New RBI Guidelines for Project Financing: Key Provisions and Implementation Phases
Introduction: The Reserve Bank of India (RBI) has issued comprehensive guidelines titled “Prudential Framework for Income Recognition, Asset Classification and Provisioning pertaining to Advances – Projects Under Implementation, Directions, 2024.” These directives are aimed at providing a structured approach for financial institutions dealing with project loans under stress. In this article, we delve into the details of these directions, including the entities to which they apply and the key provisions outlined.
Reserve Bank of India has issued Prudential Framework for Income Recognition, Asset Classification and Provisioning pertaining to Advances – Projects Under Implementation, Directions, 2024 which gives de-tailed instructions to be followed by All Commercial Banks (including Small financial Banks but excluding Payments Banks, Local Area Banks and Regional Rural Banks), All Primary (Urban) Co-operative Banks, All-India Financial Institutions (REs) and all non-banking financial companies, while financing borrower accounts under stress.
Let us look at the details of these directions inviting public comments which might have been received in RBI by 15th of May 2024. Let us look at these extant details for our knowledge.
To whom are these suggested guidelines applicable as directions after approval?
These Directions are being issued to provide a harmonized prudential framework for financing of pro-jects in Infrastructure, Non-Infrastructure and Commercial Real Estate sectors by regulated entities (REs). The names of these regulated entities are mentioned at the beginning of this article.
Also laid down are 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.
Phases of Projects
Projects shall be broadly divided into three phases namely,
(i) Design phase – This is the first phase which starts with the conception of the project and includes, inter-alia, designing, planning, obtaining all applicable clearances/approvals till its financial closure.
(ii) Construction phase – This is the second phase which begins after the financial closure and ends on the day before the (Date of Commencement of Commercial Operations (DCCO))
(iii) Operational Phase –This is the last phase which starts with commencement of commercial operation by a project.
Prudential Conditions for Project Finance
(Prudential means being careful and avoiding risks. This word has evolved due to the reckless manner of financing by financial institutions)
1. 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. More as a formal note, almost all institutions have detailed project finance guide-lines.
2. An indicative list of 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. One can recollect laying of roads, huge infrastructure projects like solar projects, huge manufacturing plants etc.
3. Lenders (financial institutions etc.) must also ensure that financial closure has been achieved and DCCO is clearly spelt out and documented prior to disbursement of funds.
4. The disbursement of funds is to coincide with the stages of implementation of the projects and infusion of equities in case of PPP projects. This starts after declaration of the appointed date of the project. The stages of implementation of the projects will be certified by lenders’ expert engineers/architects well experienced in project finance management.
5. 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.
6. The original or revised repayment tenor, including the moratorium period, if any, shall not exceed 85% of the economic life of the project.
7. A positive net present value (NPV) is a prerequisite for any Project financed by lenders. Any subsequent diminution in NPV during the construction phase, either due to changes in projected cash flows, project life-period or any other relevant factor which may lead to credit impairment, shall be construed as a credit event. Accordingly, lenders shall get the project NPV independently re-evaluated every year.
8. The financing agreement shall generally not allow any provision for moratorium on repayments beyond DCCO period and repayment structure shall be realistically designed to factor in the lower initial cash flows.
9. Provided that, in cases where a moratorium on repayments beyond DCCO is granted, the same shall not exceed six months from the commencement of commercial operations.
It is expected that financial institutions funding these huge projects would have special departments and adequately trained human resource to totally commit to these directions for projects under financing.
What will happen if changes, if any, happen in the projects under implementation?
These instances are referred as default/ credit event in the said directions.
The treatment for these instances is narrated as under:
“Any such Credit Event shall be reported to the Central Repository of In-formation on Large Credit (CRILC) by the lenders in the prescribed weekly as well as the CRILC-Main re-port in compliance with the extant instructions, as applicable. Lender(s) in a consortium/MBA shall also report occurrence of such credit event to all other members of the consortium/MBA.
All lenders shall undertake a review of the debtor account within thirty days from the date of such credit event (“Review Period”). For accounts where a credit event is already existent as on the date of these Directions, the review period shall commence immediately.
The conduct of the lenders during this “Review Period” including signing of Inter Creditor Agreement (ICA), and the implementation of a resolution plan (RP), where required, shall be guided by the provisions of the Prudential Framework.”
What happens to resolution plans in case of changes?
The following requirements are met.
1) All required documentation, including execution of necessary agreements between lenders and the debtor / creation of security charge / perfection of securities, are completed.
2) The new capital structure and/or changes in the financing agreement get duly reflected in the books of all the lenders and the debtor.
3) 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 the shift in repayment schedule will be reflected in the books as under:
The reason for the extension of DCCO—
Allowable deferment of DCCO from the original DCCO.
a) For Exogenous Risks – Up to 1 year (including CRE projects)
b) For endogenous Risks – Up to 2 years for infra-structure projects : for non-infrastructure projects up to one year.
c) For litigation cases, up to 1 year.
Any change in the repayment schedule of a project loan caused due to an increase in the project outlay on account of increase in scope and size of the project, shall continue to be classified as ‘standard’ if:
1) The increase in scope/size of the project takes place before it has started functioning commercially.
2) The rise in project cost excluding any cost-overrun in respect of the original project is 25% or more of the original outlay.
3) The lenders do reassess the viability of the project and approve it.
4) In case of rated project for viability or commercial assessment, the re-vised rating not to be one notch below the previous one.
In cases where lenders have specifically sanctioned a ‘Standby Credit Facility (SBCF) at the time of initial financial closure to fund the project, an additional cost over run can’t exceed 10% of original cost. Or, without any credit facility not considered originally, an additional 10% is permissible.
It is clearly understood that post-RP, financial parameters like D/E ratio, DSCR. etc., and external credit rating, if any, shall remain unchanged or enhanced in favor of lender.
It is interesting to know how does one recognize the income during the project under implementation?
Lenders are expected to recognize the income on accrual basis in cases of projects under implementation.
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.
For non-performing accounts, instructions issued by RBI as Master Circular – Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances dated April 02, 2024, updated will give the guidance.
How do the institutions provide as provisioning for financing these projects?
- 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.
- The instructions during operational phase are the provision stands reduced to 2.5% and will get further reduction to 1%, if 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.
- What about provisioning for” Provisioning for DCCO deferred accounts”?
For standard, and wherein the cumulative deferments are more than 2 years and 1 year for infrastructure and non-infrastructure projects respectively, lenders shall maintain additional specific provisions of 2.5% over and above the applicable standard asset provision as explained above. This addition-al provision of 2.5% shall be reversed on commencement of commercial operation.
- In cases of unsuccessful projects not implemented, the provisioning is to follow the instruc-tions contained in ‘Delayed implementation of Resolution Plan’ in the Prudential Framework dated June 07, 2019. These additional provisions can be reversed on successful implementation of resolution plan.
- For non-performing projects (accounts), the extant instructions issued by RBI may need the complete reference.
Regulatory returns
For all project finance loans extended, lenders are advised to submit a prescribed return on a quarterly basis, within 15 calendar days from the end of the quarter to RBI, Department of Supervision (DoS).
The lenders shall make appropriate disclosures in their financial statements, under ‘Notes to Accounts’, relating to RPs implemented.
Non compliance of the instructions by the institutions shall invite supervisory and enforcement action from the regulatory authority.
Conclusion: Project finance directions for distressed accounts a vital component of the infrastructure development of the nation has been updated to help the financial institutions disburse the required finance, meet the requirements of the project holders, and all other stake holders. It is intended to help all the stakeholders immensely, particularly with an enlarged manner to run the projects successfully. Stressful condition is not unexpected for very big projects and these guidelines will help all concerned.
Disclaimer: This write-up inspired by RBI web site contains bare instructions which need the guidance of lawyers, experienced bankers and expert project managers for successful implementation. It is obvious constant touch with experts lead to successful completion of projects. Yes, one will definitely consult the experts during the implementation of projects.
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