7 essentials for PPP - flowchart

Income recognition, Asset classification and Provisioning norms of
Infrastructure loan accounts for Banks

The Reserve Bank of India, introduced prudential norms for income recognition, asset classification and provisioning for advances portfolio of Banks and FIs, with an endeavour to bring about greater consistency and transparency in published accounts of Banks/ FIs. The applicable norms for Banks are as under:

A. ASSET CLASSIFICATION

Any amount due to the bank under any credit facility is said to be ‘overdue’ if it is not paid on the due date fixed by the bank/ FI.

Non-performing Assets
An asset becomes non-performing when it ceases to generate income for the bank/ FI.

A non-performing asset (NPA) is a loan or an advance where the Interest and/ or instalment of principal remain overdue for a period of more than 90 days in respect of a term loan.

Banks/FIs should classify an account as NPA only if the interest due and charged during any quarter is not serviced fully within 90 days from the end of the quarter.

Categories of NPAs

Banks are required to classify nonperforming assets further into the following three categories based on the period for which the asset has remained nonperforming and the reliability of the dues:

i. Sub-standard Assets

ii. Doubtful Assets

iii. Loss Assets

 

i. Sub-standard Assets

With effect from 31 March 2005, a substandard asset is one, which has remained NPA for a period less than or equal to 12 months. In such cases, the current net worth of the borrower/ guarantor or the current market value of the security charged is not enough to ensure recovery of the dues to the banks/ FIs in full.

In other words, such an asset indicates well defined credit weaknesses that jeopardise the liquidation of the debt and are characterised by the distinct possibility that the banks/ FIs will sustain some loss, if deficiencies are not corrected.

ii. Doubtful Assets

With effect from March 31, 2005, an asset would be classified as doubtful if it has remained in the sub-standard category for a period of 12 months.

A loan classified as doubtful has all the weaknesses inherent in assets that were classified as sub-standard with the added characteristic that the weaknesses make collection or liquidation in full – on the basis of currently known facts, conditions and values – highly questionable and improbable.

iii. Loss Assets

A loss asset is one where loss has been identified by the bank/ FI or internal or external auditors or the RBI inspection but the amount has not been written off wholly.

In other words, such an asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted although there may be some salvage or recovery value.

Caution while classification of assets

The availability of security or net worth of borrower/ guarantor should not be taken into account for the purpose of treating an advance as NPA or otherwise, as income recognition (classification of asset as NPA) is based on record of recovery.

Bank/FI should not classify an advance account as NPA merely due to the existence of some deficiencies which are temporary in nature such as non-availability of adequate drawing power based on the latest available stock statement, balance outstanding exceeding the limit temporarily, non-submission of stock statements and non-renewal of the limits on the due date, etc..

 

Up-gradation of loan accounts classified as NPAs

If arrears of interest and principal are paid by the borrower in the case of loan accounts classified as NPAs, the account should no longer be treated as non-performing and may be classified as ‘standard’ accounts. (Up-gradation of a restructured/ rescheduled account which is classified as NPA will be governed as per prescribed norms/ guidelines on Restructuring of advances).

Asset Classification to be borrower-wise and not facility-wise

All facilities granted by a bank to a borrower and investment in all the securities issued by the borrower will be treated as NPA/NPI and not the particular facility/investment or part thereof which has become irregular.

If the debits arising out of devolvement of letters of credit or invoked guarantees are parked in a separate account, the balance outstanding in that account also should be treated as a part of the borrower’s principal operating account for the purpose of application of prudential norms on income recognition, asset classification and provisioning.

The bills discounted under LC favouring a borrower may not be classified as a Non-performing advance (NPA), when any other facility granted to the borrower is classified as NPA. However, in case documents under LC are not accepted on presentation or the payment under the LC is not made on the due date by the LC issuing bank for any reason and the borrower does not immediately make good the amount disbursed as a result of discounting of concerned bills, the outstanding bills discounted will immediately be classified as NPA with effect from the date when the other facilities had been classified as NPA.

 

As the overdue receivables mentioned above would represent unrealised income already booked by the bank/FI on accrual basis, after 90 days of overdue period, the amount already taken to 'Profit and Loss a/c' should be reversed.

Advances under consortium arrangements

Asset classification of accounts under consortium should be based on the record of recovery of the individual member banks and other aspects having a bearing on the recoverability of the advances. Where the remittances by the borrower under consortium lending arrangements are pooled with one bank/FI and/or where the bank/FI receiving remittances is not parting with the share of other member banks/FI, the account will be treated as not serviced in the books of the other member banks/FI and therefore, be treated as NPA. The banks/FI participating in the consortium should, therefore, arrange to get their share of recovery transferred from the lead bank/FI or get an express consent from the lead bank/FI for the transfer of their share of recovery, to ensure proper asset classification in their respective books.

Accounts where there is erosion in the value of security/frauds committed by borrowers

In accounts where there are potential threats for recovery on account of erosion in the value of security or non-availability of security and existence of other factors such as frauds committed by borrowers, the asset will be classified as doubtful or loss asset as appropriate:

 

i. If erosion in value of the security is to the extent where realisable value of the security is less than 50 per cent of the value assessed by the bank/FI/RBI. Such NPAs will be classified under doubtful category and provisioning be made as applicable for doubtful assets.

ii. If realisable value of the security, as assessed by the bank/approved valuers/ RBI is less than 10 per cent of the outstanding in the borrowal accounts, the existence of security should be ignored and the asset will be classified as loss asset. It may be either written off or fully provided for by the bank/FI.

Government guaranteed advances

The credit facilities backed by guarantee of the Central Government only though overdue may be treated as NPA only when the Government repudiates its guarantee when invoked. However, State Government guaranteed advances would attract asset classification and provisioning norms if interest and/or principal or any other amount due remains overdue for more than 90 days.

Project Loans for Infrastructure Sector:

Project Loan' is any term loan which has been extended for the purpose of setting up of an economic venture. Banks/FI must fix a Date of Commencement of Commercial Operations (DCCO) for all project loans at the time of sanction of the loan/ financial closure.

(i) A loan for an infrastructure project will be classified as NPA during any time before commencement of commercial operations as per record of recovery (90 days overdue), unless it is restructured and becomes eligible for classification as 'standard asset' in terms of paras (iii) to (v) below:

 

(ii) A loan for an infrastructure project will be classified as NPA if it fails to commence commercial operations within two years from the original DCCO, even if it is regular as per record of recovery, unless it is restructured and becomes eligible for classification as 'standard asset' in terms of paras (iii) to (v) below:

(iii)  If a project loan classified as 'standard asset' is restructured any time during the period up to two years from the original date of commencement of commercial operations (DCCO), in accordance with the provisions of prudential guidelines on restructuring of advances as prescribed by RBI, it can be retained as a standard asset if the fresh DCCO is fixed within the following limits and further provided the account continues to be serviced as per the restructured terms:

 

(a) Infrastructure Projects involving court cases

Up to another 2 years (beyond the existing extended period of 2 years i.e total extension of 4 years), in case the reason for extension of date of commencement of production is arbitration proceedings or a court case.

 

(b) Infrastructure Projects delayed for other reasons beyond the control of promoters

Up to another 1 year (beyond the existing extended period of 2 years i.e. total extension of 3 years), in other than court cases.

 

(iv) The dispensation of para (iii) above is subject to adherence to the provisions regarding restructuring of accounts as per prudential guidelines on restructuring of advances as prescribed by RBI, which would require that the application for restructuring should be received before the expiry of period of two years from the original DCCO and when the account is still standard as per record of recovery. The other conditions applicable would be:

 

a. In cases where there is moratorium for payment of interest, banks should not book income on accrual basis beyond two years from the original DCCO, considering the high risk involved in such restructured accounts.

b. Banks should maintain provisions on such accounts as long as these are classified as standard assets as under:

Until two years from the original DCCO	0.40%
During the third and the fourth years after the original DCCO.	1.00%

(v) For the purpose of these guidelines, mere extension of DCCO will also be treated as restructuring even if all other terms and conditions remain the same.

 

 

Other Issues

Any change in the repayment schedule of a project loan caused due to an increase in the project outlay on account of increase in scope and size of the project, would not be treated as restructuring if:

 

(a) The increase in scope and size of the project takes place before commencement of commercial operations of the existing project.

(b) The rise in cost excluding any cost-overrun in respect of the original project is 25% or more of the original outlay.

(c) The bank/FI re-assesses the viability of the project before approving the enhancement of scope and fixing a fresh DCCP.

(d) On re-rating, (if already rated) the new rating is not below the previous rating by more than one notch.

B. INCOME RECOGNITION

Banks/ FIs may recognise income on accrual basis in respect of the projects under implementation which are classified as ‘standard’.

 

Internationally, income from non-performing assets (NPA) is not recognised on accrual basis but is booked as income only when it is actually received. Therefore, RBI has advised Banks/ FIs not to charge and take to income account any interest from NPA accounts.

 

Fees and commissions earned by the banks/FI as a result of renegotiations or rescheduling of outstanding debts should be recognised on an accrual basis over the period of time covered by the renegotiated or rescheduled extension of credit.

 

Reversal of income

If any advance, becomes NPA, the entire interest accrued and credited to income account in the past periods, should be reversed if the same is not realised. (This applies to all Government guaranteed accounts also).

In respect of NPAs, fees, commission and similar income that have accrued should cease to accrue in the current period and should be reversed with respect to past periods, if uncollected.

Appropriation of recovery in NPAs

Interest realised on NPAs may be taken to income account provided the credits in the accounts towards interest are not out of fresh/ additional credit facilities sanctioned to the borrower concerned.

 

Interest Application

On an account turning NPA, banks/FIs should reverse the interest already charged and not collected by debiting Profit and Loss account and stop further application of interest. However, banks/ FIs may continue to record such accrued interest in a Memorandum account in their books. For the purpose of computing Gross Advances, interest recorded in the Memorandum account should not be taken into account.

 

 

C. PROVISIONING NORMS

The primary responsibility for making adequate provisions for any diminution in the value of loan assets lies with the bank/FI managements and the statutory auditors.

 

In conformity with the prudential norms, provisions should be made on the non-performing assets on the basis of classification of assets. Banks/FIs should make provision against sub-standard assets, doubtful assets and loss assets as below:

 

Loss assets

 

Loss assets should be written off. If loss assets are permitted to remain in the books for any reason, 100 per cent of the outstanding should be provided for.

 

Doubtful assets

 

Provision with regard to secured advance covered by security having realisable value, may be made  on the following basis at the rates ranging from 20 per cent to 100 per cent of the secured portion depending upon the period for which the asset has remained doubtful:

Period for which the advance has remained in ‘doubtful’ category	Provision requirement (% of secured portion of advance)
Up to one year	20
One to three years	30
More than three years	100

 

Note:

Collaterals such as immovable properties charged in favour of the bank/FI should be got valued once in three years by valuers appointed as per the Banks/FIs approved guidelines.

 

‘Security’ will mean tangible security properly discharged to the bank/FI and will not include intangible securities like guarantees (including State government guarantees), comfort letters etc.

 

Rights, licenses, authorisations, etc., charged to the banks as collateral in respect of projects (including infrastructure projects) financed should not be reckoned as tangible security.

 

However, banks/ FIs may treat annuities under build-operate-transfer (BOT) model in respect of road / highway projects and toll collection rights, where there are provisions to compensate the project sponsor if a certain level of traffic is not achieved, as tangible securities subject to the condition that banks' right to receive annuities and toll collection rights is legally enforceable and irrevocable.

Sub-standard assets

Infrastructure loan accounts which are classified as sub-standard will attract a provisioning of 15 per cent on the outstanding balance.

 

To avail of this benefit of lower provisioning, the banks/FIs should have in place an appropriate mechanism to escrow the cash flows and also have a clear and legal first claim on these cash flows.

 

Standard assets

Banks/FI should make general provision for standard assets (infrastructure loans) at the following rates for the funded outstanding on global loan portfolio basis:

 

(a) Advances to Commercial Real Estate (CRE) Sector at 1.00 per cent;

(b) Other loans and advances at 0.40 per cent

 

If a project loan classified as 'standard asset' is restructured any time during the period up to two years from the original DCCO, in accordance with the provisions of prudential guidelines on restructuring of advances as prescribed by RBI, Banks/FIs should maintain provisions on such accounts as long as these are classified as standard assets as under:

Until two years from the original DCCO	0.40%
During the third and the fourth years after the original DCCO.	1.00%

 

 

Reference
- RBI Circular no. DBOD. No. BP.BC.21/ 21.04.048/ 2010-11 dated July 01, 2012. 

Projects under Infrastructure Finance

Types of Projects under Infrastructure Finance:

I.   PPP Projects
II.  Private Projects
III. Public (Govt) owned Projects - PSU


Public Private Partnership (PPP) – Essential parameters and Forms of PPP

I. Public Private Partnership has the following seven essential parameters:

1. It is an arrangement between two set of entities. The two set of entities shall be as follows:

a)    A private sector entity – an entity in which 51% or more of the subscribed and paid up equity is owned and controlled by a Private entity, and

b)    A government/ statutory entity/ a  government owned entity – Statutory entity is a company formed by a private statute passed in the relevant jurisdiction or bodies/  corporate established under an Act, and a government owned entity is a legal entity created by a government to undertake commercial activities on behalf of the government (i.e. government owns an effective controlling interest (>50%)).

2. The arrangement so entered shall be for providing the following:

a)    Public Services – The services that the Government and/or state is obliged or traditionally has been providing to its citizens, And/ OR,

b)    Public Asset – These are :

(i)  Asset(s) which are used independently or in combination with sovereign/ government assets to extend public services, OR,

(ii) Those assets which are essential for delivery of a public service (though they may not be directly used for providing the service) e.g. A foot over bridge over Railway tracks connecting two platforms/ pedestrian underpass under busy highways passing through cities.

Note: Mere ownership of Asset(s) by the Government does not imply that the arrangement is PPP. The arrangement has to confirm with all parameters to qualify under PPP.

3. The investment (financial / non-financial) in the arrangement shall be made by and/ or the management control in the arrangement shall be that of the private sector entity. This arrangement ensures harnessing efficient and professional capabilities of the private sector entity, hence enables the arrangement to provide quality services to the users.

4. The Arrangement with the Private sector entity shall be for a specified (pre-determined) period of time, after which the arrangement comes to an end. Such time period is commonly called the Concession Period.

5. There is a defined risk sharing allotted between the private sector & public entity. Such public entity sharing the risk is commonly called the Concession Agency.

Note: A mere outsourcing arrangement/ contract (e.g. with EPC contractor, BTG supplier contracts, service contracts, etc.) will not be PPP.

6. The Private sector entity receives Performance linked payment. Thus the arrangement ensures maintaining performance standards & quality and is not rendered as a mere facility or service providing arrangement. For example, allowing toll collection by the concession agency is not merely to ensure return on investment to the developer but also to ensure that the developer provides quality services/ facility on the road developed/ maintained by him. 

7. The Performance by the private sector entity on which its payment is based, shall conform to specified and predetermined performance standards that are measurable by the public entity (concession authority) or its representative (commonly known as the Independent Engineer). The performance standards are specified by the concession authority/ agency.

II. In addition to the essential parameters detailed under I above, some desirable conditions for a PPP arrangement are as follows:

(i). The Private sector entity receives a return over its investment (or management stake) in the project by:

a.  A performance linked fee from the government entity. Usually called the Annuity paid by the concession authority to the private developer of the project. AND/OR

b.  Through User charges being taken from the consumers of the service provided. Usually called the Toll for Road, Freight charges in Rail, User Development Fee (DF)/ Aeronautical/Non-aeronautical charges in Airport, Handling Charges in Sea Ports, etc.    

(ii). The PPP arrangement shall have an incentive and penalty based structure to ensure that the private sector entity provides services which are benchmarked against predetermined service delivery standards.

(iii). The concession authority shall define the output parameters of the PPP arrangement rather than the specific technical specifications. This will enable the private sector entity to implement/ execute the project in the most appropriate manner by harnessing its efficient, innovative and professional capabilities. 

III. Forms of PPP:

1.    The prevalent form of PPP model at present are where the Ownership of the underlying project asset (e.g. Land, etc.) remains with the public entity during the Contract period and the project along with the asset is transferred back to the public entity after the completion/termination of contract i.e. after the concession period is over.

The form of PPP is mainly determined by the Value of Money (VfM) analysis.

2.    Commonly adopted forms of PPP in India are as follows:

-       Management Contracts

-       Build Operate Transfer (BOT) and its variants

-       Build Lease Transfer (BLT)

-       Design Build Operate Transfer (DBFOT)

-       Operate Maintain Transfer (OMT), etc.

2(a) PPP Models such as performance based management/ maintenance contracts, ensure improved efficiency and optimal utilisation of available resources.

This model is commonly used for projects under water supply, sanitation, solid waste management, road maintenance, etc.

2(b) User-fee based BOT model – Under this model, the costs are recovered mainly through user charges, however in some cases Viability Gap Fund (VGF) from government also takes care of a part of the cost.

Over the years, under this model, concessions have been awarded by the public entities via competitive bidding for projects to the private entity.

Under this model, medium to large scale PPPs are awarded, mainly in energy (power) and transport (road, port and airports) sectors.

2(c) Annuity based BOT model – In sectors/ projects where recovery of cost/ investment by the private entity is not viable through user charges, the public entity/ concession authority harnesses the private sectors efficiency through the arrangement based on performance payments. This performance payment is commonly called Annuity for the project.

This model is mainly used due to sociological conditions of the project, consideration of affordability to pay by the users of the services, etc. Hence, PPP under this model is mainly awarded in rural and urban areas, health and education sectors, etc.

2(d) Design Build model – Under this model the public entity engages the private entity for implementing an project for a fixed fee which is payable on completion of the project.

This model enables to save cost and time, efficiently share risk and improve quality for implementing the project.

2(e) Turnkey Design Build model – Under this model, the public entity, instead of making a lump sum payment on completion of project, makes payment to the private entity linked to achievement of measurable intermediary/ periodic construction milestones and/or short period maintenance/ repair works, etc.

Under this model, the public entity incorporates, in the concession agreement/ contract, penalties/ incentives norms for delay/ early completion of the project/ work and may also include performance guarantee (warranty) from the private entity for implementing the project.

2(f) Operation Maintenance collection model – Under this advanced form of PPP model, the project apart from the Design, Build forms of PPP are awarded to the private entity on an Operate Maintain and collect user-fee concession.

NOTE: An arrangement under the Build Own Operate (BOO) model is normally not considered as a PPP arrangement. This is on account of the complexity associated in determining the value of the underlying asset of the project in the event of an early termination of the concession and also in imposing penalties on the private entity in an event of non-performance. Also as the underlying asset does not remain under the ownership of the public authority during construction, it is normally not treated as a PPP form of arrangement

However, in certain unique PPP initiatives by some public entities in India, projects have been awarded to private entities on Build, Own and Operate (BOO) basis under competitive bidding process under ‘Case-2 bidding’ and thus have been classified as PPP project