Concerns with RBI’s Draft Guidelines on infrastructure financing

Source-This post on Concerns with RBI’s Draft Guidelines on infrastructure financing has been created based on the article “RBI’s draft provisions create a flutter” published in “Business Standards” on 7 June 2024.

UPSC Syllabus-GS Paper-3- Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development and Employment.

Context-The article discusses the Reserve Bank of India’s (RBI) draft provisions for infrastructure lending, which have caused a stir in the infrastructure financing world.

It is important to recognize that infrastructure investments have been and will continue to be the main driver for economic growth. This underlines the significance of striking the right balance in regulating infrastructure financing.

What are RBI’s recent draft guidelines?

1) Banks must set aside 5% of the loan value as provisions for infrastructure and commercial real estate projects that are under construction. This is significantly higher than the current rates, which range from 0.4% to 1% depending on the project type.

2) Banks are mandated to classify loans as “non-performing” if projects exceed a six-month delay of completion from the original deadline.

What is the rationale behind the introduction of draft guidelines by RBI?

1) The RBI aims to tighten the prudential framework for project financing to address concerns over non-performing assets (NPAs) due to defaults on infrastructure projects.

2) Furthermore, “Twin Balance Sheet Problem,” affect both banks and companies, posed a big challenge to India’s banks. Thus, RBI does not want to repeat it.

Read more- Status of Non-Performing Assets

What are the concerns associated with these guidelines?

1) The National Highways Authority of India and the National Highways Builders Federation are concerned about the potential financial burden of the RBI’s proposals.

2) Bankers fear that the proposed 5 percent provisioning rule may raise interest rates and discourage lending.

3) Developers are concerned about funding sustainability, expecting a ripple effect throughout the sector due to increased provisioning requirements during both construction and operational phases of projects.

4) The blanket six-month moratorium on all projects is drawing criticism for its extremely stringent stance. This heavy-handed approach may hamper infrastructure investment growth.

5) A senior official from a public sector bank disagreed with the necessity of updated provisioning rules, stating that since the government is the primary partner in most projects, a single approach to project financing isn’t suitable.

Read more- RBI, inflation targeting, and the limits of monetary policy

What should be the way forward?

Finance Minister has emphasized the importance of thorough discussion and consideration of all viewpoints before deciding on the draft guidelines.

1) A more tailored approach would be preferable over general tightening of provisioning norms to balance financial health and sustainable growth.

2) The RBI needs to carefully balance protecting the banking system’s financial health with promoting an environment that supports long-term growth.

Question for practice

What is the rationale behind the introduction of draft guidelines by RBI? What are the concerns associated with these guidelines?