Lenders want the Reserve Bank of India (RBI) to reduce provisioning requirements for infrastructure loans, due to a consistent decline in the probability of default (PD) in the sector to 2% or less over the past five years.
Under the RBI’s draft guidelines for project finance, banks must set aside 5% of the exposure during the construction phase, decreasing as the project progresses. Once a project reaches the operational phase, provisions can be reduced to 2.5% of the funded outstanding, and potentially further to 1% under certain conditions.
The PD, an essential metric in credit risk assessment used to calculate expected credit losses, measures the likelihood of a borrower defaulting on debt obligations within a specified period. Historically, the PD for infrastructure loans over a decade has averaged around 5%. This higher rate was attributed to an abnormal increase in non-performing assets (NPAs) during the three to four years following the implementation of the Asset Quality Review (AQR) guidelines.
From 2018 to 2023, the average PD for infrastructure loans has been around 2%, enhancing the sector’s prospects. If the current fiscal year is considered, the PD could decrease even further. This trend has also encouraged some private sector players, traditionally hesitant about infrastructure financing, to enter the sector.
NPAs drop
According to RBI data, the gross NPA of banks has fallen from a peak of 11.2% in March 2018 to a decade-low of 3.2% in September 2023. The primary reason for the recent decline in PD is the resolution of disputes related to large infrastructure projects. Before 2015, many infrastructure loans turned NPAs due to court rulings on issues such as 2G spectrum allocation, coal and iron ore mining disputes, and thermal power projects.
Over the past five years, various auctions in telecom, iron ore, and coal mining have proceeded without significant disputes, thanks to improved systems. Issues like land acquisition and environmental clearances, which previously contributed to the surge in NPAs, have been resolved.
Experts argue that these resolved issues must be considered when calculating the probability of default, supporting their case for lower provisioning requirements for infrastructure loans.
