- The shares of public sector banks fell during trade on Monday after the Reserve Bank of India’s draft rules proposed higher provisioning norms on under-construction projects.
- PSU Bank nifty index fell 3.66% to close at 7,252.85 in trade on Monday.
- On 3 May, RBI issued a draft prudential framework for lenders undertaking project finance, which proposed an increase in standard asset provisioning to 1-5% of loans from the current 0.4% in a phased manner on project loans that are not overdue to stressed.
Public sector banks see a fall in shares following the Reserve Bank of India’s proposed higher provisioning norms on under-construction projects. The draft rules are set to impact the profitability of lenders and the credit availability for project finance.
RBI’s New Draft Rules
The Reserve Bank of India’s draft rules propose that during the construction phase of a project, lenders must set aside a provision of 5% of the loan amount. This will reduce to 2.5% once a project is operational and further to 1% once the project has adequate cash flow to repay obligations. RBI has allowed lenders three years to reach 5% provisioning—2% in FY25, 3.5% in FY26 and 5% by FY27. The draft rules also state that banks should have a clear viability on the date on which a project is expected to begin commercial operations and increase provisions in case operations are delayed. Any delay over 3 years in beginning an infrastructure project should change the classification of loan from standard to stressed.
Implications for Financial Companies
According to analysts, the draft guidelines are meant to safeguard the risks involved in project lending and to make higher prudential provisions. Suresh Ganapathy, a banking analyst at Macquarie Capital, believes that these rules will hit public sector banks more than private sector owing to their increased exposure. “From financial companies’ perspective, we think this will have two implications: 1) provisioning requirements will go up for lenders affecting their profitability; and 2) these companies may ration credit to project finance, be more selective, and/or raise lending rates, further postponing the capex cycle recovery,” he said. Analysts at IIFL Securities estimate that the impact of 5% standard asset provisioning will result in banks making additional provision of 0.5-3% of networth and a hit of 7-30 basis points on common equity tier 1 capital. Infrastructure focused NBFCs like REC, PFC and Ireda can see potential hit of 200-300bps to their capital ratio, they said.
Conclusion
The proposed draft rules by RBI are set to bring significant changes in the banking sector, particularly affecting public sector banks. The increase in provisioning requirements is likely to impact the profitability of lenders and could potentially lead to a rationing of credit to project finance. While these rules aim to safeguard the risks involved in project lending, they also highlight the need for financial institutions to reassess their strategies and prepare for the potential implications.
