The Reserve Bank of India (“RBI”) over the years has raised concerns over measures for resolution of stressed assets. Pursuant to the same, the Prudential Framework for Resolution of Stressed Assets on 7 June 2019 (“Existing Framework”) was introduced, which provided a built-in incentive to lenders for early adoption of recognition and resolution plan. The Existing Framework, however, excludes restructuring of exposures pertaining to projects under implementation on account of change in date of commencement of commercial operations (“DCCO”). In order to control risks pertaining to project financing and provide a comprehensive framework to govern lending to projects under implementation, RBI has on 3 May 2024, issued the Draft Prudential Framework for Income Recognition, Asset Classification and Provisioning pertaining to Advances - Projects Under Implementation, Directions, 2024 (“Draft Framework”) for comments from various stakeholders.

Applicability

Provisions of the Draft Framework shall be applicable to scheduled commercial banks (including small finance banks but excluding payments banks, local areas banks and regional rural banks), NBFCs, primary (urban) co-operative banks and all India financial institutions (“REs”) for financing of projects in infrastructure, non-infrastructure and commercial real estate.

General Features of the Draft Framework

Given that most project financings are under consortium arrangements, the Draft Framework has addressed the same to stipulate a de minimus exposure for individual lenders in the consortium. Where the exposure of the consortium lenders is up to INR 1500 crores, no individual lender may have an exposure less than 10% of the aggregate exposure, while in cases where the aggregate exposure exceeds INR 1500 crores, individual exposure floor is proposed to be 5% of the aggregate exposure or INR 150 crores, whichever is higher. This does not, however, preclude lenders from downselling their exposure under a multiple banking / consortium arrangement subject to compliance with RBI’s Master Direction on Transfer of Loan Exposures.

All REs desirous of having project finance exposures are now required to have a board approved policy in place for resolution of stress in the projects on occurrence of: (i) a default; (ii) extension of DCCOs; (iii) requirement for infusion of additional debt; (iv) diminution in the net present value of the project (each a “Credit Event”). For accounts where a Credit Event is subsisting as on the date of enforcement of the Draft Framework, REs shall be required to immediately undertake a review of the account, which shall include signing of an Inter Creditor Agreement and implementation of a resolution plan in accordance with the Existing Framework.

Increased Provisioning Requirements and Resolution of Stress

The key objective of the Draft Framework is to provide norms for provisioning by REs for each project phase. REs are required to maintain: (i) a general provision of 5% of the funded outstanding in the construction phase on a portfolio basis; (ii) in the operational phase, the provisioning can be reduced to 2.5% of the funded outstanding which can be further reduced to 1% of the outstanding provided that the project has a positive net operating cash flow and the total long term debt of the project has declined by at least 20% from the outstanding at the time of achieving DCCO.

DCCO may be extended as a part of the resolution process subject to compliance with specified conditions. For accounts which have availed DCCO deferment as part of the resolution process, are classified as standard, and wherein cumulative deferments are more than 2 years for infrastructure projects and 1 year for non-infrastructure projects, REs will be required to maintain additional provisions of 2.5% over and above the applicable general provision for the construction phase. Further, post-resolution plan, financial parameters (e.g. debt to equity ratios, debt service coverage rations etc.) and external credit rating requirements shall remain unchanged or enhanced in favour of the RE.

Where a viable resolution plan is not implemented, lenders are required to make additional provisions as prescribed under the Existing Framework which can be reversed on successful implementation of resolution plan. Provisioning for non- performing assets (NPAs) shall be in accordance with the extant RBI Master Circular – Prudential Norms on Income Recognition, Asset Classification and Provisioning.

Enhanced Compliances and Monitoring Requirements

Another key feature of the Draft Framework is the increased compliances and monitoring for REs which appears to aim towards reducing the risk which is inherent to project financing. The Draft Framework, inter alia, requires: (i) any project to have all mandatory pre-requisites (e.g. availability of encumbrance free land, environmental and regulatory clearances etc.) to be in place prior to commencement of the construction phase; (ii) DCCO to be clearly documented prior to disbursement of funds; (iii) the lender’s independent engineer (LIE) / architect to certify the stages of completion of the project; (iv) REs to put into place a framework to engage LIE and conduct a techno-economic viability (TEV) study and evaluate the estimated expenditure for the project, its economic viability and bankability of the project; (v) that financing agreements shall generally not allow any provision for moratorium on repayments beyond DCCO (and if granted shall not exceed 6 months from DCCO) and repayment structures ought to factor in the lower initial cash flows; (vi) repayment tenor (including any moratorium period) shall not exceed 85% of the economic life of the project.

Additional monitoring compliances include, inter alia: (i) REs to get the project’s net present value independently revaluated annually; (ii) Credit Events are required to be reported to Central Repository of Information on Large Credits by REs weekly, in addition to the main report; (iii) project specific data is required to be maintained by REs on an ongoing basis in the format prescribed in the Draft Framework and any change in the parameters of a project finance loan are to be updated no later than 15 days from such change. Furthermore, REs will also be required to submit a return on a quarterly basis for all project finance loans extended and are mandated to make appropriate disclosures in their ‘notes to accounts’ in relation to implemented resolution plans, in the format prescribed pursuant to the Draft Framework.

Critical Analysis and Our View

Given that projects and project financings are susceptible to delays and defaults, having a separate prudential framework of projects under implementation is an essential move on the part of RBI. Earlier, many project loans were classified as ‘standard’ despite the scheduled date of operation being delayed by years, the Draft Framework seeks to mitigate this risk by dispensing advantageous asset classifications if DCCO is delayed beyond stipulated time periods. This ensures timely resolution of stressed accounts and risk mitigation and may also aid in ensuring that asset quality is maintained during all phases of projects. There are also adequate ‘safety gates’ in place such as the predetermination of net present value of the project, the disbursement schedule corresponding to the stages of the project backed with LIE certification and continuous project monitoring.

A pertinent concern that must be addressed is the sharp increase in provisioning requirements for REs, since, it may impact on their profit and loss account, total networth and reduce the available funds for lending. A likely consequence could be an increased cost of lending towards project financing which may act as a deterrent to certain lenders entering with heavy exposures into the project financing space. Another possibility is that the REs may transfer this increased cost to the borrowers, resulting in higher interest rates. Whether this will impede growth in such a capital-intensive sector or deter project financing due to decreased profitability remains to be seen.

However, it cannot be denied that this is a welcome initiative by the RBI to streamline project financing and provide adequate safeguards to reduce the number of NPAs for REs in project financing, despite initial obstacles which stakeholders may face.

Authors: Zeeshan Khan, Partner, K Law,Mallika Jain, Senior Associate, K Law and Anubha Pandey, Associate, K Law