Rediscovering development banks                             (Mains GS paper III : Economy) 

Context: recently, the finance minister announced a list of measures in order to boost the economy which is presently facing a slowdown. One such announcement was setting up of a development bank in India. The DB will be set up to provide credit enhancement for infrastructure and housing project.

About Development Banks?

• As the name suggests they have been set up to provide medium to long term finance or loans at subsidized interest rates to various critical sectors like agriculture, housing, infrastructure, industries etc.
• Their importance is that it complements banking sector which provides short term loans.
• It will also reduce their burden on banking sector and help them to address the issue of asset -liability mismatch
• They will be mainly owned by Government.
• They will get funding from govt, issuance of shares, issuance of long-term bonds etc.

How are they different from commercial banks?

• They do not accept deposit from public but raise finance through govt’s infusion of capital, access to capital market through issuance of bonds.
• Nature of loans given by them is medium and long term whereas for commercial bank it is usually short term.
• The role of normal banks is commercial in nature whereas DB focus on socio-economic transformation

Nature of assistance by them

• Extend long term loans
• Subscribe to the shares of companies
• Credit guarantee on repayment of bonds

Development of financial institution in India

• Most of the advanced economies of the world such as USA, UK , japan etc. had used the tool of developmental financial institutions to promote growth
• Recently china too has started to use this tool such as agriculture development Bank.
• In India, the IFCI, previously the Industrial Finance Corporation of India, was set up in 1949. This was probably India’s first development bank for financing industrial investments.
• In 1955, the World Bank prompted the Industrial Credit and Investment Corporation of India (ICICI) — the parent of the largest private commercial bank in India today, ICICI Bank — as a collaborative effort between the government with majority equity holding and India’s leading industrialists with nominal equity ownership to finance modern and relatively large private corporate enterprises.
• In 1964, IDBI was set up as an apex body of all development finance institutions.
• We have NABARD for agriculture and rural development
• EXIM bank for tribal development
• SIDBI and MUDRA for MSMEs development.

Benefits of development banks

• It will meet the investment needs: if govt wants to achieve its $5 trillion economy goal it requires higher rates of investment and this can be met by DB
• It will reduce the pressure on commercial banks as for the longest time commercial banks have been the main source of funding for long term infrastructure projects leading to NPAs.
• It will diversify financial market
• It will lower the cost of capital as it will provide loan at cheaper interest rate and further credit enhancement will lead to reduced interest rate.
• Even other countries have used DB as a tool of socio-economic transformation and have proven successful.
• It will also educe the foreign currency exposure as economies will be able to raise loans in domestic market and avoid foreign currency exposure.