role and relevance of development financial institutions

7/29/2019 Role and Relevance of Development Financial Institutions

1/53

Index

1. Executive summary 02

2. Introduction 04

3. Types of DFIs and their contribution 10

4. Sources and uses of funds DFIs 34

5. Discussion paper 37

6. Relevance today 44

7. Conclusion 54

8. Bibliography 56

1


2/53

Executive Summary

Development Banks or Development Finance Institutions (DFIs) were

set up in India at various points of time starting from the late 1940s to caterto the medium to long term financing requirements of industry as the capital

market in India had not developed sufficiently. The endorsement of planned

industrialisation at the national level provided the critical inducement for

establishment of DFIs at both All-India and state levels.

In order to perform their role, DFIs were extended funds in the form

of Long- Term Operations (LTO) Fund of the Reserve Bank and governmentguaranteed bonds, which constituted major sources of their funds. Funds

from these sources were not only available at concessional rates, but also on

a long term basis with their maturity period ranging from 10-15 years. On

the asset side, their operations were marked by near absence of competition.

Prior to reforms, DFIs operated in an over protected environment with

most of the funding coming form assured sources at concessional terms. In

the wake of financial sector reforms, the RBI started monitoring the

functioning of DFIs with a view to impart market orientation to their

operations. In tune with the emerging scenario, their access to low cost funds

of the RBI was discontinued.

On their part, DFIs took several steps to reposition themselves and

reorient their operations in the new competitive environment. They have

diversified their activities into new areas of business such as investment

banking, stock broking, custodial services and other fee and commissioned

business so as to harness the synergies and to reduce the risk arising out of

2


3/53

narrow specialization. As a result of all these factors, profitability of DFIs,

in general, improved significantly between 1993-1994 and 1997-1998.

Nevertheless, the business of DFIs has slowed down and their

operations have become less profitable. The committee on Banking Sector

Reforms (Chairman: Mr. Narasimham) 1998 recommended that DFIs

should, over a period of time, convert themselves into banks or NBFCs and

this conversion was endorsed by the Khan Working Group under the

chairmanship of Shri. S.H. Khan to bring about greater clarity in the

respective roles of banks and financial institutions for greater harmonization

of facilities and obligations.

The Reserve Bank in the discussion paper released in January 1999

indicated that DFIs should have the freedom to retain their status and

specialise in their own activities. However, if a DFI chooses to become a

bank, that option should also be available. In response to interest showed by

DFIs, the Reserve Bank issued guidelines setting out various operational and

regulatory parameters that need to be complied with by DFIs if they are to

become banks.

It is noteworthy that ICICI, one of the leading DFIs, has merged with

the ICICI Bank.

3


4/53

Introduction to Development Financial Institution (DFI)

Meaning:-

Development finance is a specialized sector of the financial industry,

and aims to bridge the gap between commercial investments and

government development aid. Development finance aims to invest in both

public and private-sector development projects. Whereas commercial banks

often serve as vehicles for companies to invest in low-risk projects; in

mature western economies development banks play a hugely important role

in servicing the investment needs in developing and transition of economies.

The financial support these banks bring to relatively high-risk projects

help to mobilize the involvement of private capital, bringing in such diverse

factors as commercial banks, investment funds or private businesses and

companies. In addition, development banks often act in co-operation with

governments and other organizations in providing funds for technical

assistance, feasibility studies, and management consultancy, as well as

serving as channels for policy implementation in the areas of responsible

governance, compliance with environmental regulations and good business

practices in relation to staff and the wider community.

Development Finance Institutions (DFIs) are specialized development

banks; majority of them owned by national governments. DFIs come in two

types: bilateral and multilateral. Bilateral DFIs serve to implement their

government's foreign development co-operation policy while multilateral

DFIs, also known as International Finance Institutions (IFIs), usually have

greater financing capacity and provide a forum for close co-operation. Both

types of institutions retain strong operational independence.

4


5/53

DFIs provide funds, either as equity participation, loans or guarantees,

to foreign or domestic investors. These investors will initiate or develop

projects in industry fields or countries which the traditional commercial

banks are reticent to invest in without some form of official involvement.

DFIs are equally fundamental in the SME sector (small and medium

enterprise) where micro loans, traditionally viewed as high-risk, form the

bulk of investment activity.

DFIs source their capital from national or international development

funds or benefit from government backing which ensures their credit-

worthiness. DFIs can thus raise large amounts of funds on the international

capital markets and provide loans or use equity on very competitive terms,

frequently on a par with commercial banks. Their efficiency and expertise

make them self-sustaining and even profitable, and consequently form an

extremely valuable bridge as public-private partnerships.

The investment activities of DFIs, which focus mainly on economic

performance and return on investment not only mark a departure from the

past in a bid to reduce dependence on development aid, but encourage the

entrepreneurial spirit of millions of individuals and companies worldwide on

both sides of the economic divide.

The DFIs played a very significant role in rapid industrialisation of the

Continental Europe and Japan. The success of these institutions provided

strong impetus for creation of DFIs in India after independence in the

context of the felt need for raising the investment rate.

5


6/53

Evolution:-

RBI was entrusted with the task of developing an appropriate financial

architecture through institution building so as to mobilise and direct

resources to preferred sectors as per the plan priorities. While the reach of

the banking system was expanded to mobilise resources and extend working

capital finance on an ever-increasing scale to different sectors of the

economy, DFIs were established mainly to cater to the demand for long-term

finance by the industrial sector.

Before independence the development finance was lacking. There was

no single institution providing long term industrial finance. Commercial

banks were providing short term credit only. In such a situation industrial

units managed their own resources or through managing agents. Industrial

Commission, 1918 recommended to set up industrial banks for long term

finance to Indian industries.

Central Banking Enquiry Committee, 1929 also recommended to setup specialized financial institutions to meet the long term finance

requirements of the industrial sector. But before independence no positive

efforts were made to set up such specialized banks.

The course of development of financial institutions and markets

during the post-Independence period was largely guided by the process of

planned development pursued in India with emphasis on mobilization ofsavings and channelizing investment to meet Plan priorities. At the time of

Independence in 1947, India had a fairly well-developed banking system.

The adoption of bank dominated financial development strategy was aimed

at meeting the sectoral credit needs, particularly of agriculture and industry.

6


7/53

Towards this end, the Reserve Bank concentrated on regulating and

developing mechanisms for institution building. The commercial banking

network was expanded to cater to the requirements of general banking and

for meeting the short-term working capital requirements of industry and

agriculture. Specialized development financial institutions (DFIs) such as

the IDBI, NABARD, NHB and SIDBI, etc., with majority ownership of the

Reserve Bank was set up to meet the long-term financing requirements of

industry and agriculture.

To facilitate the growth of these institutions, a mechanism to provide

concessional finance to these institutions was also put in place by the

Reserve Bank. The financial institutions in India were set up under the

strong control of both central and state Governments, and the Government

utilized these institutions for the achievements in planning and development

of the nation as a whole.

In India, the first urge for a more diversified financial intermediation

was witnessed in the 1980s and 1990s when banks were allowed to

undertake leasing, investment banking, mutual funds, factoring, hire

purchase activities through separate subsidiaries. The banks which were up

till now working under the most regulated environment could expand their

product menu by incorporating several financial services which also resulted

in supplementing their non-interest income.

By the mid-1990s, all restrictions on project financing were removed

and banks were allowed to undertake several activities in-house. The role of

DFIs as the sole source of long term project or infrastructure financing

started diminishing in this era as other cheaper sources of finance like

7


8/53

primary capital market, infusion of foreign capital and availability of foreign

debt at cheaper rate came to the rescue as a result of pragmatic liberalization

and deregulation strategies. A clear shift in delivery channels from bank

branches to ATMs, internet and telephone owing to technological

revolution increased banks reach and penetration.

In the late 1990s, the focus is on Development Financial Institutions,

which have been allowed to set up banking subsidiaries and to enter the

insurance business along with the banks. DFIs were also allowed to

undertake working capital financing and to raise short term funds within

limits. It was the Narasimhan Committee II report (1998) which suggested

that the DFIs should convert themselves into banks or non-bank financial

companies and this conversion was endorsed by the Khan Working Group

under the chairmanship of Shri. S.H. Khan to bring about greater clarity in

the respective roles of banks and financial institutions for greater

harmonization of facilities and obligations.

The working group submitted its report in May 1998. The Reserve

Banks Discussion Paper (January 1999) and the feedback there on indicated

the desirability of universal banking from point of view of efficiency of

resource use.

The mid-term review of monetary and credit policy, October 1999 and

the annual policy statements of April 2000, April 2001 enunciated the broad

approach to universal banking and the Reserve Banks circular of April 2001

set out operational & regulatory aspects of conversion of DFIs into universal

banks.

8


9/53

Types of DFIs and their contribution

9


10/53

ALL-INDIA FINANCIAL INSTITUTIONS:-

I. All-India Development Banks:

i) IDBI:

The Industrial Development Bank of India (IDBI) was established on

July 1, 1964 under an Act of Parliament as a wholly-owned subsidiary of the

Reserve Bank of India. In February 1976, the ownership of IDBI was

transferred to the Government of India and it was made the principal

financial institution for co-ordinating the activities of institutions engaged in

financing, promoting and developing industry in the country. Although

Government shareholding in the Bank came down below 100% following

IDBIs public issue in July 1995, the former continues to be the major

shareholder (current shareholding: 51.4%)

During the four decades of its existence, IDBI has been instrumental

not only in establishing a well-developed, diversified and efficient industrial

and institutional structure but also adding a qualitative dimension to the

process of industrial development in the country. IDBI has played a

pioneering role in fulfilling its mission of promoting industrial growth

through financing of medium and long-term projects, in consonance with

national plans and priorities.

Over the years, IDBI has enlarged its basket of products and services,

covering almost the entire spectrum of industrial activities, including

manufacturing and services. IDBI provides financial assistance, both in

rupee and foreign currencies, for green-field projects as also for expansion,

modernization and diversification purposes.

10


11/53

In the wake of financial sector reforms unveiled by the Government

since 1992, IDBI evolved an array of fund and fee-based services with a

view to providing an integrated solution to meet the entire gamut of financial

and corporate advisory requirements of its clients. IDBI also provides

indirect financial assistance by way of refinancing of loans extended by

State-level financial institutions and banks and by way of rediscounting of

bills of exchange arising out of sale of indigenous machinery on deferred

payment terms.

IDBI has played a pioneering role, particularly in the pre-reform era

(1964-91), in catalyzing broad-based industrial development in the country

in keeping with its Government-ordained development banking charter. In

pursuance of this mandate, IDBIs activities transcended the confines of pure

long-term lending to industry and encompassed, among others, balanced

industrial growth through development of backward areas, modernization of

specific industries, employment generation, entrepreneurship development

along with support services for creating a deep and vibrant domestic capitalmarket, including development of apposite institutional framework.

In September 2003, IDBI diversified its business domain further by

acquiring the entire shareholding of Tata Finance Limited in Tata Home

finance Ltd., signaling IDBIs foray into the retail finance sector. The fully-

owned housing finance subsidiary has since been renamed IDBI Home

finance Limited.

In view of the signal changes in the operating environment, following

initiation of reforms since the early nineties, Government of India has

decided to transform IDBI into a commercial bank without eschewing its

11


12/53

secular development finance obligations. The migration to the new business

model of commercial banking, with its gateway to low- cost current/savings

bank deposits, would help overcome most of the limitations of the current

business model of development finance while simultaneously enabling it to

diversify its client/ asset base. Towards this end, the IDB (Transfer of

Undertaking and Repeal) Act 2003 was passed by Parliament in December

2003. The Act provides for repeal of IDBI Act, corporatisation of IDBI

(with majority Government holding; current share: 51.4%) and

transformation into a commercial bank.

The provisions of the Act have come into force from July 2, 2004 in

terms of a Government Notification to this effect. The Notification

facilitated formation, incorporation and registration of Industrial

Development Bank of India Ltd. as a company under the Companies Act,

1956 and a deemed Banking Company under the Banking Regulation Act

1949 and helped in obtaining requisite regulatory and statutory clearances,

including those from RBI. IDBI would commence banking business inaccordance with the provisions of the new Act in addition to the business

being transacted under IDBI Act, 1964 from October 1, 2004, the

Appointed Date notified by the Central Government. IDBI has firmed up

the infrastructure, technology platform and re-orientation of its human

capital to achieve a smooth transition.

On July 29, 2004, the Board of Directors of IDBI and IDBI Bankaccorded in-principle approval to the merger of IDBI Bank with the

Industrial Development Bank of India Ltd. to be formed/incorporated under

the Companies Act, 1956 pursuant to the IDB (Transfer of Undertaking and

Repeal) Act, 2003 (53 of 2003), subject to the approval of shareholders and

12


13/53

other regulatory and statutory approvals. A mutually gainful proposition

with positive implication for all stakeholders and clients, the merger process

is expected to be completed during the current financial year ending March

31, 2005.

IDBI would continue to provide the extant products and services as

part of its development finance role even after its conversion into a banking

company. In addition, the new entity would also provide an array of

wholesale and retail banking products, designed to suit the specific

needs/cash-flow requirements of corporates and individuals. In particular,

IDBI would leverage the strong corporate relationships built up over the

years to offer customized and total financial solutions for all corporate

business needs, single-window appraisal for term loans and working capital

finance, strategic advisory and hand-holding support at the

implementation phase of projects, among others.

IDBIs transformation into a commercial bank would provide a

gateway to low-cost deposits like Current and Savings Bank Deposits. This

would have a positive impact on the Banks overall cost of funds and

facilitate lending at more competitive rates to its clients. The new entity

would offer various retail products, leveraging upon its existing relationship

with retail investors under its existing Suvidha/Flexibond schemes. In the

emerging scenario, the new IDBI hopes to realized its mission of positioning

itself as a one stop super-shop and most preferred brand for providing totalfinancial and banking solutions to corporates and individuals, capitalising on

its intimate knowledge of the Indian industry and client requirements and

large retail base on the liability side.

13


14/53

ii) IFCI Ltd:

IFCI Ltd., Indias first development finance institution, was set up in

1948 under the Industrial Finance Corporation Act as a statutory corporation

to pioneer institutional credit to medium and large-scale industries. The

constitution of IFCI was changed in May 1993 from a statutory corporation

to a company under the Companies Act, 1956 providing the institution with

greater flexibility to respond to the needs of the rapidly changing financial

system as also greater access to the capital markets.

IFCIs operations principally comprise project finance, financial

services and corporate advisory services. IFCI has, as part of its original

mandate as a DFI, been providing long-term financial support to all the

segments of the Indian industry. Over the years, IFCI contributed to

modernization of the Indian industry, export promotion, import substitution,

entrepreneurship development, pollution control, energy conservation as also

generation of both direct energy conservation as also generation of both

direct and indirect employment. Through its subsidiaries/associate

companies, IFCI provides custodial and investor services, rating and venture

capital services.

The paid up capital of IFCI was held directly by the Central

Government and the RBI. The holdings of the two concerns were transferred

to IDBI. The balance of the paid up capital is contributed by the Commercial

banks, Insurance organizations and Cooperative banks. It first made a public

issue of equity shares in December 1993. The authorized capital of the

company has now been increased to Rs. 1,500.00 crores. IFCIs cumulative

assistance sanctioned and disbursed up to end-March 2009 amounted to Rs

14


15/53

4014 crore and Rs.3311 crore respectively. Project financing being its major

activity, its contribution to industrial development is noteworthy. With cost

and time over-runs of projects, default in the repayment of its loans

increased resulting in an enormous increase in NPAs.

Recent industrial recession further added to its problems. Its

difficulties compounded after it ceased to get cheap finance from the

government. Its net NPAs as a percentage of net loans at the end of March

2001 was as high as 20.8. Its capital adequacy ratio came down from 11.6 in

1998 to 6.2 in 2001, which is a clear indication of its weak position as a

financial institution. It is believed that the solution to its problems lies in

converting it into a bank. But the present emphasis is on its restructuring to

restore its health.

The Expert Committee constituted to formulate a medium to long-

term strategic plan for IFCI had made wide-ranging recommendations in

structural and operational areas of IFCI such as future business strategies,

recapitalization, reduction of NPAs, improvement in recoveries and revamp

of HR policies. In the interim, the Government had also put into effect a

restructuring package designed to arrest further deterioration of its financial

health.

In order to achieve long-term viability, the Board of Directors of IFCI

has agreed, in principle, for a merger with Punjab National Bank. A due

diligence exercise, covering, inter alia, all assets, liabilities (including

contingent liabilities),legal aspects, share exchange ratio etc. is being carried

out based on which a final view will be taken on the merger. (current market

capital: 1665.8735 crores)

15


16/53

iii) ICICI Ltd. (the erstwhile DFI):

ICICI Ltd i.e. Industrial Credit and Investment Corporation of India

(merged with ICICI Bank on March 30, 2002), established on 5 th January

1955 by the government of India, World Bank and others was promoted as a

public limited company. It facilitated industrial development in line with the

economic objectives of the time. It evolved several new products to meet the

changing needs of the corporate sector.

ICICI provided a range of wholesale banking products and services,

including project finance, corporate finance, hybrid financial structures,

syndication services, treasury-based financial solutions, cash flow based

financial products, lease financing, equity financing, risk management tools

as well as advisory services.

It also played a facilitating role in consolidation in various sectors of

the Indian industry, by funding mergers and acquisitions. In the context of

the emerging competitive scenario in the financial sector, the Board ofDirectors of ICICI Ltd. and ICICI Bank Ltd., in October 2001, approved the

merger of ICICI Ltd. and two of its wholly-owned retail finance subsidiaries

with ICICI Bank Ltd. Consequent upon the merger, the ICICI Groups

financing and banking operations, both wholesale and retail, have been

integrated into a single full-service banking company, effective May2002.

The aim of the post merger was aggressive capital management,optimal size technology-intensive multi-channel delivery architecture world

class skill bases, and enduring customer bases. The post merger will bring

several advantages. ICICI itself gets access to cheaper retail funds. The

major thrust area is the international division. The international business is

16


17/53

to provide 10-15 percent of ICICI Banks turnover and profits in the

forthcoming five years. The international division will be setting up a

consultancy to provide services to banks and other financial sector players

internationally. The Indian economy requires large banks to cater to its

requirements.

The ICICI merger created a significant player. The merger is clearly a

reflection of the overdue consolidation the banking industry needs. The

concept of DFIs being converted into banks in the context of Indian banking

was possible only because of KWG and NCll recommendations. Mr. KV

Kamath (CEO ICICI Bank) was one of the honourable members of KWG.

He could be considered as the architect pioneering the evolvement and

application of the concept of Universal Banking in India as he headed the

process of reverse merger of ICICI (DFI) into ICICI Bank (CB wing of the

group) successfully.

iv) Industrial Investment Bank of India Ltd:

The Industrial Reconstruction Corporation of India Ltd., set up in

1971 for rehabilitation of sick industrial companies, was reconstituted as

Industrial Reconstruction Bank of India in 1985 under the IRBI Act, 1984.

With a view to converting the institution into a full-fledged development

financial institution, IRBI was incorporated under the Companies Act, 1956,

as Industrial Investment Bank of India Ltd. (IIBI) in March 1997.

IIBI offers a wide range of products and services, including term loan

assistance for project finance, short duration on-project asset-backed

financing, working capital/other short-term loans to companies, equity

17


18/53

subscription, asset credit, equipment finance as also investments in capital

market and money market instruments.

In view of certain structural and financial problems adversely

impacting its long-term viability, IIBI submitted a financial restructuring

proposal to the Government of India on July 25, 2003. IIBI has since

received certain directives from the Government of India, which, inter alia,

include restricting fresh lending to existing clients/approved cases/rated

corporate, restrictions on fresh borrowings, an action plan to reduce the

overhead expenditure, disposal of fixed assets and a time-bound plan for

asset recovery/reconstruction.

The Government of India has also given its approval for the merger of

IIBI with IDBI and the latter has already started the due diligence process.

v) IDFC:

The Infrastructure Development Finance Company Ltd. (IDFC),

incorporated in 1997, was conceived as a specialized institution to facilitate

the flow of private finance to commercially viable infrastructure projects

through innovative products and processes. Telecom, power, roads, ports,

railways, urban infrastructure and environment-friendly infrastructure

together with food and agriculture-related infrastructure constitute the

current areas of operation for IDFC. Besides, it assists the development of

urban water and sanitation sectors.

IDFC has also taken new initiatives in the areas of tourism, healthcare

and education. IDFC provides assistance by way of debt and equity support,

mezzanine structures and advisory services. It encourages banks to

18


19/53

participate in infrastructure projects through take-out financing for a

specific term and at a preferred risk profile, with IDFC taking out the

obligation after a specific period. Besides, IDFC, through its guarantee

structure, helps promoters raise resources from international markets.

IDFC is actively involved in the process of policy formulation of

Government of India relating to infrastructure sector. It has worked on

various strategic advisory assignments including conducting a National

Strategy Study for evolving a clean development mechanism in India. IDFC

actively assists Government and Government agencies, at both Central and

State levels, in developing contractual framework/structure for Public-

Private Partnership (PPP) for projects in specific areas of interest.

vi) Small Industries Development Bank of India:

The Small Industries Development Bank of India (SIDBI) set up in

1990 under an Act of Parliament (SIDBI Act, 1989) as a wholly-owned

subsidiary of IDBI, is the principal financial institution for promoting andfinancing development of industry in the small-scale sector as also for co-

ordinating the functions of institutions engaged in similar activities. SIDBI

commenced its operations in April1990 by taking over the outstanding

portfolio and activities of IDBI pertaining to the small-scale sector.

In pursuance of the SIDBI (Amendment) Act, 2000,79.46% of equity

shares of SIDBI subscribed and held by IDBI, have since beensold/transferred to select public sector banks, LIC, GIC and other institutions

owned or controlled by the Central Government. Consequently, IDBI

currently holds only 20.54% of equity shares of SIDBI.20. Since its

inception, SIDBIs assistance has encompassed the entire definitional ambit

19


20/53

of SSI sector, including the tiny, village and cottage industries through

suitable schemes tailored to meet the requirement of setting up of new

projects, expansion, diversification, modernization and rehabilitation of

existing units therein.

SIDBI offers refinance, bills rediscounting, lines of credit and

resource support mechanisms to route assistance to SSI sector through a

network of banks and State-level financial institutions.

II. Specialised Financial Institutions:

i) Export-Import Bank of India:

The Export-Import Bank of India (Exim Bank) was established as a

wholly Government-owned financial institution, under an Act of Parliament

in1982, by relocating IDBIs International Finance Division, for the purpose

of financing, facilitating and promoting Indias foreign trade. Exim Bank is

managed by a Board of Directors, which has representatives from the

Government, Reserve Bank of India, Export Credit Guarantee Corporation

(ECGC) of India, a financial institution, public sector banks, and the

business community.

Exim Bank offers a range of fund and non-fund based support to enhance the

export competitiveness of Indian companies.

Its major operations comprise financing projects, products and

services exports, building export competitiveness, promotional programmes

and financing research and development activities of exporting companies.

20


21/53

Exim Bank provides information, advisory and support services to enable

exporters to evaluate international risks, exploit export opportunities and

improve their competitiveness. It assists Indian companies in identifying

technology suppliers, partners and in consummation of domestic and

overseas joint ventures.

It also provides market-driven export-financing solutions for small

and medium sized Indian exporters. Exim Bank made an entry into financing

of the entertainment industry which has a huge export potential and also

forayed into financing of the healthcare service sector.

The Bank's functions are segmented into several operating groups including:

Corporate Banking Group which handles a variety of financing

programmes for Export Oriented Units (EOUs), Importers, and

overseas investment by Indian companies.

Project Finance / Trade Finance Group handles the entire range of

export credit services such as supplier's credit, pre-shipment credit,

buyer's credit, finance for export of projects & consultancy services,

guarantees, etc.

Lines of Credit Group Lines of Credit (LOC) is a financing

mechanism that provides a safe mode of non-recourse financing

option to Indian exporters, especially to SMEs, and serves as an

effective market entry tool.

Agri Business Group, to spearhead the initiative to promote and

support Agri-exports. The Group handles projects and export

transactions in the agricultural sector for financing.

21


22/53

Small and Medium Enterprises Group to the specific financing

requirements of export oriented SMEs. The group handles credit

proposals from SMEs under various lending programmes of the

Bank.

Export Services Group offers variety of advisory and value-added

information services aimed at investment promotion.

Fee based Export Marketing Services Bank offers assistance to Indian

companies, to enable them establish their products in overseas

markets.

Besides these, the Support Services groups, which include: Research

& Planning, Corporate Finance, Loan Recovery, Internal Audit,

Management Information Services, Information Technology, Legal,

Human Resources Management and Corporate Affairs.

ii) Tourism Finance Corporation of India Ltd:

In pursuance to the recommendations of National Committee on

Tourism set up by Planning Commission in 1989, Tourism Finance

Corporation of India Ltd. (TFCI) was sponsored by All-India

Financial/Investment Institutions and Banks as a specialised financial

institution to cater to the needs of the tourism industry so as to ensure

requisite priority in funding tourism-related projects. TFCI was incorporated

as a public limited company in January 1989.

It provides assistance in the form of rupee loans, underwriting and

direct subscription to shares/debentures, and equipment leasing and foreign

22


23/53

loan guarantee for setting up and/or development of tourism-related

facilities, activities and services. Apart from conventional tourism projects

in the accommodation and hospitality segments, TFCI also finances non-

conventional tourism projects like restaurants, highway facilities, travel

agencies, amusement parks, dolphinaria, multiplexes, ropeways, car rental

services, ferries for inland water transport, airport facilitation centres, air

taxis and training institutes for hotel personnel.

III. Investment Institutions:

i)Life Insurance Corporation of India:

The nationalization of insurance business in the country resulted in the

establishment of Life Insurance Corporation of India (LIC) in 1956 as a

wholly-owned corporation of the Government of India. The broad objectives

of LIC are to serve people through financial security by providing productsand services of aspired attributes with particularly, in the rural areas and to

the socially and economically backward classes.

LIC currently offers over 50 plants cover life at various stages through

a network of 2048 branches, all of which are fully computerized. LIC has

installed information kiosks at select locations for dissemination of

information on its products as also for accepting premium payments. It hasalso installed Interactive Voice Response Systems in 59 urban centers,

enabling its customers to get select information about their policies.

23


24/53

With a view to widening its reach in the prevalent competitive and

deregulated business environment, and following the internationally

prevalent banc assurance model, LIC issues Corporate Agency licenses to

several public and private sector banks in India for marketing its policies to

corporate houses through their combined branch network.

Besides conducting insurance business, LIC, in pursuance of

Government guidelines, invests a major portion of its funds in Central and

State Government securities and other approved securities, including special

deposits with Government of India. In addition, LIC extends assistance to

develop. Infrastructure facilities like housing, rural electrification, water

supply and sewerage and provides financial assistance to the corporate

sector by way of term loans, underwriting of and direct subscription to

shares and debentures. LIC also provides resource support to financial

institutions through subscription to their shares/bonds and by way of term

loans.

ii) General Insurance Corporation of India:

The General Insurance Corporation of India (GIC) was formed and

registered on January 1, 1973 under the Insurance Act, 1938, in accordance

with the provisions of the General Insurance Business (Nationalization) Act,

1972. The Corporation was formed as a holding company, with four

subsidiary companies (now de-linked) viz. National Insurance Company

Ltd., New India Assurance Company Ltd., Oriental Insurance Company Ltd.

and United India Insurance Company Ltd.

GIC, along with its erstwhile subsidiaries, was operating number of

need based insurance schemes to meet the diverse and emerging needs of

24


25/53

various segments of society and was providing financial assistance to

industrial projects by way of term loans, short-term loans and direct

subscription to shares/debentures of new and existing industrial enterprises.

GICs supervisory role over its erstwhile subsidiaries was

extinguished by an administrative order and it was re-designated as the

Indian Reinsurer in 2000 by an Act of Parliament to function exclusively

as Life and non-Life Re-insurer. Subsequently, in pursuance of the General

Insurance Business (Nationalizations) Amendment Act, 2002, which became

effective from March 2002, GIC ceased to be a holding company of its

subsidiaries and their ownership was vested with Government of India.

As Indian Reinsurer, GIC provides reinsurance capacity on a treaty

and facultative basis for risks ranging from the simple to the most complex.

GIC is steadily increasing its presence in foreign countries through strategic

business tie-up with insurance and reinsurance companies in South-East

Asia, Middle East and Africa. The Corporation is also maintaining its focus

on the Indian market, capitalising on its core competence and inherent

strengths therein.

iii) National Insurance Company Ltd:

The National Insurance Company Ltd. (NIC), incorporated in 1906,

was nationalized in 1973 following the amalgamation of 22 foreign and 11

Indian insurance companies. Besides catering to the average insurance

requirements of all sections of society, NIC provides customized and

innovative insurance solutions through a wide array of products. Taking

25


26/53

advantage of the newly liberalized Indian market, NIC is taking several

initiatives in the areas of distribution channels, product development,

training, HRD and IT enabled business process improvement.

To increase penetration in the mass market, NIC has gone for tie-ups

with banks, auto manufacturers, corporate houses, State governments, co-

operatives, NGOs and other agencies. It has also introduced the system of

Extension Counters to reach insurance service to remote rural areas. Besides,

NIC offers financial assistance to the corporate sector by way of term loans,

direct subscription to shares, bonds and debentures, commercial papers, etc.

It also contributes to national development by lending funds for

infrastructure projects of the Government. Apart from domestic insurance

business, NIC also undertakes reinsurance and overseas operations.

iv) The New India Assurance Company Ltd:

The New India Assurance Company Ltd. (NIA), incorporated in 1919,

was nationalized in1973. As Indias leading general insurance company forover three decades, NIA has a pioneering presence in the Indian Insurance

sector on various fronts, right from insuring Indias first domestic airlines to

the entire satellite insurance programme the country.

It also undertakes aviation insurance, handles hull insurance

requirements of the Indian shipping fleet and deals with engineering sector-

Related insurance. Having commenced its overseas operations in 1920, NIA,the largest non-life insurer in Afro-Asia, excluding Japan, presently operates

in several countries, including Japan, UK, Middle East, Fiji and Australia.

26


27/53

Its international networked spread over 23 countries with 32 offices.

Further, the company provides global reinsurance facilities. NIA also

provides financial assistance to the corporate sector by way of term loans,

underwriting and direct subscription to shares, debentures and bonds. NIA

has been rated A (Excellent), for the fifth consecutive year, by the

international insurance rating company, A M Best Co. on the basis of its

financial strength. This rating reflects its excellent capital position, status of

the company in domestic insurance sector and returns from investment

portfolio of the company.

v) The Oriental Insurance Company Ltd:

The Oriental Insurance Company Ltd. (OIC), established in 1947, was

nationalised in 1973. In 2003, the entire shareholding of the company,

hitherto held by GIC, was transferred to the Central Government. OIC

transacts all kinds of non-life insurance business ranging from insurance

covers for very big projects to the smallest insurance needs in rural areas.

OIC offers special covers for large projects like power plants, petro-

chemical, steel and chemical plants and has devised special innovative

covers such as stock-brokers policies and special package policies. It has a

large domestic and overseas network in Nepal, Kuwait and Dubai. OIC

provides financial assistance to the corporate sector mainly by way of term

loans and subscription to shares, debentures and bonds.

vi) United India Insurance Company Ltd:

The United India Insurance Company Ltd. (UII) was formed in 1973

following the merger of 22 private insurance companies. UII currently offers

27


28/53

a bouquet of insurance products, which can be customised to meet specific

insurance needs, with fire, marine, motor and miscellaneous insurance

comprising its core competence areas. UII has undertaken risk cover for

several mega projects in the country.

Besides, UII provides assistance to the corporate sector by way of

term loans and subscription to shares/bonds. UII has taken several strategic

initiatives to face the emerging challenges in the competitive and liberalised

non-life insurance sector, including strategic partnerships with a number of

Indian banks for marketing UIIs products under the banc assurance model.

More strategic tie-ups are planned with automobile dealers, travel

agents, panchayats, co-operative banks, NGOs and self-help groups in order

to tap rural and personal insurances.UII had a market share of 22% amongst

PSU insurers as on March 31, 2004. UII occupies the top slot in energy and

power sector insurance business for which it has strategically positioned

itself by offering specialist covers.

vii) Unit Trust of India (reorganized effective Feb 1, 2003):

The Unit Trust of India (UTI), the largest mutual fund organization in

India, was set up in1964 by an Act of Parliament. It was established to fulfill

the objectives of mobilizing retail savings, investing them in the capital

market and passing on the benefits accrued from the acquisition, holding,

management and disposal of securities to the small investors.

Apart from equity, debt and balanced schemes, UTI managed schemes

aimed at meeting specific needs like low-cost insurance cover, regular

income and liquidity needs and building up funds to meet the cost of

28


29/53

childrens higher education. UTI also set up a number of associate

companies in the field of banking, securities trading, etc.

With the repeal of UTI Act, 1963, UTI has been re-organized into two

separate institutions effective February 1, 2003, viz. Administrator of the

specified undertaking of the Unit Trust of India(popularly known as UTI-I),

comprising US-64 and all other assured return schemes, and UTI Mutual

Fund (UTIMF), which houses all the net asset value-based schemes of UTI.

While UTI-I is headed by an administrator and is governed by an Advisory

Board, UTIMF is modeled on the norms of SEBI, with sponsors, a trustee

company & an asset management company, to manage its affairs.

IV.Refinance institutions:

i) National Bank for Agriculture and Rural Development:

The National Bank for Agriculture and Rural Development

(NABARD), established in 1982 under an Act of Parliament, is the apex

development bank for promotion and development of agriculture, small-

scale industries, cottage and village industries, handicrafts and other rural

crafts and other allied economic activities in rural areas.

NABARD extends credit support by way of refinance to eligible

institutions such as State Co-operative Agriculture and Rural Development

Banks (SCARDBs), State Co-operative Banks (SCBs), Commercial Banks

(CBs), Regional Rural Banks (RRBs) and Scheduled Primary (Urban) Co-

operative Banks (PCBs) for farm as well as non-farm sectors (NFS).

29


30/53

NABARD provides long-term investment credit to the farm sector for

various approved agricultural and allied activities.

Medium-term and short-term credit facilities are extended to SCBs

and RRBs for approved agricultural purposes and for financing seasonal

agricultural operations, respectively. Short-term refinance facilities under

NFS are provided for meeting working capital requirements of primary/

apex weavers co-operative societies, industrial co-operative societies and

rural artisan members of Primary Agricultural Credit Societies (PACS) for

pursuing various production, procurement and marketing activities.

NABARD also extends refinance to banks for financing various

government-sponsored programmes and for development of non-

conventional energy sources.

NABARD, along with LIC, NSE, ICICI Bank, PNB and CRISIL,

floated the National Commodity and Derivatives Exchange Ltd. (NCDEX)

aiming to cover most of the commodities under the Open General License

category. As a stakeholder, NABARD would facilitate the integration of

agriculture credit, securitization of agricultural produce and futures markets

and capacity building of State/district-level marketing co-operatives.

Further, the Government of India has designated NABARD as a nodal

agency for operationalising Lok Nayak Jai Prakash Narayan Fund of Rs.

50,000crore being created to enhance efficiency, productivity and

profitability of Indian agriculture through development of agriculture and

rural infrastructure and the credit delivery mechanism.

The amendments to NABARD Act in 2001classified NABARD as a

Development Bank and permitted NABARD to enhance its capital, subject

30


31/53

to minimum holding of 51% by the Government of India and RBI. The

amendments also imparted NABARD flexibility in resource mobilization,

credit-delivery and in setting up of subsidiaries.

Sources & Uses of Funds DFIs

The following balance sheet presented in the percentage form belongs

to the consolidated position for FY03-04 of major DFIs like IDBI, IFCI,

IDFC, SIDBI, NABARD, NHB, IIBI, TFCI, EXIM Bank.

Liabilities (total: 100) Assets (total: 100): -

Capital 03 Cash 08

Reserves 10 Investments 16

Bonds & Deb 50 Loans & adv 67

Deposits 10 Bills Dis/Redis 01

Borrowings 12 Fixed & other Assets 08

Other liabilities 15

]

31


32/53

Sources of Funds: -

1) Capital & Reserves

Unlike other CBs the reliance of DFIs has been mainly on the

government to feed them with capital. Though many of the DFIs listed

above have approached the capital market in recent past to meet their long

term funds requirement, the response has not been very encouraging.

Further, the listed scrips have not shown any appreciable capital gain

for the investors and hence their future chances of approaching the primary

market for their long term needs are remote.

Though position of reserves seems satisfactory overall, some of the DFIs

have a miserable picture on this account and some, which are a specialised

DFIs like EXIM bank, have suitable reserves.

2) Bonds & Debentures / Deposits / Borrowings

The sources of funds from all these are for medium and long term

basis. The bonds and debentures are necessarily for the long term and

Deposits & Borrowings are for medium term. The DFIs face a very critical

problem in case of long term funds. If interest rates falling, which they have

been so far, servicing the long term funds at the cost which is much higher

than the market rate becomes the big issue especially when the debt can be

off loaded with premature payment.

32


33/53

Uses of Funds: -

1) Cash & Investments

The application of funds in the shape of investments is not only for

the investments in the market to book profits but investments in the project

lending in the shape of direct participation or venture capital.

This is the critical part of the uses of funds for DFIs as the returns on

the direct participation in projects in the shape of equity are not forthcoming

in the short term. Besides that the role of the DFIs is as such that they may

not off load their stake in the project just to book profits as they undertake

the promotion and developmental role.

2) Loans & Advances / Bills Discounted & Rediscounted

The 2/3 of the Asset side is constituted by this major component of

application of funds. The obvious role of the DFIs is to encourage

investment in the infrastructural development on long term basis. The

challenge for the DFIs is two fold in this respect.

One is to ensure that the project assessment is such that the projects

get completed and turn viable. The other is that in the falling interest rate

scenario, the project finance can come from other cheaper sources while the

cost of funds available by the DFIs could be higher. Thus the dependence on

DFIs gets reduced.

33


34/53

DISCUSSION PAPER

(Released in January 1999 by governor of RBI Shri Y V Reddy)

The discussion paper was released in the presence of Mr.

Narasimham, the Bhishma Pitamaha of financial sector in India. In fact, the

Discussion Paper of the Reserve Bank of India (RBI) on "Harmonising the

Role and Operations of Development Financial Institutions and Banking"

(DP) relies heavily on the report of the Committee on Banking Sector

Reforms or Narasimham Committee (NC). In fact, if the Discussion Paper

(DP), does not appear to say much that is new, the fault entirely lies with,NC. After all, NC left little that was unsaid on the subject for Discussion

paper to make an impact!

The DP was released in January 1999 and was discussed almost

simultaneously as one of the subjects in a Seminar on Financial Markets and

Institutions: Development and Reforms organised by the Society for Capital

Market Research and Development. This was followed up by two seminars.

The first was organised jointly by the Industrial Development Bank of India

(IDBI) and Industrial Credit and Investment Corporation of India (ICICI) in

Mumbai. The second was organised jointly by the Federation of Chambers

of Commerce and Industry, and Industrial Finance Corporation of India at

New Delhi in March 1999.

RBI considers the meeting in the Administrative Staff College of

India (ASCI), as the finale, with a gathering of almost all the luminaries of

financial world. It would be possible in that seminar to come to definitive

conclusions and arrive at consensus on future actions. Indeed, that was the

purpose of this seminar, being the last in the series.

34


35/53

In the Key Note address, Shri Y V Reddy started with some

clarifications on the DP, in the light of discussions so far. This was followed

by a narration of consensus arrived at so far on some issues and, of issues

that are yet to be resolved. Some of the recent developments, international

and domestic, may necessitate looking beyond DP, especially on linkage

between banking and insurance.

Clarification

At the outset, it was necessary to be clear about focus of DP; what it sets

out to cover, so that expectations are appropriate. The main focus of the

Discussion Paper was to rationalise and harmonise the relative roles of

banks and DFIs in future. Draft proposals in the DP address this issue

keeping in view both the general approach to universal banking which has a

primary regulatory dimension, and the long-term capital needs of the

corporate sector which has a primary developmental dimension. Hence, DP

should be considered in a slightly different, though related, context from

immediate measures to solve the problems faced by Development Financial

Institutions (DFIs), in raising long-term resources at reasonable cost in lieu

of concessional resources that were available to them till the reform process

began.

In fact, improved access to short-term resources through the

traditional banking route helps diversify DFIs business but would not

necessarily add to the long-term resource base. The problems faced by

the DFIs now or in the immediate future do require attention but their

conversion into universal bank, by itself is neither a necessary nor a

sufficient option to overcome the difficulties.

35


36/53

There are no legal or regulatory restrictions on adoption of universal

banking in India. There are, however, prudential requirements as also

entry conditions applicable to all banks and DFIs could certainly do

banking business if they satisfy them. However, for DFIs, there are

two practical impediments viz., (a) backlog of liabilities in a DFI on

which reserve requirements have not been provided; and (b) the

relatively high reserve requirements, particularly Cash Reserve Ratio

(CRR).

Needless to say, once the CRR is brought down by RBI from about 10

per cent to, say the statutory minimum of three per cent, or even less

in the banking system, DFIs would find it less cumbersome to satisfy

the preconditions for becoming universal bank. RBI is committed to

bring down CRR, and the pace would depend on fiscal and monetary

conditions. Thus, DFIs should find it easier to move towards universal

banking in future, as reserve requirements are brought down.

On the issue of reserve requirement on stock of liabilities of DFIs, a

view is expressed that such reserve requirements be applied only on

incremental liabilities. The suggestion would appeal as a good

bureaucratic solution for a DFI problem, but one should pause and

consider its acceptability as a defensible and true prudential measure.

The real solution is to bring down the reserve requirements across the

board.

There is a further suggestion that reserve requirements should be

applicable only to cash and cash like liabilities in respect of banks. In

other words, the reserve requirements are to be linked to the maturity

36


37/53

profile of liabilities. This could operate in a way that would make it

easier for DFIs to become universal banks. This suggestion has large

systemic implications and validity as a prudential measure needs to e

looked at.

RBI can only indicate appropriate regulatory regime for universal

banking, but would it be proper for RBI to impose a decision or insist

on a time table for a DFI to become universal bank? The move

towards universal banking, the pace and mix of services will be

dictated by consumer demands and the response of concerned bank or

DFI. RBI can only put in place an appropriate regulatory framework

that enables rather than inhibits such a move, while ensuring

consistency with monetary policy and prudential standards.

On the status of DFIs, for purposes of regulation, a formal legally

tenable and clearly identifiable regulatory framework of RBI is

available basically for banks and for non-bank financial companies.

DFIs as a category are still loosely defined as indicated in DP and are

in a way an amalgam of State/Central level, company/corporate

forms, with different extents and degrees of public sector ownership

and performing refinance, direct finance and other functions. The DP

had given an approach to bring them under a transparent framework

as suggested by NC.

37


38/53

Consensus and Issues

It may be useful to recall major elements of the architecture of the

financial system for the future envisaged in the Discussion Paper and

identify the consensus as well as unresolved issues as evident from the

discussions held so far.

The approach to universal banking is generally endorsed, there are

differences among the participants on the pace, and sequencing. Some

felt that the DPs indication of five years was too long, while others

felt that DFIs need to continue as specialised institutions longer. Yet

another view was that RBI was too flexible and a uniform framework

and rigid timetable was preferred to flexible, case-by-case approach

advocated in the DP.

There was also a view that the consumers would drive the movement

to universal banking, but regulators have to enable such pressures to

operate, maintaining prudential standards and systemic stability.Enabling framework is to be timed and sequenced. Incidentally, a few

questioned the desirability of allowing 100 per cent DFI owned

banking subsidiary as a backdoor entry to banking. Perhaps, more

detailed discussion on these with special reference to role of the RBI

would be useful.

Some expressed that DFIs need to continue as DFIs and indeed shouldbe accorded special support, while a few felt that DFIs operations

themselves are hindering the development of corporate debt market.

There were extreme views also that the demise of DFIs is imminent

and the issue is rebirth. There was some sort of agreement that there

38


39/53

should be in future, only banks and NBFCs, but the issue is how DFIs

will transit to one of the two categories and how are they to be treated

and regulated by the RBI till a transition occurs. There is some

reluctance among some participants to DFIs becoming "mere

NBFCs".

The issue then is what they should be, under what category of

appropriate regulation by the RBI or by any other appropriate

regulator. Further, if DFI opts to continue indefinitely as DFI, would it

then be an NBFC, and if so, under a separate or an existing category.

Mr. Khan, in a recent discussion paper on Corporate Governance

mentioned that the financial institutions should be brought fully under

the regulatory and supervisory ambit of the RBI. He adds that the

RBI/Department of Supervision needs to devise suitable tools/norms

for financial institutions regulation/supervision consistent with the

nature of their operations.

There was a general agreement that banks are special for a country

like India. As and when DFI chooses to become a bank, the transition

path in terms of availability of access to public deposits on par with

banks vis--vis reserve requirements.

Though there was no detailed discussion, there appears to be consent

in favour of consolidated approach to supervision and regulation. The

dangers of universal banks being big, and risks of failure of big

universal banks, if regulation is inadequate, were touched upon. A few

felt that real focus should be on asset-liability management than on

39


40/53

business. There was a clear divergence of opinion on super regulator,

though discussion was somewhat limited.

RBI has expressed itself in favour of relinquishing its ownership roles

in respect of financial intermediaries, but, Government has to take a

view and this would need legislative action. A strong view was

expressed that RBI should itself divest its shareholding to market

rather than transfer its share to Government.

The institutions concerned have not yet indicated formal initiatives

towards harmonisation such as constituting a coordination committee.

These could be further reviewed.

Relevance Today

DFIs will continue to be relevant and important in pursuing

Government policy goals for strategic, social and economic development.

Towards achieving these goals, the role of DFIs needs to be clearly

mandated to ensure such institutions stay focused on their core activities to

complement rather than compete with existing banking institutions.

DFIs are key players for the provision of long-term capital fordevelopment projects for infrastructure, for stimulating industrial

development and value-adding, promoting entrepreneurship and private

sector development, trade finance, capital markets development through

facilitating privatization of state-owned assets, technological advancement,

40


41/53

financing of agricultural development, microfinance and gender credit and

support.

It is envisaged that DFIs would continue to progress and assume a

significant role in addressing the development strategies of the nation by

complementing the established banking institutions to meet financing

requirements of the changing economy. The DFIs would continue to provide

financing to promote the industrial sector, the services sector and the

modernization of the agricultural sector, thus providing support to the

development of these sectors. The DFIs would also continue to maintain

their role as niche providers of capital financing for projects which require

medium to long-term financing in the industrial, manufacturing, services and

agricultural sectors.

The DFIs should complement the existing banking institutions

effectively, in providing financial services to those activities not serviced by

the banking institutions. As development institutions, DFIs should continue

to meet the socioeconomic and developmental goals set by the Government.

As financial intermediaries, the DFIs should not be involved in sectors that

have matured and are able to obtain financing on their own from the banking

system or the capital market.

DFIs should complement the banking sector through extension of

credit in sectors which banking institutions are not equipped with the

expertise to appraise, including projects involving complex industrial and

agricultural technology and also in projects requiring longer term funding

which are not normally provided by the banking institutions.

41


42/53

As specialized institutions, the DFIs should enhance their range of

facilities through product and service innovation to sustain growth in the

specialized areas. Emphasis should also be given in providing value-added

advisory, consultancy and technical assistance supported by strong research

capabilities.

The DFIs operational capabilities and capacities need to be further

strengthened and improved by formulating comprehensive policies and

operational procedures in line with the organizational objectives. In order for

DFIs to successfully meet their objectives, Government support and

effective coordination among relevant ministries is essential. The

coordination and strong rapport with the relevant ministries can be achieved

through adopting a consultative approach to facilitate coordination and

communication among the regulatory and supervisory authority, the

Government, the DFIs and industry experts through regular meetings and

consultation to ensure smooth transmission and implementation of

Government policies. This consultation process can promote coordinationamong Government agencies for the effective policy development and

implementation by the DFIs.

The DFIs would continue to have a special role in the Indian financial

system, until the debt market demonstrates substantial improvements in

terms of liquidity and depth, any DFI, which wishes to do so, should have

the option to transform into bank (which it can exercise), provided theprudential norms as applicable to banks are fully satisfied. To this end, a

DFI would need to prepare a transition path in order to fully comply with the

regulatory requirement of a bank. The DFI concerned may consult RBI for

42


43/53

such transition arrangements. Reserve Bank will consider such requests on a

case by case basis.

The regulatory framework of RBI in respect of DFIs would need to be

strengthened if they are given greater access to short-term resources for

meeting their financing requirements, which is necessary. In due course, and

in the light of evolution of the financial system, Narasimham Committees

recommendation that, ultimately there should be only banks and restructured

NBFCs can be operationalised.

They are engaged in financing of sectors of economy where the risks

involved are beyond the acceptance limits of commercial banks. Also, DFIs

are mainly engaged in providing long-term assistance. DFIs generally meet

the credit needs of riskier but socially and economically desirable objectives

of the State Policy. The DFIs played a very significant role in rapid

industrialization of the Continental Europe and Japan. The success of these

institutions provided strong impetus for creation of DFIs in India after

independence in the context of the felt need for raising the investment rate.

In regard to DFIs, the basic approach of the WG is that the DFIs being

non-banks are functionally more akin to NBFCs than banks and, therefore,

should, as a general rule, be subject to the general principles of NBFC

guidelines. However, it is also recognized that the dominant theme of NBFC

guidelines is to protect the depositors interest and to ensure the viability of

the NBFCs for the purpose.

In the case of DFIs, It is observed that most of these DFIs either do

not accept public deposits or where they do so, the public deposits constitute

a very small proportion of their total liabilities / resources. As such, seen

43


44/53

solely from the viewpoint of protecting depositors interest, these DFIs as a

group may not give rise to RBIs regulatory or supervisory concerns.

However, on account of large-scale borrowings being resorted to by

these DFIs by way of bonds issued, from domestic banks, Provident Funds,

Insurance Companies, Trusts and general public, failure of any of the larger

DFIs could have adverse effect on the entire financial system. The regulation

of these DFIs should, therefore, be so designed as to ensure that the

regulatory framework along with the committed Government support

available to the DFI works towards ensuring their financial soundness so

that the overall systemic stability is not endangered.

That in the pre-reform period, DFIs faced little competition in the area

of long-term finance as funds were available to them at cheaper rates from

multilateral and bilateral agencies duly guaranteed by the Government. The

reforms in the financial sector have changed the operational environment for

the DFIs. Along with the changed operating environment for banks in a

globalised scenario, the regulatory framework for FIs has undergone a

significant change.

While on the supply side, the access of DFIs to low-cost funds has

been withdrawn, on the demand front, they have to compete with banks for

long-term lending. Out of nine select all India financial institutions being

regulated and supervised by the Reserve Bank at present, three institutions,

viz., NABARD, NHB and SIDBI extend indirect financial assistance by way

of refinance. The financial health of these three institutions is sound as their

exposures are to other financial intermediaries, which in certain cases are

also supported by State Government guarantees. Of the remaining six

44


45/53

institutions, two niche players, viz., EXIM Bank and IDFC Ltd. are also

healthy. The remaining four institutions that have been operating as

providers of direct assistance are all in poor financial health.

The Government support to DFIs, in the meanwhile, was also waning

either for fiscal reasons or in favour of building market efficiency.

Therefore, towards the end of twentieth century the heydays of DFIs were

over and they started moving into oblivion. In several economies, having

attained their developmental goals, the DFIs were either restructured or

repositioned or they just faded away from scene. The Indian experience has

also more or less traversed the same path. Although India cannot said to

have achieved the developmental goals yet, the Government's fiscal

imperatives and market dynamics has forced a reappraisal of the policies and

strategy with regard to the role of DFIs in the system.

It has been studied that the evolution of DFIs in India in the post

independence period as well as elsewhere in the world and the effects of the

developments in financial sector on these institutions during the same

period. The experience gained in conversion of one of the DFIs into a bank

and the useful lessons learnt from such conversion have been captured for

future reference. Thus, 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.

45


46/53

DFIs may also play a large role in stimulating equity and debt markets

by:-

(i) Selling their own stocks and bonds;

(ii) Helping the assisted enterprises float or place their securities

(iii) Selling from their own portfolio of investments.

India has, historically, followed a financial intermediation-based

system where banks, DFIs and other intermediaries have played a dominant

role. However, in recent years resources are increasingly being mobilized

through capital markets (both debt and equity). The information available in

regard to the resources mobilized by the real sector and summarized in Table

2, clearly indicates a conspicuous enhancement of the role of capital

markets (debt and equity) in allocation of resources to the real sector during

the 1990s, as compared to the earlier two decades.

46


47/53

Table 2: Sources of Resource Mobilization

(Per cent of GDP)

Period

1971 to 1992 1992 to 2000

A. Credit by banks and DFIs 3.9 4.3

B.Resources mobilized from Capital

Market (Debt and Equity)*0.6 1.7

It was recognized that though the DFIs would continue to have a

special role in Indian financial system, until the debt market demonstrated

substantial improvement in terms of liquidity and depth, any DFI which

wished to transform into a bank should have the option, provided the

prudential norms applicable to the banks were fully satisfied. To this end, a

DFI would need to prepare a transition path; in order to fully comply with

the regulatory requirements of a bank and, therefore, the DFIs were advised

to consult RBI for such transition arrangements, which the RBI would

consider on a case-to-case basis.

The need for strengthening the regulatory framework of RBI inrespect of DFIs, if they were to be given greater access to short-term

resources for meeting their financing requirements, was recognized. It was

expected that in the light of the evolution of the financial system, the

Narasimham Committees recommendations that ultimately there should

47


48/53

only be banks and restructured NBFCs could be operationalised.

Historically, low-cost funds were made available to DFIs to ensure that the

spread on their lending operations did not come under pressure. DFIs had

access to soft window of Long Term Operation (LTO) funds from RBI at

concessional rates.

They also had access to cheap funds from multilateral and bilateral

agencies duly guaranteed by the Government. They were also allowed to

issue bonds, which qualified for SLR investment by banks. For deployment

of funds, they faced little competition as the banking system mainly

concentrated on working capital finance. With initiation of financial sector

reforms, the operating environment for DFIs changed substantially.

The supply of low-cost funds was withdrawn forcing DFIs to raise

resources at market-related rates. On the other hand, they had to face

competition in the areas of term-finance from banks offering lower rates.

The change in operating environment coupled with high accumulation of

non-performing assets due to a combination of factors caused serious stress

to the financial position of term-lending institutions.

With the change in the operating environment, the supply of low cost

funds has dried up for the DFIs forcing them to raise resources at market

related rates. The DFIs are unable to withstand the competition from banks

due to their higher cost of funds. DFIs are 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 is almost entirely composed of long-term high risk

48


49/53

project finance and consequently the viability of their business model has

come under strain.

In a purely market-driven situation, 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 high risk credit to fund

capital formation of long gestation is unlikely to succeed on account of

threat to its spread from higher cost of funds and higher propensity to

accumulate non-performing assets, notwithstanding lower operating

expenses vis--vis banks.

DFIs are, therefore, crucially dependent for their continued existence

on Government commitment for support. As support from the government

has a social cost, Central Government need to decide, after a detailed social

cost-benefit analysis, on the areas of activities which require developmental

financing and only those DFIs which the Central Government decide to

support may continue as DFIs. The rest of the DFIs must convert to either a

bank or a regular NBFC as recommended by the Narasimhan Committee

and should be subject to full rigor of RBI regulations as applicable to the

respective category.

Further, no DFI should be established in future without the Central

Government support.

Development financing is a risky business. It involves financing of

industrial and infrastructure projects which usually have long gestation

period. The long tenor of such loans has associated with it uncertainty as to

performance of the loan asset. The repayment of the long term project loans

is dependent on the performance of the project and cash flows arising from it

49


50/53

rather than the reliability of the collaterals. The project could go wrong for a

variety of reasons, such as, technological obsolescence, market competition,

change of Government policies, natural calamities, poor management skills,

poor infrastructure etc.

DFIs were established with the Government support for underwriting

their losses as also the commitment for making available low cost resources

for lending at a lower rate of interest than that demanded by the market for

risky projects. This arrangement worked well in the initial years of

development.

As the infrastructure building and industrialization got underway the

financial system moved higher on the learning curve and acquired

information and skills necessary for appraisal of long term projects. It also

developed appetite for risk associated with such projects. The intermediaries

like banks and bond markets became sophisticated in risk management

techniques and wanted a piece of the pie in the long term project financing.

These intermediaries also had certain distinct advantages over the traditional

DFIs such as low cost of funds and benefit of diversification of loan

portfolios.

50


51/53

Conclusion

In short, DFIs were set up with specific objective of meeting the

medium to term requirement of funds. However DFIs in the present form arefinding it difficult to sustain their operations. Their business has slowed

down and their operations have become less profitable. This has raised

issues relating to the viability of DFIs. It is not clear, however whether the

perceived viability emanates from the structural constraints under which

they operate or simply from the legacy of the past.

In the present institutional infrastructure, DFIs will continue to have aniche carved out for them. Therefore DFIs should have the freedom to

remain DFIs, specializing in their own activities. However if a DFI chooses

to become a bank, venturing into commercial banking activities, that option

should also be available.

A committee as recommended by Khan Working Group could be

formed as a voluntary and purposeful self regulatory organization. It may

also be formal or ad-hoc as warranted by circumstances. The decision to

form such a committee or revamp existing arrangements should also be left

with banks and DFIs. The RBI should be available to actively interact with

such a committee without being intrusive or diluting its role as a regulator

and supervisor.

A single regulatory agency would not only supervise to ensure the

safety and soundness of the DFIs but also needs to be in a position to assess

the extent to which the DFIs have met the objectives for which the

institutions were established as well as the economic implications of the

DFIs activities.

51


52/53

Development and evolution of specialized DFIs dedicated to financing

infrastructure projects, agriculture sector, capital intensive and high-

technology industries and the services sector. DFIs should continue to

progress and assume a significant role in addressing the development

strategies of the nation by complementing the established banking

institutions to meet financing requirements of the changing economy.

Given the unique position of DFIs in relation to term-lending at this

stage, it is desirable that they remain engaged in term-lending activity even

as they diversify into new opportunities opened to them by progressive de-

segmentation of the sector.

52


53/53

BIBLIOGRAPHY

Reference Books:

Indian Financial system H.R Machiraju

Banking Developments in India 1947-2007 growth, reforms &

outlook Niti Bhasin

Banking & finance perspective on reforms

B.S.Sreekantaradhya

Reference Websites:

www.business-standard.com/banking

www.rbi.org.in

www.idbibank.com

www.newstodaynet.com

www.brickworkratings.com

Reference Magazines:

The Journal of Indian Institute of Banking and Finance October

December 2006
http://www.rbi.org.in/http://www.idbibank.com/http://www.newstodaynet.com/http://www.brickworkratings.com/http://www.rbi.org.in/http://www.idbibank.com/http://www.newstodaynet.com/http://www.brickworkratings.com/

role and relevance of development financial institutions

Documents