The New Kid On The Block

Lending to infrastructure may well become another priority sector imperative for banks.

How equipped are they to take on this challenge?

Until recently, infrastructure finance was a practically unheard of concept in India. But with the country fast hurtling into severe bottlenecks arising out of poor infrastructure that threaten to bring the economy to a standstill, it has become the latest buzzword with ministry of finance mandarins and their political masters. There is also the fact that the lack of infrastructure is becoming a major dampener on foreign direct investment (FDI) inflows. And FDI is almost an obsession with the Centre, now.

The government, therefore, is pulling out all stops to garner as much by way of resources as it can, for infrastructure development. This new-found zeal has the banking circles in a tizzy. Speculation is rife about a ruling in the forthcoming Budget, or a credit policy announcement that could make it mandatory for commercial banks to lend to infrastructure projects. Even if it does not happen now, it is just a matter of time before it will happen, feel many.

There is reason for concern. The sheer scale and long gestation period of infrastructure projects makes it imperative to raise a huge quantum of stable long-tenure funds. Besides, special analytical skills and risk management expertise is de rigeur.

And that in itself raises a few questions: are commercial banks, with their short-term deposits and little project finance expertise, the appropriate channel for sourcing such funds? And what impact would it have on non-food credit for the industry and on interest rates?

Having access mostly to only such short-term funds, banks have traditionally confined their funding operations to either trade-related activities or financing working capital requirements of corporates. If these banks were to lend their short-tenure funds to long-term infrastructure projects, there is an apparent danger of a serious maturity mismatch.

"Our banks, at present, are attuned to only the medium term at best," says B Swaminathan, executive consultant, Srei International. No wonder the 20-year-plus term loans are virtually unheard of in the commercial banking circles. "Yes, we are aware of the potential asset-liability mismatch," says S C Gupta, general manager, Oriental Bank of Commerce. "It might, therefore, be too early to push banks into lending to infrastructure projects in a big way."

Others, however, do not seem to share the same opinion. "Some Indian banks have been approaching the capital market for long term funds," says a Credit Lyonnais project finance expert. "It should make it possible for them to get into infrastructure financing." This could help them follow in the footsteps of their counterparts in South Korea and Indonesia who think nothing of contracting a 50-year debt these days.

A compounded problem

But the prevailing interest rate regime in India complicates the situation further for commercial banks. "These projects are often very interest-sensitive, and could be unviable at such exorbitant interest costs," says Yuvraj Narayan, head, corporate finance, ANZ Grindlays. " If I'm running a balance sheet with an average cost of funds at 13 per cent, how can I lend at 10 per cent? Nobody'll borrow from us at an annualised 18 per cent !"

With the limited borrowing options available, corporates which are into infrastructure might have no other choice. "Due to the highly capital intensive and time-oriented nature of the projects, interest rates do become crucial factors in determining the viability of the project," says a Credit Lyonnais analyst. "But all you need to look at is whether the paybacks can compensate for the incremental interest rate. And the projects that actually stack up can go ahead with the loan." Particularly those which have interest cost as a pass-through expense.

The need for large quantum of funds for financing infrastructure can hardly be overemphasized. "You need a large amount of zero coupon debt or convertible debt which has low coupon to keep the project financially viable," says Narayan. But commercial banks might not be able to bridge the yawning demand-supply gapthey could meet barely 5 per cent. Also, the banks would prefer to go through the consortium lending route as the amount of funds required are huge. This is exactly how the international banks went about things in the days when project finance was in a nascent stage. "No bank would like a large quantum of its net worth exposed to one single project," says Naresh Takkar, general manager, ICRA. "At least, not till they are fairly confident of their risk management skills."

Which leads us on to the next hurdle for commercial banks risk management expertise. Infrastructure financing is a specialised field, quite akin to project finance. Often these projects have a variable risk profile, and require staggered interest rates structures (low during the initial period, and higher as the project proceeds). And expertise to evaluate and hedge specific project risk is indispensable. This can come only with time.

A negative fallout

The other aspect is that if the government makes it mandatory for commercial banks to lend to infrastructure projects by way of priority sector lending, it would have some rather interesting macro-economic fallouts. To the extent that a certain portion of a bank's funds might have to be earmarked for these projects, it would have a direct impact on the non-food credit to the industry, resulting in a credit squeeze ( in so far as the size of the loanable funds remains the same). Also, there would be a concomitant rise in interest rates.

In a dynamic macro scenario, however, things would not be so straightforward. For instance, if the mandatory ruling comes in the wake of a cut in cash reserve ratio (CRR), or statutory liquidity ratio (SLR),there would be a compensatory effect as banks will have access to more funds. "The impact on non-food credit and interest rates will depend on the extent of the cut in such pre-emptions, but they can provide only a minuscule percentage of the infrastructure sectors requirements," says Narayan.

Besides, any funds released through a cut in CRR/SLR would squeeze government spending. If the government demand for funds remains the same, as is the case more often than not, the government now ends up paying for the funds which it was otherwise simply appropriating from the banks. "It would be the same case if the government asked us to put 10 per cent of our funds into infrastructure bonds, and these bonds qualify for SLR," says Narayan.

While the funds-earmarking approach does make available a ready pool of bank funds for priority sectors, there are certain downsides too. "It's time we overcame this target-driven approach to fund allocation," says Takkar. "Banks should be allowed to take commercial decisions if they are expected to keep cleaner balance sheets and approach the capital market to raise funds." Otherwise you're looking at bulk write-offs of loans as in the priority sector. Says Amul Gogna, general manager, ICRA: "Such structured obligation issues are mostly related more to market sentiment than to an economic logic."

Most senior bankers, however, expect the government's decision regarding infrastucture financing to come in the form of a advice rather than a ruling. Says Rashid Jilani, chairman, Punjab National Bank: "In this progressively liberalising economic era, we don't expect mandatory rulings like this to be imposed on banks." Says Gupta: "If it comes at all, it'll most probably be a "suggestion" rather than a diktat. Ports infrastructure, I feel, would be given a priority as the government wants to step-up exports."

In all fairness, financial institutions like IDBI and ICICI would be far better equipped to handle infratructure finance, what with their large amounts of long tenure funds and project finance expertise. And much has already been said about the potential role of provident funds, pension funds and Life Insurance Corporation.

A way out

But that is not to detract from the important role commercial banks can play in boosting infrastructure development. International commercial banks have over a period of time become major sources of infrastructure funds worldwide. But for that to happen here, banks have to be slowly introduced to the concept instead of straightaway being thrown into the deep end.

For instance, infrastructure bonds can be so structured that different people take different risks at different points in time. The government can provide low-cost funds and bear the procedural, approval and construction risk for the initial five-year period. The next five-to-ten-year period project finance risk can be borne by the FIs and development banks (like World Bank).

The commercial banks can then bear the market risk from the ten-to-twenty-year period when the need for long term money has been taken care of and short term working capital is needed. "We would have no problems lending to companies like Bombay Suburban Electric Supply, Ahmedabad Electricity Company, etc," says Narayan. Such bonds can be raised by the governement from both domestic and international sources. Any takers?

To the extent that a certain portion of a bank's funds have to be earmarked for these projects, it has a direct impact on non-food credit