RBI’s Draft Norms Update:

Lenders’ profitability may be impacted by the Reserve Bank of India’s (RBI) draft guidelines, which suggest that lenders make larger provisions for all infrastructure projects that are currently under construction. As a result, lenders’ income would be negatively impacted. These businesses may restrict credit to project financing, become more selective, or increase lending rates, all of which will further delay the recovery of the capex cycle, according to a note released by Macquarie on May 6.

According to Anand Dama, Senior Analyst at Emkay Research, the RBI’s action may have an effect on banks’ Return on Assets (RoA) of 10–15 basis points (bps). “If there is any tension building up in lending to the sector, the RBI’s draft circular is the proper route to go. However, if the provisional ceiling remains at five percent, lending to the industry may be severely damaged, according to Dama.

Research findings indicate that if the proposal is implemented, public sector banks will be more affected than private lenders. Public banks are less exposed to commercial real estate and more exposed to infrastructure loans, according to a report from Kotak Institutional Equities. However, rather than funding ongoing initiatives, private banks finance operational assets to gain exposure to the industry. According to JM Financial, public sector banks’ incremental credit costs would rise by 12–21 basis points if the rules are put into practice.

After the RBI’s draft circular was released on May 3, shares of PSU banks plummeted, causing the Nifty PSU Bank index to drop by around 3.2 percent at 11:45 am on May 6. With declines of more than four percent, Punjab National Bank, Canara Bank, Bank of Baroda, and Union Bank were the index’s biggest laggards. Because they are concentrated on financing power projects, which account for a sizeable portion of the infrastructure pie, NBFCs like REC, Power Finance, and IREDA also saw a drop of up to 12 percent.

RBI’s Draft Norms

Image source

As per the proposed guidelines, lenders would need to reserve five percent of the loan amount throughout the building phase of a project. When a project starts up, this percentage will drop to 2.5 percent. The necessary provisions will be further reduced to one percent after the project generates enough cash flow to pay off its present debt.

A five percent provision must be made by the lenders, and it must be made gradually: two percent in FY25, 3.5 percent in FY26, and five percent by FY27. Presently, on project loans that are neither past due or under stress, lenders must hold a provision of 0.4 percent.

The anticipated start date of a project’s commercial operations should also be clearly visible to banks, who should then make additional reserves in case such operations are delayed. If an infrastructure project is delayed for more than three years, the loan should be reclassified as stressed rather than standard.

Further read: Godrej Split update