The Reserve Bank of India’s (RBI) draft guidelines proposing that lenders make higher provisions for all infrastructure projects that are under construction may impact the profitability of lenders, experts said. “High provisioning requirements will go up for lenders affecting their profitability and these companies may ration credit to project finance, be more selective, and/or raise lending rates, further postponing the capex cycle recovery,” Macquarie said in a note on May 6.
Anand Dama, Senior Analyst, Emkay Research, said that banks may see an impact of 10-15 basis points (bps) on their Return on Assets (RoA) due to the RBI’s measure. “The draft circular by the RBI is in the right way if there is any stress building up in lending to the sector. But there is a possibility of the lending to the sector being impacted heavily if the limit for provisions stays at 5 percent,” said Dama.
According to research reports, public sector banks will see a bigger impact compared to private lenders if the draft is implemented. In a report, Kotak Institutional Equities noted that public banks have a higher exposure to infrastructure loans and less to commercial real estate. On the other hand, private banks take an exposure to the sector through financing operational assets, instead of funding projects under construction. JM Financial predicted that if the guidelines are implemented, the incremental credit costs for public sector banks would increase in the range of 12-21 bps.
Shares dive
On May 6, shares of PSU banks fell, with the Nifty PSU Bank index plunging around 3.2 percent at 11.45 am, following the release of the RBI’s draft circular on May 3. The top laggards in the index were Punjab National Bank, Canara Bank, Bank of Baroda and Union Bank, all slumping over four percent. NBFCs such as REC, Power Finance and IREDA also crashed up to 12 percent as they are focused on financing power projects, which are a significant part of the infrastructure pie.
RBI’s draft norms
According to the draft norms, when a project is in the construction phase, the lenders would have to set aside a provision of five percent of the loan amount. This will reduce to 2.5 percent once a project is operational. The required provisions will further be cut to one percent after the project has adequate cash flow to repay current obligations.
The lenders are required to make a five percent provision in a phased manner: two percent in FY25, 3.5 percent in FY26 and five percent by FY27. Currently, lenders are required to have a provision of 0.4 percent on project loans that are not overdue or stressed.
Also, banks should have clear visibility on the date on which a project is expected to begin commercial operations and increase provisions in case operations are delayed. Any delay over three years in beginning an infrastructure project should change the classification of the loan from standard to stressed.
The RBI also asked the lenders to ensure strict monitoring of any emerging stress.
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