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Where Are the DFIs?

February 28, 2004

859

WEEKLYECONOMIC

AND POLITICAL

Financial sector reform in India has often followeda convoluted path one step forward, two stepsbackward. Nowhere is this more evident than in

the context of the development finance institutions (DFIs).Even as the governments actions as reflected in the

withdrawal of concessional long-term funds from theRBI to FIs and approval of ICICIs reverse merger withits offspring ICICI Bank seem to suggest the growingirrelevance of DFIs, its words have often been to thecontrary.

The most recent instance of this schizophrenic attitudeto financial sector reform came during the financeminister, Jaswant Singhs speech while presenting hisinterim budget. There is no alternative to developmentfinance said the FM, adding that steps to revive IDBIand restructure Industrial Finance Corporation of India(IFCI) are already in hand. He then dashed whatever

hopes votaries of reform may have had of IDBI toobreaking free of its shackles by stating that IDBI wouldretain its role as the lead DFI even after its Act had beenamended to allow it to do banking business.

His words are bound to have come as music to theears of corporate leaders who, just a few weeks ago,had banded together under the FICCI banner to complainto the prime minister about the lack of low-cost, long-term funding from banks/FIs. Their grouse is not thatthey do not have access to funds. But rather that theydo not have the kind of access to low-cost funds thatthey had in the 1970s and 1980s, the heydays of de-

velopment finance. Clearly, corporates which havelong been pampered with no-questions-asked cheapinstitutional finance, find it hard to come to terms withthe new ground realities where rates of interest aredetermined by the riskiness of the loan rather than thepedigree and the networking ability of the corporate.

But does that mean they have the FMs sympathies?It would seem so. On paper at least the FM seems tohave conceded the need for DFIs. But whether this willtranslate into anything more concrete or whether thisis just another instance of clever manoeuvring by the

minister remains to be seen. Agreed he has said IDBIwill play the role of the lead DFI but surely he is awarethat, for all practical purposes, there are no DFIs for IDBIto lead?

Consider ICICI, which once vied with IDBI to attain

top slot in sanctions and disbursements, has quietly shedits FI status and merged with its offspring, ICICI Bank.From being a major term-lender in 2001-02, it ac-counted for more than 50 per cent of the disbursementsof all FIs today it is vying with HDFC Bank to becomethe top dispenser of retail loans! Thats how far it hasshifted from its original mandate. IFCI, the oldest of theDFIs, is tottering on its last legs and would have goneunder but for government compelling the public sectorPNB to throw a lifeline. The former Industrial Recon-struction Bank of India (IRBI), now IIBI, is beyondredemption, much like the city where it is headquartered

and perhaps partly because of it.So what does that leave us with? With minor players

like Infrastructure Development Finance Corporation(IDFC), an institution that was set up with much fanfare,but is yet to live up to its promise, preferring insteadto limit itself to the more attractive task of bringing outglossy reports? With the Small Industries DevelopmentBank of India (SIDBI), an offshoot of IDBI meant tocater exclusively to SSI units. And of course, with amotley collection of relatively small sectoral players likeExim Bank, Tourism Finance Corporation, NABARD,National Housing Bank, Power Finance Corporation and

so on. With the exception of SIDBI, the quantum lentby these institutions is minuscule. Some like NABARDand NHB are only refinancing agencies.

The idea of a lead DFI is, therefore, meaningless. Thereare no players left in the field to lead. But thats arelatively minor point. What is far more crucial is whetherthere is a place at all for DFIs in the emerging milieu.

The answer is an emphatic no. For a number of reasons.DFIs were established to address a specific need in aspecific milieu: shortage of long-term investments andthe perceived risk-aversion of savers and creditors. Today

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not only is that need far less acute, but with the market forlong-term contractual savings like pensions and insuranceopening up, the supply of long-term funds is also likely tobe enough to take care of whatever need there is.

Moreover, as the experience of countries like South Korea,Japan, Germany, China as well as India has shown, there isa huge cost that society pays for this. Witness the repeatedinfusions of capital into both IDBI and IFCI over the past

few years, all of which has come out of taxpayer money.Project financing, once the core activity of DFIs is no longertheir exclusive preserve. With financial sector liberalisation,banks too have started extending long-term loans. Accordingto the RBIs latestReport on Trends and Progress in Banking,commercial bank lending to infrastructure stood at Rs 26,880crore in 2002-03. Sure, banks are constrained by the fact thattheir deposits are mostly short-term while project loans arelong-term. But that has never deterred banks from investing inlong-term assets. If it were so, they would never have investedin government securities in such a big way. Indeed what sets asuccessful bank apart from an unsuccessful one is how skilfulit is in creating and managing asset-liability mismatches.

Last but not the least, we now have a vibrant capital market.And though it is true the debt market is not as developed assay the equity market, today even medium-sized corporatescan access global markets. The governments latest policyannouncement allows corporates to borrow up to $ 500 millionabroad without prior approval. Unlike in the past, FIs nolonger have access to cheap finance from, say, sources likethe RBIs Long-Term Operations Fund.

Clearly, therefore, there is no case for DFIs in todaysmilieu. The sooner the government and corporates realise thatthe better for all concerned, especially for taxpayers.