Demise of Development Financial Institutions in India: Issues and Implications

The emerging economies in post colonial era faced a difficult choice of appropriate mechanism of channelizing the resources into development effort. Many of them had inherited capital starved primitive financial systems. Such systems could not be relied upon to allocate resources among competing demands in the economy. The task of institution building was too important to be left at the mercy of the market forces at the budding stage of development. In such a situation, several governments in Continental Europe and East Asian economies decided to take the matter into their hands and established institutions specifically to cater to the needs of financial resources for developmental effort. Such institutions were called Development Financial Institutions. Development financing is a risky business. It involves financing of infrastructure and industrial projects which usually have long gestation period. The long tenure of such loans has associated with its uncertainty as to performance of the loan asset. The repayment of the long term project loans is dependent on the performance of the project and cash flows arising from it rather than realisability of the collaterals. The project could go wrong for a variety of reasons, such as, technological obsolescence, market competition, change of government policies, natural calamities, poor management skills, poor infrastructure etc. The markets and banking institutions were highly averse to such uncertain outcome, besides without possessing enough information and skills to predict with any certainty the outcome. There were also cost considerations associated with such risky ventures. The long term loan comes with a high price tag due to the long term premium loaded into the pricing. In such a condition, long term financing would be scarce as well as costly so as to render the project financially unviable. DFIs were established with the government support to indemnify their losses as also the commitment for making available low cost resources for lending at the lower rate of interest than that demanded by the market for such risky projects. This arrangement worked well in the initial years of development. As the infrastructure building and industrialization got underway the financial system moved higher on the learning curve and acquired information and skills necessary for the appraisal of the long term projects, it also developed appetite for risk associated with long term projects. The intermediaries like banks and bond markets became sophisticated in risk management and also have certain advantages over the traditional DFIs such as low cost funds and benefit of diversification of loan portfolios. The government support to DFIs, in the meanwhile, was also declining either for fiscal reasons or in favour of building market efficiency. Therefore, towards the end of twentieth century, existence and role of DFIs began to be questioned. In several economies, having attained their developmental goals, DFIs were either restructured or repositioned, or they just faded away from the scene. The Indian experience has also traversed the same path. Although, India cannot be said to have achieved developmental goals yet, the government fiscal imperatives and market forces have forced for a reappraisal of policies and strategy with regard to the role of DFIs in the system. Therefore, it has also become the need of the hour to identify not only the nature and magnitude of requirement of development finance but also the various resources of long-term finance other than DFIs in Indian economy. Furthermore, sources of the supply of development or long term finance in the absence of DFIs are needed to be examined in terms of their availability and sufficiency. This paper aims at highlighting the issues and implications emerging out of demise of Development Financial Institutions in India by evaluating the views in favor and against the DFIs.

Authors Name: 
Ms Renu Gupta