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Burning Issues

[Burning Issue] Development Financial Institutions (DFIs)Bill

Finance Minister has introduced the National Bank for Financing Infrastructure and Development (NaBFID) Bill 2021 in the Lok Sabha to pave way for setting up a government-owned DFI to fund infra projects.

NaBFID Bill

  • The NaBFID Bill, 2021 was introduced in Lok Sabha on March 22, 2021.
  • The Bill seeks to establish the National Bank for Financing Infrastructure and Development (NBFID) as the principal development financial institution (DFIs) for infrastructure financing.

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With inputs from PRS.

What are DFIs?

  • The Bill describes DFI as the principal financial institution and development bank for providing and enabling infrastructure financing throughout the life cycle of the projects concerned.
  • A DFI is basically an organization, either owned by the government or charitable institutions to finance infrastructure projects that are of national importance without expecting the standard commercial return.

Easy explanation:

  • The government wants to create jobs and it wants to do it in a way that’s sustainable.
  • One possible solution is to incentivize the private sector.
  • Because when they invest in creating large infrastructure projects, it has a ripple effect on the economy. It creates new jobs. It creates productive assets. It creates value in the long run.
  • However, these private entities won’t invest if they are strapped for cash.
  • So in a bid to free them from such constraints, the government will set up a new financing institution that will lend long term loans at quite reasonable interest rates.

This would become the DFIs.

DFIs: A Backgrounder

  • DFIs provide long-term credit for capital-intensive investments spread over a long period and low yielding rates of return, such as urban infrastructure, mining and heavy industry, and irrigation systems.
  • They are different from commercial banks, which mobilize short- to medium-term deposits and lend for similar maturities to avoid a maturity mismatch (a potential cause for a bank’s liquidity and solvency).

Their inception

  • In India, the first DFI was operationalized in 1948 with the setting up of the Industrial Finance Corporation (IFCI).
  • Subsequently, India’s Industrial Credit and Investment Corporation (ICICI) was set up with the World Bank’s backing in 1955.
  • The Industrial Development Bank of India (IDBI) came into existence in 1964 to promote long-term financing for infrastructure projects and industry.

Their disbanding

  • However, during the 1970-80s, DFI got discredited for mounting non-performing assets, allegedly caused by politically motivated lending and inadequate professionalism in assessing investment projects for economic, technical, and financial viability.
  • Due to these factors, Narsimhan Committee (1991) recommended disbanding of the DFI, and the existing DFI were converted into commercial banks.

With the NaBFID Bill, the DFI model has made a comeback.

Why need DFIs?

The intent behind setting up a DFI is to provide long-term financing for infrastructure. India has since long time needed infra push due to various reasons:

Infra boost: Infrastructure projects are complex, capital-intensive, and have long gestation periods that often pose risks to project financiers. The scale and complexity of infrastructure projects make financing a challenge.

Banking limitations: There are difficulties in bank-led financing of infrastructure; their liability profile is not suited for financing long-term high-risk infrastructure projects.

NPA Crisis: The surge in NPAs in the banking sector, and the need to augment financing of infrastructure for kick-starting the growth cycle have led to a renewed policy attention on setting up DFIs.

Pandemic induced crisis: Covid-19 pandemic is impacting business and economy, globally. It has exacerbated inequality, the poverty gap, unemployment, and the economy’s slowing down. Thus, infrastructure building through DFIs can help in quick economic recovery.

Economic boost: The government has envisaged attaining the target of becoming a USD 5 trillion economy by 2025.  However, this goal will depend on infrastructure across the country. DFI is a step in the right direction towards this goal.

Global success stories: DFIs in China, Brazil, and Singapore has been successful in both domestic and international markets.

Various challenges

(1) Sources of funds

The lack of a sustainable source of funds, however, can prove to be a serious constraint to the proposed DFIs. Subsidised credit from the government and the Reserve Bank of India (RBI) has not proved to be a sustainable source in the past.

(2) Banking Crisis

At the heart of this old idea coming back in a new shape is the banking crisis in India, which emerged as a consequence of banks trying to fulfill the funding requirements of infrastructure projects.

(3) Regulatory forbearance

There could also be need for some regulatory forbearance — the older DFIs (IDBI, ICICI) operated in an era with no regulatory norms for quite a while, save their own internal guidelines.

Way Forward

Overcoming finance hurdles

  • To ensure that the proposed institution is able to finance infrastructure investment, it should be allowed to raise long-term financing from domestic and external sources.
  • The DFI should be allowed to tap the pools of capital in the form of pension funds, insurance companies and mutual funds.
  • The proposed DFI should also be allowed to raise long-term financing from external markets and from multilateral financial institutions.

Sound management structure

  • The proposed DFI needs to have a sound management structure.
  • The government’s commitment to have a professional board with 50 per cent non-executive members is a step in the right direction.

Competency

  • The proposed DFI should be able to attract competencies such as those of investment professionals and other experts who are able to assess the project from the development standpoint and the risks involved.

Going beyond infra

  • NABFID must also help take infrastructure beyond roads and power, because there are other crucial sectors, especially health, social and urban infrastructure (water supply, sanitation) that has more pressing needs.
  • More importantly, these sectors need the benefit of private expertise and skills more than finance.

Ensuring Good Governance

  • While freeing a DFI from political interference or crony lending is necessary, 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.

Ensuring Ease of Doing Business

  • In the past, ambitious highway and pipeline projects have been continually held up by local protests and land acquisition woes, retrospective taxes, 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.

Lastly, fix the distorted demand side (grappled with twin balance sheet) before increasing supply. Any number of institutions can be launched, but cannot be expected to work miracles in a corroded system.

Conclusion

NABFID, with the support of the government, must go beyond being a provider of capital, to helping enable the return of private sector to infrastructure; else it could end up as just one more DFI in the financing spectrum.

While boosting investment in the infrastructure sector is imperative for sustained growth, the need for the hour is to resolve persistent issues in the debt market that impede long-term financing flow.


References

https://www.thehindubusinessline.com/opinion/editorial/return-of-dfis/article33794397.ece

https://www.prsindia.org/content/examining-rise-non-performing-assets-india

https://www.thehindubusinessline.com/opinion/the-new-dfi-must-look-beyond-financing/article34217199.ece

https://www.livemint.com/opinion/columns/nostalgia-holds-lessons-for-new-financial-institutions-11616951998342.html

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