Prudential Framework for Income Recognition, Asset Classification and Provisioning pertaining to Advances – Projects under Implementation, Directions, 2024
♦ Introduction:
> The Reserve Bank of India has released draft guidelines on ‘Prudential Framework for Income Recognition, Asset Classification and provisioning pertaining to Advances – Projects under Implementation.
> These Directions are issued to provide a harmonised prudential framework for financing of projects in Infrastructure, Non-Infrastructure and Commercial Real Estate sectors by regulated entities (REs). These Directions also lay down revised regulatory dispensations for changes in the date of commencement of commercial operations (DCCO) of such projects in the backdrop of a review of the extant instructions and analysis of the risks inherent in such financing.
♦ Preliminary:
1. Applicability & Effective Date:
> These directions shall come into force with immediate effect whenever it will be released by the RBI
> The provisions of these Directions shall apply to Scheduled Commercial Banks (including Small Finance Banks but excluding Payments Banks, Local Area Banks and Regional Rural Banks), Non-Banking Financial Companies (NBFCs), Primary (Urban) Cooperative Banks, All India Financial Institutions (AIFIs).
♦ General Guidelines:
1. Phase of Projects
> For the purpose of application of prudential guidelines contained in these Directions, Projects shall be broadly divided into three phases as follows:
| Types of Phases | Period |
| Design Phase | This is the first phase which starts with the conception of the project and includes, inter-alia, designing, planning, and obtaining all applicable clearances/approvals till its financial closure. |
| Construction Phase | This is the second phase which begins after the financial closure and ends on the day before the DCCO. |
| Operational Phase | This is the last phase which starts with commencement of commercial operation by the project. |
2. Prudential Conditions for Project Finance
Following are prudential conditions that every regulated entities required to follow before financing any project:
> Lenders desirous to have project finance exposures shall have a Board-approved policy for resolution of stress in the projects on occurrence of a credit event.
> For any project, all mandatory pre-requisites should be in place before financial closure. An indicative list of such pre-requisites includes availability of encumbrance free land and/or right of way, environmental clearance, legal clearance, regulatory clearances, etc., as applicable for the project. However, for infrastructure projects under PPP model, land availability to the extent of 50% or more can be considered sufficient by lenders to achieve financial closure.
> For all projects financed by the lenders, it must be ensured that financial closure has been achieved and DCCO is clearly spelt out and documented prior to disbursement of funds. Additionally, lenders shall ensure that disbursal is proportionate to the stages of completion of the project as also to the progress in equity infusion, as agreed. In case of PPP projects, disbursement of funds should begin only after declaration of the Appointed date of the project. The project specific disbursement schedule vis-à-vis stage of completion of the project shall be prescribed by the lenders. Further, the lender’s Independent Engineer (LIE)/Architect must certify the stages of completion of the project.
> In projects financed under consortium arrangements, where the aggregate exposure of the participant lenders to the project is upto ₹1,500 crores, no individual lender shall have an exposure which is less than 10% of the aggregate exposure. For projects where aggregate exposure of lenders is more than ₹1,500 crores, this individual exposure floor shall be 5% or ₹150 crores, whichever is higher.
> Notwithstanding the above, post DCCO, lenders may acquire from or sell exposures to other lenders (new/existing) in the multiple banking/consortium arrangements, and in compliance with guidelines contained in the Master Direction on Transfer of Loan Exposures as updated from time to time.
♦ Resolution and Prudential Norms:
1. Resolution Plans involving extension of DCCO
> A project finance account classified as ‘standard’ in the books of REs shall continue to be classified as ‘standard’ on account of extension of DCCO and consequential shift in repayment schedule for equal or shorter duration (including the start date and end date of revised repayment schedule) under the following conditions:
| Reason for Extension of DCCO | |||
| Exogenous Risks | Endogenous Risks | Litigation (Court cases) | |
| Allowable deferment of DCCO from the DCCO originally envisaged in the financing agreement | Upto 1 year (including CRE projects) | Upto 2 years for Infrastructure Projects
Upto 1 year for Non-infrastructure Projects (excluding CRE projects) |
Upto 1 year (including CRE projects) |
*“Exogenous Risks” – risks which are exogenous to a specific project and which may adversely impact some or most of the entities in the economy or in a specific sector or in a specific geographic region. These factors may be natural calamities, pandemic, change in government policy/regulation/law, etc., and their impact may give rise to cost overruns and/or time overruns.
**“Endogenous Risks” – risks which are endogenous to the specific project, and mainly arise on account of deficiencies in planning/execution capability of the project sponsor/concessionaire. These may lead to cost overruns, time overruns, change in ownership, etc.
2. Provisioning for Standard Assets
> All lenders shall maintain provisions on exposures to projects under implementation at various stages as under:
> Construction Phase: A general provision of 5% of the funded outstanding shall be maintained on all existing as well as fresh exposures on a portfolio basis.
> Operational Phase: Once the project reaches the ‘Operational phase’, the above provisions specified at paragraph 33 above, can be reduced to 2.5% of the funded outstanding. This can be further reduced to 1% of the funded outstanding provided that the project has (a) a positive net operating cash flow that is sufficient to cover current repayment obligation to all lenders, and (b) total long-term debt of the project with the lenders has declined by at least 20% from the outstanding at the time of achieving DCCO.
♦ Timelines for compliance :
The provisioning of 5% for Standard Assets during construction phase shall be achieved in a phased manner as per the following timeline:
| Rate of Provisioning | Effective from |
| 2 per cent | March 31, 2025 (spread over the four quarters of 2024-25) |
| 3.50 per cent | March 31, 2026 (spread over the four quarters of 2025-26) |
| 5.00 per cent | March 31, 2027 (spread over the four quarters of 2026-27) |
3. Income Recognition
Lenders may recognise income on accrual basis in respect of loans to projects under implementation, which are classified as ‘standard’. In cases involving DCCO deferred accounts which are classified as ‘standard’ and where there is a moratorium on payment of interest and principal, lenders shall book income only on cash basis beyond original DCCO, considering the high risk involved in such accounts. For non-performing accounts, income recognition shall be as per extant instructions contained in Master Circular – Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances dated April 02, 2024, as amended from time to time.
7. Conclusion:
> Learning from experiences of delinquencies in infrastructure lending during the past credit crisis, RBI has proactively introduced stronger provisioning norms for this segment at a time when financial institutions are gearing up to increase credit to this segment, in support of government initiatives and plans.
> Further, the new prudential framework also induces better governance, transparency and discipline in sanctioning loans to the risky infrastructure and commercial real estate sectors. It ensures that lenders adopt collective and carefully designed restructuring and resolution strategies for stressed project loans.
> Large commercial banks and infrastructure project financiers like PFC, REC and IREDA are expected to face the biggest short-term impact of the proposed framework in terms of profitability and capital adequacy. Equity markets already factored in this effect with a one-day fall in prices by 2 – 6% for the relevant companies when the draft framework was first published by RBI.
> This may be a concern for the government, given that there is a renewed push towards public-private partnerships in infrastructure and there still exists a substantial infrastructure funding gap. Lenders will need to review their project finance portfolios and derive their own strategies for material sectors going forward. However in the long run, RBI’s conservative treatment of project loans will do well for financial stability.
Authors:
Rohan Gaikar | Article Assistant
Mohit Gurjar | Senior Manager | LinkedIn
Email: blogs@bilimoriamehta.com
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