REDISCOVERING DEVELOPMENT BANKS – CURRENT AFFAIRS BY EDEN IAS

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REDISCOVERING DEVELOPMENT BANKS – CURRENT AFFAIRS BY EDEN IAS

Recently the Finance Minister Nirmala Sitharaman while, announcing a slew of measures to boost the economy and financial market sentiments, had an interesting idea. It was about setting up a development bank.

Ms. Sitharaman said: “In order to improve access to long-term finance, it is proposed to establish an organisation to provide credit enhancement for infrastructure and housing projects, particularly in the context of India now not having a development bank and also for the need for us to have an institutional mechanism. So, this will enhance debt flow toward such projects.” The announcement could have far-reaching implications for India’s financial system.

What are Development Banks?

  • Development banks are financial institutions that provide long-term credit for capital-intensive investments spread over a long period and yielding low rates of return, such as urban infrastructure, mining and heavy industry, and irrigation systems.
  • Such banks often lend at low and stable rates of interest to promote long-term investments with considerable social benefits. Development banks are also known as term-lending institutions or development finance institutions.
  • To lend for long term, development banks require correspondingly long-term sources of finance, usually obtained by issuing long-dated securities in capital market, subscribed by long-term savings institutions such as pension and life insurance funds and post office deposits.
  • Considering the social benefits of such investments, and uncertainties associated with them, development banks are often supported by governments or international institutions. Such support can be in the form of tax incentives and administrative mandates for private sector banks and financial institutions to invest in securities issued by development banks.
  • Development banks are different from commercial banks which mobilise short- to medium-term deposits and lend for similar maturities to avoid a maturity mismatch — a potential cause for a bank’s liquidity and solvency. The capital market complements commercial banks in providing long-term finance. They are together termed as the Anglo-Saxon financial system.

Industrial Development Banks

They include for example. Industrial Finance Corporation of India (IFCI), Industrial Development Bank of India (IDBI), and Small Industries Development Bank of India (SIDBI).

Industrial Finance Corporation of India (IFCI)

The IFCI was the first specialised financial institution set up in India to provide term finance to large industries in India. It was established on 1st July, 1948 under the Industrial Finance Corporation Act of 1948.

 

Objectives of IFCI

The main objective of IFCI is to provide medium and long term financial assistance to large scale industrial undertakings, particularly when ordinary bank accommodation does not suit the undertaking or finance cannot be profitably raised by it from the issue of shares.

 

Functions of IFCI:

  1. For setting up a new industrial undertaking.
  2. For expansion and diversification of existing industrial undertaking.
  3. For renovation and modernisation of existing concerns.
  4. For meeting the working capital requirements of industrial concerns in some exceptional cases.

 

Industrial Development Bank of India (IDBI)

Industrial development Bank of India (IDBI) came into being on 1st July, as a Development Institutions under IDBI Act 1964. It is headquartered at Mumbai.

It is regarded as a Public Financial Institution in terms of Companies Act. It continued as DPI till 2004 when it was transferred into a Bank. To transform this into Bank/ Industrial Development Bank Act 2003 was passed.

A new company under the name of Industrial Development Bank of India Ltd. was incorporated as a Govt company under the Companies Act on 27th September, 2004, and thus now it came to be known as IDBI Ltd w.e.f 1st October 2004 but it also worked as a Bank in terms of the Repeal Act.

With effect from 2nd April, 2005, IDBI Bank Ltd was finally amalgamated with IDBI Ltd and was known as IDBI Ltd. It is a Public Sector Bank as government has above 70% shareholding in this Bank.

 

SIDBI

Small Industries Development Bank of India (SIDBI) was set up under an Act of Parliament in 1990. Though it was a wholly owned subsidiary of Industrial Development Bank of India, presently the ownership is held by 33 Government of India owned / controlled institutions. It is headquartered in Lucknow.

 

Functions:

  • To initiate steps for technological up gradation and modernisation of existing units.
  • To expand the channels for marketing the products of SSI sector in domestic and international markets.
  • To promote employment oriented industries especially in semi-urban areas to create more employment opportunities and thereby checking migration of people to urban areas.

 

Agricultural Development Bank:

It includes, for example. National Bank for Agriculture & Rural Development (NABARD).

  • National Bank for Agriculture and Rural Development (NABARD) is an apex development bank in India having headquarters based in Mumbai (Maharashtra) and other branches are all over the country. It was established on 12 July 1982 by a special act by the parliament and its main focus was to uplift rural India by increasing the credit flow for elevation of agriculture & rural non-farm sector. NABARD is the apex institution in the country which looks after the development of the cottage industry, small industry and village industry, and other rural industries.

Role:

  • Undertakes monitoring and evaluation of projects refinanced by it.
  • Refinances the financial institutions which finance the rural sector.
  • Regulates the institutions which provide financial help to the rural economy.
  • Provides training facilities to the institutions working in the field of rural upliftment.
  • Regulates the cooperative banks and the RRBs.

 

Export-Import Development Bank:

It includes, for example, Export-Import Bank of India (EXIM Bank).The Export-Import Bank of India (Exim Bank) is a public sector financial institution created by an Act of Parliament, the Export-import Bank of India Act, 1981. The business of Exim Bank is to finance Indian exports that lead to continuity of foreign exchange for India. The Exim Bank extends term loans for foreign trade.

 

Housing Development Bank:

It includes, for example. National Housing Bank (NHB). The National Housing Bank (NHB) is a state owned bank and regulation authority in India created on July 8, 1988 under section 6 of the National Housing Bank Act (1987). Its headquarter is in New Delhi. The institution owned by the Reserve Bank of India was established to promote private real estate acquisition. The NHB is regulating and re-financing social housing programs and other activities like research etc. Its vision is promoting inclusive expansion with stability in housing finance market.

 

MUDRA BANK

Micro Units Development and Refinance Agency Bank (MUDRA Bank) is a new institution set up on 8 April 2015 by the Government of India for development of micro units and refinance of MFIs to encourage entrepreneurship in India and provide the funding to the non-corporate small business sector.

It was announced by the Finance Minister while presenting the Union Budget for FY 2016. MUDRA has a corpus of Rs. 20,000 crore and credit guarantee corpus of Rs. 3,000 crore.

 

Products and Offerings:

The initial products and schemes under this umbrella have already been created and the interventions have been named ‘Shishu’, ‘Kishor’ and Tarun’ to signify the stage of growth of the beneficiary micro unit / entrepreneurs.

Shishu: covering loans up to Rs. 50,000/-

Kishor: covering loans above Rs. 50 000/-and up to Rs. 5 lakh

Tarun: covering loans above Rs. 5 lakh and up to Rs. 10 lakh

 

Indian Postal payment Bank:

The India Post Payments Bank (IPPB) was a Public Limited Company under the Department of Posts with 100% GOI equity.

  • IPPB will offer demand deposits such as savings and current accounts up to a balance of Rs. 1 Lakh The corpus of the payments bank is of Rs. 800 crore (650 branches).

 

NBFC (Non-Banking Financial Company)

It is engaged in the business of loans and advances, acquisition of bonds/debentures/ securities issued by Government or local authority or other marketable securities, leasing, hire-purchase, insurance business, chit business but does not include any institution whose principal business is that of agriculture activity, industrial activity, purchase or sale of any goods or providing any services and sale or purchase of immovable property.

 

Difference between Banks & NBFCs

  • NBFC cannot accept demand deposits
  • NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on itself
  • Deposit insurance facility of Deposit Insurance and   Credit   Guarantee Corporation is not available to depositors of NBFCs, unlike in case of banks.

 

There is no Ombudsman for hearing complaints against NBFCS. In respect of credit card operations of an NBFC, which is a subsidiary of a bank if a complainant does not get satisfactory response from the NBFC within a maximum period of thirty 30 days from the date of lodging the complaint/ the customer will have the option to approach the Office of the concerned Banking Ombudsman for redressal of his grievances.

Need for Developmental Banks in India

India’s economic downturn in recent quarters and the high NPAs of banks affecting their credit culture have forced the government to think about reviving the Development banks to boost the economy through infrastructure financing.

 China’s development banks to finance long-term Projects

The Agricultural Development Bank of China, China Development Bank and the Export-Import Bank of China have been at the forefront of financing its industrial prowess.

After the global financial crisis, these institutions have underwritten China’s risky technological investments helping it gain global dominance in IT hardware and software companies.

Germany’s development bank, KfW, has been spearheading long-term investment in green technologies and for sustainable development efforts requiring long-term capital.

 Ways for Financing Development Banks

As the domestic saving rate was low, and capital market was absent, development finance institutions were financed by:

  • Lines of credit from the Reserve Bank of India (that is, some of its profits were channelled as long-term credit); and
  • Statutory Liquidity Ratio bonds, into which commercial banks had to invest a proportion of their deposits.

In other words, by sleight of government hand, short-term bank deposits got transformed into long-term resources for development banks. The missing capital market was made up by an administrative fiat. However, development banks got discredited for mounting non-performing assets, allegedly caused by politically motivated lending and inadequate professionalism in assessing investment projects for economic, technical and financial viability.

After 1991, following the Narasimham Committee reports on financial sector reforms; development finance institutions were disbanded and got converted to commercial banks. The result was a steep fall in long-term credit from a tenure of 10-15 years to five years. The development of the debt market has been an article of faith for over a quarter-century, but it has failed to take off as in most of Europe and industrialising Asia, where the bank-centric financial system continues to prevail.

 

Role of Development Banks for Indian economy

  • Capital formation: The significance of Development Banks lies in their making available the means to utilize savings generated in the economy, thus helping in capital formation. Capital formation implies the diversion of the productive capacity of the economy to the making of capital goods which increases future productive capacity
  • Entrepreneurial role: Developing countries lack entrepreneurs who can take up the job of setting up new projects. It may be due to lack of expertise and managerial ability. Development banks were assigned the job of entrepreneurial gap filling.
  • Joint finance: Another feature of the development bank’s operations is to take up joint financing along with other financial institutions. There may be constraints of financial resources and legal problems (prescribing maximum limits of lending) which may force banks to associate with other institutions for taking up the financing of some projects jointly.
  • Subscription to guarantees: It is well-known that when an entrepreneur purchases some machinery or fixed assets or capital goods on credit, the supplier usually asks him to furnish some guarantee to ensure payment of installments by the purchaser at regular intervals.
  • Assistance to backward areas: Institutional finance to projects in backward areas is extended on concessional terms such as lower interest rate, longer moratorium period, extended repayment schedule and relaxed norms in respect of promoters’ contribution and debt-equity ratio.
  • Impact on corporate culture: Over the years, Development Banks have succeeded in infusing a sense of constructive partnership with the corporate sector. Institutions have been going through a continuous process of learning by doing and are effecting improvements in their systems and procedures on the basis of their cumulative experience.

Issues with the Development Banks

Big business houses: main criticism of development banking in India is that big business groups were able to garner a disproportionate share of the disbursals made by these institutions.

Lack of control: The Government did not use its influence to exert control over the firms with which development finance institutions were involved. The latter, as providers of equity and credit to companies, were eligible to have nominees on the boards of directors of such companies

Time taking: The inability of the banks to process loans in a reasonable time frame and to provide loans to projects lacking quality, along with the need for them to reorient their financing towards new industries

Non-performing Assets: Development Banks got discredited for mounting non-performing assets, allegedly caused by politically motivated lending and inadequate professionalism in assessing investment projects for economic, technical and financial viability.

After 1991, following the Narasimham Committee reports on financial sector reforms; development finance institutions were disbanded and got converted to commercial banks. The result was a steep fall in long-term credit from tenure of 10-15 years to five years.

Conclusion

In this light, the Finance Minister’s agenda for setting up a development bank is welcome. However, a few hard questions need to be addressed in designing the proposed institution. How will it be financed? If foreign private capital is expected to contribute equity capital (hence part ownership), such an option needs to be carefully analysed, especially in the current political juncture. The design of the governance structure is fraught with dangers with many interest groups at work. One sincerely hopes that the political and administrative leadership carefully weigh in the past lessons to lay a firm foundation for the new institution.

 

 

 

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