Reserve Bank warning on infra projects' loan refinancing

Following the issuance of the Reserve Bank of India (RBI)' 5/25 scheme, banks had taken up flexible structuring of a few projects

The Reserve Bank of India (RBI) has said banks might be exposing themselves to undue risk by back-loading most of their repayments for infrastructure projects refinanced under the '5/25 scheme'.

According to RBI Deputy Governor H R Khan, following the issuance of the guidelines for the 5/25 scheme, banks had taken up flexible structuring of a few projects. However, there have been some reports that banks have incorporated long moratorium periods in their revised loan amortisation schedules and they are not clear on the methodology to compute the net present value of these loans.

Under the 5/25 scheme, banks were allowed to fix longer amortisation period for loans to projects in infrastructure or core industries sector for, say, 25 years. This would be based on the economic life or concession period of the project with periodic refinancing, say, every five years. This scheme was announced for addressing the loan maturity mismatches in financing the infra projects.

Khan, who was addressing an infrastructure group conclave here on Wednesday, said the fresh loan amortisation schedule was heavily back-ended with repayment obligations pushed to later part of project life. "While debt repayment should be aligned to project cash flows, pushing a large part of debt obligations into later part of project life may lead to undue risk to lenders. Moreover, a long principal moratorium or an interest moratorium for a project, which has commenced commercial operations could be a sign of credit weakness and, hence, needs to be recognised appropriately," said Khan.

He emphasised the regulator has provided certain flexibilities given the critical role infrastructure plays in the overall economic growth. However, such flexibility should be judiciously used by the participants and certainly not as a tool for hiding the stress in the assets or for mere postponement of the inevitable, he noted.

Khan also spoke about the steps that can be taken to strengthen municipal bond markets in India. "The regulatory and legal conditions that currently hinder the municipal borrowing in India need to be altered to encourage appropriate expansion of the scope of bond financing." There is also a need to introduce flexibility in setting interest rate cap for issuance of municipal bonds by linking it to a benchmark market rate, he added. "Treating tax-free municipal bonds in the same way as other tax free instruments is necessary."

Ring-fencing municipal bond funds is essential by clearly earmarking the same for a defined project and is, thus, insulated from interventions. Besides that, to gain investor confidence, municipalities need to obtain credit rating for raising funds from the market. According to Khan, introduction of a bankruptcy law applicable to municipal bodies could improve investor confidence and boost demand for municipal bonds.