Proposed framework on partial credit enhancement

The Reserve Bank of India (“RBI”) has issued the draft guidelines on non-fund-based credit facilities on April 9, 2025 (“Draft Guidelines”). The Draft Guidelines propose a new and overhauled Framework for Partial Credit Enhancements (“Proposed PCE Framework”) to be issued by regulated entities. The Proposed PCE Framework intends to revamp the existing Partial Credit Enhancements (“PCE”) Framework introduced by the RBI pursuant to the circular dated September 24, 2015, on ‘PCE to Corporate Bonds’, as amended (“Existing PCE Framework”).

The Proposed PCE Framework is amongst the latest initiatives to bolster the growth in the infrastructure sector. This was outlined by the Government of India in the latest Union Budget which contemplated the setting up of a partial credit guarantee scheme for corporate bonds for infrastructure to address liquidity concerns. The Proposed PCE Framework will enable the issuers with a credit rating of less than ‘AA’ to access the bond market and not restrict their funding source to bank financing for infrastructure projects.

Overview of the Proposed PCE Framework

The key changes proposed in the Draft Guidelines are discussed below:

Applicability

• Regulated Entities: The Proposed PCE Framework will be applicable to the following entities (collectively, “REs”):
  • commercial banks;
  • co-operative banks;
  • all India financial institutions; and
  • Non-Banking Finance Companies (“NBFCs”) in top, middle and upper layers (including, Housing Finance Companies (“HFCs”)).
• Applicable instruments: Bonds issued by: (a) corporates and/or their special purpose vehicles for funding all types of projects; and (b) NBFCs with an asset size of INR 1,000 crore (Indian Rupees one thousand crore) or above.
• Rating requirement: Issuers with a pre-enhanced rating of at least ‘BBB–’ are eligible to avail PCEs. Further, the bonds must be rated by 2 (two) registered credit rating agencies. The reports for both the pre-enhanced and post enhanced credit rating are required to be disclosed.

Nature of PCEs

• Key Features: The following are the salient features of the PCE proposed under the Proposed PCE Framework:
  • PCE cannot be in the nature of a guarantee;
  • PCE must be provided at the time of issuance of the bonds;
  • PCE must be irrevocable;
  • PCE facilities to the extent drawn will be treated as an on-balance sheet advance in the balance sheet of the RE, unlike undrawn portions, which will be an off-balance sheet item;
  • PCE must be provided by way of contingent lines of credit which may be drawn in case of shortfall of funds for servicing the bonds; and
  • PCE may be revolving in nature.

Other salient features such as documentation and disclosure requirements in relation to the PCE to be provided by REs remain unchanged under the Proposed PCE Framework.

• Permissible end use:
  • The Proposed PCE Framework intends to enable issuers to tap the domestic debt market for long-term infrastructure projects. However, the PCE proceeds can only be utilised for servicing the bond and not for any other purpose. PCEs can only be provided at the time of issuance of the bonds and may be drawn down in case of any shortfall of funds for servicing such bonds.
  • PCEs cannot be used for asset acquisition, project expenses, or corporate purposes. Further, the PCE proceeds cannot be utilised for servicing other lenders of the issuer irrespective of the seniority of claims of other creditors in relation to the bond holders or the end-use of the facilities availed from other lenders.
• Restriction on RE participation: REs cannot participate in the bonds which have been credit enhanced by the other REs.

Coverage of PCEs

The coverage of PCEs is proposed to be increased from the exposure limit of 20% of the issue size by a single RE to 50% of the issue size of the bond under the Proposed PCE Framework.

The aggregate limit of all REs to a corporate bond backed by PCEs remains unchanged at 50% of the issue size.

Provisioning requirements

• Capping of capital requirements for PCEs:
  • The Proposed PCE Framework proposes to provide capital relief to REs granting PCEs to corporates.
  • The provision requirement of REs will be relaxed and linked to the amount of the PCE granted. The Existing PCE Framework mandates provisioning for the difference between: (a) the capital required on the entire bond amount, corresponding to its pre-credit enhanced rating (regardless of the PCE provided by the RE); and (b) the capital required on the bond amount corresponding to its post-credit enhanced rating, as per the risk weights applicable to claims on corporates under the relevant provisioning guidelines.
  • By way of an illustration, under the Proposed PCE Framework, for a bond issuance of INR 100 (Indian Rupees one hundred) and a pre-enhanced rating of the bond as ‘BBB’, the applicable risk weight at the pre-enhanced rating of ‘BBB’ is 100%. Accordingly, the capital requirement for the carrying amount of PCE will be as follows:

It is clarified that a PCE to a bond issuer will not amount to restructuring of the underlying project loan if: (a) the issuer has availed a loan from the RE which is a ‘standard asset’ (which is being refinanced out of the bonds being backed by the PCE); and (b) the borrower is not declared to be in financial distress.

• Risk weights assigned to ratings
  • The Proposed PCE Framework prescribes the following:
    • In case of change in the pre-enhanced rating of the bond, the capital required will be recalculated based on the risk weight applicable to the revised pre-enhanced rating, subject to a floor, i.e., the capital requirement on the PCE at the time of issuance of the PCE enhanced bonds;
    • If the outstanding amounts under the bonds exceed the aggregate PCE offered, then the capital held by the RE in such cases must not be less than the amount required to be held at the time of issuance of the PCE enhanced bond. However, if the bond outstanding has amortised below the aggregate PCE amount, the capital can be computed taking into account the outstanding bond amount; and
    • If the pre-enhanced rating of the bond slips below investment grade i.e. (BBB -), full capital to the extent of PCE provided must be maintained by all REs, including NBFCs and HFCs.

Repayment of PCE

Given that PCEs are to be used as a contingent measure to meet any shortfall in servicing requirements, the Proposed PCE Framework mandates that any drawn-down portion of the PCE must be repaid within a period of 30 (thirty) days. In the event such amounts remain unpaid for more than 90 (ninety) days, then the account will be classified as a non-performing asset in accordance with the extant RBI guidelines. Further, the aggregate PCE exposure of an RE must not exceed 20% of its Tier 1 capital.

PCEs for bond issuances by NBFCs and HFCs

Bonds issued by NBFCs and HFCs having a tenor of more than 3 (three) years will also be permitted to be supported by PCEs. However, the proceeds of such bonds must only be utilised for refinancing existing debt with robust monitoring of the end-uses. However, the exposure to REs regarding PCEs granted in connection with NBFCs and HFCs is capped at 1% of the capital funds of the RE within the single/group borrower exposure limits.

Conclusion

The Proposed PCE Framework is a welcome step in enhancing retail and non-retail participation in the funding requirements of the infrastructure sector and in NBFCs and HFCs (with an asset size of INR 1,000 crore (Indian Rupees one thousand crore) and above) and broadening the bond market. The capital relief proposed is likely to result in freeing up the balance sheets of the REs and would also address the deep-rooted concern of wider accessibility of capital of infrastructure companies which are generally restricted to financing by banks and NBFCs.

While the Proposed PCE Framework is being finalised, the RBI should consider providing for objective parameters signifying a genuine cash shortfall in debt service requirements with respect to drawing down of the PCEs.

In our view, the RBI has also provided for a well-rounded approach for the REs to analyse the creditworthiness of the issuer for providing the PCEs (including through due diligence and robust internal monitoring and rating systems) under the Proposed PCE Framework thereby enabling uniformity of credit appraisal between non fund based facilities and funded facilities.

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