The “Terminator” was a super-efficient fighting machine till, afflicted by the ravages of continuous strife, it had to exit but departed with an ominous, “I’ll be back!” In a different context today, these words power the discussion around reviving the once mighty Development Finance Institutions (DFIs).
In her last Budget speech, Finance Minister Nirmala Sitharaman proposed to set up DFIs for promoting infrastructure funding. About 7,000 projects were identified under the National Infrastructure Pipeline (NIP) with projected investment of a whopping ₹111-lakh crore during 2020-25.
The proposed DFI would play a key developmental role, apart from providing conventional innovative financial mechanisms.
DFIs: The Fallen Stars
The DFIs of the pre and early liberalisation era could be broadly categorised as all-India or state/regional/functional institutions depending on their geographical or specialised coverage. Despite their undeniable contribution to the growth of infrastructure and industrial sectors after independence, the role of DFIs as the future lodestars of development began to be questioned in the post liberalisation period.
In the 1990s, following economic liberalisation and a spurt in economic activity, DFIs suffered huge NPAs, with many sliding to actual or near unviable status. It was also noted that (Desai-1999) the DFIs had failed in several crucial areas.
They financed industrial groups rather than new entrepreneurs, diluted the standard of scrutiny of proposals, had weak project/ implementation monitoring skills, etc. The report also noted that DFIs had inherited a bureaucratic attitude, which prevented a comprehensive achievement of their founding objectives.
Judged in these terms, although the quantity of funds that flowed through these channels was huge, DFIs failed to create dependable resources by way of funds and skills to accelerate the tempo of industrial and infrastructure development.
This state of affairs confronted the two Narasimham Committee on Financial Sector Reforms in the 1990s which noted that the DFIs may not be viable, since these institutions were raising funds at the current market rates and lending to businesses with long gestation and often high risk of failure with high credit cost.
Accordingly, the committee recommended that the DFIs be converted either into banks or NBFCs and should be subject to the full rigour of RBI regulations as applicable to the respective categories. Consequently, both ICICI and IDBI were converted into commercial banks and IFCI into an NBFC.
It was also felt that since the banking system had acquired skills in managing credit risks in different sectors, including the long-term finance and capital market, they were better placed to finance the corporate sector from their relatively vast pool of low-cost funds.
DFI: Resurrection?
Unfortunately, the effort to pass the development finance baton to banks was equally ill-starred. Banks lend out of deposits collected from many small and large depositors.
They normally have relatively short savings horizons and would prefer to focus on liquidity and safety as against high returns. Further, lending for infrastructure development requires making lumpy investments on the one hand and allocating large sums to single borrowers, with resultant higher risks of non-recovery and illiquidity, on the other.
Efforts by banks to operate within acceptable exposure tenures of 10-12 years often resulted in pressure on borrowers to artificially reduce the project completion time at the cost of viability.
In order to address the issue, RBI introduced a flexible financing 5:25 scheme in July 2014, allowing banks to extend long-term loans of 20-25 years to match the cash flow of projects, while refinancing them every five or seven years.
However, the emerging stressed assets crisis, aggravated by an inadequacy of skills, adversely impacted the banks’ capacity to make the desired impact.
This has brought us back, full circle, to the need for specialised financial institutions to carry the developmental agenda forward.
I’ll be back! – But in what form?
India is standing at the threshold of an industrial revolution. The fear, however, is that the current trend may reverse abruptly, as in the mid-1990s, and we may be stuck in the lower 5-6 per cent growth rut.
DFIs or multilateral development banks have been a feature of the global economic system since the early days of post-World War II reconstruction.
Over these last seven decades, however, there has been a perceptible shift in the global economic architecture, particularly evident in the increasing share of the global economic pie commanded by countries such as China, India, Brazil and South Africa.
There is a growing reliance on domestic resources for public investment across all these nations while professional expertise in development and policy planning are being globalised.
It is against this backdrop that the role of the proposed ‘new’ DFI should be assessed. The need to effectively combine financial/technical approaches with the unique features of their geographical footprint and client base is necessary. The New Development Bank (NDB) and Asian Infrastructure Investment Bank (AIIB), the world’s youngest DFIs with participation from India, are a step in this direction.
The extent of private collaboration, is another issue being deliberated globally.
Closer home, the proposed ‘new’ DFI, could build with agreed sets of principles for creating buy-in for innovative financing mechanisms, introduce blended finance, adopt a portfolio approach in which a number of projects are aggregated for a broader funding participation, greater collaboration with last-mile players and other national development banks.
As private players increasingly focus on sustainability and impact investing, DFIs must continuously evolve to support business models that mainstream investors may not yet be comfortable with.
The work of DFIs isn’t likely to get easier, because of rising expectations and emerging competition from alternate funding sources like Global FIs, Capital Markets and governments themselves.
The proposal for specialised term finance institution(s) to cope with the aftermath of Covid induced economic disruptions and development imperatives, presents interesting opportunities for Indian DFIs in their new avatars.
The writer is CGM (Retd), SBI and former CEO, Indian Institute of Insolvency Professionals of ICAI. Views are personal
