Banking Sector Reforms

Lessons from past for the new financial institutions

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Not much

Mains level : Paper 3- Lessons from the past for the success of NBFID

The article explains the factors that resulted in the failure of several financial institutions created by the government.

Establishment of Development Finance Institution

  • As promised in the Budget, the Lok Sabha recently passed The National Bank for Financing Infrastructure and Development (NBFID) Bill, 2021.
  • The Bill seeks to establish a development finance institution (DFI) to fund infrastructure.

Providing finance to NBFID

  • The government will initially own 100% of the proposed NBFID’s 20,000-crore share capital.
  • The government’s stake will be reduced later to 26%.
  • The government will also support NBFID in raising cheap, long-term finance.
  • Apart from the initial share capital, the government will also provide a 5,000-crore grant at the end of its first financial year, presumably to defray initial costs.
  • The government has also committed to guarantee NBFID’s borrowings and bond issuances in the domestic and overseas markets.
  • In addition, the government will underwrite NBFID’s foreign exchange hedging costs.

Concerns and lessons from the past

  • Studying the performance of IL&FS Ltd and IDFC Ltd, two infrastructure financing institutions, set up in the public sector, will be instructive.
  • IL&FS had borrowed short-term loans to finance long-term infrastructure assets.
  • Sustaining this became difficult when a slowing economy and political interference forced infrastructure borrowers to stop repaying loans.
  • Also, it had grown unwieldy, was mismanaged, and escaped scrutiny for too long by handing out plum postings to select bureaucrats.
  • Similarly, 1996 budget speech announced the setting up of IDFC to address the lack of long-term infrastructure financing.
  • In 2004, interference by the bureaucrats to tackle slow growth of loan led to the resignation of several senior executives in IDFC.
  • IDFC, created originally to finance infrastructure projects, has since then wound down its project finance book.
  • 2021-22 Budget speech also mentioned the creation of another institution that will acquire the banking sector’s stressed assets.
  • On the similar lines, Industrial Reconstruction Corporation of India was create in 1971.
  • Mandated with nursing sick and weak companies, it collapsed under this onerous burden.
  • The institution was eventually shut down in 2012.

Consider the question “Examine the role the National Bank for Financing Infrastructure and Development will play in the infrastructure development in the country. Also, examine the factors that led to the failure of development finance institutions in the past.”

Conclusion

The short lesson is this: Fix the distorted demand side before increasing supply. Any number of institutions can be launched, but cannot be expected to work miracles in a corroded system.

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