Development Finance Institutions (DFIs)

Why DFIs is in news ?

In the budget for 2021-22, the government has proposed the setting up of a new development finance institution called the National Bank for Financing Infrastructure and Development .
The institution will be set up on a capital base of Rs 20,000 crore and will have a lending target of Rs 5 lakh crore in three year.
Debt financing through the infrastructure investment trust (InvIT) and real estate investment trust (REIT) routes will be enabled through necessary amendments in the rules.

What is A Development Finance Institution?

A development finance institution is an agency that finances infrastructure projects that are of national importance but may or may not conform to commercial return standards. In most cases, these agencies are government owned and their borrowings enjoy the comfort of government guarantees, which help bring down the cost of funding.

Objectives of Development Finance Institutions(DFIs)

The prime objective of DFI is the economic development of the country

These banks provide financial as well as the technical support to various sectors
DFIs do not accept deposits from people
They raise funds by borrowing funds from governments and by selling their bonds to the general public
It also provides a guarantee to banks on behalf of companies and subscriptions to shares, debentures, etc.

Underwriting enables firms to raise funds from the public. Underwriting a financial institution guarantees to purchase a certain percentage of shares of a company that is issuing IPO if it is not subscribed by the Public.
They also provide technical assistance like Project Report, Viability study, and consultancy services.

Some Important DFIs (Sector Specific)

Industry

IFCI – 1^st DFI in India. Industrial Corporation of India was established in 1948.

ICICI – Industrial Credit and Investment Corporation of India Limited established in 1955 by an initiative of the World Bank.

It established its subsidiary company ICICI Bank limited in 1994.
In 2002, ICICI limited was merged into ICICI Bank Limited making it the first universal bank of the country.

Universal Bank – Any Financial institution performing the function of Commercial Bank + DFI

It was established in the private sector and is still the Only DFI in the private sector.

IDBI – Industrial Development Bank of India was set up in 1964 under RBI and was granted autonomy in 1976

It is responsible for ensuring adequate flow of credit to various sectors

It was converted into a Universal Bank in 2003

IRCI – Industrial Reconstruction Corporation of India was set up in 1971.

It was set up to revive weak units and provide financial & technical assistance.

SIDBI

Small Industries development bank of India was established in 1990.
To provide refinance facilities and short-term lending to industries, and serves as the principal financial institution in the MSME sector.

Foreign Trade

EXIM Bank – Export-Import Bank was established in January 1982 and is the apex institution in the area of foreign trade investment.
Provides technical assistance and loan to exporters

Agriculture Sector

NABARD – National Bank for agriculture and rural development was established in July 1982
It was established on the recommendation of the Shivraman Committee
It is the apex institution in the area of agriculture and rural sectors
It functions as a refinancing institution

Housing

NHB- National Housing Bank was established in 1988.
It is the apex institution in Housing Finance

Tourism

1989 : Tourism finance corporation of India (TFCI)

Renewable Energy

1987 : Indian Renewable Energy Development Agency (IREDA)

Shipping

1986 : Shipping Credit and Investment Company of India

Why DFI needed now ?

Economy needs infrastructure investments more than ever to help it overcome scars left behind by the Covid-19 pandemic.
Since few commercial lenders are willing to take on infrastructure risk, particularly after the experience of the last lending cycle, a development finance institution has become necessary.
Using public sector banks to finance such projects, as India did, led to the banks being straddled with huge NPAs.
For one, such banks did not have the expertise to assess risk accurately. Moreover, regular banks faced an asset-liability mismatch — in other words, they accepted deposits (their liabilities) for a short term but extended loans (their assets) over a much longer term.
This is not the first time that India would have a DFI and, as such, it is important that the mistakes of the past are not repeated.

Why failed earlier ?

The earlier generation of DFIs ran into the problem of financing because retail deposit access was cornered by banks and availability of long-term financing without government guarantees was limited.

But, Today we have a robust capital market so there is access to funds. We have global access, as India is a strong investment proposition. So, we have access there. This development bank could also borrow from multilateral development banks and the government could also give a cover.

What care should we exercise now ?

It should, however, exercise great care in how it is structured and operationalized. Indeed, there are learnings from the experience of India Infrastructure Finance Company Ltd (IIFCL), which was set up with the same intent but failed to make a worthwhile contribution. Being a government firm, it lacked the autonomy to act as a vibrant financial institution or spur infrastructure investment. Also remember that DFIs like IDBI racked up non-performing assets (NPAs) and were converted into regular banks.

For a DFI to be successful, it should be set up with an ownership and management structure like that of HDFC and ICICI.
The strength of a DFI lies in its domain expertise, and it may therefore be advisable to create sector-specific DFIs .Further, these should also be allowed to raise medium- to long-term deposits, akin to commercial banks.
Infrastructure finance companies could be asked to transition into infrastructure banks over a period of 1-3 years, which would also help them overcome their asset-liability mismatches, as was recommended by the Usha Thorat Committee. The proposed DFI can use the network of such infrastructure banks to finance or refinance projects.
Equally important for success is the broadening and deepening of India’s corporate debt market, which is just 16% of gross domestic product, compared with 46% in Malaysia and 73% in South Korea.
The budget proposal of an institutional framework to purchase investment-grade bonds may help in achieving the objective of a robust market for corporate debt.
It would also be helpful to bear in mind that funding of projects is necessary but not the only condition for the rapid development of infrastructure. I
Investors are concerned about procedural and legal hassles in land acquisition and environmental clearances, defaults in payments by concessionaires, and various contractual and regulatory uncertainties.
As per a recent report, 1,687 large infrastructure projects have suffered cost overruns in aggregate of about 20%, and out of these, 447 are delayed for more than one year. Sickness even before a project is commissioned for use remains a problem.

This suggests that apart from setting up a DFI, the government should institutionalize mechanisms for time-bound approvals and clearances, coordination between the central and state governments (and their agencies), enforcement of contracts, and resolution of disputes.

Also refer: