Shares of public sector banks and non-banking financial companies were dropping on Monday amid fears that the country’s central bank will impose steeper norms for infrastructure lending.

What Happened: The Reserve Bank of India (RBI) proposed stricter lending norms and increased monitoring for under-construction infrastructure projects in a draft, causing a sharp decline in PSU bank stocks. The draft suggests higher provisions for such projects and emphasises vigilant monitoring to address emerging stress.

What’s Are The Proposals: The RBI’s proposal aims to mitigate risks associated with infrastructure lending, given historical defaults in the banking sector. Specifically, the draft suggests that banks should set aside a provision of 5% of the loan amount during the construction phase of a project, which would decrease to 2.5% once the project becomes operational.

This provision would further reduce to 1% once the project generates sufficient cash flow. Currently, banks are required to set aside a provision of 0.4 percent on project loans that are not overdue or stressed.

The RBI recommends a phased implementation of these provisions: 2% in FY25, 3.5% in FY26, and 5% by FY27. Moreover, banks must reassess loans if project operations face delays exceeding three years, potentially reclassifying them as stressed assets, the central bank proposes.

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Impact On Banks: This move, if implemented, could impact banks’ profitability and their appetite for infrastructure financing, particularly for PSU banks, which have a higher exposure to such loans compared to private lenders. The proposed guidelines represent a prudent risk management approach but could also hinder infrastructure sector growth due to increased capital requirements.

Analysts suggest that infrastructure loans currently represent a smaller portion of banks’ portfolios compared with previous years, even though the pain of past pressure on banks due to non-performing infrastructure loans is still fresh in investors’ minds. Private banks, which typically finance operational assets rather than under-construction projects, may face lesser impacts compared to their PSU counterparts.

The RBI’s proposed guidelines signal a cautious approach to infrastructure lending, aiming to prevent potential defaults and strengthen risk management practices in the banking sector.

Price Action: Shares of Punjab National Bank were down 6.55%, Bank of Baroda shares sank 3.68%, Canara Bank fell 5.39%, Union Bank was down 4.16% and State Bank of India fell 2.68%.

Non-banking financial companies (NBFCs) like REC, Power Finance and IREDA, which primarily focus on financing power projects, also experienced significant drops, down between 4% and 8%.

The Nifty PSU Bank index was trading almost flat in afternoon trade on Monday, recovering from steep falls earlier in the session.

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