Development finance bodies to be revived to fund infrastructure projects

The government is working on a strategy to give a fresh lease of life to so-called development finance institutions (DFIs) for funding infrastructure projects as rising non-performing assets in the banking sector — which dominated infrastructure funding — limits their heft and threatens to spoil ambitious infrastructure-building plans.

As a first step, the government has indicated its intent to modify India Infrastructure Finance Co Ltd (IIFCL) into a DFI by increasing its equity capital by ₹15,000 crore. “IIFCL has had limited success in financing of infrastructure thus far. With increased equity capital, the idea is to create requisite headroom for borrowing such that IIFCL can finance big infrastructure projects,” a government official said.

To facilitate this goal, suitable governance and regulatory reforms that enables IIFCL to be developed as a DFI are being examined by the government.

The government has also sanctioned funds in the Budget for capitalisation of the infrastructure NBFC of the National Investment and Infrastructure Fund (NIIF) as part of efforts to build up the capacity of banking and financial institutions to provide long-term infrastructure finance.

Infrastructure financing is currently dominated by bank lending, with outstanding credit to the infrastructure sector by, as a percentage of gross non-food credit, touching 15 per cent until FY16. However, due to rising non-performing assets in the banking sector driven by declining asset quality in infrastructure sector, the share has declined to 12 per cent in FY19.

Long-term financing

The government’s policy managers acknowledge the need to have access to long-term finance (most likely from long-term bonds from capital markets) at competitive cost so that funding of long-term infrastructure projects could be done in an economically viable manner and without the associated asset-liability mismatches.

Between 2000 and 2010, DFIs such as ICICI, IDBI and IDFC extended long-term finance to industry and funded greenfield infrastructure projects. However, after achieving critical mass, these transformed into universal banks as they did not have the advantage of low-cost liabilities to de-risk their business models.

Besides paucity of low-cost funds, factors such as the withdrawal of government guarantee for bond issuance and the resultant non-statutory liquidity ratio (SLR) status of their bonds, and high concentration risk led to financial stress for many DFIs. These developments further hampered DFIs’ lending to greenfield projects. Also, many DFIs faced asset quality issues attributed to the ongoing stress in the infrastructure sector and high exposure to stressed sectors, such as power generation.

Over the past few years, some of the major DFIs have amalgamated with their banking outfits (like ICICI and IDBI) due to these factors, while some others have been reclassified as systemically important non-deposit taking NBFCs (such as IFCI).

Diversification of portfolios

A review of the DFIs in the infrastructure space has revealed a high number of sector-specific DFIs housed within a specific line ministry. However, individual entities have tried to diversify their portfolios across specific sub-sectors.

For example, infra NBFCs such as Power Finance Corporation Ltd (PFC) and REC Ltd (acquired by PFC in 2019) have fairly diversified portfolios across the power sector value chain (generation, distribution and transmission), while Housing and Urban Development Corporation Ltd (HUDCO), by virtue of its urban infrastructure mandate (including water supply, sewerage and housing), has a wide sectoral presence, thereby limiting the size and scale of diversification.

Entities such as PTC Financial Services Ltd have been attempting to look beyond opportunities in the power sector and create a pan-infrastructure portfolio, with limited success.

The government will also start an exercise to review the role and functioning of existing central public sector DFIs, such as PFC, IREDA, NHB, HUDCO and State DFIs to encourage these sector-specific DFIs to diversify into new avenues that have potential for growth, the government official said.

“It is necessary that DFIs have a diversified asset base across all sectors to protect against cyclical nature of the infrastructure/industrial sectors and prevent concentration risk. This will also enable greater investor confidence,” he said.

A differential licensing system with an enabling regulatory framework to encourage setting up of DFIs in the infrastructure sector with domestic or foreign capital is also on the table.

Some of the existing DFIs could also be capitalised with the help of multi-lateral agencies such as International Finance Corporation, Asian Development Bank and New Development Bank, and also seek equity investment from local and global pension funds.

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