Government Considers RBI's Proposal for More Infrastructure Funding: Bankers and NBFCs Worry

Tanushree Jaiswal Tanushree Jaiswal 8th May 2024 - 11:43 am
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Reports indicate that the central government is currently reviewing the Reserve Bank of India's suggested rules, which call for greater financial reserves for infrastructure projects. It is anticipated that lenders will challenge these rules across different platforms. Officials are concerned that these regulations could lead to higher interest rates and potentially disrupt the ongoing growth in capital investments.  

According to information from a report in the Economic Times, once the evaluation process is complete, the draft regulations will be discussed with the Reserve Bank of India.

Fears of possible interest rate increases and interruptions in capital spending have led to concerns following the announcement of these proposals, which prompted a decline in the stock market. Bank and NBFC stocks, in particular, experienced a sell-off due to concerns about their financial impact. Following the introduction of these proposals, various public sector banks shares (PSBs), non-banking finance companies (NBFCs), and infrastructure companies witnessed a downturn in the market.

"These are draft guidelines, and the consultation process is on. All stakeholders will try to find a common ground to manage risks while supporting infrastructure financing," a government official stated. “Any concerns raised by banks or other ministries will be communicated with the RBI,” he added. The regulator has asked for feedback on its proposed guidelines by June 15.

Last Friday, the RBI released a draft circular concerning project financing aimed at strengthening balance sheets. Under the proposed guidelines, lenders would be required to allocate provisions amounting to up to 5% of the outstanding exposures for construction projects. This provisioning requirement would be reduced to 2.5% once the project is operational.

Banks are preparing to push back against the significant rise in provisioning requirements, arguing that such measures could hinder India's position as the fastest-growing major economy during a period of global uncertainty. They plan to express their concerns through the Indian Banks' Association (IBA). Lenders argue that increased provisioning for ongoing projects could compromise their financial viability, leading to higher costs, potential project delays, and stressed loans.

"This is a very steep increase and comes when there are no real risks that one can see in project finance," told a senior private sector bank executive to ET. "No one has a clue on what led RBI to increase the provisions so sharply, because when you look at banking results, or even fresh slippages, they are lower than what is being recovered."

"Banks will have to give feedback based on what they see," the executive said. "But since RBI has started at 5%, it is very difficult to see what the logic is, or what could be a fair level, for provisions. It could force the handful of banks which do infrastructure lending to rethink lending to this sector."

According to the guidelines proposed on May 3, lenders are required to set aside up to 5% of their outstanding exposure as provisions during the construction phase of projects, a significant increase from the current 0.4%. Once the project is operational, this requirement would decrease to 2.5% and further drop to 1% after the project starts generating adequate cash flow. The phase-in of these provisions is planned to be gradual, starting with 2% in FY25, increasing to 3.5% in FY26, and reaching 5% by FY27.

Stocks of infrastructure-focused NBFCs like Power Finance Corp, REC, and Indian Renewable Energy Development Agency experienced declines for the second consecutive day. Additionally, public sector stocks witnessed a significant reduction in market value, losing 1.83 lakh crore the previous day.

The government has yet to finalize its stance on the regulations, but it must consider potential unintended effects, such as a hesitancy to lend to under-construction projects, according to a source familiar with the government's deliberations.

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