RBI Warns Banks On Equity Play In Project Finance

The Reserve Bank of India has cautioned banks against taking a higher equity exposure while financing projects. In a notification on Tuesday, the central bank advised banks "to have a clear policy regarding the debt equity ratio (DER)."

"Banks are advised in their own interest to have a clear policy regarding the debt equity ratio (DER) and to ensure that the infusion of equity/fund by promoters should be such that the stipulated level of DER is maintained at all times. Further they may adopt funding sequences so that possibility of equity funding by banks is obviated," the RBI said.

Currently, banks can't lend more than 15 per cent of their net worth to a single project. This limit is 20 per cent if it is an infrastructure project.

In most projects there are two parts of finance. The first part is which the promoters bring in the money for the project (called equity) while the other part is the money lent by banks (called debt).

How the finance is divided between the bank and the promoters is defined by the agreement between the two. Sometimes the promoters bring in their part of the money upfront. On other occasions they bring in a part (40-50 per cent) of their finance commitment at the start of the project.

The RBI is worried about projects where promoters don't bring any part of their finance upfront but bring it in proportionately as the bank brings the debt part. It cautioned banks that this way of financing has "greater equity-funding risk."

Bankers say the notification by the RBI is just a warning to banks to be more cautious. Yes Bank chairman and managing director Rana Kapoor said there are hardly any projects he knows of where promoters bring in equity only after the bank infuses debt.

"Its very rare and only in extraordinary situations with larger companies when they bring in finance after the bank. Promoters mostly bring in equity in advance or, in special circumstances, in parts."

Kapoor said the RBI guidelines show the prudent way to finance a project. "A project is viewed on a standalone basis. There are different risks like business risk and management risk which the bank analyses before releasing finance. Mostly banks are more conservative and a start-up promoter usually is scrutinised more than an established company."