Shares of Power Finance Corporation Ltd (PFC) experienced a significant drop today, falling as much as 12.40 percent to a low of Rs 420.85 on the Bombay Stock Exchange (BSE). This decline, along with similar drops in REC Ltd and Indian Renewable Energy Development Agency Ltd (IREDA), is attributed to concerns surrounding tighter project finance norms proposed by the Reserve Bank of India (RBI).
The RBI’s draft harmonised prudential framework for project finance lenders proposes stricter lending criteria aimed at improving project viability. A key change is the phased increase in standard asset provisioning to 1-5 percent of loans, up from the current 0.4 percent. This increase in provisioning requirements is expected to impact lending institutions in various ways.
IIFL Securities estimates that the additional provisioning requirement will range from 0.5 to 3 percent of banks’ net worth, potentially reducing their Common Equity Tier 1 (CET1) ratio by 7 to 30 basis points. While infrastructure-focused Non-Banking Financial Companies (NBFCs) like REC, PFC, and IREDA are not expected to see a direct impact on their Return on Equity (RoE), their Tier 1 ratio could decrease by 200-300 basis points. This reduction could negatively affect their valuation multiples.
The draft guideline applies to all lenders, but NBFCs adhere to Indian Accounting Standards (IndAS). Existing regulations require adjustments for differences between RBI rules and IndAS provisioning requirements through impairment reserves. This accounting nuance further complicates the impact assessment of the new framework.
CLSA notes that the primary impact on PFC and REC from higher standard asset provisioning will be on their capital adequacy ratios, not their profit and loss statements. Both companies currently maintain a healthy Tier 1 ratio of 23 percent, indicating strong capitalization. However, IIFL Securities warns that the adjusted net worth of these NBFCs could be 8-13 percent lower due to the new regulations, potentially impacting their valuations.
Alt: Graph depicting the falling share price of PFC alongside other Indian companies.
The proposed framework also includes a minimum exposure requirement of 10 percent for individual lenders in consortium projects up to Rs 1,500 crore. This requirement could limit opportunities for smaller players in the project finance market. Additionally, financial closure and documentation of the Debenture Charge Creation Order (DCCO) are mandatory before fund disbursement, with a maximum moratorium of six months beyond DCCO.
The proposed changes to provisioning for standard assets include a reduction from 5 percent Project Completion Ratio (PCR) during the construction phase to 2.5 percent once the project is operational. This can be further reduced to 1 percent if specific financial benchmarks are met. This tiered approach aims to incentivize project efficiency and performance. These comprehensive changes to project finance norms have introduced uncertainty into the market, leading to the observed decline in PFC’s share price today.
