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Setting up of Development Finance Institution – All India Radio (AIR) IAS UPSC

  • IASbaba
  • June 20, 2021
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Topic: General Studies 3:

  • Indian Economy

In News: The cabinet has approved a detailed proposal for setting up the developmental finance institution (DFI) that was announced in the budget last month, clearing the decks for a dedicated government-owned infrastructure financier.

The National Bank for Financing Infrastructure and Development (NaBFID)

  • The National Bank for Financing Infrastructure and Development (NaBFID) will be set up with a corpus of ₹20,000 crore and an initial grant of ₹5,000 crore from the government
  • The institution will use it as a lever to raise up to ₹3 lakh crore in the next few years
  • Initially, it will be wholly owned but the government stake will be lowered to a quarter. It will start with 100% government of India ownership and gradually, in the long run, government ownership will come down to 26%.
  • A bill to set up the DFI will soon be introduced in Parliament.
  • The proposed entity will also enjoy some tax benefits for an initial 10-year period and some amendments will be carried out in the Indian Stamp Act in this regard.

The Composition

  • The DFI will have a professional board and at least 50% of members will be non-official directors.
  • Emoluments will be market driven to attract the best talent, higher age limit and longer tenure for managing directors and DMDs (deputy managing directors).
  • An eminent person will be appointed chairperson.

There is a suggestion that the Indian Infrastructure Finance Co. Ltd (IIFCL), a government enterprise, be merged into the new DFI.

What Is A Development Finance Institution? 

A development finance institution is an agency that finances infrastructure projects that are of national importance but may or may not conform to commercial return standards. In most cases, these agencies are government owned and their borrowings enjoy the comfort of government guarantees, which help bring down the cost of funding.

How is it different from commercial banks?

  • It strikes a balance between commercial operational norms as followed by commercial banks on the one hand, and developmental responsibilities on the other.
  • DFIs are not just plain lenders like commercial banks but they act as companions in the development of significant sectors of the economy.

Objectives of Development Finance Institutions

  • The prime objective of DFI is the economic development of the country
  • These banks provide financial as well as the technical support to various sectors
  • DFIs do not accept deposits from people
  • They raise funds by borrowing funds from governments and by selling their bonds to the general public
  • It also provides a guarantee to banks on behalf of companies and subscriptions to shares, debentures, etc.
  • Underwriting enables firms to raise funds from the public. Underwriting a financial institution guarantees to purchase a certain percentage of shares of a company that is issuing IPO if it is not subscribed by the Public.
  • They also provide technical assistance like Project Report, Viability study, and consultancy services.

The Current Need for Development Finance Institutions

The economy needs infrastructure investments more than ever to help it overcome scars left behind by the Covid-19 pandemic. Since few commercial lenders are willing to take on infrastructure risk, particularly after the experience of the last lending cycle, a development finance institution has become necessary

In setting up a DFI, India will return to an earlier experiment with the idea. ICICI, it in original form, and IDBI were both set up as DFIs but were later converted into universal banks as it was perceived that they needed access to public deposits. The earlier generation of DFIs ran into the problem of financing because retail deposit access was cornered by banks and availability of long-term financing without government guarantees was limited.

Today we have a robust capital market so there is access to funds. We have global access, as India is a strong investment proposition. So, we have access there. This development bank could also borrow from multilateral development banks and the government could also give a cover

The DFI is envisaged to play a catalytic role in funding projects under the Rs 111-lakh-crore National Infrastructure Pipeline and help the country turn into a $5 trillion economy by 2025.

Conclusion

India needs wide-ranging institutional and regulatory reforms, and not just a DFI, to bolster the corporate bond market, the size of stands at only about 15-16% of GDP. Nevertheless, the DFI proposal, backed by deft implementation, could be one of the important steps in that direction.

The move to enable the DFI to have access to low-cost funds comes amid realisation that since banks have access to CASA (current account savings accounts) deposits, their cost of funds is going to be cheaper than the DFI’s. So, the DFI has to be granted some flexibilities to stay competitive. Else, as witnessed in the past (DFIs like IDBI and ICICI were forced to morph into banks), it will struggle to stay afloat.

Note: Some important DFI’s (sector specific)

Industry

  • IFCI – 1st DFI in India. Industrial Corporation of India was established in 1948.
  • ICICI – Industrial Credit and Investment Corporation of India Limited established in 1955 by an initiative of the World Bank.
  • It established its subsidiary company ICICI Bank limited in 1994.
  • In 2002, ICICI limited was merged into ICICI Bank Limited making it the first universal bank of the country.

Universal Bank – Any Financial institution performing the function of Commercial Bank + DFI

  • It was established in the private sector and is still the Only DFI in the private sector.

IDBI – Industrial Development Bank of India was set up in 1964 under RBI and was granted autonomy in 1976

  • It is responsible for ensuring adequate flow of credit to various sectors
  • It was converted into a Universal Bank in 2003

IRCI – Industrial Reconstruction Corporation of India was set up in 1971.

  • It was set up to revive weak units and provide financial & technical assistance.

SIDBI – Small Industries development bank of India was established in 1989.

  • Was established as a subsidiary of IDBI
  • It was granted autonomy in 1998

Foreign Trade

  • EXIM Bank – Export-Import Bank was established in January 1982 and is the apex institution in the area of foreign trade investment.
  • Provides technical assistance and loan to exporters

Agriculture Sector

NABARD – National Bank for agriculture and rural development was established in July 1982. It was established on the recommendation of the Shivraman Committee It is the apex institution in the area of agriculture and rural sectors It functions as a refinancing institution

Housing

NHB- National Housing Bank was established in 1988. It is the apex institution in Housing Finance

Connecting the Dots:

  1. What is a Development Finance Institution (DFI)? Discuss. What are its key objectives?

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