Development Finance Institution: Role, Features, Classification, Evolution Commerce YouTube Lecture Handouts Part 4

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Development Finance Institution: Role, Features, Classification, Evolution | Commerce
Development Finance Institution
  • A Development Financial Institution (DFI) is defined as an institution endorsed or supported by Government of India primarily to provide development/Project finance to one or more sectors or sub-sectors of the economy.
  • It emphasizes the long-term financing of a project rather than collateral based financing.
  • Apart from provision of long-term loans, equity capital, guarantees and underwriting functions, a development institution normally is also expected to upgrade the managerial and the other operational requirements of the assisted projects.
  • Its association with its clients is of an on-going nature and of being a companion in the project than that of a plain lender like banks.
  • The basic stress is on long-term finance and support for activities to the sectors of the economy where the risks may be higher that may not be feasible for commercial banks to finance them.
  • So, the role is not just long-term financing but more of development of significant sectors of our economy for hastening growth.
  • These DFI are also known as Development banks.
  • After independence, the role of commercial banking was limited to working capital financing on short term basis so thrust of DFIs was on long term finance to industry and infrastructure sector in India.
  • India՚s first DFI was operationalized in 1948 and it set up State Financial corporations (SFCs) at the state level after passing of the SFCs act, 1951, succeeded by the development of industrial Finance corporation of India (IFCI) -1st July 1948.

Role of DFIs in Indian Economy

  • Specialized development financial institutions (DFIs) ,
    • such as, Industrial Finance Corporation of India (IFCI) ,
    • Industrial Development Bank of India (IDBI) ,
    • National Bank for Agriculture and Rural Development (NABARD) ,
    • National Housing Board (NHB) and
    • Small Industry Development Bank of India (SIDBI) ,
    • with majority ownership of the RBI were launched to meet the long-term financing needs of industry and agriculture in India for driving growth in our economy post-independence.
  • There have been three phases in the evolution of DFIs in India.
  • The first phase began with Independence and spreads to 1964 when the Industrial Development Bank of India was set up.
  • The second phase stretched from 1964 to the middle of the 1990s when the role of the DFIs grew in importance, with the funding disbursed by them amounting to 10.3 per cent of Gross Capital Formation in 1990 - 91 and 15.2 per cent in 1993 - 94.
  • In third phase after 1993 - 94, the prominence of development banking declined with the decline being particularly severe after 2000 - 01, as liberalization resulted in the exit of some firms from development banking and in a waning in the resources mobilised by other firms.

Features of Development Banks

  • It is a specialized financial institution, provides medium and long-term finance to business units.
  • Unlike commercial banks, it does not accept deposits from the public, it is not just a term-lending institution. It՚s a multi-purpose financial institution.
  • It is essentially a development-oriented bank. Its primary objective is to promote economic development by promoting investment and entrepreneurial activity in a developing economy. It encourages new and small entrepreneurs and seeks balanced regional growth.
  • They provide financial assistance not only to the private sector but also to the public sector undertakings, it aims at promoting the saving and investment habit in the community.
  • It does not compete with the normal channels of finance, i.e.. , finance already made available by the banks and other conventional financial institutions. Its major role is of a gap-filler, i.e.. , to fill up the deficiencies of the existing financial facilities.
  • Its motive is to serve the public interest rather than to make profits. It works in the general interest of the nation.

Classification of DFIs

DFIs can be classified in four categories of institutions as per their functions:

  • National Development Banks e. g. , IDBI, SIDBI, ICICI, IFCI, IRBI, IDFC
  • Sector specific financial institutions e. g. , TFCI, EXIM Bank, NABARD, HDFC, NHB
  • Investment Institutions e. g. , LIC, GIC and UTI
  • State level Institutions e. g. , State Finance corporations and SIDCs
Classification of DFIs

Functions of Development Banks

Refinance Facility

The institutions which provide funds to units are refinanced by development banks. In India, the Industrial Development Bank of India (IDBI) provides reliance against term loans granted to industrial concerns by state financial corporations.

Undertake Entrepreneurial Role

They undertake the task of discovering investment projects, promotion of industrial enterprises, provide technical and managerial assistance, undertaking economic and technical research, conducting surveys, feasibility studies, etc.

Financial Gap Fillers

Development banks provide medium-term and long-term loans and also help undertakings to acquire machinery from within and outside the country.

Joint Finance

The requirements of a foreign loan in a particular currency, met by one institution and under the writing of securities met by another.

Commercial Banking Business

Development banks extend financial assistance for meeting working capital needs to their loan if they fail to arrange such funds from other sources. So far as taking up other functions of banks such as accepting of deposits, opening letters of credit, discounting of bills, etc. there is no uniform practice in development banks.

Underwriting of Securities

The banks try to disinvest in these securities in a systematic way which should not influence the market prices of these securities and also should not lose managerial control of the units.

Credit Guarantee

A Credit Guarantee scheme was introduced in 1960 with the object of enlarging the supply of institutional credit to small industrial units by granting a degree of protection to lending institutions against possible losses in respect of such advances.

Evolution of DFIs in India

  • The process started instantly after Independence, with the setting up of the Industrial Finance Corporation (IFCI) in 1948 to embark on long term term-financing for industries.
  • State Financial Corporations (SFCs) were formed under an Act that came into effect from August 1952 to endorse state-level, small and medium-sized industries with industrial finance.
  • In January 1955, the Industrial Credit and Investment Corporation of India (ICICI) , the first development finance institution in the private sector, came to be set up, with backing and funding of the World Bank.
  • In June 1958, the Refinance Corporation for Industry was established, which was later taken over by the Industrial Development Bank of India (IDBI) .
  • Other DFIs that were launched included the Agriculture Refinance Corporation (1963) , Rural Electrification Corporation Ltd. and HUDCO.
  • Two other major steps in institution building were the setting up of IDBI as an apex term-lending institution and the Unit Trust of India (UTI) as an investment institution, both starting operations in July 1964 as subsidiaries of the Reserve Bank of India.
  • There were new initiatives at the level of the states as well in the 1960s.
  • State governments setup State Industrial Development Corporations (SIDCs) to inspire industrial development in their territories.
  • Specialized financial institutions set up after 1974 included
    • NABARD (1981) ,
    • EXIM Bank (1982) ,
    • Shipping Credit and Investment Company of India (1986) ,
    • Power Finance Corporation,
    • Indian Railway Finance Corporation (1986) ,
    • Indian Renewable Energy Development Agency (1987) ,
    • Technology Development and Information Company of India, a venture fund later known as IFCI Venture Capital Funds Ltd. and ICICI Venture Funds Management Ltd. (1988) ,
    • National Housing Bank (1988) , the Tourism Finance Corporation of India, set up by IFCI (1989) ,
    • Small Industries Development Bank of India (SIDBI) , with functions relating to the micro, medium and small industries sector taken out of IDBI (1989)

Summary

  • Private financial institutions and banks focused on profit are likely to be less willing to take on board environmental concerns, especially if they result in the loss of profit opportunities or reduction in profitability as well as societal goals while providing project financing which is major concern from holistic and equitable regional development point of view of our economy.
  • India՚s experience with development banking suggests that it would be inclined to promoting greater private participation in financing the bank՚s activities and favour lending to projects that directly or indirectly ensure private profit rather than social benefit.
  • Moreover, it is unlikely to emphasize environmental and social concerns when lending and investment decisions are made.
  • Hence, our Govt. need to revive DFIs concept again to keep societal, cultural, regional, rural and environmental concerns intact while sanctioning credit to long term infrastructure projects.

MCQs

Q. DFIs are also known as ________

Answer: Development Banks

Q. Name a few examples of National Development Banks.

Answer: National Development Banks e. g. , IDBI, SIDBI, ICICI, IFCI, IRBI, IDFC

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