towards enhancing the management of project financing within the banking sector. By stipulating prerequisites before financial closure, setting exposure limits in consortium arrangements, mandating board-approved policies for stress resolution, and emphasizing the importance of a positive NPV, these provisions aim to strengthen risk management practices and promote early detection and resolution of stress in projects. Compliance with these norms is crucial for maintaining financial stability, transparency, and accountability in lending activities, ultimately safeguarding against potential risks and contributing to the resilience of the banking sector.
End Note
[i] RBI/DOR/2024-25/DOR.STR.REC./21.04.048/2024-25 dated 03.05.2024.
Authored by Shivam Mishra, Advocate at Metalegal Advocates. The views expressed are personal and do not constitute legal opinion.