Return of DFIs

| Updated on February 09, 2021

Setting up a development financial institution is a good idea, but past errors should be avoided

The Centre is banking on long-term infrastructure creation to sustainably lift India’s economic growth rate. This makes it imperative for the Centre to figure out a way to bankroll the ambitious ₹100 lakh crore National Infrastructure Pipeline. With banks having burnt their fingers on project lending, it appears pragmatic for the country to go back to the idea of a Development Finance Institution (DFI). Naysayers may point out the failed experiment with institutions such as ICICI and IDBI which were converted into universal banks at the turn of the century. But India’s financial markets have grown by leaps and bounds since then, other economies have demonstrated success with DFIs, and policymakers have the luxury of learning from past mistakes. This makes the DFI idea worth exploring again.

Three major aspects may need consultation and fleshing out as India revisits the idea of a DFI. One, if industrial lending institutions of the earlier era were over-reliant on cheap government funds, universal banks ran into asset-liability mismatches due to their reliance on retail deposits to fund long-term projects. Therefore, it may be best for new-age DFIs to focus on diversified sources of funding that balance the two. While the Centre must adequately capitalise the DFI to give it the status of a sovereign-backed entity, alternative routes such as capital gains/tax-free bond issues, external borrowings and loans from multilateral agencies must also be explored to avoid over-dependence on the fisc. Two, history tells us that in India, specialised project lenders focussed on specific verticals tend to do better at building project appraisal skills and managing risks than ‘supermarket’ lenders who fund any project that comes their way. The Centre must therefore be open to the idea of multiple specialised DFIs modelled on the success of refinancing institutions such as NHB and NABARD and direct finance institutions such as Exim Bank, IREDA and IRFC. Three, while freeing a DFI from political interference or crony lending is a necessary condition, merely having private shareholders or professional managers on board isn’t sufficient to ensure good governance. This has to be backed by a robust system of external checks and balances such as supervision by RBI and proper due diligence by auditors and rating agencies.

Of course, the Centre must also keep in mind that project lending institutions in India tend to be tripped up by factors outside their control, as much as by their inherent weaknesses. In the past, ambitious highway and pipeline projects have been interminably held up by local protests and land acquisition woes, telecom players have been hamstrung by litigation over AGR and retrospective taxes and mega power projects have been stalled by irregular fuel allocations and poor contract enforcement. The success of DFIs is contingent on ironing out such issues and removing on-ground impediments to the ease of doing business.

Published on February 09, 2021

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