7 PM | Rediscovering development banks | 28th August, 2019

Context:Significance of Development banks for Indian economy

Development Banks:

• A development bank is a ‘bank’ established for the purpose of ‘financing development’. They provide medium and long-term finance to the industrial and agricultural sector. They provide finance to both private and public sector.
• Development banks are multipurpose financial institutions. They do term lending, investment in securities and other activities. They even promote saving and investment habit in the public.
• The first development bank In India incorporated immediately after independence in 1948 under the Industrial Finance Corporation Act as a statutory corporation to pioneer institutional credit to medium and large-scale.

Special characteristics of Development Banks:

• A development bank does not accept deposits from the public like commercial banks and other financial institutions who entirely depend upon saving mobilization.
• The role of a development bank is of gap filler. When assistance from other sources is not sufficient then this channel helps. It does not compete with normal channels of finance.
• It is a multipurpose financial institution. Besides providing financial help it undertakes promotional activities also. It helps enterprises from planning to operational level.

Role of Development Banks for Indian economy:

• Capital formation:The significance of Development Banks lies in their making available the means to utilize savings generated in the economy, thus helping in capital formation. Capital formation implies the diversion of the productive capacity of the economy to the making of capital goods which increases future productive capacity
• Entrepreneurial role:Developing countries lack entrepreneurs who can take up the job of setting up new projects. It may be due to lack of expertise and managerial ability. Development banks were assigned the job of entrepreneurial gap filling.
• Joint finance: Another feature of the development bank’s operations is to take up joint financing along with other financial institutions. There may be constraints of financial resources and legal problems (prescribing maximum limits of lending) which may force banks to associate with other institutions for taking up the financing of some projects jointly.
• Subscription to guarantees: It is well-known that when an entrepreneur purchases some machinery or fixed assets or capital goods on credit, the supplier usually asks him to furnish some guarantee to ensure payment of installments by the purchaser at regular intervals.
• In such a case, Development Banks can act as guarantors for prompt of installments to the supplier of such machinery or capital under a scheme called ‘Deferred Payments Guarantee’
• Assistance to backward areas:Institutional finance to projects in backward areas is extended on concessional terms such as lower interest rate, longer moratorium period, extended repayment schedule and relaxed norms in respect of promoters’ contribution and debt-equity ratio.
• Moreover, in recent years, development banks in India have launched special programmes for intensive development of industrially least developed areas, commonly referred to as the No-industry Districts (NID’s) which do not have any large-scale or medium-scale industrial project.
• Impact on corporate culture:Over the years, Development Banks have succeeded in infusing a sense of constructive partnership with the corporate sector. Institutions have been going through a continuous process of learning by doing and are effecting improvements in their systems and procedures on the basis of their cumulative experience.

Issues with the Development Banks:

• Big business houses: main criticism of development banking in India is that big business groups were able to garner a disproportionate share of the disbursals made by these institutions.
• Lack of control: The Government did not use its influence to exert control over the firms with which development finance institutions were involved. The latter, as providers of equity and credit to companies, were eligible to have nominees on the boards of directors of such companies
• Time taking:The inability of the banks to process loans in a reasonable time frame and to provide loans to projects lacking quality, along with the need for them to reorient their financing towards new industries
• Non-performing Assets: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 tenure of 10-15 years to five years.

Need of Development Banks:

• Infrastructure needs:World Economic Forum’s Executive Chairman Klaus Schwab said that in order to compete effectively on the international level, India needs to spend 8 hundred billion dollars on its infrastructure in next ten years.
• Commercial banks in India provide short term capital with the tenure of 5 years. So government should initiate to launch development banks to fulfill the needs of infrastructure lending.
• Other countries:China’s development banks-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.

Way forward:

• Development bank plays a very important role in economic development of our country. Since independence they have contributed to the inception of industrialization and all other technological innovations.
• There basic objective is to assist the development in country which perform by proving every kind of help possible i.e. financial, advisory, technological etc. In this light, the Finance Minister’s agenda for setting up a development bank is welcome.
• One sincerely hopes that the political and administrative leadership carefully weigh in the past lessons to lay a firm foundation for the new institution.

Source: https://www.thehindu.com/opinion/op-ed/rediscovering-development-banks/article29271773.ece.