Why DFIs have regained relevance today

Gopalkrishna Tadas | Updated on June 22, 2021

Infra pressures The challenge of long-term financing   -  Siva Saravanan S

We perhaps failed to review mandates given to development finance institutions in the past to enable them to change course

Development Financial Institutions (DFIs) are critical intermediaries for channelling long-term finance required for infrastructure and key manufacturing projects for realising higher economic growth. Inadequate and inefficient infrastructure leads to high transaction costs, which in turn stunts an economy’s growth potential.

Irrespective of the level of development, countries across the world have set up development banks to finance key infrastructure and manufacturing projects. Many multilateral institutions and country specific DFIs have come up in the past to address global and regional development financing needs.

For instance, the European Investment Bank (EIB) acts like a DFI for Europe and the German Kreditanstalt für Wiederaufbau (KfW) provides funding to sub-national institutions within Germany. In Asia, the China Development Bank (CDB) and Agricultural Development Bank of China (ADBC) have been playing a pivotal role in the country's efforts to build infrastructure, manufacturing and agri-sectors. Similarly, in Latin America, Brazil has its own development bank.

DFIs in India like IDBI, 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. After the 1991 reforms, these DFIs had to change their tack due to changed policy stance and business environment.

Earlier they were getting concessional funding from RBI and the government, which was no longer available in the subsequent years. As a consequence, IDBI and ICICI had to convert themselves into universal banks. IFCI continued but remained a beleaguered institution. With the conversion of the major DFIs into commercial banks, there were few institutions in the country which could take care of industrial or infrastructure development.

While these DFIs disappeared, new set of institutions like IDFC (1997), IIFCL (2006) and more recently, NIIF (2015) emerged to focus on funding infrastructure. While they played some role in the beginning, they also tended to attenuate over time. While IDFC was converted into a bank (IDFC First Bank), there has not been much of traction in IIFCL lending for the last 10 years nor is NIIF’s contribution significant.

The new DFI

It is a positive development that the government has recognised the criticality of financing long-term infrastructure requirements by announcing the setting up of a new DFI.

The new DFI is expected to build a portfolio of ₹5 trillion in the next three years. 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. We need to draw lessons from our own past experiences as also success stories of development banks in other countries.

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. If it needs to build a portfolio of ₹5 trillion over a period of three years, the capital base needs to be augmented further by three times. If it is proposed as 100 per cent government entity, then government will have to infuse capital from time to time.

Alternatively, government may allow equity investment by institutions having long term horizon like insurance companies, pension funds to augment the capital, which means the government holding would have to go down. From the perspective of making the DFI dynamic to cater to the changing development needs, this could be a preferred option as these institutions will bring with them diversified perspectives and expertise.

It is critical to hire experts with good understanding of infrastructure, policies, financing and risk management to work with the institution by offering market-driven compensation package. Besides, proper organisation structure and professional board is very critical in guiding the future path of DFI and in directing finance to desirable projects. Market perceptions are very important and the potential investors would look forward to competence of the board, corporate governance and risk management standards.

Enabling environment

Achieving a ₹5 trillion portfolio over the next three years requires resources from long-term institutions like insurance companies, pension funds. The government is also proposing to encourage setting up of private sector DFIs.

All these would require an assurance of an enabling environment. Private players may be reluctant if there are uncertainties as regards government policies, regulations and delays in getting approvals. These risks are beyond the control of both the DFI and the project promoters. The designing of framework for risk allocation is crucial to attract private participation.

This would greatly reduce uncertainties associated with project implementation and bring more clarity as regards choice of business model for the project. The pension funds or insurance companies invest long-term (10-20 years) hoping that at the end of the period they can fulfil their obligations of giving back the money (with reasonable returns) to their investors when needed, who are dependent on them for pension and insurance claims.

Although India has long-term debt market for the government securities and corporate bonds, it is still out of reach of retail investors and unable to meet the large infrastructure financing needs. Most of the corporate bonds are issued for a period of 5-7 years. 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 mandate

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. In India, we perhaps failed to review the mandates given to the DFIs in the past with view to enable them to change course to meet changing development priorities.

Most of the successful development banks around the world have seen that the mandates given to them were reviewed periodically and the fresh mandates were given if the existing ones had lost relevance. For a developing country like India, it is desirable that the new DFI remains viable and sustainable to be able to cater to the long-term development financing requirements.

The writer is former Executive Director, IDBI Bank

Published on June 22, 2021

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