Development Financial Institutions

June 26, 2021

Syllabus:

Context:

Government has announced the setting up of a new dfi. The new dfi is expected to build a portfolio of ₹5 trillion in the next three years.

Introduction:

The development finance institutions (dfi) are usually owned by the government or public institutions. Dfis provide funds for infrastructure and large-scale projects. Large scale banks are often not interested in lending for such projects due to viability issues.
The prime objective of dfi is the economic development of the country via financing infrastructure activities.
Their cost of borrowings also reduces because of the attached government guarantees.

Background:

In india, the first dfi was operationalized in 1948 with the setting up of the industrial finance corporation (ifc).
Dfis in india like industrial development bank of india (idbi), industrial credit and investment corporation of india (icici) and ifci did play a significant role in aiding industrial development in the past with the best of the resources made available to them.
However, after 1991 reforms, the concessional funding they were getting from reserve bank of india (rbi)and the government was no longer available in the subsequent years.
- As a consequence, idbi and icici had to convert themselves into universal banks.
While these dfis disappeared, a new set of institutions like idfc (1997), iifcl (2006) and more recently, national investment and infrastructure fund (niif) (2015)emerged to focus on funding infrastructure.
In budget 2021, with the initial capital base of ₹20,000 crore as committed by the government, the new dfi, assuming a leverage of around 7 times, can lend up to ₹1.4 trillion

Need for dfi:

Infrastructure building:inadequate and inefficient infrastructure leads to high transaction costs, which in turn stunts an economy’s growth potential.
- Therefore, dfis makes sense as the centre government envisages mobilizing nearly ₹100 lakh crore for the ambitious national infrastructure pipeline.
International precedent:irrespective of the level of development, countries across the world have set up development banks to finance key infrastructure and manufacturing projects.
- For instance, the european investment bank (eib) acts like a dfi for europe.
Lack of finance for infrastructure:although india has a long-term debt market for the government securities and corporate bonds cut, it is still out of reach of retail investors and unable to meet the large infrastructure financing needs.
Economic crisis triggered by covid-19 pandemic:the covid-19 pandemic has exacerbated inequality, the poverty gap, unemployment, and the economy’s slowing down.
- Thus, infrastructure building through dfis can help in quick economic recovery.

Way forward

Mobilizing capital for dfi:to lend for the long term, dfi requires correspondingly long-term sources of finance.
- In this context, the government may allow equity investment by institutions having a long term horizon like insurance companies, pension funds to augment the capital.
- Further, dfi can be adequately capitalized by the sovereign-backed funds, alternative routes such as capital gains/tax-free bond issues, external borrowings, and loans from multilateral agencies.
Administration of dfi:the ownership and organisation structure are critical and require greater clarity as this would have bearing on the functioning, flexibility, governance of the institution and its long-term sustainability.
Functionality of dfi:it is critical to hire experts with a good understanding of infrastructure, policies, financing and risk management to work with the institution by offering market-driven lending packages.
Reaching out retail investors:the government needs to set up institutions and network platforms to reach retail investors and incentivise and structure the bonds/instruments so that they are attracted to invest long-term in those instruments.
Periodic review of dfi:periodic reviews are necessary to ensure that the dfi remains relevant by taking into account changing priorities of the economy and making consequential adjustments in the role.

Question-development financial institutions (dfis) are important intermediaries for finance required and economic growth. Discuss.