ARE DEVELOPMENT FINANCIAL INSTITUTIONS ON THE ROAD TO RECOVERY ? BY GURDIP SINGH

In the post independence era, the government set up the Industrial Finance Corporation of India in 1948 to finance development finance especially in the industrial sector. Since then a number of Development Financial Institutions (DFI) have been promoted by the government to cater to the diversified and multi dimensional needs of economic growth. These financial institutions (FIs) make available finance to those sectors of the economy to which commercial banks provide only part of the finance. These institutions handle the problem of long terms financing. Broadly speaking these institutions are known as Development Banks.

There are separate development institutions for agriculture, industry, investment and small scale industry. In recent years, a number of public sector mutual funds set up by banks and financial institutions have been added to the institutional framework. However, development banks and financial institutions of late have acquired disrepute because of the misgivings on account of large bailouts given to prominent financial institutions. There can be no disagreement that better management of DFIs is required to minimize the level of Non-Performing Assets (NPAs). Besides, the assistance they provide needs to undergo a change periodically as economic development proceeds and financial sector evolves. The argument, however, being put forward by some experts that they have lost relevance is not tenable.
The government has recently taken some steps to tone up these DFIs. Moreover, the upturn in the economy bids well as far as disbursements and sanctions are concerned as well as their performance. The recent economic slowdown took a toll on some leading financial institutions, with the quantum of loans disbursed by Industrial Investment Bank of India (IDBI), Industrial Finance Corporation of India Limited (IFCI) and Industrial Investment Bank of India (IIBI) registering a steep decline.

Operational performance of DFIs in general had come under strain in recent years due to a combination of factors. The slackening of the pace of investment compounded by depressed business sentiments and sluggish capital market conditions led to decline in demand for assistance for traditional industries and a smaller flow of applications for fresh assistance. Paucity of equity capital led to delays in completion of several projects. These factors led to a decline in the level of annual sanctions and disbursements of DFIs. However, in the case of Small Industries Development Bank of India (SIDBI) and Export Import Bank of India (EXIM) disbursements have recorded good growth during the last three years.

The advances of ICICI Bank as on March, 2003 registered an increase of 11.72 percent over the previous year (2001-2002). The lending by the Mumbai based Industrial Development Bank of India came down to Rs.3,924 crores in 2002-2003 from Rs.11,151 crore in 2001-2002 and Rs.17,474 crores in 2000-2001. In the case of Delhi based IFCI, the disbursements were Rs.1,792.81 crore in 2002-2003. In the year 2001-2002 they were of the order of Rs.1,078.75 crores and Rs.2,144.65 crore in 2000-2001.

The EXIM bank’s lending improved to Rs.5,320.3 crore in 2002-2003 from Rs.3,452 crore in 2001-2002 and Rs.1,896.4 crore in 2000-2001. This is largely accounted for by increase in exports.

SIDBI’s lending was to the tune of Rs.6,789 crore in 2002-2003 from Rs.5,919 crore in 2001-2002 and Rs.6,441 crore in 2000-2001. ICICI Bank’s lending was Rs.20,555 crore in 2001-2002 as compared to Rs.31,665 crore in 2000-2001. ICICI Bank is a banking company incorporated under the Banking Regulations Act, 1949. The erstwhile ICICI Limited, a financial institution, has merged with ICICI Bank w.e.f. May 03, 2002, the appointed date for the merger being March 30, 2002. The figures pertaining to erstwhile ICICI are provided only upto December 31, 2001.

The Kolkata based IIBI’s lending fell to Rs.51.52 crore in 2002-2003 from Rs.283 crore in 2001-2002 and Rs.644.20 crore in 2000-2001. Government sources cite several reasons for revival of disbursements in the current fiscal by the DFIs. Macro economic initiatives in general and the thrust on infrastructure are expected to improve the investment climate. The government has also introduced several enabling measures for improving the situation arising out of growing incidence of NPAs through strengthening of Debt Recovery Tribunals, introduction of Corporate Debt, Restructuring Mechanism, enactment of Securitisation and Reconstruction of Financial assets and Enforcement of Security Interest Act, 2002 and the setting up of Asset Reconstruction Companies (ARCs). ICICI having merged with ICICI Bank would get advantage of lower cost of borrowing in the form of savings and current deposits. As regards IDBI, a Bill has been ntroduced to corporatise and vest it with the banking licence.

RBI has also issued circulars to Financial Institutions and Banks to enter into non-discretionary mechanism for recovery of NPAs in all sectors through compromise settlements under One Time Settlement Scheme (OTS) which is expected to clean up bad debt. Two events in recent times signalled in some way, the end of an era. ICICI was merged with ICICI Bank and Rs.2000 crore government support was extended to the largest financial institution of the country, IDBI. While the first marked the re-birth of ICICI as a new age private bank, the second was a more open acknowledgement of the fact that stand-alone DFI is not a viable business model.

There is little doubt that some of the DFIs are now grappling for survival. The problem with all the three FIs - IFCI, IDBI and IIBI - is mounting non-performing assets which have eroded their capital.

Interestingly, there is no uniform solution since each FI s is unique. IDBI is a statutory body and suffered the most political inteference while IIBI, initially formed to restructure bad loans, subsequently were converted into a DFI. However, the case of IFCI was similar to that of ICICI, both the FIs were governed by the Companies Act with the large portion of shares held by government owned institutions.

ICICI foresaw the inviability of the DFI model. Being in the private sector, the institution had the flexibility to plan its transition path towards becoming a bank. IIBI’s concerns are similar to IFCI - a large part of the borrowing is by way of private placement with high net worth individuals or banks. The FI is unable to lend due to inadequate capital and high NPAs. The environment in which DFIs operate has undergone a sea change. DFIs are no longer the sole providers of project finance. Already banks are offering all the products and facilities that a DFI can offer. The average term loan portfolio of public sector banks is close to 30 percent of their advances.

The Finance Ministry has ruled out a merger between IFCI and IDBI. Sources in the banking circles say that merger of IDBI Bank and IIBI Act is repealed and the FI is corporatised. The Union Cabinet has already approved the conversion of IDBI into a universal bank which will also continue development financing. It, however, took no decision on the proposed merger of IDBI with IIBI.


In the case of IFCI, the government has written off loans worth over Rs.1,500 crore to improve its financial condition. While the government pins its hopes on economic revival and the steps it has taken to improve their performance, it is important to examine the relevance of DFIs in the present day context.

Despite substantial progress in the field of industrialisation, India’s achievements are well below the level of developed countries and even Asian countries. There is need for further development of the industrial base. It is thus obvious that the objective with which DFIs were set up is yet to be fully attained. The importance of the FIs in fact has increased with the opening up of the economy and increasing competition faced by Indian industries. Large initial capital is necessary to start an industrial company.

A key factor that will determine the growth potential of the economy is investment in infrastructure sector. According to a Construction Industry Development (CIDC) report, nearly 4-9 billion dollars need to invested in infrastructure projects over the next decade to attain 7 to 8 percent GDP growth. For reasons of lumpiness of investment, long gestation periods and divergence of private and social marginal returns, the government has a critical role to play in the infrastructure sector. Removing the existence of infrastructure constraints, requires large investments by Central and State Governments and private investors in these sectors. Given their experience in financing, Greenfield projects with long gestation periods, DFIs can play a major role in financing such projects.

Corporates in India are able to generate only a minor portion (25 to 35 percent) of their total fund requirements (short and long term) internally. The rest has to come from external sources. Major external sources of debt finance are FIs, commercial banks, foreign financial markets, loans from collaborators or JV partners and market borrowing through commercial papers, fixed deposits and debentures. Although foreign borrowings constitute an important source of corporate borrowings, it is, however, the large companies that have access to this source. This has declined during the 1990s, partly due to the exchange rates, risks involved and as a result of the steady weakening of the rupee.

Over time, the importance of equity capital (excluding preference capital) in financing project costs has surged, while that of internal resources (retained earnings) has come down. Although the importance of loan capital (from external sources) has come down, it still contributes to more that 43 percent of the total funds required for financing projects. The three major FIs (IFCI, IDBI and ICICI) have contributed significantly in providing loan for financing projects, although their share has come down during the 1990s, mostly because of the problems faced by them in the post reform period. The share of banks has also increased in the second half of the 1990s due to their entry in the area of long term financing.

The relative contributions of other FIs (SIDCs, SFCs, UTI, LIC and GIC) too have come down over the years. The rapid increase in the share of loans from promoters, directors and their friends indicates that the promoters are depending more on personal means to fund their projects. While this may partly reflect the increasing stand taken by banking and FIs to ensure that promoters bring in some matching funds, at a macro level it reflects a virtual reversal of the process of development wherein personal financing is increasingly substituted for institutional and market sourced funds.

Given the high debt equity ratio in infrastructure, manufacturing and other sectors like telecom, the role of DFIs in future development of the country cannot be undermined. What is required is their early restructuring and strict adherence to corporate governance norms.

The author is Special Correspondent, UNI

Courtesy : KaleidoScope