How will banks respond to the IDF allowance by the government? BK Batra, Executive Director, IDBI Bank, explains that this well thought-out scheme nevertheless needs to be tweaked to be fully productive.How will the new move to allow banks to start infrastructure funds boost infrastructure funding?Recent Public Private Partnership (PPP) private infrastructure projects in India have been financed by domestic banks and institutions. While a few banks have developed expertise and experience in financing infrastructure projects, they are approaching exposure limits and will no longer be able to support the sector. Hence, it has become necessary to develop alternative sources of infrastructure funding.Infrastructure Debt Funds (IDFs) will seek to channel funds from insurance companies, pension funds, high-net worth individuals and other such sources into the infrastructure sectors. Off-shore funds would also be in a position to invest in Indian infrastructure sector through these IDFs. This will provide alternative sources of foreign currency funds. To attract off-shore funds into IDFs, withholding tax on interest payments on the borrowings by the IDFs would be reduced from 20 per cent to 5 per cent. Income of IDFs would also be exempt from income tax. In this background, the proposed IDF is a good initiative and it should boost infra funding.Infrastructure financing has certain unique challenges: No or little tangible security (except few sectors like power generation projects), high debt equity ratio, low DSCR, limited concession period, long implementation and repayment periods, etc. IDFs promoted by banks would benefit from the expertise and experience of their sponsors in managing these challenges. Banks' ability to provide other services particularly TRA account, Escrow account and capex LC/buyers' credit services would also help in the implementation and operations of the projects. Hence, it would be advantageous for banks to set up IDFs.What issues are inherent in the announcement? Will the regulatory norms (to float the fund as a separate entity, not being able to invest in mutual funds, etc) come in the way of a smooth journey?It is only logical for the fund to be floated as an entity separate from its promoters/sponsors. Hence, it should not come in the way of a smooth journey. However, the stipulation that may restrict some of the banks from setting up IDFs is that banks acting as sponsors to IDFs (MFs or NBFCs) would be subject to existing prudential limits including limits on investments in financial services companies and limits on capital market exposure.Once the construction is completed and project's cash flows are at satisfactory levels, the existing lenders themselves would want to continue and would be generally reluctant to accept prepayment of their loans.An IDF set up in the form of MFs may not have the required expertise to properly assess project risks before providing financial assistance for project implementation. In this structure, the risk and return will be passed on to the investors. Risk-averse investors may not be willing to invest in schemes meant for project finance assistance. Therefore, the arrangement should be flexible.This means that all IDFs should be allowed to finance any infrastructure project at any stage, subject to suitable risk mitigants being in place.Would the RBI be correct if it decides to limit greenfield investments by this fund only for PPP projects? IDFs are not allowed to invest in greenfield projects even if they are under PPP structure. Further, with the clause of termination payment, all the power projects will also be out of their scope. Since most of the banks have very large exposures to the power sector, it would be preferable to allow IDFs (set up as NBFCs) to invest in all infra projects, particularly power projects (PPP or private) at any stage.Will IDBI Bank be interested in floating an IDF now or in the future?IDBI Bank is already exploring the possibility of floating an IDF in partnership with a few other banks and institutions. A few other large banks with substantial exposure to infrastructure sector are also likely to float IDFs in due course.