Context:

Recently, the finance minister announced a list of measures in order to boost the economy which is presently facing a slowdown. One such announcement was setting up of a development bank in India.

The Development Bank will be set up to provide credit enhancement for infrastructure and housing projects.

A strong national development bank is the need of the hour that will be in the forefront of funding India’s strategic and long-term development.

About Development Banks:

Development banks are also known as term-lending institutions or development finance institutions (DFIs).

Development banks are financial institutions that provide long-term credit for capital-intensive investments spread over a long period and yielding low rates of return, such as urban infrastructure, mining and heavy industry, and irrigation systems.

Such banks often lend at low and stable rates of interest to promote long-term investments with considerable social benefits.

Development banks are different from commercial banks which mobilise short- to medium-term deposits and lend for similar maturities to avoid a maturity mismatch-a potential cause for a bank’s liquidity and solvency.

Need for Developmental Banks in India:

• After independence, the institutional framework for development banking began- IFCI (1948), IDBI (1964), IIBI (1972), NABARD and EXIM Bank (1982), SIDBI (1990), etc.
• IFCI, previously the Industrial Finance Corporation of India, was set up in 1948. This was probably India’s first development bank for financing industrial investments.
• The World Bank’s new broad-based index of financial development placed India in 38th place in regard to financial markets but 102 in respect of financial institutions, which reiterates that India needs to do a lot to strengthen domestic financial institutions.
• Global Financial Crisis of 2008 reignited the need of development banks globally.
• An IMF paper (2016) noted, “the initial hopes that the privatisation wave of the 1980s would fuel a private sector funded greenfield infrastructure investment boom have fallen well short of expectations”.
• The World Bank devoted its Global Financial Development Report (2015) to the theme of importance of long -term finance.
• The UNCTAD study asserted “the time is ripe to promote development banks.”
• India’s economic downturn in recent quarters and the high NPAs of banks affecting their credit culture have forced the government to think about reviving the Development banks to boost the economy through infrastructure financing.

China’s development banks to finance long-term Projects:

The Agricultural Development Bank of China, China Development Bank, and the Export-Import Bank of China have been at the forefront of financing its industrial prowess.

After the global financial crisis, these institutions have underwritten China’s risky technological investments helping it gain global dominance in IT hardware and software companies.

Germany’s development bank, KfW, has been spearheading long-term investment in green technologies and for sustainable development efforts requiring long-term capital.

Ways for Financing Development Banks:

As the domestic saving rate was low, and capital market was absent, development finance institutions were financed by:

• Lines of credit from the Reserve Bank of India (that is, some of its profits were channelled as long-term credit); and
• Statutory Liquidity Ratio bonds, into which commercial banks had to invest a proportion of their deposits.

In other words, by sleight of government hand, short-term bank deposits got transformed into long-term resources for development banks. The missing capital market was made up by an administrative fiat.

However, development banks got discredited for mounting non-performing assets, allegedly caused by politically motivated lending and inadequate professionalism in assessing investment projects for economic, technical and financial viability.

After 1991, following the Narasimham Committee reports on financial sector reforms, development finance institutions were disbanded and got converted to commercial banks.

The result was a steep fall in long-term credit from a tenure of 10-15 years to five years.

The development of the debt market has been an article of faith for over a quarter-century, but it has failed to take off as in most of Europe and industrialising Asia, where the bank-centric financial system continues to prevail.

Issues that need to be addressed in way Ahead:

The Finance Minister’s agenda for setting up a development bank is welcome.

However, a few hard questions need to be addressed in designing the proposed institution.  How will it be financed?

If foreign private capital is expected to contribute equity capital (hence part ownership), such an option needs to be carefully analysed, especially in the current political juncture.

The design of the governance structure is fraught with dangers with many interest groups at work. One sincerely hopes that the political and administrative leadership carefully weigh in the past lessons to lay a firm foundation for the new institution.

Conclusion:

In order to improve access to long-term finance, it is proposed to establish an organisation to provide credit enhancement for infrastructure and housing projects, particularly in the context of India now not having a development bank.

It also became necessary for the need for us to have an institutional mechanism. So, this will enhance debt flow toward such projects. The announcement could have far-reaching implications for India’s financial system.

Considering the social benefits of such investments, and uncertainties associated with them, development banks are often supported by governments or international institutions.

Such support can be in the form of tax incentives and administrative mandates for private sector banks and financial institutions to invest in securities issued by development banks.