RBI’s Prudential Framework on Project Finance: Implications for Infrastructure Lending

Introduction

Global economic growth is closely tied to infrastructure investment, but such projects often carry high risks due to long construction timelines, complex regulations, and delays in achieving commercial operations. To address these challenges, the Reserve Bank of India (RBI) in 2024 released the Draft Prudential Framework for Income Recognition, Asset Classification, and Provisioning relating to Advances for Projects under Implementation (“Draft Framework”). This framework aims to simplify lending complexities for both infrastructure and non-infrastructure projects that are already underway but face delays in reaching commercial commencement.

Key Provisions of the Draft Framework

Applicability and Scope

• The Draft Framework applies to direct project loans extended by banks and financial institutions for both infrastructure and non-infrastructure projects.
• It specifically covers advances where the Date of Commencement of Commercial Operations (DCCO) has not been achieved. Once the DCCO is achieved and project loans begin generating cash flows, the standard prudential norms apply.

Definition of DCCO

• The framework introduces a uniform definition of DCCO, referring to the date when the project is ready for commercial operations and begins to generate revenue.
• Standardisation of this definition is critical since earlier, the treatment of delays varied across lenders, leading to inconsistency in loan classification.

Treatment of Delays in DCCO

• If the DCCO is achieved within the prescribed time limit, the account may continue to be treated as a standard asset.
• If delays extend beyond the permitted period without restructuring, the account must be classified as non-performing.

This brings much-needed clarity and uniformity to the recognition of stressed project loans.

Provisioning Norms

• Lenders must maintain specific provisioning for project loans until financial closure and DCCO are achieved.
• These norms are aimed at improving capital adequacy and ensuring that potential losses are recognised early.

Restructuring of Project Loans

• The Draft Framework allows one-time restructuring of project loans before the achievement of DCCO.
• If restructuring is carried out within the prescribed timelines, it will not automatically lead to an asset downgrade.

This strikes a balance between providing flexibility for genuine project delays and maintaining overall credit discipline.

Documentation and Financial Closure

• Before disbursing substantial sums as loans, lenders are required to conduct rigorous financial closure.
• Increasing the certainty whilst reducing the credit risks requires comprehensive documentation of project, project viability, cash flow forecasts, their sponsors’ commitments, and other variables.

Implications for Stakeholders

For Banks and Financial Institutions

• The Draft Framework enhances transparency and standardisation in project loan classification.
• While early provisioning requirements may increase short-term capital pressure, they will ultimately strengthen balance sheets.
• Clear restructuring norms allow banks to manage project delays without immediately recognising loans as NPAs, thereby protecting asset quality.

For Borrowers and Project Developers

• Uniform rules on DCCO recognition provide greater clarity in financial planning.
• Borrowers may face higher scrutiny at the loan sanction stage, particularly regarding viability and financial closure.
• Although restructuring offers relief in genuine cases of delay, any misuse could invite stricter regulatory oversight.

For the Infrastructure Sector

• Consistency in lending practices may boost investor confidence in the sector.
• However, stringent provisioning requirements could make lenders more cautious in financing greenfield projects, potentially tightening credit availability.

Practical Challenges

1. Project-Specific Realities: The scale and intricacy of infrastructure projects pertain to each other in both a positive and negative manner. A complete provisioning and DCCO framework seem to be too comprehensive in the adversities of land and legal acquisitions, environmental clearances, or force majeure events.
2. Increased Cost of Borrowing: Higher provisioning requirements may be passed on to borrowers through increased lending costs, making projects less viable.
3. Implementation Burden: Banks will need to invest in monitoring mechanisms to ensure compliance with documentation, viability assessments, and restructuring norms, increasing operational complexity.
4. Risk of Over-Cautious Lending: Excessively stringent prudential norms may discourage lenders from financing new infrastructure ventures, especially those with long gestation periods, slowing down infrastructure growth.

Way Forward

• Balanced Approach: While enhancing prudential regulation is commendable, flexibility is necessary to accommodate project-specific realities.
• Differentiated Treatment: Certain infrastructure categories, such as renewable energy and public-private partnerships (PPP), may require tailored treatment given their unique risk structures.
• Strengthened Monitoring: Lenders must invest in specialised project appraisal teams and milestone-based monitoring systems.
• Policy Support: Complementary measures, such as faster dispute resolution, streamlined regulatory approvals, and government-backed credit enhancement, will support effective implementation of the framework.

Conclusion

The RBI’s Draft Prudential Framework on project finance for construction and development of enduring infrastructure assets is the first of its kind reform which seeks to improve consistency, transparency, and stability. Drafts Framework seeks to provide a middle path between the twin goals of financial prudence and development financing in infrastructure/specialized lending by standardizing terms, minimum provisioning requirements, and provisioning/restructuring the provisioning of loans.

The ability of the banks, the borrowers, and the policymakers to change will determine their success. This shouldn’t pose a challenge if there is a desire to achieve the lofty infrastructure objectives of the country. Sustainable project financing requires the opposite of regulatory nonsense to be in place.