DFI will be no panacea; managing risks before operations and structuring bankable projects are real issues

January 29, 2021 6:55 AM

While the exact liability profile of the proposed DFI is a moving target, some flaunt its ability to raise 50-year foreign capital from multilateral agencies at about 1% as a game-changer.

Ingenious structuring by banks with the assistance of nodal sectoral institutions can help—for instance, to improve prospects of its PPP projects, NHAI could encourage bank funding by showing flexibility/ mitigating risk. (Representative image)

By Ashish Kapur

Many development finance institutions (DFIs) since Independence have failed due to inadequate focus on cost-effective liabilities and elevated construction-risks making projects unbankable.

While a sustainable, low cost-liability profile is a DFI’s primary challenge, banks with ready access to retail liabilities face asset liability (ALM) mismatches in financing projects. Our inability to manage the risk before a project reaches commercial operations date and incapability to structure bankable projects is the real issue requiring a solution.
By postulating a new financing entity as the panacea for all our infrastructure woes, I am afraid we are only barking up the wrong tree!

Commentators tom-toming the new DFI cite its low funding cost as a cure for the low pace of infrastructure development. There are two fundamental problems with this argument.

Firstly, how low is really low. The primary funding source for PSU banks are the current and savings account (CASA) balances. Considering interest free CA, 3% SB coupon, deposits across tenors and their percentage contribution, the average cost of demand and time liabilities works out to about 3.5%.

Agreed, banks have a 40% commitment to priority sector lending (PSL), 18% SLR and 3% CRR obligation. Doing a simple math, critics argue that out of every Rs 100 raised, banks can lend/make money from only Rs 39 (100-40-18-3). Alas! That’s unacceptable, since efficient banks undertake small ticket-size PSL financing for 40% book, at a profit.

While the exact liability profile of the proposed DFI is a moving target, some flaunt its ability to raise 50-year foreign capital from multilateral agencies at about 1% as a game-changer. Sure, long tenor capital is welcome, but don’t forget currency hedging that increases landed funding cost to over 5%!

Regarding fundraising via rupee bonds, what stops the government from asking SBI or sectoral DFIs to issue more long-term bonds with tax incentives? It is imperative to develop a robust secondary bond market. Given high government borrowings and preference of Indian banks to hold G-Secs in the HTM segment, there’s hardly any trading, and capacity of banks to subscribe further remains limited.

The second problem with the ‘low pace of infrastructure development’ argument is the absence of sufficient bankable infra-projects. The real issue is not so much about financing per se, but the availability of bankable projects.
Bankable projects, for the sake of simplicity, can be defined here as projects where the humongous construction-stage risk has been identified and structuring strategies for tackling it formulated. Managing operations-stage risk, like discoms reneging on PPAs or toll collections being arbitrarily stopped, demands a policy-/legal-certainty framework too.

How, then, to deal with this?
Tighten the regulatory framework, nodal sectoral institutions monitoring payment delays and co-ordinating with authorities for cutting approval red-tape and multilateral agencies for concessional financing of ventures can help make projects more bankable.

Leveraging financing capability of overseas export-credit agency of successful bidders is a simpler solution rather than taking the complete risk on the DFI’s books

Ingenious structuring by banks with the assistance of nodal sectoral institutions can help—for instance, to improve prospects of its PPP projects, NHAI could encourage bank funding by showing flexibility/ mitigating risk. If NHAI guarantees fixed repayments to banks for funding timely completion by good developers having stressed balance-sheets, it could be a win-win for all. Developers make money, say, Rs 700 crore on project completion, the bank provides competitive 5-year financing with repayment risk on highly-rated borrower and asset gets transferred, say, to NHAI, which then auctions the constructed TOT toll project to concessionaires for 30 years against upfront payment.

Believing the notion of easy DFI money availability being an elixir could potentially lead to a situation of good money chasing bad money. Just as money alone can’t buy long term happiness, mere long tenor capital availability won’t guarantee the development of world-class infrastructure.

Certified treasury manager, credit and relationship banking veteran of BNP Paribas, FirstRand, Global Trust and L&T Infra Finance (LTFS)

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