Development Financial Institutions

Development Financial Institutions are specialized institutions set up primarily to provide development/ Project finance especially in developing countries. These development banks are usually majority-owned by national governments. The source of capital of these banks is national or international development funds. This ensures their creditworthiness and their ability to provide project finance in a very competitive rate.

Difference from Commercial Banks

DFIs differentiates itself from commercial banks as it strikes a balance between commercial operational norms as followed by commercial banks on one hand, and developmental responsibilities on the other. They provide long-term loans, guarantees and underwriting functions. DFIs provide long term finance to fund the activities to those sectors where the risk is higher for the commercial banks to finance. So, DFIs are not just plain lenders like commercial banks but they act as companions in the development of significant sectors of the economy. After independence, as the role of commercial banks were limited to providing working capital financing for short periods, the DFIs were set up to finance the development on long term basis for the significant sectors of the economy like infrastructure sector.

Classification

The Development Finance Institutions can be classified into four categories:

  • National Development Banks Ex: IDBI, SIDBI, ICICI, IFCI, IRBI, IDFC
  • Sector specific financial institutions Ex: TFCI, EXIM Bank, NABARD, HDFC, NHB
  • Investment Institutions Ex: LIC, GIC and UTI
  • State level institutions Ex: State Finance Corporations and SIDCs.

Role of DFIs in Indian Economy

In India, the role of DFIs is to support long term infrastructures of industry and agriculture. The DFIs were set up under the full control of both Central and State Governments. These institutions were used by the government for spurring economic growth and aid social development. The DFIs provide finance to all those entities which are not adequately served by the banks and capital markets like households, SMEs, and private corporations.

Evolution of DFIs in India

In India, the first DFI was operationalised in 1948 with the setting up of the Industrial Finance Corporation (IFCI). After the passage of state Financial corporations (SFcs) Act, 1951, state level small and medium-sized financial corporations were established. It was succeeded by the establishment of industrial Finance Corporation of India (IFCI). In 1955, the first DFI in private sector, the Industrial Credit and Investment Corporation of India (ICICI), was set up with the backing of the World Bank. In 1958, Refinance Corporation for Industry, which was taken over by the Industrial Development Bank of India (IDBI) was established. In 1963, Agriculture Refinance Corporation was established.

The major development in the institution building was the establishment of IDBI as an apex term-lending institution, and that of the Unit Trust of India (UTI), as subsidiaries of the Reserve Bank of India (RBI) in 1964. Similarly, in 1960s, State Industrial Development Corporations (SIDCs) were developed in the states.

The following are some of the major institutions set up after 1974:

  • 1981: NABARD
  • 1982: EXIM Bank
  • 1986: Shipping Credit and Investment Company of India (SCICI)
  • 1987: Indian Renewable Energy Development Agency (IREDA)
  • 1988: ICICI Venture Funds Management Ltd.
  • 1988: National Housing Bank (NHB)
  • 1989: Tourism Finance Corporation of India (TFCI)
  • 1990: Small Industries Development Bank of India (SIDBI)

Industrial Finance Corporation of India (IFCI), Industrial Development Bank of India (IDBI), National Bank for Agriculture and Rural Development (NABARD), National Housing Board (NHB) and Small Industry Development Bank of India (SIDBI) were all launched with majority ownership of the Reserve Bank of India (RBI).

Declining role of DFIs post-liberalization

After 2000-2001, the prominence of development banking has started to decline as many firms from development banking had quit post liberalization. During 2002-2004, ICICI and IDBI were turned into commercial banks. From then, the share of the development banks fell down to just 30% from two-thirds. The government found that the DFIs failed miserably to provide credits to small scale sector and rural farm sectors for long term. Also, they do not have low cost deposits in the form of current and savings accounts similar to that of commercial banks. Until reforms in 1991, the DFIs had access to state funding. But after 1991 reforms, reduced public spending in DFIs resulted in their decline. So, the DFIs had to rely on a variety of methods to fill the gap created by the reduced state funding. There were growing reliance on bank credit, private equity in corporate financing and external commercial borrowing (ECBs).

Universal banking replacing DFIs in India

At present the line between the role of DFIs and commercial banks have blurred due to overlapping of their functions. Nowadays, the commercial banks are actively involved in developmental financing similar to that of the DFIs, especially after the merger of ICICI and IDBI within the banking system. So, nowadays the commercial banks are often called as the universal banks as it provides all types of financial services.

Conclusion

The DFIs role of industrialization and the developmental finance till the onset of liberalization cannot be denied. They were crucial to realize the larger developmental goals as prescribed by the Five Year Plans. Though, as of now, the commercial banks have largely taken the place of DFIs in developmental financing, they are unlikely to emphasize environmental and social concerns while making investment decisions and lending, especially if they result in reduction in profitability. In India, it has been observed that the greater private participation in developmental banking has often resulted in accumulation of private profit rather than social benefit. Hence, it would be wise to revive the concept of DFI if the government wishes to keep societal, cultural, regional, rural and environmental concerns intact while financing long term developmental projects.

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