Why power sector financiers shouldn’t diversify into banking
4 min read 05 Jun 2013, 10:18 AM ISTInstead of aspiring to become banks, power sector financiers should utilise their niche skills in related areas
Premium(Mint )
Power sector financing has been a curious game in India. We are probably the only country where there are dedicated power financiers, Power Finance Corporation (PFC) and Rural Electrification Corporation (REC), both majority-owned by the government. Elsewhere, there are infrastructure finance entities, but seldom dedicated to power.
These were set up at a time when banks were not expected to undertake project finance activities. Today, banks do more power financing than PFC/REC put together (former—approx 55% of total, latter—42%). How the power sector is the major bane for banks’ loan portfolios and PFC/REC are unscathed, remains one of the enduring mysteries, but that’s another story.
Why two of them? Back to Indian power sector idiosyncrasies. REC was first set up, as the name suggests, to aid rural electrification, and PFC much later, for lending to state electricity boards, which at that time being government departments as against companies, were not able to access external finance. Over time, due to dilution of focus, these two have become operationally similar.
Actually, PFC’s recently articulated intention to take a substantial stake in a public sector bank, is not entirely new. Ever since the talk of new bank licences began, PFC has admitted to being an aspirant. Though the ostensible interpretation for the interest in banking was just “exploratory", rumblings within the company, REC as well as in the power ministry suggest that the real genesis is the apprehension about the future of the power financiers.
It may not be far-fetched to suggest that opinions would have got fashioned further by the unsavoury incidents surrounding IFCI, the other disgraced and directionless government-owned project finance company.
This author remembers being in a small group meeting slightly over two years ago where a senior executive of PFC said “Whether right or wrong, we believe that in the next 10 years or so, our raison d’être will cease. Either banks will become too dominant in this area, or there will be simply no need for so much finance to power. It is time we think of diversifying into other financial products. No better form and structure than a bank".
I was pleasantly surprised by the foresight displayed by this gentleman—we normally do not associate public sector entities with such proactiveness since they are not run by boards but ministries, where denial is institutionalised. Personally I disagreed with him because I think the power sector will need tonnes of money in the next 20 years, but that’s besides the point. My only objection is the proposed format of the intended “diversification".
It is remarkable how many believe that making mortgage loans, writing performance guarantees and issuing credit cards is their cup of tea. The problem with PFC/REC is not that they believe that they will run great banks, but that they have to force themselves to believe that, out of the sheer need for survival, as per the posturing.
The challenges of primarily wholesale financing entities in thinking retail has been the subject of tomes. Just take one example—recovery. Presently, PFC/REC’s primary recovery leverage with recalcitrant state utilities is escrow accounts, direct payments to material suppliers instead of the utilities, or political nudge-and-wink by the Centre to states. What happens once home loan clients default? Straightaway apply the textbook Securitisation Act and seize the asset? Try that on the ground and see what happens.
The logical future for PFC and REC will be to get merged into a commercial bank, preferably a large one. This should be done at a proper valuation, after taking into account that by all means, PFC and REC’s project appraisal capabilities, for their domain, are a notch above that of commercial banks.
But of course, turf issues and memories of the Air India-Indian Airlines merger mess will preclude such a possibility. So here are a few suggestions for the two power financiers to become more powerful financiers:
• • The most obvious one—broaden themselves to infrastructure finance. Several elements of financing power, roads, ports, water supply and airports are common. Widening of scope will increase the perceived longevity of these institutions.
• • Finance activities at the fringes of the power plants. For example, why not lend for employee housing construction? There is no reason for housing construction finance to be captured by, say, HDFC, for a power plant financed 75% by PFC and REC.
• • Another obvious one—actively participate as consultants, and later even financiers for other emerging market power projects. This is already being done in a small measure but it needs to be a flood, not a trickle. Most certainly, PFC and REC, who have financed projects near Maoist affected areas in India, should not be scared off by geopolitical risks.
Dipankar Choudhury has been a senior research analyst on financial services as well as other sectors at various investment banks, and is currently an independent consultant focusing on banks and financial services.
