“The next phase of growth for banks will come from corporate lending,” said the CEO of a bank I met recently. But he was also quick to add that much will depend on the outcome of the recent draft prudential framework for income recognition, asset classification and provisioning pertaining to ‘advances — projects under implementation’.
Popularly referred to as the draft norms for project finance lending, the Reserve Bank of India’s circular was published on May 3 and comments from stakeholders are welcome until June 15. Those in banking circles are fretting over the circular already. Many say it hit them from nowhere and comes just as banks are warming up to the idea of writing big cheques to fund wholesale loans, most of which may be in the nature of project finance.
Simply put, banks aren’t welcoming the circular for two reasons: the impact on the profit-and-loss statement will be direct and unavoidable, and can swell significantly under it, compared to current norms; and, more often than not, the tightened norms could put them in a chicken-and-egg situation.
Here’s why. Much as it is popularly assumed that banks have the pricing power to pass on additional cost to borrowers, including the estimated increase in provisioning costs, the reality may be far different. It’s not so much the fear of competition that banks are worried about this time around, but whether the project dynamics may change with an increased pricing. Sample this: a project may be viable at 11 per cent interest. But at 15 per cent (if banks were to load provisioning costs), revenue and cash-flow projections may go awry. Not just that, what happens to the net present value (NPV) estimates of the project — the basic premise on which the entire funding is decided?
NPV may seem very different if the rate of interest changes and/or the project gestation takes longer. In effect, when banks have to make an additional five per cent provisioning it could lead to a 15 per cent jump in provisioning cost over time, and the viability of the project could come under question.
Yet, the draft guidelines on project financing (the third major move by the RBI since 2016 to streamline exposure to large conglomerates) is a bullet that banks should bite, and preferably way before corporate lending gathers momentum. Reason being, this time around the RBI is forcing banks to not just go by excelsheet calculations to assess a project, but also take a hands-on approach to evaluate and fund a project. In short, be not just a lender but also an active partner in the project — an aspect that has been missing all this while.
It not just resets the clock on project loans, but also moves a step closer to the famous June 7, 2019, circular that drilled into the minds of promoters the fear of losing their companies. If a parallel were to be drawn, not many corporate loans were restructured during the Covid years because there were stringent norms on how a loan exposure could be regularised, keeping banks in check.
Seen in that context, the draft project finance circular suggests that prevention is better than cure, even if the norms seem restrictive. In effect, it may also ensure that project financing doesn’t become everyone’s cup of tea, like it was during 2011–13.
The draft norms are a good starting point to ensure a healthy infra loan book from Day 0. Even if that comes at a cost, it’s worth it. Banks that have the wherewithal for these loans should front-load capital rather than replenish it for bad loans, like they did in 2017–19.