RBI's Risky Project Finance Rules

The Reserve Bank of India's (RBI's) recent project financing guidelines have led to much cheer in the stock markets.

- PRASANNA TANTRI

One highlight is that the provisioning requirement on project finance is now 1 per cent, instead of 5 per cent proposed in the discussion paper issued earlier. Many lenders feared that a blanket requirement of 5 per cent, provisioning would absorb all capital and slow down lending. Thus, the RBI has avoided a short-term slowdown in economic activity. However, are these guidelines net positive from a long-term point of view, or are some tweaks necessary, given our experience of the Indian banking crisis between 2008 and 2018? My focus here is on the provision that allows lenders to grant extensions to projects that miss their pre-committed commencement timelines.

Let us first understand the basic structure of project financing. A typical project goes through three phases, namely, the design phase, the construction phase, and the operational phase. The project is conceived and planned during the first phase. Prospective lenders evaluate the plan prepared during the design phase and approve or disapprove project finance. In case they approve, they also finalize the terms of the loan.