rbi

RBI's 2024 Prudential Framework for Project Financing and Income Recognition

Prudential Framework for Income Recognition, Asset Classification, and Provisioning for Advances – Projects under Implementation, Directions, 2024

Introduction

The Reserve Bank of India (RBI) has issued draft guidelines titled ‘Prudential Framework for Income Recognition, Asset Classification, and Provisioning pertaining to Advances – Projects under Implementation.’ These guidelines aim to create a harmonized prudential framework for financing projects across the Infrastructure, Non-Infrastructure, and Commercial Real Estate sectors by regulated entities (REs). Additionally, the framework reevaluates guidelines concerning the date of commencement of commercial operations (DCCO) for such projects, taking into account the inherent risks associated with this type of financing.

Preliminary

Applicability & Effective Date

  • These directions will take effect immediately upon release by the RBI.
  • The guidelines apply to Scheduled Commercial Banks (including Small Finance Banks), Non-Banking Financial Companies (NBFCs), Primary (Urban) Cooperative Banks, and All India Financial Institutions (AIFIs), excluding Payments Banks and Regional Rural Banks.

General Guidelines

Phases of Projects

To apply the prudential guidelines effectively, projects are categorized into three phases:

  1. Design Phase

    • Initiates with project conception and encompasses designing, planning, and obtaining necessary clearances until financial closure.

  2. Construction Phase

    • Commences post-financial closure and concludes the day before the DCCO.

  3. Operational Phase

    • Begins with the start of commercial operations of the project.

Prudential Conditions for Project Finance

Regulated entities must adhere to the following prudential conditions before financing any project:

  • Lenders must establish a Board-approved policy to address project stress upon a credit event.
  • All mandatory prerequisites, such as encumbrance-free land, environmental clearance, and legal approvals, must be fulfilled before financial closure. For Public-Private Partnership (PPP) infrastructure projects, land availability of 50% or more suffices.
  • Lenders must ensure that financial closure is achieved, and DCCO is clearly documented prior to fund disbursement, which should coincide with the project’s progress.
  • In consortium arrangements, for aggregate lender exposure up to ₹1,500 crores, no one lender should have less than 10% exposure. For exposures above ₹1,500 crores, the minimum is set at 5% or ₹150 crores, whichever is greater.
  • Following DCCO, lenders may transfer exposures among existing lenders according to guidelines from the Master Direction on Transfer of Loan Exposures.

Resolution and Prudential Norms

Resolution Plans for DCCO Extensions

A project classified as ‘standard’ will maintain this status despite DCCO extensions under specific conditions:

  • Exogenous Risks:

    • Allowable deferments:
      • Up to 1 year (including CRE projects)
      • Up to 2 years for Infrastructure Projects
      • Up to 1 year for Non-infrastructure Projects (excluding CRE projects)

  • Endogenous Risks:

    • Up to 1 year (including CRE projects)

Definitions:

  • Exogenous Risks: External factors affecting projects, such as natural disasters or regulatory changes.
  • Endogenous Risks: Internal deficiencies in project planning or execution.

Provisioning for Standard Assets

Lenders must maintain provisions on project exposures as follows:

  • Construction Phase: A general provision of 5% of the outstanding amount for all existing and new exposures.
  • Operational Phase: Can reduce to 2.5% after reaching operational status. This may decrease to 1% if the project has a positive net operating cash flow and a long-term debt reduction of at least 20%.

Timelines for Compliance

Provisioning timelines for Standard Assets during the construction phase are outlined as:

  • 2% effective March 31, 2025
  • 3.5% effective March 31, 2026
  • 5% effective March 31, 2027

Income Recognition

Lenders may recognize income on an accrual basis for ‘standard’ classified loans for projects under implementation. For DCCO-deferred accounts under moratorium, income should be recorded on a cash basis to account for heightened risks. Non-performing accounts adhere to the Master Circular - Prudential Norms on Income Recognition, Asset Classification, and Provisioning, dated April 2, 2024.

Conclusion

In response to past delinquencies in infrastructure lending, the RBI has introduced robust provisioning norms to improve financial support for infrastructure projects. This new prudential framework enhances governance, transparency, and discipline in loan sanctioning across high-risk sectors. While large commercial banks and infrastructure financiers may experience short-term impacts on profitability and capital adequacy, the long-term effects of conservative project loan management are expected to enhance financial stability. Lenders are encouraged to reassess their project finance portfolios in light of the improved regulatory framework.