Investing in risk assessment

Over the last two months, HDFC Bank recruited heads for four verticals, including infrastructure finance, to grow its investment banking business. Recently, several banks have been hiring up infrastructure experts, and as innocuous as the news may seem, it reflects a longer term goal to get specialised. As with most other lessons in India’s infrastructure sector, the solution is reactive, not innovative. So banks have a job on their hands, and don’t they know it.

Although banks have come a long way since they were established in India-they now partner with infrastructure and other projects, participate in consortium financing of big ticket projects, and rely less on collateral and more on future cash flow. This calls for accurate and reliable projection of the future. As many of the country’s infrastructure projects start to gain orbit velocity and produce reliable data, it is often observed-and lamented-that projections fail to take into consideration ground realities, therefore prove tricky and obfuscating to banks. Recently, Ramky Infra, a relatively well managed, high-growth infrastructure company, reported a 19 per cent fall in profit after tax (PAT) and a small drop in consolidated revenues, and attributed it to external factors-mainly, unpredictables such as higher finance costs and delay in receivables.

Infrastructure is reputed to be one of the steadiest-if slow on returns-sectors. Yet in India, it is considered a high-risk proposition by most investors, especially international ones. How do banks factor in these risks? The simple truth is, they have been trying grapple with the risks after they encounter them. Banks that have invested in specialists understand the risks better and factor in the margins of error better. In recent times, banks that cannot afford a whole project finance division-typically those with lower infrastructure finance levels-have been hiring expertise from those that do. For example, affiliated and other banks depend on State Bank of India, which has the requisite expertise, for pre-finance feasibility reports. External agencies have also been hired, and these agencies have been learning the hard way that their pre-set templates of assessment hide large holes in India-specific context-the most common being delays in clearance and approvals. Asset-liability mismatch and tenor have been often quoted as hurdles, but as the government evolves new methods such as Infrastructure Debt Funds (IDFs), financiers of infrastructure must move towards evolving standard and reliable methods to assess risks.

Several head honchos of banks have often seen the need to form pools of experts, affiliated to groups of banks, to help overcome uncertainties of infrastructure lending and investment. This is perhaps the most cost-effective way to minimise lending risks without compromising on the project.

The real problem, however, may lie in relying too much on quantitative data. The Overdependence on the ratings criteria can be an artificial deterrent to good projects, especially through Special Purpose Vehicles (SPVs). Financial institutions must evolve an independent system of assessment in project finance, and this may be possible only by creating pools of experts, even if shared, who can evolve assessment criteria that are a judicious mix of quantitative and qualitative-call it judgement-call-in nature while tackling project lending risks.

We wish all our readers a Very Happy Diwali.