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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
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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
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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.
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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.
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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.
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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.
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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
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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.
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Types of DFIs and their contribution
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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.
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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
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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
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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.
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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
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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)
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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
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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
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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
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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
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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.
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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.
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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
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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.
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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
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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
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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.
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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
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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
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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).
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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
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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
]
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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.
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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.
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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.
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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.
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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
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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.
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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
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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
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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,
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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.
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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
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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
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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
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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.
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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.
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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
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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
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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
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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.
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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.
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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.
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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/