THE GIST of Editorial for UPSC Exams : 29 August 2019 (Rediscovering development banks (The Hindu))

Rediscovering development banks (The Hindu)

Mains Paper 3: Economy
Prelims level: Banking
Mains level: Evolution of development banks

Context

• The Union Finance Minster recently announced the setting up of a development bank.
• The announcement could have far-reaching implications for India’s financial system.

What are development banks?

• Development banks are financial institutions that provide long-term credit.
• They are also known as term-lending institutions or development finance institutions.
• It generally supports capital-intensive investments spread over a long period and yielding low rates of return.
• E.g. urban infrastructure, mining and heavy industry, irrigation systems
• Such banks often lend at low and stable rates of interest to promote long-term investments with considerable social benefits.

How do they work?

• To lend for long term, development banks require correspondingly long-term sources of finance.
• This is usually obtained by issuing long-dated securities in capital market.
• These are subscribed by long-term savings institutions such as pension and life insurance funds and post office deposits.
• The long-term investments associated here have notable social benefits as well as involve considerable uncertainties.
• Given this, development banks are often supported by governments or international institutions.
• Such support can be in the form of tax incentives and administrative mandates for private sector banks and financial institutions.This is to help them invest in securities issued by development banks.

What is the recent proposal?

• It was proposed to establish an organisation to provide credit enhancement for infrastructure and housing projects.
• A development bank would enhance debt flow toward such projects.
• It comes in the context of India not having a development bank and also for the need to have an institutional mechanism in this regard.
• The overall aim is to improve access to long-term finance.
• The announcement could have far-reaching implications for India’s financial system.

How did development banks evolve in India?

• 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).
• [This is the parent of the largest private commercial bank in India today, the ICICI Bank.]
• It was a collaborative effort between the government with majority equity holding and India’s leading industrialists with nominal equity ownership.
• The objective was to finance modern and relatively large private corporate enterprises.
• In 1964, IDBI (Industrial Development Bank of India) was set up as an apex body of all development finance institutions.
• As the domestic saving rate was low, and capital market was absent, development finance institutions were financed by - lines of credit from the RBI e. some of its profits were channeled as long-term credit, Statutory Liquidity Ratio bonds, into which commercial banks had to invest a proportion of their deposits.
• In other words, with government’s role, short-term bank deposits got transformed into long-term resources for development banks.

How did they perform?

• Development banks got discredited for mounting non-performing assets.
• This was allegedly caused by politically motivated lending.
• Inadequate professionalism in assessing investment projects for economic, technical and financial viability was also a reason.
• After 1991, following the Narasimham Committee reports on financial sector reforms, development finance institutions were disbanded and got converted to commercial banks.
• The result was a steep fall in long-term credit from a tenure of 10-15 years to 5 years.

How has it been for China?

• China’s development banks include the Agricultural Development Bank of China, China Development Bank, and the Export-Import Bank of China.
• These have been at the forefront of financing its industrial prowess.
• After the global financial crisis, these institutions have underwritten China’s risky technological investments.
• This helped it gain global dominance in IT hardware and software companies.
• Likewise, Germany’s development bank, KfW, has been supporting long-term investment in green technologies and sustainable development efforts requiring long-term capital.

Way forward

• The greater the backwardness of a country, the greater the role of the state in economic development.
• This is particularly true in providing long-term finance to catch up with the advanced economies in the shortest possible time.
• In this light, the Finance Minister’s agenda for setting up a development bank is welcome.
• However, a few hard questions need to be addressed in designing the proposed institution.
• The key one among them is the source of finance.
• If foreign private capital is expected to contribute equity capital (hence part ownership), such an option needs to be carefully analysed.
• The political and administrative leadership should carefully analyse the past lessons to lay a firm foundation for the new institution.

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Prelims Questions:

Q.1) With respect to ‘Award of Senior/Junior Fellowships to Outstanding Artistes in the Fields of Culture’, consider the following statements:
1. All the languages from 8th Schedule of the Indian Constitution are included in the Sub-Field of Field “Literature” in the scheme component.
2. Centre for Cultural Resources and Training (CCRT), Hyderabad is the Nodal institute for handling the Scheme of Sr. /Jr. Fellowship till selection process.

Which of the statement(s) given above is/are correct?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2

Correct Answer: A
Mains Questions:
Q.1) What do you mean by the development banks? How did development banks evolve in India?