PFC, REC, IREDA: What RBI’s Tighter Project Finance Norm Mean To Top NBFC PSUs

The Reserve Bank of India (RBI) recently unveiled a draft proposal aimed at harmonising prudential frameworks for lenders engaged in project finance. The proposed changes are poised to impact the lending landscape, particularly key players in the non-banking financial company (NBFC) sector, including REC, PFC, and IREDA, according to IIFL Securities.

The primary thrust of the RBI's proposal is to bolster lending criteria and enhance standard asset provisioning, with a phased approach to implementation. Under the proposed norms, lenders will be subject to tighter lending criteria, including a requirement for individual lenders within consortia to maintain a minimum exposure threshold of 10% for projects with aggregate exposure up to Rs 15 billion.

Additionally, the proposal mandates that financial closure be achieved and a documented construction completion date (DCCO) be established before fund disbursement. Moreover, a maximum moratorium period of six months beyond DCCO is stipulated, along with criteria for resolution plans involving DCCO extension and NPA account upgrades.

"The implications of these proposed changes are far-reaching. For one, the minimum exposure requirement of 10% within consortia is likely to constrain opportunities for smaller players, potentially reshaping the competitive landscape,IIFL Securities said in the report.

In terms of standard asset provisioning, the proposal entails a significant increase, from the current 0.4% to 1-5% of loans, phased in over time. During the construction phase, lenders will be required to provide 5% of the outstanding funded exposure, which can be reduced to 2.5% once the project reaches the operational phase. A further reduction to 1% is contingent upon the project meeting specified financial benchmarks.

"The enhanced standard asset provisioning norms are expected to necessitate additional provisions, estimated at 0.5-3% of net worth for banks, and have a potential impact on CET1 ratios, particularly for PSU banks," according to IIFL Securities.

However, for NBFCs, the impact may vary. While the additional provisions will not directly impact the profit and loss (P&L) statement, they will be apportioned to the impairment reserve, bypassing capital ratio and non-performing asset (NPA) calculations.

Consequently, NBFCs are not anticipated to experience a significant return on equity (RoE) impact. However, infra-focused NBFCs such as REC, PFC, and IREDA could witness a potential decline of 200-300 basis points in their capital ratios, potentially impacting their valuation multiples.

The proposed phased implementation of higher provisioning requirements, starting with 2% by March 31, 2025, followed by increments to reach 5% by March 31, 2027, aims to mitigate the immediate impact on lenders. Nevertheless, the adjustment period poses challenges, particularly for institutions with significant exposure to project finance.

Moreover, the proposal defines credit events and outlines procedures for managing and mitigating associated risks. It restricts moratorium periods to a maximum of six months from DCCO, with repayment tenors not exceeding 85% of the project's economic life.

The RBI's proposed tighter project finance norms signify a concerted effort to enhance the resilience and stability of the lending ecosystem. While aimed at mitigating risks associated with project finance, the implications for lenders, particularly NBFCs, underscore the need for strategic recalibration and proactive risk management strategies to navigate the evolving regulatory landscape.