RBI Notifications

RBI’s Proposed Framework to Administer Project Financing | Explained


From UPSC perspective, the following things are important :

Prelims level: Functions of RBI; Date of Commencement of Commercial Operations;

Mains level: Banking and Regulations; Issue of NPA’s;

Why in the News?

The RBI has issued draft regulations for a Harmonized Prudential Framework and revised DCCO criteria, to enhance the Regulatory Framework for long-term (infrastructure, non-infrastructure, and commercial real estate sectors) project financing.

  • RBI’s purpose behind this is to regulate and supervise payment and settlement systems in the country, ensuring safe, secure, and efficient mechanisms for financial transactions.

What is the Date of Commencement of Commercial Operations (DCCO)?

The DCCO is a critical milestone for project loans, indicating the start of revenue-generating activities for the project.

Banks maintain the DCCO for project loans for several key reasons:

  • Asset classification: The DCCO is crucial for determining the asset classification of a project loan. If the project fails to commence commercial operations by the stipulated DCCO, the loan may be classified as a Non-performing asset (NPA).
  • Restructuring: The DCCO is used as a reference point for allowing the restructuring of project loans without treating it as an NPA. RBI guidelines permit banks to extend the DCCO by up to 1 year for commercial real estate projects and up to 2 years for infrastructure projects, without downgrading the asset classification, provided certain conditions are met.
  • Viability assessment: When extending the DCCO, banks must satisfy themselves about the viability of the project and the restructuring plan.
  • Provisioning: If a loan remains in the pre-commencement of the commercial operations phase for an extended period, banks may need to make higher provisions, considering the risk involved.
  • Monitoring and control: Maintaining a clear DCCO allows banks to monitor the project’s progress and take timely action if there are delays or cost overruns. This helps in managing the bank’s exposure and mitigating risks.

Key Highlights of the Proposed New Framework:

  • Income Recognition and Asset Classification: The draft framework outlines guidelines for Income Recognition, Asset Classification, and Provisioning of Advances for Projects Under Implementation (IRACP-PUIMP).
    • It emphasizes the importance of monitoring stress in projects and initiating resolution plans proactively.
    • Increase in general provisioning at the construction stage from 0.4% to 5% on all existing and fresh exposures, phased over three years (2% for FY25, 3.5% for FY26, and 5% for FY27).
  • Restructuring Norms: The RBI has prescribed norms for restructuring exposure in projects due to changes in the DCCO.
    • Lenders are required to have a board-approved policy for resolving stress in projects, triggered by a credit event during the construction phase.
    • Provisioning can be reduced to 2.5% and 1% at the operational phase if certain conditions are met.
  • Consortium Arrangements: In projects financed under consortium arrangements, specific exposure limits have been set based on the aggregate exposure of lenders.
    • Individual lenders must maintain a Minimum Exposure Percentage to ensure a balanced risk-sharing mechanism.
  • Financial Closure and Repayment Structure: The framework mandates that financial closure must be achieved before the disbursement of funds.
    • It discourages moratoriums on repayments beyond the DCCO period and sets guidelines for the repayment tenor not exceeding 85% of the economic life of the project.
    • Projects must demonstrate a positive net operating cash flow to cover all repayment obligations and a reduction in total long-term debt by at least 20%.
  • Net Present Value (NPV) Requirement: A positive NPV is a prerequisite for any project financed by lenders. The RBI stresses the importance of reevaluating the project NPV annually to ensure financial viability and address credit impairment risks.
    • Guidelines for a standby credit facility to fund cost overruns due to delays, with incremental funding of 10% of the original project cost.

ICRA Observations:

ICRA set up in 1991 is an independent and professional investment Information and Credit Rating Agency. It observed the proposed new framework could have the following implications:

  • Profitability Impact: Higher provisioning requirements for projects under implementation could impact the profitability of Non-banking Financial Companies and Infrastructure Financing Companies. The impact will be spread over 3 years.
  • Funding Costs: Estimated increase in funding costs by 20-40 basis points as lenders build additional risk premiums.
    • Major banks like SBI, Union Bank of India, and Bank of Baroda do not foresee significant impacts, although the pricing of loans may need adjustments.

Way Forward:

  • Enhanced Monitoring and Compliance: Implement robust monitoring mechanisms to ensure compliance with the new regulations. Regularly review and update the prudential framework to adapt to evolving market conditions.
  • Capacity Building: Train bank staff and stakeholders on the new regulatory requirements and best practices for project financing.

Prelims PYQ: 

Q The Reserve Bank of India regulates the commercial banks in matters of:  (UPSC CSE 2013)

  1. liquidity of assets
  2. branch expansion
  3. merger of banks
  4. winding-up of banks

Select the correct answer using the codes given below.

(a) 1 and 4 only

(b) 2, 3 and 4 only

(c) 1, 2 and 3 only

(d) 1, 2, 3 and 4

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