Development Banks – Why India Need it?

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The Finance Minister on August this year had announced a series of measures to boost the economy and the financial market sentiments of the country. Among them was the setting up of a development bank. This comes during the time when there is an increasing call for sustainable development of the economy and the promotion of eco-friendly technologies. This announcement was in response to the economic slowdown and discouraging capital market sentiments. The idea for the establishment of a sound development bank is encouraging as it helps in providing investments on long-term projects that may have little or no profitable returns but are essential for the sustainable development of the country. This move allows for risky investments, the ones that are essential for addressing the environmental concerns, technological growth, and rural economic development.

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What is the Development Bank?

  • As the name suggests, these banks focus on the development of the economy by providing medium and long term finance.
  • Development Banks also known as Development Finance Institutions (DFIs) are financial institutions that provide risk capital for the economic development of the country on a non-commercial basis.
  • They are often public sector banks or charitable institutions.
  • These banks are set up mostly to provide finance for infrastructural facilities for the industrial growth of the nations.
  • It invests in both the public and private industries.
  • These financial institutions often provide long-term loans for capital intensive projects that spread over a longer period of time.
  • These financial institutions usually provide credit that yields low returns at a cheaper and unwavering rate of interests.
  • They often provide loans for projects related to agriculture, industrial developments etc.

What are the objectives of the development banks?

The objectives of development Banks include the following:

  • To promote the industrial development of the country
  • To boost the employment opportunities within the country
  • Promote the growth of the underdeveloped areas of the country.
  • To generate self-employment opportunities.
  • To boost the exports while simultaneously encouraging the import substitution within the economy.
  • To encourage modernisation and innovative technologies.
  • To promote scientific and technological development in new areas by providing venture capital.
  • To save the non-performing units.
  • Providing training to improve the performance and the management of the large industries.
  • Improving the performance of the capital market of the country

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How are they different from commercial banks?

  • Unlike commercial banks, the Development Banks do not accept deposits from the public.
  • They provide long-term and medium-term finance while commercial banks provide short-term loans.
  • The most unique feature of the development banks is their role in the promotion of economic development by providing investments and enterprises in their allotted spheres like agriculture, industries etc.

What are development banks that exist within India?

  • The idea of development banks was at its peak in the post-independence era.
  • Their tasks and goals vary – some of them may seek to promote industrial developments while some aim for agricultural growth. Some of them are all-India institutions while others operate at state-level or local-level.
  • At the all-India level, the industrial development banks include:
  1. The Industrial Development Bank of India (IDBI) (Commercialized in 2004)
  2. Industrial Finance Corporation of India (IFCI)
  3. Industrial Credit and Investment Corporation of India (ICICI) (Commercialized in 2002)
  4. Industrial Reconstruction Corporation of India (IRCI)
  5. Small Industries Development Banks of India (SIDBI)
  • National Bank for Agriculture and Rural Development (NABARD) is for the rural and agricultural development of the nation.
  • The state level industrial development banks are State Financial Corporation’s State Industrial Development Corporation (SIDC) and State Industrial Investment Corporation (SIIC).
  • The land development banks play a critical role in stimulating agriculture and rural development at the district-level.
  • The Export-import Bank of India (Exim Bank) is another example of India’s development banks. It was established under the Export-import Bank of India Act, 1981. It plays an important role in the promotion of cross-border trade and investment.

Genesis of Development Banks in India:

  • Industrial Finance Corporation of India (IFCI) was established in the year 1948. This might probably be the first industrial development bank set up in India.
  • Later, IDBI (1964), IIBI (1972), NABARD and Exim Bank (1982) were established.
  • The Industrial Credit and Investment Corporation of India (ICICI), the parent company of the current ICICI Bank was established in the year 1955 as a joint venture by the World Bank, India’s public Sector Bank and Public Sector insurance companies to provide credit to the Indian industrial development projects.
  • This company was later merged with the ICICI Bank.
  • Industrial Development Bank of India (IDBI) was previously set up as an apex body of all development banks.
  • After 1991, as per the Narasimham Committee reports on financial sector reforms, the development banks were disbanded to be converted into commercial banks.
  • This, as a result, reduced the long-term credit from the tenure of 10-15 years to five years.

Why does India need development bank?

  • India is currently facing an economic slowdown.
  • This coupled with the increasing NPAs is creating a negative implication to India’s credit culture.
  • To resolve these issues, a need for long-term finance at a low or stable rate of interest is a viable solution.
  • Clearly, forming of the development banks to invest in long-term projects like infrastructure development and housing projects is a step in the right direction.
  • Currently, commercial banks are wary of investing in long-term development projects.
  • Establishment of the development banks to deal with the infrastructural and industrial growth of the country is a need of the hour.
  • This step will enhance the debt flow on the long-term, low return developmental projects like urban infrastructure, mining, heavy industry, irrigation systems, etc.
  • Development Banks are crucial for the economic growth of the country.
  • For example, China’s development banks – the Agriculture Bank of China, China Development Bank and the Export-Import Bank of China have been at the forefront in enabling China’s industrial prowess.
  • After the global financial crisis, these development banks have guaranteed China’s risky investments in its technological developments. This has helped China gain global dominance in the IT hardware and software market.
  • Like China, Germany too had made use development bank, KfW to finance the long-term projects on the development of the green technologies and sustainable development efforts. These projects need very high long-term capitals and the development bank was a vital asset for their achievement.

What are the ways through which development banks can be financed?

  • As the domestic savings were low and the capital market was absent, the development banks were financed through
  1. Lines of credit from the RBI. Some of the profits gained by the RBI were channelled as long-term credit.
  2. Statutory Liquidity Ratio Bonds, into which the commercial banks had to invest a part of their deposits. That is, through government policies, short-term bank deposits were converted into the long-term assets of the development banks. The missing capital market was provided for by the administrative sanctions.

What are the issues that need to be addressed with regards to the development banks in the future?

  • The government’s agenda of setting up of development bank is a welcome step in the current scenario.
  • However, before this plan is implemented, certain questions must be considered beforehand.
  • For example, how will the development banks be financed?
  • If the foreign private capital is contributing to the equity capital (has part ownership), then the government should weigh all possible outcomes that may arise due to this choice.
  • These development financial institutions are often financed by governments or international organisations.
  • The government assistance often comes in the form of tax incentives or administrative orders for the private financial institutions and these institutions are mandated to invest in securities issued by the development banks.
  • In the past, the development banks were discredited for the mounting NPAs mainly due to corruption or lack of professionalism in assessing the risk of investment on the developmental projects with regards to their technical, financial and economic viability.
  • The past lessons must be carefully analysed so as to prevent the repetition of the history of India’s development banks to ensure a firm foundation for the new development financial institution.
  • This, in turn, allows for the inclusive financial growth of the country.

Conclusion

  • According to the World Bank’s New Broad-based Index of Financial Development that was released in 2016, India stood at 38th place with regards to the financial markets and 102nd place in the context of financial institutions.
  • This clearly states that India must ensure the strengthening of domestic financial institutions.
  • Reviving the Development Financial Institutions is a step in the right direction.
  • It not only is a catalyst for the long-term goals of the Indian economy, but also a key to address India’s sociological, regional, rural and environmental concerns.
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Sourav
Sourav
2 years ago

Thnx a lot. You make my work easier. Great quality. Quick respose..of issues. Again Thnk you very much

Santhosh
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Santhosh
2 years ago
Reply to  Sourav Kumar

You’re welcome :)

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