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SPECIAL ARTICLE
Rise and Fall of Industrial Finance in India
Partha Ray
Examining the sources of finance for Indian industry, this
paper traces the transition from a state-owned and
state-dictated financial sector to a regime of financial
liberalisation. There are still a number of rough edges to
this transition. With the initiation of financial sector
reforms and the demise of development banking, there
are indications that the industrial sector faces a credit
crunch. While newer sources of finance could have
compensated for the paucity of bank financing, the exit
of development banks before establishing a successful
corporate debt market has turned out to be costly for
long-term financing. In this context, the experience of
the Brazilian Development Bank could serve as a useful
model for India.
This paper was presented at the national conference on “India’s
Industrialisation: How to Overcome the Stagnation” in New Delhi,
19-21 December 2013, organised by the Institute for Studies in Industrial
Development. The author is indebted to the participants of the
conference for their comments. The author thanks R Nagaraj in
particular for his detailed comments on an earlier draft. The usual
disclaimer applies.
Partha Ray (pray@iimcal.ac.in) teaches at the Indian Institute of
Management Calcutta.
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vol l no 5
1 Introduction
D
oes finance matter for growth and development?
While the question seems to be at the heart of the process of growth and development, finance was a neglected issue in mainstream models of growth till recently.
Was this a slip in the theories that look into complex realities?
Or, was it because the mainstream growth literature as “a basic
theoretical paradigm focuses on the fundamental mechanisms
of the growth process, whereas finance is like the lubrication
that reduces frictions and thereby enables the machinery to
function” (Aghion and Howitt 2009)? Why would finance matter to growth? The literature distinguishes between two kinds
of complementary channels. In the first channel, innovative
financial technologies tend to lessen the informational asymmetries that act as impediments to the efficient allocation of
funds, thereby improving total factor productivity (for example, Greenwood and Jovanovic 1990). The second channel,
stemming from Gurley and Shaw (1955), focuses on the
“spread of organised finance at the expense of self-finance and
the former’s ability to overcome indivisibilities through the
mobilisation of otherwise unproductive resources” (Bell and
Rousseau 2001). Thus, it is based on the debt accumulation
hypothesis (Bencivenga and Smith 1991).
Apart from these theoretical models in the neoclassical tradition, there is a large literature on the role of finance in industrialisation in the historical context. For example, Gerschenkron’s writings on industrialisation in Europe tend to suggest
that both the timing and character of growth might have conditioned the institutional structure in the 19th century, in
which banks played a crucial role. The more “economically
backward” a country is, the more active would be the role
played by its government and large banks in supplying capital
and entrepreneurship. In particular, it was shown how late industrialising countries of continental Europe created bank finance for long-term lending to overcome the lack of financial
markets and speed up industrialisation (Gerschenkron 1962).
At the risk of oversimplification, in the taxonomy of bankbased versus market-based financial systems, it is well known
that the Indian economy emerged as a bank-based system over
the years. After the nationalisation of leading commercial
banks in 1969, detailed plan processes evolved for making
finance available to different sectors of the economy. Industrial finance occupied a key role in this. While there were
detailed norms for working capital finance from commercial
banks, a number of term-lending institutions came into being,
primarily under government auspices. This process has been
reversed after the initiation of financial sector reforms. Moving
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away from a regime of assured finance from commercial
banks (for working capital) and development banks (for term
finance), the Indian industrial sector has been accessing a
variety of sources for finance since the late 1990s. Further,
most of the term-lending institutions closed due to lack of
government funding at concessional rates and re-emerged as
full-fledged universal banks.
An objective evaluation of the movement from a dirigisme
financial regime to a more market-friendly regime is fraught
with difficulties, and the assessment often tends to get caricatured in terms of a state versus market debate. The case of
industrial finance is all the more complicated as Indian industrial growth has suffered since liberalisation, which has seen
the service sector emerge as the key driver of growth. Now
that questions are increasingly being asked about the sustainability of service-led growth, it is important to examine the
constraints facing the industrial sector.
How far is finance (or its lack) responsible for lacklustre industrial growth? How far is the lack of industrial/manufacturing dynamism in India due to the operation of a finance
constraint? A number of authors have emphasised credit constraints and the way they have affected industrial growth in
India. In an early evaluation of the effect of financial sector
reform on the performance of the industrial sector, Khanna
(1999) found that, contrary to expectations, there was a hardening of interest rates rather than an easy availability of
credit. Using Annual Survey of Industries data at the threedigit level, Gupta, Hasan and Kumar (2008) pointed out that
the post-reform performance of the manufacturing sector
was heterogeneous across industries. In particular, industries
that were dependent on infrastructure or external finance
and were labour-intensive had not been able to reap the benefits of the reforms. More recently, Banerjee and Duflo (2012)
have showed that a sample of firms under the ambit of
directed credit programmes in 2000 were themselves creditconstrained. Analysing the significance of the credit constraint on Indian industries, Bhattacharjee and Chakrabarti
(2013: 66) noted,
The Indian manufacturing sector that was mainly credit-centric in the
earlier years experienced a significant decline in the availability of loanable funds in the post-liberalisation period mainly due to the risk
averse behaviour of the banking sector and the gradual withdrawal of
the DFIs [development finance institutions].
Even official documents cite lack of credit as a factor responsible for subdued industrial growth. For instance, the Economic
Survey (2012-13) noted,
The moderation in industrial growth, particularly in the manufacturing sector, is largely attributed to sluggish growth of investment,
squeezed margins of the corporate sector, deceleration in the rate of
growth of credit flows and the fragile global economic recovery (195;
emphasis added).
Nevertheless, segregating the influence of financial factors
impeding industrial growth from the other policy-induced factors (such as trade or investment policy) is difficult. This paper
makes no such attempt. Instead, it attempts to present some
broad stylised facts on industrial finance in a before-and-after
62
framework, and flag some contemporary issues facing industrial finance.
Section 2 deals with the specialised institutions that were
set up after Independence to deal specifically with providing
industrial finance. Section 3 gives a synoptic view of the trends
in industrial finance following bank nationalisation in 1969.
Section 4 presents the story of industrial finance since the
1990s. Section 5 flags a few contemporary issues for industrial
finance. Section 6 concludes the paper.
2 Industrial Finance and Specialised Institutions
Looking at the history of industrial finance in India, one may
note that despite the existence of a capital market, risk capital
for the industrial sector was not very forthcoming in preIndependence days. The managing agency system also inhibited growth of the capital market as the managing agents
acted both as promoting and marketing agencies. The capital
market was characterised by an absence of special institutions
to float new issues. Faced with the lukewarm response of the
capital market, some princely states such as Mysore and Hyderabad founded state-supported banks to finance industrialisation. For example, the State Bank of Mysore was established
in 1913 as Bank of Mysore under the patronage of the government of Mysore, at the instance of a committee headed by engineer-statesman M Visvesvaraya.1
Immediately after Independence, a “network of financial institutions” was “set up to fill the gaps in the supply of longterm finance to industry” (Rosen 1962: 83). The Industrial
Finance Corporation of India (IFCI) was set up in 1948. In the
next five years, a number of state governments, with the encouragement of the central government, set up their own state
financial corporations (SFCs). In the initial years, the IFCI was
empowered to extend loans above Rs 10 lakh and the SFCs
were mandated to extend loans below this threshold. While
the SFCs were created on the lines of the IFCI, they were intended to “serve the financial requirements of small- and
medium-sized enterprises” (Gupta 1969: 88). Later, in 1954,
the National Industrial Development Corporation (NIDC) was
set up as an agency of the central government to provide both
entrepreneurship and finance to the industrial sector, and it
functioned till early 1963.
The Industrial Credit and Investment Corporation of India
(ICICI) was floated in 1955 as a public limited company with the
support of the World Bank, the Government of India, and representatives of Indian industry. While its primary objective
was to provide medium-term and long-term project financing
to businesses, it emerged as the major source of foreign currency loans to Indian industry, and for underwriting corporate
finance. Despite the involvement of the World Bank and the
private sector, the central government played a significant role
in the establishment of the ICICI.
In 1964, the Industrial Development Bank of India (IDBI)
was set up as an apex institution in the sphere of medium- and
long-term finance. It took over the business of the Refinance
Corporation for Industry (RCI), which was set up in 1958 for
the SFCs. The control of the IFCI was transferred to the IDBI
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from the central government. The IDBI was constituted as a
wholly-owned subsidiary of the Reserve Bank of India (RBI),
which created a new long-term fund known as the National
Industrial Credit (Long-term Operations) Fund with an initial
contribution of Rs 10 crore. The RBI used to make annual allocations to the fund out of its surplus profits before they are
transferred to the government.
Following the model of “development central banking”, the
RBI built up a three-pronged strategy of developing an institutional framework for industrial financing alongside extending
rural credit and designing concessional financing schemes for
economic development (Singh, Shetty and Venkatachalam
1982). The RBI played a key role in establishing the IFCI (1948),
RCI (1958), IDBI (1964), and the Industrial Reconstruction Corporation of India (1971) alongside a network of SFCs to meet
the term credit needs of local medium- and small-scale industries (SSI) and for funding land development banks. The RBI
also subscribed 50% of the initial capital of the Unit Trust of
India (UTI) (Jadhav et al 2005).2
As a result of all these developments, by the time the banking system was proceeding towards nationalisation, India
already had a network of specialised institutions that were
active in providing industrial finance (Table 1).
Table 1: Loans Disbursed by Special Industrial Financing Institutions
(Rs crore)
Year
IFCI
SFCs
ICICI
1948
0.7
-
-
Refinance to Banks
-
IDBI (Direct Loans) NIDC
-
-
Total
1949
1.7
-
-
-
-
-
1.7
1950
2.2
-
-
-
-
-
2.2
1951
2.1
-
-
-
-
-
2.1
1952
2.1
-
-
-
-
-
2.1
1953
2.7
0.2
-
-
-
-
2.9
1954
2.2
1.1
-
-
-
-
3.3
1955
1.9
1.7
0.1
-
-
-
3.7
1956
6.0
2.7
0.4
-
-
0.2
9.3
1957
9.1
3.5
1.4
-
-
0.3
14.3
1958
7.9
3.4
1.4
-
-
2.2
14.9
1959
8.0
3.8
2.4
0.8
-
1.9
16.9
1960
7.5
4.5
1.8
1.4
-
1.7
16.9
0.7
1961
8.7
7.3
4.5
4.7
-
2.3
27.5
1962
12.4
10.5
8.0
8.0
-
3.2
42.1
1963
15.1
12.3
8.8
15.4
-
2.6
54.2
1964
17.3
12.7
13.4
18.8
-
-
62.2
1965
21.2
15.3
15.4
16.4
1.8
-
70.1
Source: Gupta (1969: 94).
Apart from these specialised institutions catering exclusively to industries, investment institutions such as the Life
Insurance Corporation (LIC), which had been set up in 1956,
played an active role in purchasing industrial securities.
Over the years, many more term-financing institutions were
established and these institutions played a significant role in
providing long-term finance to Indian industries. The broad
structure that prevailed at the end of the last century consisted
of various types of all-India financial institutions (AIFIs). They
comprised (a) all-India development banks (IFCI, ICICI, IDBI,
Small Industries Development Bank of India (SIDBI), and
Industrial Investment Bank of India (IIBI)); (b) specialised
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institutions (Export-Import Bank of India (EXIM Bank), IFCI
Venture Capital Funds (IVCF), ICICI Venture, Tourism Finance
Corporation of India (TFCI), and Infrastructure Development
Finance Company (IDFC)); (c) investment institutions (UTI, LIC,
and General Insurance Corporation (GIC) and its subsidiaries);
and (d) refinance institutions (National Bank for Agriculture
and Rural Development (NABARD) and National Housing
Board (NHB)). Besides, there were 18 SFCs and 26 state industrial development corporations (SIDCs). The spread of their
activities was significant till the 1990s (Table 2).
Table 2: Trends and Composition of Disbursements of Financial Institutions
Period
Total
Shares of Disbursements as Percentage of
Disbursements
Total Disbursements
as Percentage All-India
Specialised Investment State-level Total
of GDP
Development Institutions Institutions Institutions
Banks
1970-71 to 1974-75
1975-76 to 1979-80
1980-81 to 1984-85
1985-86 to 1989-90
0.5
0.8
1.4
1.9
66.0
71.5
68.8
66.1
0.0
0.0
0.0
0.1
8.5
7.8
10.2
15.0
25.5
20.7
21.0
18.9
100.0
100.0
100.0
100.0
Source: RBI, Report on Currency and Finance, 1999-2000.
The DFIs have been an important source of long-term funds
(mainly debt) for the industrial sector. Two of their specific
achievements need to be mentioned. First, development banks
such as the IDBI played an active role in promoting small enterprises in backward areas, particularly by supporting the technical consultancy organisations (TCOs) set up as autonomous
corporate units in each backward state by financial institutions and the Technical Consultancy Service Centre (TCSC). By
the end of 1980, there were 13 TCOs and many of them were
successful (Bhatt 1981). Second, DFI lending to the Indian corporate sector was not governed by lobbying, precedence, or
even sponsoring socially desirable projects that were not privately profitable. Rather, their primary role was to reduce the
financial constraints faced by firms (Bhandari et al 2003).3
3 Finance for Industries Following Bank Nationalisation
It may be useful to recall that Indian banking was entirely in
the private sector at the time of Independence. The banking
sector was fairly oligopolistic and, “in addition to the Imperial
Bank, there were five big banks, each holding public deposits
aggregating Rs 100 crore and more, viz, Central Bank of India,
Punjab National Bank, Bank of India, Bank of Baroda, and
United Commercial Bank” (RBI 2008).4 Most of the banks were
owned by industry houses, and allegations of interconnected
lending (whereby typically a bank used to lend to its owner)
were rampant between 1947 and 1967. There were also largescale bank failures.5
The story of bank nationalisation is quite well known. Postnationalisation, the banking sector and monetary policies became increasingly subsumed under what came to be known as
“credit planning”. The key features of the credit planning
regime were as follows. First, an administrative interest rate
structure, dictated by societal needs, emerged. Second, some
sectors, primarily agriculture and the small-scale industrial
sector, were designated “priority sectors” – commercial banks
were obligated to extend a fixed proportion of their total credit
to them.6 Third, since banking was seen as a source of
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resources for planning, there was an increase in the statutory
liquidity ratio, that is, the proportion of aggregate liabilities
that a bank is supposed to hold in government securities and
other safe/liquid assets. Fourth, for normal working capital
loans, various parameters/norms were prescribed in 1975 (inventory and receivables) for an approach to lending, style of
credit, and follow up (RBI 2008).7
Bank Credit for Industries
What has been the effect of these policies? Notwithstanding
claims of financial repression, it was apparent that the amount
of credit increased at a spectacular rate during the postnationalisation years (Figure 1). The diverging trend between
deposits and credit is due to the increasing investment of commercial banks during this period, reflecting among other
things an increase in the statutory liquidity ratio.
Figure 1: Commercial and Cooperative Banks Deposits and Credit,
1950 to 1990 (% of gross domestic product)
35
30
25
Deposits
20
15
10
Bank Credit
5
1990-91
1986-87
1988-89
1982-83
1984-85
1978-79
1980-81
1974-75
1976-77
1972-73
1970-71
1968-69
1966-67
1962-63
1964-65
1958-59
1960-61
1956-57
1952-53
1954-55
1950-51
0
What has happened to the industrial credit extended by
commercial banks? As the main aim of nationalisation of
banks was to channelise credit to agriculture and SSI, there
was a marginal decline in the share of credit to medium- and
large-scale industries. But taking the SSI sector into account,
total industrial credit as a proportion to aggregate gross bank
credit was very stable (Figure 2).
Figure 2: Industrial Credit from 1979-80 to 1990-91
(% of total gross bank credit)
60
55
50
45
40
35
Total Industrial Credit
30
Credit to Medium and Large Industries
1990-91
1989-90
1988-89
1987-88
1986-87
1985-86
1984-85
1983-84
1982-83
1981-82
1980-81
Credit to SSI
1979-80
25
20
15
10
To sum up, a close look at the proportion of major sources of
industrial finance establishes the primacy of bank credit. However, the development banks played a significant complementary role (Table 3).
Table 3: Major Sources of Industrial Finance (% of GDP)
Period
Bank Credit
Development Finance Institutions
Capital Market
Total
1970s
1980s
1990s
1.8
2.7
2.6
0.3
0.7
1.0
0.1
0.6
1.2
2.2
4.0
4.8
Source: Mohan (2009).
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4 Trends in Industrial Finance since the 1990s
Financial Sector Reforms: Broad Contours
The story of economic liberalisation in India is well known.8
What is less well known is that industrial finance has been decreasing since the beginning of the new millennium. Monthly
data on sectoral deployment of credit collected from 47 scheduled commercial banks, accounting for about 95% of the total
non-food credit deployed by all scheduled commercial banks,
are released by the RBI. Trends in these data are reported in
Table 4. It appears that industrial credit as a proportion of nonfood credit or total credit has experienced a secular decline.
Table 4: Sectoral Deployment of Gross Bank Credit: Old Format (Rs crore)
Period
Agriculture
SmallScale
Industries
1999-2000 44,400
2000-01
51,900
2001-02
60,800
2002-03
73,500
2003-04
90,500
2004-05 1,25,300
2005-06 1,74,000
2006-07 2,30,400
2007-08 2,75,300
2008-09 3,38,700
2009-10
4,16,100
2010-11 4,80,600
2011-12
5,48,400
2012–13 5,89,900
52,800
56,000
57,200
60,400
65,900
74,600
91,200
1,17,900
1,32,700
1,69,000
2,06,400
2,10,200
2,36,300
2,84,300
Medium
and Large
Industries
Wholesale
Trade
Other
Sectors
1,47,300 16,800
79,200
1,62,800 17,800
94,100
1,72,300 20,500 1,14,700
2,35,200 22,600 1,50,700
2,47,200 24,900 1,92,500
3,52,300 32,500 2,33,500
4,59,200 39,700 3,95,200
5,79,400 50,100 5,35,700
7,25,600 55,700 6,75,300
8,85,400 67,400 7,16,500
11,05,100 86,400 7,52,600
13,94,400 94,700 9,16,000
17,01,100 1,20,200 10,48,100
19,45,800 1,50,100 12,33,800
Non-Food Memo:
Gross Aggregate
Bank
Credit to
Credit
Industry
(NFC)
as % of
NFC
375,100
429,200
482,700
620,100
728,400
999,800
14,04,800
18,01,200
22,04,800
26,01,800
30,40,000
36,67,400
42,89,700
48,69,600
53.3
51.0
47.5
47.7
43.0
42.7
39.2
38.7
38.9
40.5
43.1
43.8
45.2
45.8
Source: Handbook of Statistics on the Indian Economy, RBI.
The classification scheme of sectoral disaggregation could
be somewhat archaic and not reflect existing reality. Thus, a
new format for reporting the sectoral deployment of bank
credit was devised in 2007-08. A look at these data reveals the
emergence of personal loans in recent years, which accounted
for nearly one-fifth of gross bank credit (Table 5, p 65). Personal loans, together with credit to the services sector, account
for nearly 45% of gross bank credit. Nevertheless, as a proportion of manufacturing gross domestic product (GDP), industrial credit seemed to have gone up from 1.2% in 2007-08 to
1.7% in 2013.
Demise of Development Banking
Another major development after financial sector reform has
been the gradual demise of development banking. Interestingly, this was in line with the recommendations of the Narasimham Committee II, which said,
To provide the much needed flexibility in its operations, IDBI should be
corporatised and converted into a Joint Stock Company under the
Companies Act on the lines of ICICI, IFCI and IDBI. For providing focused attention to the work of State Financial Corporations, IDBI
shareholding in them should be transferred to SIDBI which is currently
providing refinance assistance to State Financial Corporations. To give
it greater operational autonomy, SIDBI should also be delinked from
IDBI (Chap V, para 5.34).9
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But this recommendation was initially rejected by the government. Later, the RBI constituted a committee under the
chairmanship of S H Khan to examine the concept of development financing, given the changed global challenges of 1999.
The committee noted,
A gradual elimination of extant boundaries between Commercial Banks
and Development Financial Institutions (DFIs), both on the assets as well
as on the liabilities side, is necessary if Indian financial institutions and
commercial banks are to prepare themselves to compete in a deregulated and increasingly global marketplace. The Group therefore recommends a progressive move towards universal banking and the development of an enabling regulatory framework for the purpose.10
identified (Mathur 2003). First, some structural infirmities
cropped up in the functioning of DFIs. The ownership of IDBI
makes an interesting point. Illustratively, it has been noted:
IDBI, in which government shareholding is 58.5%, has a 31.7% shareholding in IFCI which in turn has 19% shareholding in TFCI …. IDBI has its
shareholding in SIDBI (49%), IDFC (5%) and NEDFi [North Eastern Development Finance Corporation] (25%) as well … in fact till end March 1999
IDBI had its shareholding in ICICI as well (1.4%) (Mathur 2003: 800).
Essentially, such an interlinked ownership structure could
give an incorrect idea about the extent of public ownership in
these institutions and the government guarantee implicit in
any rescue operation. Second, with RBI stopping the National
Based on the recommendations of the Narasimham Com- Industrial Credit (Long-Term Operations) Fund and an inmittee II and the Khan Committee, the RBI released a “discus- crease in the non-performing assets of some of these institusion paper” in January 1999 for wider public debate and feed- tions, the sustainability of their business model was in quesback. Noting that “the feedback on the discussion paper indi- tion. Third, the complementary role of the stock market had
cated that while universal banking is desirable from the point not materialised. Fourth, the incumbent policy regime (as epitomised in Narasimham Committee II)
Table 5: Sectoral Deployment of Non-Food Gross Bank Credit in Recent Years (New Format) (Rs crore)
was in favour of winding up the DFIs.
2008
2009
2010
2011
2012
2013
2014
While each of the development banks
Non-food credit (1 to 4)
22,04,800 26,01,800 30,40,000 36,87,100 42,89,700 48,69,600 55,66,000
could have faced a unique set of restric1 Agriculture and allied
activities
2,75,300 3,38,700 4,16,100 4,83,500 5,46,600 5,89,900 6,69,400 tions, each of them generically faced
2 Industry
8,58,300 10,54,400 13,11,500 16,13,200 19,37,300 22,30,200 25,22,900 some sort of a finance constraint when
Micro and small
1,32,700 1,69,000 2,06,400 2,11,300 2,36,700 2,84,300 3,51,700
finances from the government budget
Medium
1,10,800 1,22,200 1,32,600 1,17,000 1,24,800 1,24,700 1,27,400
(or from the RBI’s long-term operations
Large
6,14,800 7,63,200 9,72,400 12,84,900 15,75,900 18,21,100 20,43,800
fund) dried up. As an RBI committee put
3 Services
5,49,300 6,46,300 7,26,800 8,90,800 10,23,000 11,51,900 13,37,000
it, “The change in operating environ4 Personal loans
5,21,800 5,62,500 5,85,600 6,99,700 7,82,800
8,976 10,36,700
ment coupled with high accumulation of
of view of efficiency of resource use, there is need for caution in non-performing assets due to a combination of factors caused
moving towards such a system by banks and DFIs”, the RBI’s an- serious financial stress to the term-lending institutions” (2004).
nual policy statement of April 2000 spelt out the broad contours Thus, by end of the 1990s, despite their significant presence in
of reforming DFIs to form universal banking institutions.11
all-India lending operations (Table 6), the viability of develop(a) The principle of “Universal Banking” is a desirable goal and ment banks was seriously in question.12
some progress has already been made by permitting banks to Table 6: Trends and Composition of Disbursements of Financial Institutions
Total
Shares of Disbursements as
diversify into investments and long-term financing and the Period
DisbursePercentage of Total Disbursements
DFIs to lend for working capital, etc.
ments as
All-India Specialised Investment State-level Total
Percentage Development Institutions Institutions Institutions
(b) Though the DFIs would continue to have a special role in
of GDP
Banks
the Indian financial system, until the debt market demon- 1990-91 to 1994-95
2.9
64.9
0.5
23.6
11.0
100.0
strates substantial improvements in terms of liquidity and 1995-96 to 1999-2000 3.3
75.1
0.4
16.8
7.6
100.0
depth, any DFI, which wishes to do so, should have the option All-India development banks comprise the IDBI, ICICI, IFCI, IIBI, and SIDBI; specialised
to transform into bank (which it can exercise), provided the institutions comprise the RCTC, TDICI, and TFCI; investment institutions comprise the
UTI, LIC, and GIC and its subsidiaries; and state-level institutions comprise SFCs and state
prudential norms as applicable to banks are fully satisfied. To industrial development corporations (SIDCs).
this end, a DFI would need to prepare a transition path in order Source: RBI, Report on Currency and Finance, 1999-2000.
to fully comply with the regulatory requirement of a bank. The
The next few years witnessed the demise of a number of
DFI concerned may consult RBI for such transition arrange- DFIs and a move towards universal banking. In January 2001,
ments. Reserve Bank will consider such requests on a case by the RBI permitted the reverse merger of the ICICI with its comcase basis.
mercial bank subsidiary, and the ICICI became the first DFI to
(c) The regulatory framework of RBI in respect of DFIs would convert itself into a bank. The reverse merger led to a sharp
need to be strengthened if they are given greater access to increase in the market share of new private sector banks in the
short-term resources for meeting their financing requirements, total assets of the banking sector. Later, on 1 October 2004, the
IDBI was converted into a banking company. In April 2005, it
which is necessary.
(d) In due course, and in the light of evolution of the financial merged its banking subsidiary (IDBI Bank) with itself. While
system, Narasimham Committee’s recommendation that ulti- both these banks still have some term-lending on their portmately there should be only banks and restructured NBFCs can folios, there has been a distinct change in the character of
their lending operations. The IFCI, on the other hand, despite
be operationalised.
But what necessitated such a drastic change in favour of changing its status to a limited company in 1999, has been
universal banking, abandoning DFIs? Four factors have been plagued by huge non-performing assets and issues related to
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65
SPECIAL ARTICLE
corporate governance. In March 2002, the outstanding bal- financial liberalisation, which depended on increasing comance of DFIs, such as the IDBI, EXIM Bank, IIBI, and SIDBI, from petitiveness and the capacity of local enterprises to innovate
the National Industrial Credit (Long-Term Operations) Fund and incorporate new technologies; and the insufficient scale of
(Rs 3,791.75 crore) was transferred to the government in lieu operations on the domestic capital and credit markets for proof 10.25% of Government Stock, 2021 of an equal amount. The viding financing to firms (Hermann 2010). Such an experience
RBI transferred its shareholding in the IDFC to the central gov- seems to have profound implications for India.
ernment in 2004-05. The large annual allocations to statutory
funds were also discontinued. While some of the development Diversification of Sources of Financing
banks such as NABARD and SIDBI are still alive, the involvement With the demise of development banking and the limited ability of bank credit to keep pace with financing requirements,
of the RBI in funding these institutions has been minimal.
Is this demise of development banking indicative of a con- the Indian industrial sector has moved to alternative sources
scious policy agenda dictated by the compulsions of neo-liberal of financing. Table 7 enumerates these alternative sources, and
financial reforms? Or, had these institutions long lost their a number of interesting facts emerge from Table 8. First, bank
relevance and were slated to expire in line with a Table 7: Resource Mobilisation by the Commercial Sector (Rs crore)
2009-10
2010-11
2011-12
2012-13
Schumpeterian process of creative destruction?
4,78,600
7,11,000 6,77,300 6,84,900
Opinions are divided. However, development A) Adjusted non-food bank credit (NFC)
(45.0)
(57.4)
(55.7)
(48.3)
banks as term-finance institutions have survived
(i) Non-food credit
4,67,000 6,81,500 6,52,700 6,33,500
all over the world. A World Bank Global
(ii) Non-SLR investment by commercial banks
11,700
29,500
24,600
51,400
Survey of Development Banks in 2012 revealed B) Flow from non-banks (B1+B2)
5,85,000 5,28,600 5,38,300 7,33,500
(55.0)
(42.6)
(44.3)
(51.7)
that of 90 development banks in the world,
B1) Domestic sources
3,65,200 2,95,600 3,07,900 4,21,200
nearly 40% were established during 1990-2011.
(34.3)
(23.8)
(25.3)
(29.7)
Nearly 40% of them receive direct budgetary
(1) Public issues by non-financial entities
32,000
28,500
14,500
11,900
support from the government, and more than
(2) Gross private placements by
40% accept public deposits (Luna-Martinez and
non-financial entities
1,42,000
67,400
55,800 1,03,800
Vicente 2012).
(3) Net issuance of CPs subscribed to by
non-banks
26,100
17,200
3,600
5,200
Internationally, there are successful instances
(4) Net credit by housing finance companies 28,500
38,400
53,900
85,900
of development banking that are still active.
(5) Total gross accommodation by four
Hermann (2010) noted, “The fact that developRBI-regulated AIFIs*
33,800
40,000
46,900
51,500
ment banks also exist in G-7 countries – for ex(6) Systemically important non-deposit-taking
ample, Germany’s Kredintaltanlt fur WeidarufNBFCs (net of bank credit)
60,700
67,900
91,200 1,18,800
(7) LIC’s net investment in corporate debt
42,200
36,100
41,900
44,100
ban (KfW), the Japan Development Bank and the
B2) Foreign sources
2,19,800 2,33,000 2,30,400 3,12,300
Business Development Bank of Canada (BDC), all
(20.7)
(18.8)
(19.0)
(22.0)
of which are wholly government owned – shows
(1) External commercial borrowings/FCCBs
12,000
55,500
42,100
46,600
that they are not rendered obsolete by more ad(2) ADR/GDR issues, excluding banks and
vanced levels of economic and financial developfinancial institutions
15,100
9,200
2,700
1,000
ment, but they merely adapt.” In this context, the
(3) Short-term credit from abroad
34,900
50,200
30,600 1,17,700
(4) Foreign direct investment to India
1,57,800
1,18,100 1,55,000 1,47,000
experience of the Brazilian Development Bank
10,63,600 12,39,600 12,15,600 14,18,400
(Banco Nacional de Desenvolvimento Econô- C) Total flow of resources (A+B)
(100.0)
(100.0)
(100.0)
(100.0)
mico e Social, or BNDES) deserves special men- Figures within brackets are percentages to total; * NABARD, NHB, SIDBI and EXIM Bank.
tion. It is a federal public company associated Source: RBI.
with the Ministry of Development, Industry and Foreign credit tends to explain only half Table 8: G-Sec and Corporate Bond
Trade. Since its establishment on 20 June 1952, the BNDES has the aggregate financing. Second, Markets in Select Asian Countries:
March 2013 (% of GDP)
financed large-scale industrial and infrastructure projects, non-bank domestic resources Country
Government Corporate Total
with assets exceeding that of the World Bank Group. It contin- that include diverse components
Bond
Bond
77.5 126.2
ues to play a significant role in the support of investments in (such as public issues, private South Korea 48.7
62.4
43.1 105.5
agriculture, commerce, and the service industry, as well as in placements, commercial papers, Malaysia
Singapore
53.1
37.0
90.1
13
small and medium-sized private businesses. To support its credit by housing finance comHong Kong
37.8
31.4
69.2
activities, the BNDES has depended on the following sources – panies, or the LIC’s net investThailand
58.6
15.9
74.5
(a) workers’ assistance fund (4% of the total); (b) Brazilian na- ment in corporate debt) account
China
33.1
13.0
46.1
tional treasury (16% of the total); and (c) returns from financ- for nearly one-third of aggre- Philippines 32.2
4.9
37.1
ing operations, corporate shareholding, foreign fundraising on gate financing. Third, foreign Indonesia
11.4
2.3
13.7
international capitals market, and multilateral entities (77% of sources account for nearly one- India
40.2
2.4
42.6
the total). When financial liberalisation was initiated in Brazil fifth of aggregate resources. Source: FICCI (2013: 24).
in the late 1980s, the BNDES could hold on to its turf. During Notwithstanding the emergence of these alternative sources,
1990-2006, there was a significant increase in its lending due the numbers are unable to shed any light on the presence or
to two major factors – development challenges after trade and absence of a finance constraint in the industrial sector.
66
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SPECIAL ARTICLE
5 Issues Facing Industrial Finance
The paper has presented a set of stylised facts on industrial
finance in India. Its broad findings may be summarised as
follows. Since the initiation of financial sector reforms and
the demise of development banking in India, there were
initial indications that credit to the industrial sector could
have declined (or increased at a very slow pace). But this is
subject to two key caveats. First, as industrial and manufacturing GDP have not gone up substantially during this period,
there is a chicken-egg problem in discerning causality
between industrial credit and industrial growth. Was credit a
constraint to subdued industrial growth? Or, did credit fail to
pick up because of a lull in industrial growth? Second, the
emergence of alternative sources of financing makes conducting any controlled experiment on finance and growth in India
difficult. Against this backdrop, this section flags some
emerging issues.
Long-term/Infrastructure Financing
Long-term/infrastructure finance has come to haunt India in
recent years, and there are various unofficial estimates of it.
Finance Minister P Chidambaram reportedly told the World
Bank in Washington DC in April 2013 that India would have a
$1 trillion infrastructure deficit over the next five years, which
had to be financed by private sector participation (Economic
Times, 21 April 2013). How far is this financing plan realistic?
Corporate Bond Market in India
It is difficult for commercial banks to provide long-term
financing because of their asset-liability mismatch. And the
standard private sector answer to such a problem has been the
development of a vibrant corporate debt market. However, the
development of corporate debt markets globally has not been
uniform. Among the major countries in developing Asia, the
size of the Indian corporate debt market is small (Table 8). In
India’s case, the market for corporate debt is primarily a
private placement market and it is heavily tilted in favour of
big corporates.
More importantly, even in this small corporate bond
market, the share of manufacturing is typically less than
10% while finance occupies nearly three-fourths (FICCI 2013).
Thus, contrary to the expectations of the Narasimham Committee II, corporate bonds are yet to emerge as a source of
long-term finance.14
Infrastructure Finance
EPW
6 Concluding Observations
The Indian industrial sector is passing through a bad phase. Its
inability to take off in recent years could be attributed to
several factors such as poor infrastructure, regulatory bottlenecks, and neglect of demand factors. A financial constraint
could be one factor on this list. While tracing the transition
from a state-owned and state-dictated financial sector to a
regime of financial liberalisation, this paper notes that the
possibility of throwing away the baby with the bathwater
cannot be ignored. New sources of finance could have compensated for the paucity of bank financing to a limited extent,
but in the case of term financing the demise of development
banks has turned out to be very costly. In this context, the
Brazilian experience with the BNDES could serve as a useful
model for India.
Notes
Another important issue is infrastructure financing. With the
demise of development banks, it is pertinent to note that “outside of budgetary support, that accounts for about 45% of the
total infrastructure spending, commercial banks are the second largest source of finance for infrastructure (about 24%)”
(Chakrabarty 2013). The share of bank finance to infrastructure in gross bank credit increased from 1.63% in 2001 to
13.37% in 2013.
Apart from commercial banks, two new institutions have been
set up for infrastructure financing. First, the Infrastructure
Economic & Political Weekly
Development Finance Company (IDFC) was founded in 1997 on
the recommendations of the Expert Group on Commercialisation of Infrastructure Projects (headed by Rakesh Mohan) as a
joint venture between the central government, RBI, domestic
financial institutions, and foreign investors such as the Asian
Development Bank (ADB), and the International Finance Corporation (IFC), among others.15 The RBI contributed Rs 150
crore (Rs 20.30 crore in 1996-97 and Rs 130 crore in 1997-98)
to the share capital of the IDFC. Second, the India Infrastructure Finance Company Ltd (IIFCL) was incorporated under the
Companies Act as a wholly government-owned company in
January 2006. It commenced operations from April 2006 to
provide long-term finance to viable infrastructure projects.
The sectors eligible for financial assistance from the IIFCL are
transportation, energy, water, sanitation, communication, and
social and commercial infrastructure. The IIFCL accords overriding priority to public-private partnership (PPP) projects.16
More than 80% of infrastructure projects are now financed by
state-owned banks with increasing asset-liability mismatches.
To address this issue and provide more infrastructure financing, the IIFCL has implemented a Takeout Financing Scheme to
purchase infrastructure loans from public sector banks. The
IIFCL is also considering plans to provide guarantees for bonds
issued by infrastructure companies. Besides, the 2010-11
budget introduced a deduction of an additional Rs 20,000 on
tax savings for investment in long-term infrastructure bonds.
These are, however, piecemeal measures to handle a crisis of
massive proportions.
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vol l no 5
1 In 1911, Visvesvaraya as chairman of the industrial and trade committee of
the Mysore Economic Conference put up a proposal to start a bank by raising resources from the state for the development of trade and industries.
2 Such developmental activities by a central bank have a long history in the
West; see Epstein (2005) for a discussion on the developmental activities of
central banks across the world.
3 Bhandari et al (2003) evaluated the role of DFIs during 1989-97 by examining how firms’ investment decisions were affected by their ability to access
DFIs. They found that firms that had prior access to DFIs continued to
receive funds from these sources only if they could be classified as more
financially constrained.
4 The RBI was also not fully state-owned until it was nationalised in 1948.
5 From a total of 566 banks in 1951, the number came down to 109 in 1965.
The reduction in non-scheduled banks has been phenomenal – from 473 to
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6
7
8
9
10
11
12
13
14
15
68
merely three. The number of scheduled banks
came down from 92 in 1951 to 76 in 1965.
Under priority sector lending guidelines, domestic commercial banks have a target of 40%
of their net bank credit for priority sectors. In
this, sub-targets of 18% and 10% of net bank
credit, respectively, have been stipulated for
lending to agriculture and the weaker sections.
A target of 32% of net bank credit has been
stipulated for lending to the priority sector by
foreign banks. See Roy (2006) for details.
A maximum permissible limit on bank finance
also became the basis for consortium arrangements, which have been in existence from
1972. Guidelines were also issued to commercial banks for supervising credit to ensure its
proper use.
See, for example, Ahluwalia (2002) for an account of Indian liberalisation, and Bhaduri and
Nayyar (1996) for a critique.
In some sense, the Narasimham report echoed
the spirit in the World Development Report
(1989), which commented, “Non-bank financial intermediaries, such as development finance institutions, insurance companies, and
pension funds, are potentially important
sources of long-term finance. Most of the existing development banks are insolvent, however” (4). Moreover, WDR (1989) saw a diminishing role of the Indian capital market in the
functioning of development banks, “In the
1950s India’s capital markets helped to mobilise financial resources for the corporate sector.
The importance of these markets then diminished, because subsidised credits were available from commercial and development banks,
equities had to be issued at a discount substantially below market value, the capital market
lacked liquidity, and investor safeguards were
inadequate” (108).
This sentiment favouring “universal banking”
also echoed the spirit of WDR 1989.
See http://www.rbi.org.in/scripts/BS_ViewMonetaryCreditPolicy.aspx?Id=2261#N3A.
The Annual Report of the RBI for 2001-02
noted, “The National Industrial Credit (Long
Term Operations) Fund was established by the
Reserve Bank in July 1964 with an initial corpus of Rs 10 crore and annual contributions
from the Reserve Bank’s disposable surplus in
terms of Section 46-C(1) of the Reserve Bank of
India Act, 1934 for the purpose of making loans
and advances to eligible financial institutions.
Consequent upon the announcement in the
Union Budget for 1992-93, the Reserve Bank
decided to discontinue the practice of crediting
large sums to the said Fund. No further disbursements from the Fund have been made. It
was decided in 1997-98 to transfer the unutilised balance in the Fund arising from repayments to Contingency Reserve (CR) on a yearto-year basis. Accordingly, an amount of Rs 4,224
crore has been transferred to CR in 2001-02 as
against Rs 400 crore transferred in the preceding year.” From the next year, the RBI routinely
transferred Rs 1 crore to the long-term fund out
of its income. This continued till 2012-13 and
the balance in the fund stood at Rs 22 crore on
30 June 2013.
Interestingly, the Organisation for Economic
Co-operation and Development (OECD) in its
latest country report on Brazil (22 Oct 2013)
has mentioned that the BNDES is crowding out
private-sector banks from corporate credit
markets, and that the government should
phase out financial support for it.
There are several reasons for the failure of the
corporate debt market in India; see Mohan
(2011) for a discussion on this.
The basic strategy proposed in the report has
been criticised by Ghosh, Sen and Chandrasekhar (1997) for its approach – “the
government to retreat as investor, to provide
space for private participation, even while continuing to facilitate and provide numerous financial crutches for the private sector.” They
added, “But even all of these very expensive
measures do not guarantee that the private
sector would respond positively to invest in areas which are both risky and not-so-profitable.”
16 The authorised and paid-up capital of the company on 31 March 2013 was Rs 5,000 crore and
Rs 2,900 crore, respectively.
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