two years back, on March 30 2002, the Industrial Credit and Investment
Corporation of India (ICICI) was through a reverse merger, integrated with
ICICI Bank. That was the beginning of a process that is leading to the
demise of development finance in the country. The reverse merger was the
result of a decision (announced
on October 25, 2001) by the ICICI to
transform itself into a universal bank that would engage itself not only
in traditional banking, but also investment banking and other financial
activities. The proposal also involved merging ICICI Personal Financial
Services Ltd and ICICI Capital Services Ltd with the bank, resulting in
the creation of a financial behemoth with assets of more than Rs. 95,000
crore. The new company was to become the first entity in India to serve as
a financial supermarket and offer almost every financial product under one
Since the announcement of
that decision, not only has the merger been put through, but similar moves
are underway to transform the other two principal development finance
institutions in the country, the Industrial Finance Corporation of India (IFCI),
established in 1948, and the Industrial Development Bank of India (IDBI),
created in 1964. In early February, Finance Minister Jaswant Singh
announced the government's decision to merge the IFCI with a big public
sector bank, like the Punjab National Bank. Following that decision, the
IFCI board has approved the proposal, rendering itself defunct.
It is expected that the decision would be implemented despite considerable
scepticism among both PNB shareholders and IFCI employees with regard to
the proposal. On his last day in office, the erstwhile Chairman and
Managing Director of IFCI, V. P. Singh, sought to assuage the fears of PNB
shareholders by saying that IFCI would clear most of its liabilities
before the merger. Freed of them, PNB, in his view, could leverage IFCI's
existing expertise on project financing, monitoring, advisory services and
term-lending to complement its existing business.
recently the Parliament has approved the corporatisation of the IDBI,
which had been debated for more than a year, paving the way for its merger
with a bank as well. IDBI had earlier set up IDBI Bank as a subsidiary.
However, the process of restructuring IDBI has involved converting the
IDBI Bank into a stand alone bank, through the sale of IDBI's stake in the
institution. Since there is no clear declaration that IDBI Bank would be
chosen as the partner bank for the proposed merger of the DFI, talk of an
alternative is very much in the air. Among the banks being mentioned are:
Bank of Baroda, Punjab National Bank, Indian Bank and Canara Bank.
bill to corporatise IDBI was put through with some difficulty in the Rajya
Sabha, it appeared that the government had provided two commitments. The
first was that the government would retain a majority stake in the entity
into which the IDBI would be transformed.
The government currently
has a 58.47 per cent stake in IDBI.
And, second that the
development finance emphasis of the institution would be retained. But
already doubts are being expressed about the government's willingness to
stick to the first of these commitments. And once the merger creates a
universal bank as a new entity, with multiple interests and a strong
emphasis on commercial profits, it is unclear how the second commitment
can be met either.
As part of
the corporatisation process, the
IDBI has received a forbearance of five
years with respect to the SLR requirement. It is however ready to meet the
obligation of cash reserve ratio (CRR) of around Rs 2,000 crore to the RBI
immediately. The SLR requirement for the institution is pegged at around
Rs 18,000 crore. The non-performing assets (NPAs) of around Rs 15,000
crore are likely to be transferred out of the institution as and when the
merger with a bank takes place.
These developments on the development banking front do herald a new era.
An important financial intervention adopted by almost all
late-industrialising developing countries, besides pre-emption of bank
credit for specific purposes, was the creation of special development
banks with the mandate to provide adequate, even subsidised, credit to
selected industrial establishments and the agricultural sector. According
to an OECD estimate quoted by Eshag, there were about 340 such banks
operating in some 80 developing countries in the mid-1960s. Over half
these banks were state-owned and funded by the exchequer, the remainder
had a mixed ownership or were private. Mixed and private banks were given
government subsidies to enable them to earn a normal rate of profit.
The principal motivation for
the creation of such financial institutions was to make up for the failure
of private financial agents to provide certain kinds of credit to certain
kinds of clients. Private institutions may fail to do so because of high
default risks that cannot be covered by high enough risk premiums because
such rates are not viable. In other instances, failure may be because of
the unwillingness of financial agents to take on certain kinds of risk, or
because anticipated returns to private agents are much lower than the
social returns in the investment concerned.
In practice, financial intermediaries seek
to tailor the demands for credit from them with their funds by adjusting
not just interest rates, but also the terms on which credit is provided.
Lending gets linked to collateral, and the nature and quality of that
collateral is adjusted according to the nature of the borrower and supply
and demand conditions in the credit market. In the event, depending on the
quantum and costs of funds available to the financial intermediary, the
market tends to ration out borrowers to differing extents. In such
circumstances, borrowers are rationed out because they are considered
risky, but they may not be the ones that are the least important from a
social point of view.
These problems can be
aggravated because certain kinds of insurance markets for dealing with
risk are absent and because in some (especially, developing-country)
contexts, certain kinds of long-term contracts may not just exist. They
need to be created by the state, and till such time state-backed lending
would be needed to fill the gap.
Industrial development banks also help deal
with the fact that local industrialists may not have adequate capital to
invest in capacity of the requisite scale in more capital-intensive
industries characterised by significant economies of scale. They help
promote such ventures through their lending and investment practices and
often provide technical assistance to their clients. Some development
banks are expected to focus on the small scale industrial sector,
providing them with long-term finance and working capital at subsidised
interest rates and longer grace periods, as well as offering training and
technical assistance in areas like marketing.
Fundamentally of course, development banking is required because social
returns exceed private returns. This problem arises because private
lenders are concerned only with the return they receive. On the other
the total return to a project includes the
additional surplus (or profit) accruing to the entrepreneur. The projects
that offer the best return to the lender may not be those with the highest
total expected return. As a result, good projects get rationed out,
necessitating measures such as development banking or directed credit.