RBI issues Instructions for Flexible Loan Structuring; Gives Incentives to raise Long Term Bonds for Infrastructure Financing

The Reserve Bank of India has issued a number of instructions to banks specifying the operational guidelines and incentives in the form of flexibility in loan structuring and refinancing, and also granting exemptions from regulatory pre-emptions, such as, cash reserves ratio (CRR), statutory reserves ratio (SLR) and Priority Sector Lending (PSL). The objective of these instructions is to mitigate the Asset-Liability Management (ALM) problems faced by banks in extending project loans to infrastructure and core industries sectors, and also to ease the raising of long term resources for project loans to infrastructure and affordable housing sectors.

While the instructions in the first notification fleshes out operational guidelines for flexible structuring and refinancing of new project loans to infrastructure and core industries sectors, the instructions in the second notification lays down the guidelines for issuance of long term bonds by banks for financing infrastructure project loans and affordable housing, and exemption from regulatory pre-emptions, such as, CRR, SLR and PSL on such bonds. A collateral benefit if bank bond issuances prove successful is the development of the domestic corporate bond market.

Background

The economy will face large needs for financing infrastructure in the coming years. There are substantial risks associated with infrastructure at the construction phase, which requires flexible bank financing. Post construction, however, suitably structured long term loans can be taken-out by long term lenders, such as, infrastructure funds, pension funds and insurance companies. Banks need the flexibility to structure loans to mitigate risks as well as to ensure easy refinancing.

Equally, infrastructure and affordable housing need relatively long term financing compared to the standard bank loan. If banks finance such long term loans with short term deposits, they create a risky asset liability mismatch, as well as a need to maintain liquid assets to mitigate the risk of illiquidity. Banks would be better off if they could issue long term bonds to finance such loans, but regulatory pre-emptions may make such issuance costly.

In the Union Budget 2014-15, presented on July 10, 2014, the Hon'ble Finance Minster announced that:

Long term financing for infrastructure has been a major constraint in encouraging larger private sector participation in this sector. On the asset side, banks will be encouraged to extend long term loans to infrastructure sector with flexible structuring to absorb potential adverse contingencies, sometimes known as the 5/25 structure. On the liability side, banks will be permitted to raise long term funds for lending to infrastructure sector with minimum regulatory pre-emption such as CRR, SLR and Priority Sector Lending (PSL).

The Reserve Bank had also issued the Framework for Revitalising Distressed Assets in the Economy on February 26, 2014, which, among other things, addressed the issue of refinancing of project loans and the present endeavour is a continuation of that effort to ensure credit flows to productive sectors of the economy.

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