Topic 06

Answer

Introduction:-

In Union Budget 2021-22, Government announced that it will set up a Development Finance Institution, namely National Bank for Financing Infrastructure and Development, with an initial corpus of Rs.20,000 crore, fully funded by the Government of India and later reduce the stakes to 26% to create a dedicated agency for providing low-cost capital for physical and social infrastructure projects in India.

Body

• Development Finance Institutions (DFIs) are development banks that not only provide cheap credit for long-term developmental projects but also provide institutional handholding, stakeholder capacity building, and expertise in the area of funding.
• DFIs are not new to India. Immediately after independence, India set up three national DFIs-IFCI, IDBI, and ICICI from the 1940s to 1960s to provide long-term funding to the industrial sector.
• In the 1970s and 1980s, sector-specific DFIs like NABARD, EXIM Bank, SIDBI, HUDCO, NHB, etc. came into existence.
• Since the 1990s, the advantage of sourcing low-cost funds from RBI’s Long-Term Operation ceased under financial reforms undertaken during LPG. This forced DFIs to source funds from the capital market which itself was thrown wide open for resource mobilization to enterprises.
• As a result, the business of DFIs became unviable. Consequently, ICICI and IDBI were converted into full-fledged commercial banks and IFCI was closed.
• However, in the aftermath of the 2008 financial meltdown, the concept of DFIs has again been revisited. DFIs have played a crucial role in development financing in China, Brazil, Singapore, and South Korea. Similarly, developed countries like UK, Germany, and Japan have set DFIs to promote green financing, new technologies, SME (small and medium enterprises) development, and start-ups, etc.
• While India already has sectoral DFIs there is a felt need for specialized agencies for promoting infrastructure development financing. COVID-19 pandemic-induced economic recession has accentuated this felt need. In this context, India needs a DFI as proposed in the Union Budget 2021-22.

DFI: Potential in the creation of social and public value

1. Commercial Banks faced the issue of asset-liability mismatches due to entering into the funding of long-gestation projects thereby raising their NPS levels. DFIs can deal with this issue as a sophisticated entity meant specifically for funding long-term projects.
2. Unlike Commercial banks, DFIs are not meant for maximising profits. While they function within the limits of market forces, their objective is to attain developmental goals while remaining commercially viable.
3. DFIs can channel credit to futuristic areas. DFIs have a better risk appetite to invest in long-term projects with high social returns but the risk of financial default.
4. DFIs can provide counter-cyclical financing during economic downturns.

However, face numerous internal and external challenges:

1. Diluted mandate of DFIs. There is an example of DFIs in India which are meant for funding the housing sector, actually funding Race Course when there is a lack of slum dwellers in our cities.
2. Being the custodian of public money, DFIs should be transparent and accountable.
3. Quality of internal controls and management can be ensured by appointing professionally qualified directors. The Practise of political appointees should be stopped.
4. Commitment to environmental, social, and human rights while doing project appraisal.
5. Government should not interfere in the day-to-day functioning of the DFI.

Conclusion:-

Therefore, a DFI is the need of the hour but it should be well-capitalized, well-managed, and well committed to its goal to ensure delivery of social and public good. Development financial institutions provide long-term credit for capital-intensive investments spread over a long period and low yielding rates of return, such as urban infrastructure, mining and heavy industry, and irrigation systems.