The State Financial Corporations Act (SFCs Act) was enacted by Parliament in 1951 to set up the institutional framework for financing medium and small scale industries in the states. The State Financial Corporations were set up in the states in 50s and early 60s with the objective of promoting economic growth, balanced regional development and widening of entrepreneurial base by financing small and medium enterprises. The State Financial Corporations have been functioning for the last more than four decades in the country. The SFCs Act had been under constant review and based upon the recommendations of several working Groups/Committees set up from time to time, the SFCs Act was amended on ten occasions; the last one being in 1985, to effect amendments in the Act to meet the emerging  requirements of industrial growth in the country. The economic reforms and liberalization introduced in the country in 1991 resulting in deregulation of the financial sector, had warranted large-scale amendments to the SFCs Act so that the SFCs could respond to the emerging business environment.  Keeping in view the emerging situation emanating from financial sector reforms, COSIDICI had been making strenuous  efforts to project the problems faced by SFCs to the Govt. of India and had been suggesting large-scale amendments to the SFCs Act to do away with restrictive provisions so that the SFCs could play a level playing field with commercial banks and other financial institutions. It was at the initiative of COSIDICI that a High Level Committee under the Chairmanship of the then CMD of IDBI Shri S. H. Khan, was constituted in October, 1993, to undertake a comprehensive review of the SFCs Act, 1951, and suggest amendments to the Act ibid. Two representatives of COSIDICI were nominated on the said Committee. The Committee had submitted its report to the Ministry of Finance, Govt. of India, through IDBI in June, 1994, for further follow-up. The Govt. of India, Ministry of Finance, had taken almost six years to process the recommendations of the above Committee and carry out desired amendments to the SFCs Act.

Impact of Amended Act on SFCs:

2. The inordinate delay on the part of the Govt. of India to carry out the desired amendments in the SFCs Act, 1951, to bring it in tune with the changing business environment had adversely affected the working of SFCs. As a result of de-regulation of the financial sector and gradual move towards universal banking, the traditional turf of SFCs in financing SSIs had been usurped by commercial banks and other financial institutions and SFCs were facing acute competition from these institutions. The SFCs were  placed at a most disadvantageous position vis-a-vis commercial banks and other financial institutions in as-much-as while the SFCs had to function within the bounds of SFCs Act which was highly restrictive in character, the commercial banks and other financial institutions were functioning with greater autonomy and operational flexibility. Therefore, during the past 8 years, when the process of liberalization and financial sector reforms were introduced, the working and financial position of SFCs registered a steep fall because of its inability to compete with commercial banks and other financial institutions. COSIDICI has all along been pleading with the Government during the course of its discussions on various occasions to bring reforms to the SFCs Act to enable them to enjoy a level-playing field vis-a-vis commercial banks and other financial institutions. It was also emphasized that there was an imperative need to remove restrictive provisions in the SFCs Act so that the SFCs may be able to enjoy operational flexibility and functional autonomy.

3. The amendments carried out in the SFCs Act,  by the Government will certainly have a positive impact on the functioning of SFCs. The most important amendments relate to widening and broad-basing the definition of ‘industry’ and ‘enlarging the scope of activities of SFCs’. The SFCs will have a very wide spectrum of field for diversifying their loan portfolio and will have more avenues for investment. Further, restructuring of capital base of SFCs, removal of restrictions in mobilizing resources from the market, borrowings from other institutions and accepting deposits from general public, will go a long way in enabling SFCs to mobilize adequate resources to meet their business commitments. The steep rise in the authorised share capital of SFCs from Rs. 50 crores (Rs. 100 crores) to Rs. 500 crores (Rs. 1,000 corers) and provision to allow general public/individuals to hold equity in SFC to the extent  of 49% of the total share capital and allocation of shares to commercial banks, LIC, other financial institutions owned by Central Government and other institutions owned by Central or State Governments is a very significant step to broad-base the share-holding pattern of the SFC. This step, if implemented in letter and spirit will facilitate recapitalisation of SFCs to the extent needed for strengthening their bottom-line. Another redeeming feature of these amendments is steep hike in the limit of accommodation to an industrial concern. The limit up to which SFC can provide finance to an  industrial  concern  has been  increased to  Rs. 5   crores  and   Rs. 2 crores, which can go up to Rs. 20 crores and Rs. 8 crores with the prior approval of SIDBI. The SFCs under the new dispensation will now be able to meet the genuine credit requirements of their borrowing constituents. It will be observed that in so far as operational flexibility is concerned, the amendments largely meet the expectations of the SFCs, although the SFCs, despite these relaxations, will still find it difficult to enjoy a level-playing field with commercial banks and other financial institutions.

4. The most disquieting feature of the amendments is the near status-quo relating to the management of SFCs. No doubt, the composition of the Board of Directors has been changed and to some extent it has been broad-based with the inclusion of representatives of individual shareholders to a prescribed extent. While the part-time Chairman of the SFC will be nominated by SIDBI in consultation with the State Government, the Managing Director of SFC, who will be in overall command of the affairs of the Corporation, will continue to be appointed by the State Government in consultation with SIDBI. The management and day-to-day control of the affairs of the corporation, for all intents and purposes, will continue to vest with the State Government, as hitherto. In this connection, it is relevant to reproduce the observations of the Khan Working Group on Harmonizing the Role and Operations of DFIs and Banks and Kapur Committee on Credit to SSIs (1998):

“A thorough revamp of the management structure and an infusion of professionalism into the operations of the SLIs, which is imperative for their sustainable turnaround.”

“The chief executives of SLIs, who are usually serving IAS officers, are appointed by the State Government.  It has been the practice of most of the State Governments to change the chief executives frequently resulting in lack of continuity at the top management level. With a view to fostering professionalism and efficiency, the CEOs of the SLIs should ideally be a professional/technocrat and be appointed by the Board and shareholders for a fixed term to whom he should be accountable for his performance.”

6. Revival of Weak SFCs–Recapitalization and financial restructuring:

The financial health of State Financial Corporations has been steadily deteriorating during the past one decade, particularly after the introduction of liberalization and financial sector reforms in the country. Their overall operations have shown a declining trend and their sanctions and disbursements have recorded a negative growth. Most of these Corporations have been afflicted with heavy non-performing assets and overdues, which have, in large number of cases, knocked off their owned funds and reduced their net-worth to negative. In this connection, select financial data regarding working of SFCs as on 31st March, 1999, is furnished below :

(Rs. in crore)
 

7. Although there is an absolute need for undertaking financial restructuring of all the SFC, for the purpose  of recapitalization, however, we have classified the  SFCs into three categories, viz., (a)  SFCs, which are doing well and comply with minimum capital adequacy ratio, viz., DFC, GSFC and KFC, (b) SFCs where capital adequacy ratio is below 8% - HFC, KSFC, RFC, TIIC and WBFC. In the remaining 10  SFCs, the financial position of AFC, BSFC, OSFC and PFC, was, indeed, critical and need special measures for re-vitalization.

8. The Govt. of India and the respective State Governments may have to immediately undertake re-capitalization and financial restructuring of the weak SFCs on case-to-case basis in consultation with SIDBI. With the augmentation of the capital base of the SFCs under the amended Act, which provides for authorized capital up to Rs. 1,000 crores, the Central Government/State Governments may persuade commercial banks, all India financial institutions and the institutions controlled by them to liberally contribute towards the equity of these corporations. Besides, the Govt. of India\State Government, in collaboration with SIDBI, may allocate sufficient funds for writing off the bad debts of SFCs and thus cleanse their balance sheets. Further, on selective basis where urgent relief is required, SIDBI may be approached to convert part of its refinance outstanding into equity.

Level-playing field for  SFCs

9. A significant fallout of the ongoing economic liberalization and financial sector reforms in the country has been that the State Financial Corporations were denied a level playing field on account of the restrictions imposed upon them by the SFCs Act coupled with non-availability of adequate resources at cheap rates for meeting their business commitments. The main source of funds for  SFCs has been the refinance from IDBI/SIDBI, besides small doses of advances made by State Governments from time to time. The State Financial Corporations have been facing a financial crisis since they have not been able to mobilize necessary resources from the market and the re-finance facility from IDBI/SIDBI was not sufficient to sustain the loaning operations.  As a result of deregulation of financial sector commercial banks and financial institutions are progressively moving towards universal banking in as much as commercial banks are advancing term-loans, besides working capital to the industrial units, while financial institutions are sanctioning working capital along with term-loans. The  SFCs have thus been facing competition from the commercial banks in the matter of financing small scale industries. SIDBI, which is a refinancing body at the apex level, is also competing with SFCs in the  matter of financing individual SSIs. The SFCs, with their poor resource base and higher cost of borrowing, have been unable to compete with the commercial banks in financing SSIs. This has resulted in a large-scale loss of clientele to the SFCs and they are compelled to finance only those units which are unable to get finance from the commercial banks and are therefore, vulnerable to increase  in their NPAs and consequent losses. The average cost of borrowing of commercial banks ranges between 7.5% and 8.5%,  while that of SFCs is above 12%. With a view to providing a level-playing field to SFCs and continue to play their developmental role in the rural and backward regions of the states, it is necessary to provide adequate and cheap resources to them. The Govt. of India may consider providing the following reliefs to the SFCs :

9 (i) Since SIDBI has been assigned the role of a nodal agency for promoting and developing SSIs in the country, as also promoting the interests of primary lending agencies, it should provide refinance facilities to the State Financial Corporations to the extent of 90% of their advances to SSIs at a rate of interest not exceeding 10%. This will go a long way in meeting the funds requirement of SFCs.

(ii) Since SIDBI is also borrowing from the market at market related rates, besides getting concessional finance from other sources, the Govt. of India may consider allocating substantial share of tax-free bonds to SIDBI, the proceeds of which should be exclusively used to provide refinance support to SFCs at a lower rate of interest, i.e. 10%. Besides, larger share of SLR bonds should also be allocated to SIDBI to enable it to meet the refinance requirements of SFCs.

(iii) Commercial banks may provide a line of credit to SFCs at 2% below their prime lending rates. The SFCs have a legitimate claim on the portion of public deposits mobilized by commercial banks from the rural and backward regions of the States since they are engaged in the development of small scale and tiny industries in those areas. The deposits mobilized by commercial banks from such areas in the states predominantly served by SFCs are being deployed elsewhere and those regions are deprived of the finance for developmental purposes. This was quite apparent from the low credit deposit ratio of commercial banks in the rural and backward regions  of the States. Opening of a line of credit to SFCs by commercial banks for providing loans in such areas at lower rates of interest would push up the credit-deposit ratios in those areas and will go a long way in providing cheap resources to SFCs to augment their operations. The Govt. of India and RBI may, therefore, be approached to issue necessary directives in this regard to commercial banks.

(iv) The Reserve Bank of India may have to be advised by Govt. of India to resume financial support to SIDBI out of National Industrial Credit (Long-Term Operations) Fund maintained by RBI for the development and promotion of industries in the country. Loans out of this Fund generally carry very low rate of interest say 5 to 6%. Such support to SIDBI from RBI will greatly help in bringing down the interest rate on refinance to be provided to SFCs by SIDBI.

(v) The Reserve Bank of India may be approached through Govt. of India for permitting SFCs to set up banking subsidiaries, which will enable them to mobilize public deposits at comparatively cheaper cost for being lent to the small and medium sector as term-loan and working capital finance. The resources thus mobilized would be entirely deployed in the states and will resultantly push up the credit deposit ratio, which has been showing declining trends in most of the states. This will also help SFCs to utilise their surplus man-power, which can be conveniently shifted to the banking subsidiaries.

Conclusion 

10. The amendment of SFCs Act has removed a big legal hurdle in bringing about desired reforms in the working of SFCs. As already explained in the preceding paragraphs, most of the SFCs (15 out of 18) would not be able to derive any advantage out of the relaxations provided to them, particularly in the financing of newer areas and mobilizing resources on their own from the market. Only 3 SFCs, namely DFC, GSFC and  KFC, whose financial position is quite sound and have been making consistent profits would be able to go ahead with the schemes for providing loans and advances in the additional sectors open up and mobilizing resources by issue of bonds, debentures and accepting deposits from general public. They may also attract share-holding from the general public to the extent of 49% of their issued capital. The remaining 15 corporations would be able to take advantage only after re-capitalizing them and strengthening their equity bases. No doubt, the need for providing cheap resources to all the SFCs, regardless of their present position on the lines suggested above, would be necessary to sustain their loaning operations and to enable them to compete with commercial banks and other financial institutions. 
 

K. K. Mudgil, Secretary General, COSIDICI