The future of the New Development Finance Bank
Government needs to understand that basic infrastructure is the responsibility of government and efforts should be made to build it through budgetary resources as far as possible. For that, the need will be to reduce subsidies and revenue deficits. — Anil Javalekar
Recently, one more financial institution has come up. This institution has been named as ‘National Bank for Financing Infrastructure and Development (NBFID)’ and is the new development financial institution (DFIs) for infrastructure financing. The central government will own 100% shares of the institution initially and may go down to 26% in the future. The new DFI is expected to provide long-term finance for such segments of the economy where the risks involved are beyond the risk appetite of commercial banks and other financial institutions. This bank is expected to not accept deposits from public but source funds from the market, government, as well as multi-lateral institutions. The government will also provide guarantee at a concessional rate for borrowing from multilateral institutions. It is however, to be remembered that this new DFI is not the first one in India and there is a long history of many such institutions. it is, therefore, desirable to understand the background and history of DFIs and hypothesize the future of this new DFI.
The idea behind the DFIs is that in a developing country, financial sectors are incomplete as the markets – particularly in relation to risk capital, projects requiring long gestation periods and those that work with emerging technologies. The challenge principally lies in meeting financial needs of such capital guzzling projects. The DFI is expected to meet long-term financial needs of such projects. A DFI is defined as “an institution promoted or assisted by Government mainly to provide development finance to one or more sectors or sub-sectors of the economy. The basic emphasis of a DFI is on long-term finance and on assistance for activities or sectors of the economy where the risks may be higher than that the ordinary financial system is willing to bear.
So many DFIs took shape in India
India established many DFIs since independence. RBI can be said as the first development institution of India as is entrusted with the job of developing an appropriate financial architecture through institution building. DFIs established later can be broadly categorized as all-India or state/regional level institutions depending on their geographical coverage of operation. Functionally, all-India institutions can be classified as (i) term-lending institutions (IFCI Ltd., IDBI, IDFC Ltd., IIBI Ltd.) extending long-term finance to different industrial sectors, (ii) refinancing institutions (NABARD, SIDBI, NHB) extending refinance to banking as well as non-banking intermediaries for finance to agriculture, SSIs and housing sectors, (iii) sector-specific/specialized institutions (EXIM Bank, TFCI Ltd., REC Ltd., HUDCO Ltd., IREDA Ltd., PFC Ltd., IRFC Ltd.), and (iv) investment institutions (LIC, UTI, GIC, IFCI Venture Capital Funds Ltd., ICICI Venture Funds Management Co Ltd.). State/regional level institutions are a distinct group and comprise various SFCs, SIDCs and NEDFi Ltd.
What happened to all these DFIs?
Some got converted to full-fledged and commercially operated banks (ICICI, IDBI). As of now, only three categories of institutions remain in the list of DFIs. The first category is the DFIs established by statute viz., NHB, SIDBI, NABARD and EXIM Bank. The second is the state level institutions set up by statute viz., SFCs. The third is the DFIs that have been constituted as companies under the Companies Act, 1956 and hence are, by definition, NBFCs. These are IIBI Ltd., TFCI Ltd., PFC Ltd., REC Ltd., IRFC Ltd., IREDA Ltd., NEDFi Ltd., IDFC Ltd., and SIDCs.
DFIs lost relevance
DFIs have lost relevance in current economic environment – may be because the financed projects were unviable, or allocation and rotation of capital was inefficient. As is known, the Indian financial system has improved over the years. The capital markets (equity and debt) are enabling high capital exchange and for long tenures. The banking system is well diversified with public, private and foreign banks of varying sizes operating efficiently and has acquired the skills of managing risks involved in extending finance to different sectors of the economy including long term finance. Markets are now diversified; the banks are also encouraged to extend high risk project finance and larger global funds participating in infrastructure space. And due to such developments, the DFIs are unable to withstand the competition from banks and other FIs. DFIs were also burdened with large NPAs due to exposure to certain sectors, which have not performed well due to downturn in the business cycle, further adding to their cost of doing business. Further, their portfolio was almost entirely composed of long-term high risk project finance.
RBI’s working Group on DFIs (2004)
RBI’s working Group on DFIs (2004) categorically said that the need for DFIs as the exclusive providers of development finance has diminished as the banking system acquired the skills of managing risks in extending finance to different sectors of the economy including long term finance and the capital market, (both equity and debt taken together) providing significantly larger resources to the corporate sector. The WG has also said that the business model of any DFI which raises long term resources from the market at rates governed by the market forces and extends only very long-term credit to fund capital formation of long gestation is unlikely to succeed on account of threat to its spreads from high cost of funds and high propensity to accumulate NPAs owing to exposures to very high credit risks. The WG opined that DFIs are crucially dependent for their existence on Government commitment for continued support.
New DFI may not survive
The idea of DFI has a background and all earlier DFIs either took different route of converting into banks or have changed their operations. The desirable approach is to see that existing DFIs are strengthened and supported appropriately, particularly NABARD and SIDBI, instead of going for new. The future of new DFI will be uncertain if not taken proper care. Government needs to understand that basic infrastructure is the responsibility of government and efforts should be made to build it through budgetary resources as far as possible. For that, the need will be to reduce subsidies and revenue deficits. Establishing new institutions may not help much. More than that, if government must help them survive, it is better government itself invest in such projects.
Reference: RBI’s ‘REPORT of the WORKING GROUP on DEVELOPMENT FINANCIAL INSTITUTIONS’ (2004).