Rajan asks banks to tap casa deposits for project financing

Reserve Bank Governor Raghuram Rajan today voiced concern over banks, especially state-run lenders, shunning project loans, and said they should tap their large low-cost deposits from casa accounts to finance infrastructure projects.
Stating that there is a large room for them to make enough profits from financing infrastructure, Rajan rued that since the crisis in infra space, banks are shunning project loans and are aggressively targeting retail borrowers.
"There are inputs to making profitable project loans such as the availability of casa deposits that will be accrued to the banks that build out their IT to access and serve the broader saver cheaply and effectively," Rajan told the national bankers summit organised by Ficci in association with bankers body IBA here.

He, however, was quick to admit that currently no bank has in-house talent to do all this, and said preparation for this is imperative as he thinks "none of this is really futuristic, but it requires a much stronger marriage between information technology and financial engineering, with an important role for practical industry knowledge and incentive design."
Rajan pointed out that the banks with a large pool of low cost deposits are better placed. He said bank's comparative advantage lies in their access to lower cost deposit financing, the data they've on customers, the reach of their network, their ability to manage and warehouse risks, and their ability to access liquidity from the central bank.

Admitting that the infra space has one of the highest NPA levels, he called for moving the focus to improving the operational efficiency of stressed assets, and creating the right capital structure so that all stakeholders can benefit.

It can be noted that infra funding imbalances banks'
asset-liability as a bank's funds are of short term duration of say one to three years, while its funding to an infra project is really long-term stretching up to 30 years.
Warning banks about turning a Nelson's eye to project loans instead lapping up retail loans, the Governor pointed out that this segment of credit is also fraught with many risks which will be visible over time.

"It seems today that having abandoned project loans, every bank is targeting the retail customer. Clearly, the risks in this herding will mount over time, as banks compete for less and less credit-worthy customers. But some of this risk can be mitigated if they do sufficient due diligence" by using more intensive use of IT and analysis is customer loans.
Rajan also said there is an equal need to revamp the capital structure of infra project.
"The capital structure should be tailored to what is reasonable, given the project's situation. If the loan is already an NPA, there is no limit to the kind of restructuring that is possible. If it is standard but the project is struggling, we have a variety of schemes by which a more sensible capital structure can be crafted for the project."

He mentioned the schemes like the 5/25, the SDR, and the S4A as examples which the regulator has unveiled to help both banks and project developers to tide over the crisis.
He, however, was quick to point out that some of the present difficulties with stressed loans come from unrealistic application by banks of a scheme so as to prevent a loan turning dud, rather than due to a carefully analysed effort by the bank to effect management or capital structure change.
Noting that the nation will have enormous project financing needs in the coming days, the Governor said even though bankers are very risk averse today, and few projects are coming up for financing, this will change soon.

"What is in the pipeline is truly enormous - airports, railway lines, power plants, roads, manufacturing plants etc. But bankers will remember the period of irrational exuberance in 2007-08 when they lent without asking too many questions. I am hopeful that this time will be different," Rajan said.
"Bankers will have to develop industry knowledge in key
areas since consultants can be biased," he said, adding "real risks have to be mitigated where possible, and shared where not," the Governor said.
"Real risk mitigation requires ensuring that key permissions for land acquisition and construction are in place up front, while key inputs and customers are tied up through purchase agreements.

"Where these risks cannot be mitigated, they should be shared contractually between the promoter and banks, or a transparent arbitration system agreed upon," he said, adding that if demand falls below projections, perhaps an agreement among promoters and financiers can indicate when new equity will be brought in and by whom.
Calling for rational and timely restructuring of projects with an appropriately flexible capital structure, he said "the capital structure has to be related to residual risks of the project. The more the risks, the more the equity component should be (genuine promoter equity, not fake borrowed equity, of course), and the greater the flexibility in the debt structure".

"Promoters should be incentivised to deliver, with significant rewards for on-time execution and debt repayment. Where possible, corporate debt markets, either through direct issues or securitised project loan portfolios, should be used to absorb some of the initial project risk. So that more such arm's length debt should typically refinance bank debt when construction is over," Rajan said.
Asking banks to have a robust system of project monitoring, Rajan said financiers should put in a robust system of project monitoring and appraisal, including where possible, careful real-time monitoring of costs.
He also said bankers need to be incentivised for taking risks in financing large loans.

"The incentive structure for bankers should be worked out so that they evaluate, design, and monitor projects carefully, and get significant rewards if these work out. This means that even while committees may take the final loan decision, some senior banker ought to put her name on the proposal, taking responsibility for recommending the loan," the Governor said.