Banks in India are now allowed to structure infrastructure loans for up to 25 years by refinancing every five years on fresh terms. This can be done by the existing banks or even by a new set of banks. Since such restructuring will not be treated as traditional loan recast, the banks will not have to set aside money when they refinance infrastructure loans under the so-called 5:25 model.
What’s more, banks have also been allowed to raise long-term bonds to finance infrastructure projects. Money raised through such bonds will not be subjected to cash reserve ratio (CRR), statutory liquidity ratio (SLR) as well as priority sector loan norms. Under CRR, for every Rs.100 deposit raised, banks are to keep Rs.4 with the Reserve Bank of India (RBI). Under SLR, banks need to invest at least 22.5% of their deposits in government bonds. And, in accordance with the priority loan norms, 40% of a bank’s loan portfolio must flow towards agriculture and allied activities, small industries and economically weaker sections of the society.
Exemptions from these norms will bring down the cost of funds for banks as they don’t earn any interest on CRR. Typically, earnings from investment in government bonds are less than those from corporate loans, and returns from priority loans are relatively low while the transaction cost of such small-ticket loans is high.
So, are good days here for banks and companies setting up infrastructure projects? I’ve a slightly different take on RBI’s two-pronged approach to prop up infrastructure financing and protect banks from asset-liability mismatches. Since there is no cap on maturity of bank loans and no bar on refinancing loans, there is nothing new about the 5:25 model. Banks are always encouraged to resort to take-out financing—a method of providing finance for longer duration projects by sanctioning medium-term loans with an understanding that the loan will be taken out of books of the financing banks after a certain number of years. The take-out financing model has not taken off. So, RBI has tweaked it and allowed lending banks to keep the loan on their books and refinance it after every five years with new terms in case it is not taken over by another institution.
It’s hard to be convinced by the age-old asset-liability mismatch argument used by banks against infrastructure financing. This is simply because banks always have a steady flow of current and savings accounts (CASA). At any given point, depending on efficiency of liability management, CASA accounts for between 30% and 50% or more of a bank’s deposit portfolio and this can support infrastructure projects to some extent.
Let’s look at the second part of RBI action. CRR has always been considered a monetary tool. It is increased to soak up money supply and pared when a loose monetary policy is followed. So, if CRR is waived from certain liabilities, it should be raised for certain other liabilities to keep the balance. This has not been done. Similarly, differentiated SLR is something which RBI has never been comfortable with but it has made an exception this time. Finally, by exempting money raised for infrastructure loans from priority loan norms, RBI has made it official that priority loans are a drag on the banking system. In normal course, many banks miss the 40% priority loan target and 18% agriculture loan sub-target and are penalized for that. Now, exempting long-term bonds from SLR, CRR and priority loan targets, RBI is discouraging banks from giving loans to agriculture, small and medium enterprises and other business segments. If long-term bonds are exempted from these norms, why shouldn’t long-term deposits get the same benefits?
The new norms to boost infrastructure financing are at best an example of discretion-based and not rule- or principle-based policy and they may not yield the desired results as the problem lies elsewhere. Public sector banks don’t have the expertise to appraise infrastructure projects. Few of them know how to monitor such projects and assess their risks. Often, driven by herd mentality, they sanction big-ticket loans to such projects simply because others are doing it and they don’t regret such decisions, till the loans go bad. External factors such as lack of approvals by environment and forest ministries and problems in land acquisition also contribute to the delays in completion of projects.
The growth in banks’ exposure to the infrastructure sector over the past few years has been more than the average credit growth of the banking system. In the past year, between May 2013 and May 2014, banks’ infrastructure loan portfolio has grown from Rs.7.7 trillion to Rs.8.6 trillion. Out of this, the power sector accounted for around Rs.5 trillion in May 2014, up from Rs.4.4 trillion a year ago. Incidentally, the asset quality of bank loans to infrastructure developers is deteriorating at a faster pace than that of loans advanced to any other sector. As of 31 March, banks had restructured Rs.50,239 crore of loans given to the infrastructure sector—21% of all loans they recast in the last fiscal year under the so-called corporate debt restructuring (CDR) mechanism. About 40% of total infrastructure loans are likely to be restructured by March 2015 as against 20% in March 2013, says a report by rating agency India Ratings and Research Pvt. Ltd. Out of Rs.1.91 trillion infrastructure loans given by the State Bank of India, the nation’s largest lender, as on 31 March, Rs.5,070 crore have turned bad.
Globally, the onus on funding the infrastructure sector is not on commercial banks alone. There are other agencies and long-term funds such as pension funds that support infrastructure. It will be a blunder if we push our banking system to go the whole hog to support core projects before they build expertise. Appetite can be forcefully created but they need to have the stomach for the risks.