Commercial Banks Support For Infrastructure
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ASSIGNMENT ON
MCM 513: FINANCIAL SERVICES, MARKETS & INSTITUTONS
Submitted by Venkata Pavan Kumar Akula (221006) Anand Dalal (221007) Ansari Noorul Huda (221008) Shailender Aware (221009) Vinoth B (221010)
NATIONAL INSTITUTE OF CONSTRUCTION MANAGEMENT & RESEARCH
NICMAR
PUNE Introduction The construction industry is the second largest economic activity in India & plays a important role in the nation’s economy. Construction accounted for about 35-40% of the development investment of India during the last 50years. About 16% of the nation’s working population depends on construction for livelihood. Construction industry is an essential contributor to the process of development. Roads, dams, irrigation works, schools, houses, hospitals, factories and other construction works are the physical foundations on which the development efforts and improved standards of living are established. Financing in these particularly infrastructure projects is both capital-intensive and long-gustative, with comparatively low rates of return, at least in the initial stages. Most infrastructure projects in developing countries have been funded directly from fiscal budgets. However, public financing rarely meets crucial infrastructure expenditure requirements in a timely and adequate manner. The traditional way of financing infrastructure from financial budgets is no longer a viable proposition, particularly in developing economies so private public participation has come into existence. This collaboration between public and private sectors is crucial in order to increase the sources of funding available for infrastructure and reduce the pressure on fiscal budgets. In these the financial institutions along with commercial banks assists the private sector by mobilizing capital. Very recently, the RBI revised its guidelines for infrastructure funding by banks and institutions. The idea is to give incentives and additional safeguards to the lenders, including institutions, banks and non-banking finance companies. The projects that qualify for finance have been carefully defined. The lenders have been given precise guidelines in terms of the extent of exposure they can assume in a particular project. Since these projects have a long gestation period, forcing their cash-rich commercial bank lenders to go in for a potentially dangerous mismatch between assets and liabilities, they have been encouraged to adopt risk-minimizing practices.
COMMERCIAL BANKS: SUPPORT FOR INFRASTRUCTURE
NICMAR
Characteristics of Infrastructure Projects •
These projects are critical for economic growth.
•
They involve large capital outlays.
•
They have long gestation periods.
•
They are governed by much legislation and need statutory approvals.
•
They have back ended cash flows.
•
They involve issues related to security creation.
•
These projects are highly vulnerable to tariff changes.
•
They require long moratorium and repayment periods.
•
Environmental and social issues such as pollution, rehabilitation and relocation may be involved.
•
As these projects involve returns over a longer period of time, uncertainties are high and hence risk is more.
These differences make infrastructure financing more and more complicated. The conventional techniques that have been used to finance industrial projects cannot be used to finance infrastructure projects. Hence financial institutions have been using various innovative techniques to meet the needs of such projects. Commercial Banks have traditionally funded working capital requirements of large and medium industrial projects in India. However, with the onset of financial sector reforms, banks have expanded their role from mere providers of working capital finance, to cover rupee term loan guarantees and to a limited extent foreign exchange loans for large projects.
COMMERCIAL BANKS: SUPPORT FOR INFRASTRUCTURE
NICMAR
As part of a banking sector reform, RBI has relaxed many of the restrictions governing bank participation in project finance. This relaxation could result in banks emerging as an important source of long term funds for medium sized infrastructure projects.
Definition of ‘Infrastructure Lending’ Any credit facility in whatever form extended by commercial banks to an infrastructure facility as specified below falls within the definition of ‘infrastructure lending’. In other words, a credit facility provided to a borrower company engaged in: •
Developing or
•
Operating and maintaining, or
•
Developing, operating and maintaining
Any infrastructure facility that is a project in any of the following sectors: •
Power
•
Transport
•
Airports and ports
•
Telecom Services
•
Urban Infrastructure
•
Special Economic Zones
Criteria for financing
COMMERCIAL BANKS: SUPPORT FOR INFRASTRUCTURE
NICMAR
Commercial banks are free to finance technically feasible, financially viable and bankable projects undertaken by both public sector and private sector undertakings subject to the following conditions: •
The amount sanctioned should be within the overall ceiling of the prudential exposure norms prescribed by RBI for infrastructure financing.
•
Banks should have the requisite expertise for appraising technical feasibility, financial viability and bankability of projects, with particular references to the risk analysis and sensitivity analysis.
•
In respect of the projects undertaken by public sector units, term loans may be sanctioned only for corporate entities
•
Banks may also lend to SPVs in the private sector, registered under Companies Act for directly undertaking infrastructure projects that are financially viable and not for acting as mere financial intermediaries.
•
Banks may ensure that the bankruptcy or financial difficulties of the parent/sponsor should not affect the financial health of the SPV.
Types of Financing by Commercial Banks In order to meet the financial requirement of the infrastructure projects, banks may extend credit facility by way of working capital finance, term loans, project loan, subscription to bonds and debentures/ preference shares/ equity shares acquired as a part of the project finance package Take-out Financing Take-out financing structure is essentially a mechanism designed to enable banks to avoid assetliability maturity mismatches that may arise out of extending long tenor loans to infrastructure projects. Under the arrangements, banks financing the infrastructure projects will have an arrangement with IDFC or any other financial institution for transferring to the latter the outstanding in their books on a pre-determined basis. COMMERCIAL BANKS: SUPPORT FOR INFRASTRUCTURE
NICMAR
Inter–institutional Guarantees In terms of the extant RBI instruction, banks are precluded from issuing guarantees favoring other banks/lending institutions for the loans extended by the latter, as the primary lender is expected to assume the credit risk and not pass the same by securing itself with a guarantee i.e. separation of credit risk and funding is not allowed. Financing Promoter’s Equity Banks were advised that the promoter’s contribution towards the equity capital of a company should come from their own resources and the bank should not normally grant advances to take up shares of other companies. In view of the importance attached to infrastructure sector, it has been decided that, under certain circumstances, an exception may be made to this policy for financing the acquisition of promoter’s shares in an existing company that is engaged in implementing or operating an infrastructure project in India.
Conclusion The objective of a sound infrastructure policy is to ensure growth and sustainable delivery of high quality infrastructure services at low prices. The strategy adopted in India, as in many other parts of the world, comprises attracting private investments in the infrastructure sectors, inducing competition where feasible and allowing the role of the government to change from a provider to a facilitator. The infrastructure finance market is increasing in size as the government is once again focusing on the development of infrastructure in the country. FI’s and banks lack proper lending norms for the construction industry; hence a new technique needs to be devised for each project. As the need for infrastructure financing increases new and more suitable innovative techniques need to be evolved so as to make it viable for both the lenders and the borrowers. Each infrastructure project has a unique structure and the FIs/Banks will need to resort to financial engineering to suit the needs of every project and to protect their own interest at the same time. Bibliography •
www.planningcommision.nic.in COMMERCIAL BANKS: SUPPORT FOR
INFRASTRUCTURE
NICMAR
•
www.sbi.com
•
www.worldbank.org
•
www.indiainfoline.com
COMMERCIAL BANKS: SUPPORT FOR INFRASTRUCTURE
MCM 513: FINANCIAL SERVICES, MARKETS & INSTITUTONS
Submitted by Venkata Pavan Kumar Akula (221006) Anand Dalal (221007) Ansari Noorul Huda (221008) Shailender Aware (221009) Vinoth B (221010)
NATIONAL INSTITUTE OF CONSTRUCTION MANAGEMENT & RESEARCH
NICMAR
PUNE Introduction The construction industry is the second largest economic activity in India & plays a important role in the nation’s economy. Construction accounted for about 35-40% of the development investment of India during the last 50years. About 16% of the nation’s working population depends on construction for livelihood. Construction industry is an essential contributor to the process of development. Roads, dams, irrigation works, schools, houses, hospitals, factories and other construction works are the physical foundations on which the development efforts and improved standards of living are established. Financing in these particularly infrastructure projects is both capital-intensive and long-gustative, with comparatively low rates of return, at least in the initial stages. Most infrastructure projects in developing countries have been funded directly from fiscal budgets. However, public financing rarely meets crucial infrastructure expenditure requirements in a timely and adequate manner. The traditional way of financing infrastructure from financial budgets is no longer a viable proposition, particularly in developing economies so private public participation has come into existence. This collaboration between public and private sectors is crucial in order to increase the sources of funding available for infrastructure and reduce the pressure on fiscal budgets. In these the financial institutions along with commercial banks assists the private sector by mobilizing capital. Very recently, the RBI revised its guidelines for infrastructure funding by banks and institutions. The idea is to give incentives and additional safeguards to the lenders, including institutions, banks and non-banking finance companies. The projects that qualify for finance have been carefully defined. The lenders have been given precise guidelines in terms of the extent of exposure they can assume in a particular project. Since these projects have a long gestation period, forcing their cash-rich commercial bank lenders to go in for a potentially dangerous mismatch between assets and liabilities, they have been encouraged to adopt risk-minimizing practices.
COMMERCIAL BANKS: SUPPORT FOR INFRASTRUCTURE
NICMAR
Characteristics of Infrastructure Projects •
These projects are critical for economic growth.
•
They involve large capital outlays.
•
They have long gestation periods.
•
They are governed by much legislation and need statutory approvals.
•
They have back ended cash flows.
•
They involve issues related to security creation.
•
These projects are highly vulnerable to tariff changes.
•
They require long moratorium and repayment periods.
•
Environmental and social issues such as pollution, rehabilitation and relocation may be involved.
•
As these projects involve returns over a longer period of time, uncertainties are high and hence risk is more.
These differences make infrastructure financing more and more complicated. The conventional techniques that have been used to finance industrial projects cannot be used to finance infrastructure projects. Hence financial institutions have been using various innovative techniques to meet the needs of such projects. Commercial Banks have traditionally funded working capital requirements of large and medium industrial projects in India. However, with the onset of financial sector reforms, banks have expanded their role from mere providers of working capital finance, to cover rupee term loan guarantees and to a limited extent foreign exchange loans for large projects.
COMMERCIAL BANKS: SUPPORT FOR INFRASTRUCTURE
NICMAR
As part of a banking sector reform, RBI has relaxed many of the restrictions governing bank participation in project finance. This relaxation could result in banks emerging as an important source of long term funds for medium sized infrastructure projects.
Definition of ‘Infrastructure Lending’ Any credit facility in whatever form extended by commercial banks to an infrastructure facility as specified below falls within the definition of ‘infrastructure lending’. In other words, a credit facility provided to a borrower company engaged in: •
Developing or
•
Operating and maintaining, or
•
Developing, operating and maintaining
Any infrastructure facility that is a project in any of the following sectors: •
Power
•
Transport
•
Airports and ports
•
Telecom Services
•
Urban Infrastructure
•
Special Economic Zones
Criteria for financing
COMMERCIAL BANKS: SUPPORT FOR INFRASTRUCTURE
NICMAR
Commercial banks are free to finance technically feasible, financially viable and bankable projects undertaken by both public sector and private sector undertakings subject to the following conditions: •
The amount sanctioned should be within the overall ceiling of the prudential exposure norms prescribed by RBI for infrastructure financing.
•
Banks should have the requisite expertise for appraising technical feasibility, financial viability and bankability of projects, with particular references to the risk analysis and sensitivity analysis.
•
In respect of the projects undertaken by public sector units, term loans may be sanctioned only for corporate entities
•
Banks may also lend to SPVs in the private sector, registered under Companies Act for directly undertaking infrastructure projects that are financially viable and not for acting as mere financial intermediaries.
•
Banks may ensure that the bankruptcy or financial difficulties of the parent/sponsor should not affect the financial health of the SPV.
Types of Financing by Commercial Banks In order to meet the financial requirement of the infrastructure projects, banks may extend credit facility by way of working capital finance, term loans, project loan, subscription to bonds and debentures/ preference shares/ equity shares acquired as a part of the project finance package Take-out Financing Take-out financing structure is essentially a mechanism designed to enable banks to avoid assetliability maturity mismatches that may arise out of extending long tenor loans to infrastructure projects. Under the arrangements, banks financing the infrastructure projects will have an arrangement with IDFC or any other financial institution for transferring to the latter the outstanding in their books on a pre-determined basis. COMMERCIAL BANKS: SUPPORT FOR INFRASTRUCTURE
NICMAR
Inter–institutional Guarantees In terms of the extant RBI instruction, banks are precluded from issuing guarantees favoring other banks/lending institutions for the loans extended by the latter, as the primary lender is expected to assume the credit risk and not pass the same by securing itself with a guarantee i.e. separation of credit risk and funding is not allowed. Financing Promoter’s Equity Banks were advised that the promoter’s contribution towards the equity capital of a company should come from their own resources and the bank should not normally grant advances to take up shares of other companies. In view of the importance attached to infrastructure sector, it has been decided that, under certain circumstances, an exception may be made to this policy for financing the acquisition of promoter’s shares in an existing company that is engaged in implementing or operating an infrastructure project in India.
Conclusion The objective of a sound infrastructure policy is to ensure growth and sustainable delivery of high quality infrastructure services at low prices. The strategy adopted in India, as in many other parts of the world, comprises attracting private investments in the infrastructure sectors, inducing competition where feasible and allowing the role of the government to change from a provider to a facilitator. The infrastructure finance market is increasing in size as the government is once again focusing on the development of infrastructure in the country. FI’s and banks lack proper lending norms for the construction industry; hence a new technique needs to be devised for each project. As the need for infrastructure financing increases new and more suitable innovative techniques need to be evolved so as to make it viable for both the lenders and the borrowers. Each infrastructure project has a unique structure and the FIs/Banks will need to resort to financial engineering to suit the needs of every project and to protect their own interest at the same time. Bibliography •
www.planningcommision.nic.in COMMERCIAL BANKS: SUPPORT FOR
INFRASTRUCTURE
NICMAR
•
www.sbi.com
•
www.worldbank.org
•
www.indiainfoline.com
COMMERCIAL BANKS: SUPPORT FOR INFRASTRUCTURE
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