Whether he wanted to stay back or not, or what he would have liked to do if the government would have extended his tenure, talking about these issues is meaningless. Raghuram Rajan has done well as RBI Governor and there is no doubt that it will be difficult to find a worthy successor, but the good part is that he is trying his best to suggest measures that can guide the country’s financial system to safety and strength, going ahead.

Governor Raghuram Rajan will be leaving RBI in less than three weeks from now as his term ends on September 4.

But, his successor and also the financial sector would do well by keeping in mind his cautionary notes as it has been seen in the past that what he can see now as emerging challenges, and others can’t, comes out to be correct often.

So, at a time when not many think there would be a pick-up in project financing in any significant manner in the near future, Rajan is optimistic and has added a new dimension to it while addressing the FICCI-IBA Annual Banking Conference in Mumbai on Tuesday.

What he said would please prime minister Narendra Modi and finance minister Arun Jaitley, though they could/did not retain Rajan, but the more important part is his suggestion for handling the project financing going ahead to avoid the mistakes made earlier.

“Even though bankers are very risk averse today, and few projects are coming up for financing, this will change soon. What is in the pipeline is truly enormous – airports, railway lines, power plants, roads, manufacturing plants, etc. Bankers will remember the period of irrational exuberance in 2007-2008 when they lent without asking too many questions. I am hopeful that this time will be different,” Rajan said.

So, he has recommended strict discipline and involvement of financiers and promoters, both, in the whole process of project financing and debt servicing.

To begin with, Rajan has suggested that, “significantly more in-house expertise can be brought to project evaluation, including understanding demand projections for the project’s output, likely competition, and the expertise and reliability of the promoter. Bankers will have to develop industry knowledge in key areas since consultants can be biased.”

While this is significant to start well, risk mitigation as far as possible in terms of clearances for land, etc. before financing, and wherever they are not available, putting in place a sharing mechanism of those risks between the financier and the promoter, according to Rajan, would be crucial.

“Where these risks cannot be mitigated, they should be shared contractually between the promoter and financiers, or a transparent arbitration system agreed upon. So, for instance, if demand falls below projections, perhaps an agreement among promoters and financier can indicate when new equity will be brought in and by whom.”

Once this is done, the chances of any loan turning bad get minimised to a large extent.

Then comes the capital structure, and here he said that it has to mirror the risks involved: The more the risks, the more the equity component should be (genuine promoter equity, not fake borrowed equity, of course), and the greater the flexibility in the debt structure.

But, even after doing all this, financiers need to put in place a robust system for monitoring projects, including real-time monitoring of costs.

In the end, and this is extremely important, there has to be accountability, and according to Rajan, “….even while committees may take the final loan decision, some senior banker ought to put her name on the proposal, taking responsibility for recommending the loan. IT systems within banks should be able to pull up overall performance records of loans recommended by individual bankers easily, and this should be an input into their promotion.”

Banks and financial institutions must remember this Rajan code if they want to avoid the mistakes that propelled the NPA burden post 2007-08 growth euphoria.

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