Why in News

Major points

YEARS AFTER some of India’s biggest Development Finance Institutions (DFIs), such as ICICI, IDBI, IFCI and IRBI, either reinvented themselves or faded away, the government is veering towards setting up a new DFI essentially to fill the gap in long-term finance for infrastructure sectors.

“Discussions have been held at the highest level over the last couple of months. The two options being discussed are: i) whether it should be promoted by the government or, ii) it should be given a private sector character with the government restricting its holding to 49 per cent,” a top government official told The Sunday Express.

The proposed DFI will be used to finance both social and economic infrastructure projects identified under the National Infrastructure Pipeline (NIP).

There are clear advantages if the DFI is fully held by the government, the most important being fund-raising. “The securities from the DFI could be made SLR (Statutory Liquidity Ratio) eligible,” the official said. This will encourage banks to subscribe to the securities issued by DFI and fulfil their SLR obligations. RBI requires banks to set aside 18 per cent of their net demand and time liabilities towards SLR

Long-term financing

The government’s policy managers acknowledge the need to have access to long-term finance (most likely from long-term bonds from capital markets) at competitive cost so that funding of long-term infrastructure projects could be done in an economically viable manner and without the associated asset-liability mismatches

Between 2000 and 2010, DFIs such as ICICI, IDBI and IDFC extended long-term finance to industry and funded greenfield infrastructure projects. However, after achieving critical mass, these transformed into universal banks as they did not have the advantage of low-cost liabilities to de-risk their business models.

§  Issues in Infrastructure Funding:

o    Funding Gap: Banks are unable to provide long-term finance to infrastructure projects.

·         Infrastructure financing is currently dominated by bank lending, with outstanding credit to the infrastructure sector touching 15% until FY16.

·         However, due to rising non-performing assets in the banking sector driven by declining asset quality in the infrastructure sector, the share has declined to 12% in FY19.

o    Asset/Liability Management Mismatch: In India, most lenders borrow funds with maturity under 5 years. The reason is primarily the absence of a deep bond market to borrow from. As a result, they lend to a project with a maturity of, say 20 years, with funds of 2-year maturity. This leads to a mismatch in the maturities of assets and liabilities for the lender.

·         Asset/liability management is one of the main tools for evaluating financial risk and for periodic testing and preparation of financial policies.

DEVELOPMENT FINANCE INSTITUTION

A development finance institution (DFI) also known as a development bank or development finance company (DFC) is a financial institution that provides risk capital for economic development projects on non commercial basis. They are often established and owned by governments or charitable institutions to provide funds for projects that would otherwise not be able to get funds from commercial lenders. Some development banks include socially responsible investing and impact investing criteria into their mandates. Governments often use development banks to form part of their development aid or economic development initiatives.

DFIs can include multilateral development banks, national development banks, bilateral development banks, microfinance institutions, community development financial institution and revolving loan funds.These institutions provide a crucial role in providing credit in the form of higher risk loans, equity positions and risk guarantee instruments to private sector investments in developing countries.DFIs are typically backed by countries with developed economies.

Development banks include:

·         Community development banks which fund low-income areas in the United States

·         International financial institutions conducting development-oriented finance on a bilateral or multilateral basis

·         National development banks are government-owned financial institution that provides financing for economic development.

Way Forward

§  If India has to grow 8-10% continuously, credit growth for infrastructure must be 12-14%. Since, infrastructure projects require long-term funds, and given the scale of investment required, a large DFI is a good idea.

§  Compared with banks, a DFI provides long-term finance for social and economic infrastructure. However, DFIs involve higher risk than what the ordinary financial system may be willing to bear.