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Presented byDr. Sailendra Narain

SINGNIFICANCE OF LOCAL DEVEOPMENT FINANCIAL INSTITUTIONS IN DEVELOPING COUNTRIES

Relevance, Role & Suggested Framework

World Economic Forum – Financing for Development Workshop - Hong Kong

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Financing for Development (FfD) : Which Financing for Development (FfD) : Which Way To GoWay To Go

Over the year, Development Financial Institutions (DFIs) have played significant role in economic growth.

DFIs are however, now converting themselves into Universal Banks mainly affected by ‘Cost of Resources’

The World Bank had in late 1980s observed :

‘DFIs have no future’ ‘DFIs to Universal Banks’ ….. Is it the only

alternative to sustain FfD…..???

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The ProposalThe Proposal

Restructure existing Development Financial Network Restructure existing Development Financial Network with more local / regional flavour without government’s with more local / regional flavour without government’s intervention intervention

Setup Local DFIs with new face as Public-Private Setup Local DFIs with new face as Public-Private Partnerships (PPPs) or Joint-Venture Companies (JVCs) Partnerships (PPPs) or Joint-Venture Companies (JVCs) without government ownership.without government ownership.

The proposal is either to

The cardinal principles for both the forms being

Less or no reliance on government’s support, donors’ Less or no reliance on government’s support, donors’ grants and concessional funding; andgrants and concessional funding; and

Self-relianceSelf-reliance mainly on local resources, domestic and mainly on local resources, domestic and later international capital markets, in due course later international capital markets, in due course

- OR -

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The BenefitsThe Benefits

Local DFIs will : Local DFIs will : Stimulate sustained flow of FfD particularly Stimulate sustained flow of FfD particularly

for SMEs and other important segments;for SMEs and other important segments; Ensure adequate private finance and Ensure adequate private finance and

investments, crucial to economic growth; investments, crucial to economic growth; and and

Help attaining Millennium Development Help attaining Millennium Development GoalsGoals

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Who needs to do what ??Who needs to do what ??

For mobilising private finance and For mobilising private finance and investments, Government must create an investments, Government must create an enabling environment forenabling environment for Good Governance Good Governance Private Sector Development Private Sector Development Regional integration for competitivenessRegional integration for competitiveness

(A) Government(A) Government

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Should help:Should help: Improving aid effectiveness for capacity building Improving aid effectiveness for capacity building Capacity building through technical, financial Capacity building through technical, financial

assistance and business development services assistance and business development services (BDS)(BDS)

Improving synergies between international Improving synergies between international investment funds and private finance investment funds and private finance

Becoming strategic partners by investing in Becoming strategic partners by investing in equities, promoting suitable capital market and equities, promoting suitable capital market and new financial instruments for mitigating new financial instruments for mitigating investment risks, such as co-financing and joint investment risks, such as co-financing and joint venture funds, export and risk guarantees, etc. venture funds, export and risk guarantees, etc.

Who needs to do what ??Who needs to do what ??

(B) Donors, Bilateral and Multilateral Agencies(B) Donors, Bilateral and Multilateral Agencies

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Suggested FrameworkSuggested Frameworkfor Local DFIsfor Local DFIs

How to restructure Regional DFIs ….. ?? How to restructure Regional DFIs ….. ??

or or How to setup Local DFIs with new face so How to setup Local DFIs with new face so

as to better leverage multilateral agencies, as to better leverage multilateral agencies, fund banks, bilateral donors, national fund banks, bilateral donors, national governments and aid agencies ……??governments and aid agencies ……??

Central theme of this presentation is : Central theme of this presentation is :

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Suggested Suggested FrameworkFramework

Awareness must emerge that: “FfD” is Awareness must emerge that: “FfD” is different from commercial banking and for different from commercial banking and for which Local DFIs are the most suitable which Local DFIs are the most suitable institution. institution.

National governments should take National governments should take necessary steps to recapitalize/restructure necessary steps to recapitalize/restructure ailing DFIs, [like State Financial ailing DFIs, [like State Financial Corporations (SFCs) and State Industrial Corporations (SFCs) and State Industrial Development Corporations (SIDCs) in Development Corporations (SIDCs) in India], which are nearer the ground and India], which are nearer the ground and have wider reach. have wider reach.

The Local DFIs should be promoted as The Local DFIs should be promoted as NBFCs, PPPs or JVCs in the private NBFCs, PPPs or JVCs in the private sector on commercial lines. sector on commercial lines.

Government should only be facilitators and Government should only be facilitators and not the administrators/ownersnot the administrators/owners

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Suggested Suggested FrameworkFramework

Governments and Central Banks to ensure Governments and Central Banks to ensure that Local DFIs have "level playing field" that Local DFIs have "level playing field" for raising resources including Open for raising resources including Open Market Borrowings. Market Borrowings.

Multilateral and Bilateral donor agencies Multilateral and Bilateral donor agencies might become co-promoters and also might become co-promoters and also extend financial support to the Local DFIs. extend financial support to the Local DFIs. Assistance towards Business Development Assistance towards Business Development Services (BDS) by DFIs should come as Services (BDS) by DFIs should come as technical support.technical support.

Restructuring / recapitalisation of Regional Restructuring / recapitalisation of Regional DFIs should be assisted by Multilateral DFIs should be assisted by Multilateral agencies. Multilateral agencies should agencies. Multilateral agencies should increasingly become co-promoters of such increasingly become co-promoters of such ventures and withdraw in phased manner.ventures and withdraw in phased manner.

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SMEs the backbone of any developing country, SMEs the backbone of any developing country, should be encouraged to corporatise. This will should be encouraged to corporatise. This will help them to play effectively in Local Capital help them to play effectively in Local Capital markets and have less reliance on institutional markets and have less reliance on institutional borrowings.  Efforts should be to promote second borrowings.  Efforts should be to promote second tier Stock Markets for the SMEs. tier Stock Markets for the SMEs.

New and innovative financial instruments should New and innovative financial instruments should be promoted and active equity markets be be promoted and active equity markets be developed rather than heavy reliance on debts developed rather than heavy reliance on debts only.only.

Special Development Funds like Technology Special Development Funds like Technology Development and Innovation Funds, Development and Innovation Funds, Modernization Fund, Risk Capital and General Modernization Fund, Risk Capital and General Fund, Small Equity Fund etc., to be co-Fund, Small Equity Fund etc., to be co-promoted or jointly set up by the government promoted or jointly set up by the government and multilateral agencies, which might go a long and multilateral agencies, which might go a long way in promoting economic development. way in promoting economic development.

Suggested Suggested FrameworkFramework

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Suggested FrameworkSuggested Framework

Subsidized formal finance has failed. Subsidized formal finance has failed. Connect informal lending agencies i.e. – Connect informal lending agencies i.e. – Micro Finance with Local DFIsMicro Finance with Local DFIs

Despite its popularity and potential, Despite its popularity and potential, informal finance has many drawbacksinformal finance has many drawbacks

Difficulties may be overcome through Difficulties may be overcome through links between informal and formal Local links between informal and formal Local DFIs, but much remains to be learned DFIs, but much remains to be learned about these linkages. about these linkages. (World Development Report 1990)(World Development Report 1990)

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Obstacles & LimitationsObstacles & Limitations

Development finance with longer gestation period, have significantly contributed to various development programmes. However, of late, DFIs role is fast changing.

DFIs are at cross - roads

“Project investments may see big fall in FY04: RBI: The Reserve Bank of India (RBI) has said that fixed capital investments by corporates could be much lower in ’03-04, with no large projects sanctioned in the last two years. Accordingly to a recent RBI study, aggregate capital expenditure on projects in the current year in unlikely to be anywhere close to the previous years figure of Rs. 37.154 crore”.

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Obstacles & Obstacles & LimitationsLimitations

Under-capitalised DFIs like in Latin America-Under-capitalised DFIs like in Latin America-Mexico. Private debt averages less than 15% of GDP. Large banks apathy encouraging small players to come

in like BBVA-Bancomer and Serfin-Santander in Mexico. Large banks in search of alternative channels for small Large banks in search of alternative channels for small

loans / development finance.loans / development finance. Innovative instruments like equity, promoters’ Innovative instruments like equity, promoters’

contribution, start-up loans, venture capital, R&D and contribution, start-up loans, venture capital, R&D and innovation finance, technology up-gradation, etc. are innovation finance, technology up-gradation, etc. are beyond reach and capacity of commercial banks system. beyond reach and capacity of commercial banks system.

Banks borrowing Banks borrowing Short Short can not lend can not lend Long Long (Asian (Asian Crisis)Crisis)

Bank finance to SMEs in Latin America (Argentina, Bank finance to SMEs in Latin America (Argentina, Brazil, Chile, Colombia, Mexico & Peru) during 1998-Brazil, Chile, Colombia, Mexico & Peru) during 1998-2002 indicates that large banks have neglected SMEs & 2002 indicates that large banks have neglected SMEs & development finance. development finance.

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AII-India Dev. Banks(IDBI, IFCI,ICICI,IIBI,IDFC,SIDBI)

Specialized Financial Institu(Exim Bank, & NABARD)

Investment Institutions(LIC,GIC,NIC,NIA,OIC,UII,UTI)

Others:(NEDFi, NSIC, KVIC,TFCI, ICICI Venture, IVCF)

State level Institutions-State Financial Corporations-SFCs- 18)

- State Industrial Development Corporations- SIDCs- 28)

-State Small Industries Development Corporations- SSIDCs-17)

-Technical Consultancy Organisations –TCOs-18)

Development Finance Matrix- INDIA -

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20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

Mar-90 Mar-95 Mar-00 Mar-02

Year

Amt (in Crs)

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%% of Tot. Credit

Amt(Crs) % of Tot. CreditSource : RBI Website

0

20000

40000

60000

80000

100000

120000

140000

Mar-90 Mar-95 Mar-00 Mar-02

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

LT Credit % to totalcreditSource: RBI website

-

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

180,000

Mar-90 Mar-95 Mar-00 Mar-02

Banks AIFI

Rs in crores

Source: RBI website

Long term loans by commercial banks Long term loans by AIFIs

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

Mar-90 Mar-95 Mar-00 Mar-02

Banks AIFI

Source: RBI website

Comparative Chart – in Rs cr Comparative Chart - in %

- INDIA -

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-40.0

-20.0

0.0

20.0

40.0

60.0

80.0

1991

-92

1992

-93

1993

-94

1994

-95

1995

-96

1996

-97

1997

-98

1998

-99

1999

-200

0

2000

-01

2001

-02

2002

-03

Bank + AIFIs Term Loan Growth rate IIP (Gen) Growth rate

-INDIA-Trend in Growth Rate of Banks & AIFIs Term

Loan & IIP

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Liberalised economic policy regime led to blurring of DFIs and commercial banks roles

Commercial banks now lend long term loans

Unhealthy competition to win the limited clients

Limited access to low-cost retail deposit

Difficulty in pricing lending products at competitive rates

Paucity and higher cost of resources made sustainability of viability difficult

Virtually term-loan dominated DFIs portfolio did not keep pace with the market changes & new demands

Common Problems of DFIs

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Specialised development financing channel for any developing economy is a Must

Whether “DFIs to Universal Banks” …. necessary?

International experiences have shown that suitable restructuring can give DFIs a Strong foot-hold

Major factor in survival of DFIs is the ‘Cost of Resources’ as compared to commercial banks :

Is Government / Central Bank ready to address this issue in favour of DFIs.or leave it to market forces..??

Answer is : Retain Local DFIs with ‘Levels playing field’

New Agenda for ‘FfD’

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Email: snpn@vsnl.net Web: www.cesmed.org

Thanks from

Chairman : Centre for SME Growth and Development Finance (Mumbai, India)Regional Adviser : SDC-CESMED South Asia-South East Asia

Multilateral Economic Co-operation Program.

Dr. Sailendra Narain

(Views expressed in this presentation are entirely personal)