FINANCIAL SECTOR REFORMS

FINANCIAL SECTOR REFORMS AND THE ROLE OF DEVELOPMENT BANKING IN THE SMALL AND MEDIUM SECTOR

By
UDAY SANKAR MAJUMDAR ^*

INTRODUCTION

Financial sector is the backbone of any economy and it plays a crucial role in the mobilisation and allocation of resources. The constituents of the financial sector are Banks, Financial Institutions, Instruments and markets which mobilise the resources from the surplus sector and channelise the same to the different needy sectors in the economy. The process of increasing capital accumulation through institutionalisation of savings and investment fosters economic growth. The main objectives of the financial sector reforms are to allocate the resources efficiently, increasing the return on investment and accelerated growth of the real sectors in the economy. The measures initiated by the Government of India under the reform process are meant to increase the operational efficiency of each of the constituent of the financial sector. The discussion of the present text has been restricted to the role of the development banks in the era of reforms.

ROLE OF DEVELOPMENT BANKING

Traditionally, commercial banks were the main source of finance during the pre-independence era. After Independence, the Government of India announced the Industrial Policy in 1948 with a view to build a sound industrial base and a strong village and small industry sector. The enactment of the State Financial Corporation Act in 1951 and the consequent establishment of the different development banks acted as a positive step to ensure balanced growth of industry throughout the country. The development banks supply capital, knowledge and enterprise, the three major ingredients of development, for business enterprises. These enterprises in turn by augmenting their productivity can help the nation to develop rapidly. These institutions extend longterm finance to the small and medium scale units under different schemes and their lending operations are supplemented with promotional and developmental activities to facilitate entrepreneurship. The development banks are of two types; namely, the all India level institutions like IFCI, ICICI, IDBI, SIDBI, NSIC and the State Level Institutions like the State Financial Corporations (SFCs), State Industrial Development Corporations (SIDCs) and the State Industrial Investment Corporations (SIICs).

The all India level financial institutions like IFCI, IDBI, ICICI extend financial assistance to the medium and large sectors whereas institutions like SIDBI and the NSIC cater to the need of the Small Scale Industry (SSI) sector. The State level institutions provide financial support to the small and the medium sectors. Besides the lending, these corporations act as the implementing agency of the various government sponsored schemes in order to ensure a fair distribution of wealth. The total value of the financial assets of SFCs over the years is about Rs. 10,999 crores (upto 1996-97) which is quite encouraging.

PERFORMANCE OF THE SMALL AND MEDIUM SCALE SECTOR

The Small and the Medium sector in India covers a wide spectrum of industries ranging from small, tiny and cottage segments to modern production units with significant investments. These sectors account for around 98% of the industrial units in India and contribute 65% of the output in the manufacturing sector. It has generated employment opportunities to an estimated 22 million persons in the country. The criterion for defining an industry as SSI or Medium Scale Industry (MSI) depends on the investment limit which is fixed by the government from time to time. This sector has acquired a prominent place in the socio-economic development of the country as it not only acts as a ‘nursery’ for the development of the entrepreneurial talent, but also produces a wide range of products. Industrial policies relating to the SSI sector in India were hitherto largely based on policy measures of a protective nature such as reservation, fiscal concession and preferential procurement by the government etc. The concession granted to the medium sector is comparatively less as the investment limit of this type of units are higher and also the entrepreneurship skill of the promoter are assumed to be better. The overall industrial growth of the Indian industries during the period 1989-90 is 7.2% and 6.5% during the period 1997-98. The lower growth after the liberalisation indicates that the industries are yet to avail of the benefit of liberalisation. The average growth of the Small and Medium sector during the period 1998-99 was 7%, whereas the overall industrial growth was only 5%.

It has been observed that the average growth of the Small and Medium sectors is higher than the overall industrial growth of the country in the consecutive years. It is expected that these sectors will act as prime mover in realising not only the estimated industrial growth but also in giving a boost to the overall economic growth in the years to come.

IMPACT ON THE REFORM MEASURES

The broader objectives of the financial sector reform process are to formulate the policy for improving the financial health and to strengthen the institutions. As part of the reforms process many private banks were granted licence to operate in India. This has resulted into a competitive environment in the banking industry which in turn has helped in using the resources more efficiently. Traditionally the industrial units were sanctioned term loan by the development banks and working capital by the commercial banks. The reform process has changed the pattern of financing and now both the institutions are willing to extend long term loan as well as working capital loan. But there is some difference in the mode of operation. This has enabled the industrial units to avail credit facilities from a single institution. Despite the fact that the banks provide both the term loan and the working capital loans, the industrial units prefer the development banks for the following reasons.

It provides equal support to the new as well as existing industries.
The period of repayment of loan is comparatively longer.
Besides providing financial assistance, it acts as the implementing agency for the different government sponsored schemes. Hence the industrial units can avail of both the financial assistance as well as the incentives offered under various development schemes through a Single Window System.
As lending is the prime activity of these institutions, it acquires specialisation in this field and can share its expertise with the industrial units.

As part of the reform process the Central as well as the State Governments have devised various schemes for the development of suitable infrastructure to encourage the growth of SSIs and MSIs. The programme for the establishment of industrial estates was started in the year 1955, which envisages the acquisition of land and construction of factory sheds etc. The establishment of the Export Processing Zones (EPZ) at various parts of the country and the special incentives offered to these units undertaking operation therein came as a boon to the government. The financial sector reform witnessed the reorganisation of different development banks like abolition of cross holding by the different financial institutions and the delinking of ownership of SIDBI from IDBI. The reform process has also stressed the need of applying the prudential norms on the developmental banks which were hitherto exempted from the same. This will improve the health of the development banks and dependence on the government will be reduced. But considering the social objective of these institutions, it is felt that the application of stringent norms may vitiate the very purpose of the objective.

FUTURE ROLE OF THE DEVELOPMENT BANKING

In the context of the emerging scenario of liberalisation and the financial sector reforms the development banks need to gear themselves to meet the varied requirements of the small and medium scale sector. They need to create new product that are relevant and impactful. In the new economic scenario, the role of technology has emerged as a strategic variable influencing manufacturing systems of the industrial units who need to reorient their strategies to meet the challenges of the competition. With the upward revision of the investment ceiling, much potential has now been created for technological upgradation and the vertical integration of the industrial units so as to derive advantage from economies of scale.

The liberalisation regime has also opened the doors for a large number of entrepreneurs to embark upon the setting up of venture with innovative technologies and their commercial applications with a high risk high return profile, which requires assistance through the venture capital route. Many development banks have, therefore, taken steps to provide sector specific Venture Capital funds to the small and the medium sectors. Various State Governments have already launched the Venture Capital fund scheme for the targetted sectors.

Another thrust area of the development bank is the marketing finance which hitherto the promoters had to bear. Marketing is the crucial area in the present competitive market and the development banks need to help the industrial units to market their product and/or encourage entrepreneurs to develop the common marketing infrastructure.

It has been suggested by the different industry associations to extend the merchant banking services to the small and medium scale units which hitherto were available mainly for the large scale units.

CONCLUSION

The economic reforms have favoured the need for shifting the policy objective from protection to promotion of industries and the creation of more integrated infrastructural facilities. The employment potential of the SSIs and MSIs is also a pointer to the government to take adequate steps to ensure a smooth start of these units. Among them, the timely and adequate availability of credit is the crucial one, and the development banks have a major role to ensure the same. As the banks are generally unwilling to extend credit facilities at the initial stage of an industrial unit, the major portion of the financial assistance of the development banks are availed by the new unit/ new generation entrepreneur at liberal terms. Hitherto, the social objectives acted as the backdrop of the major policies of the development banks and hence the profit earning motive was treated secondary. This has adversely affected the financial health of the development banks as there is always an inherent risk of failure lies in the financing the new units/new generation entrepreneur. The reform process has suggested for the restructuring of the development banks and making them abide by the prudential norms, but the same is difficult to achieve as the social objectives and the prudential banking cannot go hand in hand. Hence, steps should be taken to ensure the smoother flow of funds to these development banks who in turn will channelise the same to the needy sectors of the society in order to foster balanced economic growth.

* Uday Sankar Majumdar, Officer (F), Tamilnadu Industrial Investment Corporation, Chennai (This Essay has been awarded second prize in the Essay Competition under the aegis of ‘COSIDICI COURIER’)