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Project financing UPSC NOTE

 What is Project financing

  • Project finance is the funding of long-term infrastructure, industrial projects, and public services using a non-recourse or limited recourse financial structure

  • The debt and equity used to finance the project are paid back from the cash flow generated by the project.

  • Project financing is a loan structure that relies primarily on the project's cash flow for repayment, with the project's assets, rights, and interests held as secondary collateral

  • Project finance is especially attractive to the private sector because companies can fund major projects off-balance sheet (OBS).


Current challenges

  • Infrastructure projects usually have a long gestation period, with a higher probability of not being financially viable

  • Depending on scale and technology, these projects may require a loan with a longer tenure

  • Such projects may also face multiple obstacles leading to delays or cost-overruns

  • The Ministry of Statistics and Programme Implementation’s March review of 1,837 projects observed that 779 of them were delayed and 449 faced cost overruns. 

  • The review attributed the delay to land acquisition, obtaining forest/environment clearances, changes in scope (and size) etc

  • These factors are dampeners for banks, which would have priced the risks associated with the project in a certain way on their books.

The key revisions

  • The RBI’s focus is on mitigating a ‘credit event’, that is, a default or a need to extend the original Date of Commencement of Commercial Operations (DCCO) or infuse additional debt, and/or diminution in the Net Present Value (NPV) of the project

  • One of the more important revisions concerns ‘provisioning’, that is, setting aside some money ahead of time to compensate for a potential loss

  • The proposed framework recommends that, at the construction stage (that is, when the financial assessment is finalised and before DCCO), a general provision of 5% is to be maintained on all existing and fresh exposures. 

  • This is a revision from the erstwhile 0.4%.


Prudential conditions

  • The framework seeks that all mandatory pre-requisites must be in place before financial closure (that is, before the finalising of financial conditions). 

  • The indicative list must provide environmental, regulatory and legal clearances relevant to the project

  • The DCCO must be clearly spelt out. 

  • Financial disbursals would be made and the progress in equity infusion agreed to based on the stages of completion

  • The onus is on the bank to deploy an independent engineer or architect who would be responsible for certifying the project’s progress.

  • RBI proposes to mandate that a positive NPV be a prerequisite to obtain project finance. 

  • It also seeks that lenders get the project NPV independently re-evaluated every year

  • This is to help them avert the possibility of any build-up of stress and have an action plan in place.

  •  Also repayment norms can be revised

  • However, the framework proposes that the original or revised repayment tenure, inclusive of the moratorium period, must not exceed 85% of the economic life of the project.

  • RBI’s proposed framework also recommends certain criteria for evaluating a change in repayment schedule due to an increase in the project outlay if there’s an increase in scope and size of the project

  • This revision will have to take place before the DCCO, after lenders offer a satisfactory re-assessment about the viability of the project, and if the risk in project cost, excluding any cost overrun, is 25% or more of the original outlay

  • Significantly, the framework also introduces guidelines to trigger a standby credit facility

  • This is to be sanctioned at the time of financial closure to fund overruns arising due to delays.

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Learnerz IAS | Concept oriented UPSC Classes in Malayalam: Project financing UPSC NOTE
Project financing UPSC NOTE
Learnerz IAS | Concept oriented UPSC Classes in Malayalam
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