Development banks in India

INDIAN FINANCIAL SYSTEM: Indian financial system is one of the world largest financial systems. Indian economy is world 4th biggest economy but this Indian financial system has under gone through various changes or we can say that it has different stages since its inception. Basically Indian financial system can be divided into 3 categories: Before independence Pre- 1991 era Post-1991 era BEFORE INDEPENDENCE: In British rule India first time has seen the organized financial system, although all that was meant for British but that provided us the layout for future course of action i.e. to build our own financial system. At that time banks and other financial institutions were at their infantry stage but the given a base to build the whole system on them. That time can be considered as the preliminary stage of Indian financial system and at that time there were no development banks as the motive of colonial rule was to draw the wealth not to make country developing. PRE 1991 ERA: This era has seen the gradual rise in the economy of India. After independence banks and other financial institutions to provide funds were established and development banks were also a part of them which were established specially to provide financial aid to industrial sector and to promote entrepreneurship in India. The financial system in this era was based on socialistic pattern of society andthe economy was of mixed type but basically it was public sector basedeconom y. The motive was to promote every sector of society to uplift and earn for him. Indian financial system continued with this pattern for about 40 years but in true sense the economic growth never boosted up as there was so many hindrances and

lacks in system itself which taken country in such a crisis that it has to borrow funds by pledging its gold that was called the crisis of 1991. POST 1991 ERA: To come out the crisis, India has to adopt the new policy regarding the financial system to speed up the growth and to raise the economy and in order to perform that a new policy of LIBERALIZATION-PRIVATIZATION- GLOBALIZATION i.e. LPG was adopted. The basic motive was to reduce the government control over the economy and to let it flourish itself. Indian financial system is currentlywo rking on this policy and now the economic growth rate has also risen. Now the development banks are working in accordance with the industry in order to satisfy their need of funds and to provide every possible help required. Although the growth is still slow in comparison with other countries but soon India will become the strongest economy of world. INTRODUCTION TO DEVELOPMENT BANKS DEVELOPMENT banks in India have had a cheered and not always a happy history. Some have managed to come back from the brink by taking to universal banking, or merging with a normal bank. In general, it may be said thatdevelopmen t banking has lost its charm. So much so that when an official was shifted from the none-too-healthy Indian Bank to NABARD, a banking veteran said that she deserved not congratulations but commiseration. Political interference and flawed industrial policy have been the main reasons why development banks have fared badly. At the same time, it needs to be said that some conceptual errors about the nature of development banking have made matters worse. From the time of Independence, political interference in the functioning of banks has been both overt and covert. For instance, loan Melas made many banks sick. Even now, many villagers think that a loan from a government bank is a gift; it need not be repaid. In spite of such impressive sounding institutions as Debt Recovery Tribunals, it is still difficult for banks to recover in full the amounts due; more often than not, banks have no option but write-off most of the dues. Periodic concessions to borrowers ordered by the Reserve Bank of India have made debt recovery quite difficult. In consequence, ill health has dogged the banks in India. Though development banks did not have to suffer from loan Melas, they too were

subject to political pressure to fund projects of dubious value. For long years, there was no culture of financial closure; many projects started more with hope and hype than with calculated design, and with no clear idea of where the funds would be found to complete them. Even if the project had been well conceived, administrative delays made many projects unviable. Development banking is different: Loans are made not to those who haveaccumula ted wealth in the past but to those who show promise to become wealthy in the future. Normal banking looks for safety in assets accumulated from the past; in development banking, possible accumulation of assets in the future is the true collateral. Thus, while in normal banking, the collateral is real andtangible, in development banking, the collateral is a dream; it is intangible. Innormal banking, an interest default of more than 90 days becomes a nonperforming asset. In the case of development, growth is rarely smooth; development happens in fits and starts; cash flows are subject to wild fluctuations and become negative at times. Hence, development banks need to have a longer perspective than three months; they should show patience for years. Normal banks can afford to be myopic; development banks should take the long view. For development banks, it is the trend line and not the current surplus that is important. As one development banker blithely explained: "When I see any risk, I take my money and run away. But that is not development banking; development banks take risks that ordinary banks will not. In other words, development banks should think differently, and should have a long time horizon. They should acquire the expertise to assess the optimum waiting period and fix the rate of charge on wage costs and rents paidaccordingly. Incidentally, this kind of charge is not only transparent; it will also make firms cost-conscious. That is an added benefit, additional safety. If development banks charge variable returns, they will need a complementary deposit regime. Pensioners like to have constant real returns that are protected against erosion by inflation. Hence, they need returns that rise with time. Thus, development banks would do well to devise a Pension Fund with inflation-linked returns. Then, they will have a matched programmed for assets and liabilities.

HISTORY OF DEVELOPMENT BANKS The concept of development banking rose only after Second World War, Successive of the Great Depression in 1930s. The demand for reconstruction funds for the affected nations compelled in setting up a worldwide institution for reconstructions. As a result the IBRD was set up in 1945 as a worldwideinstitut ion for development and reconstruction. This concept has been widened all over the world and resulted in setting up of large number of banks around the world coordinating with the developmental activities of different nations with different objectives among the world. The course of development of financial institutions and markets during the post-Independence period was largely guided by the process of planned development pursued in India with emphasis on mobilization of savings and channelizing investment to meet Plan priorities. At the time of Independence in 1947, India had a fairly well-developed banking system. The adoption of bank dominated financial development strategy was aimed at meeting the sectorial credit needs, particularly of agriculture and industry. Towards this end, the Reserve Bank concentrated on regulating and developing mechanisms for institution building. The commercial banking network was expanded to cater to the requirements of general banking and for meeting the short-term working capital requirements of industry and agriculture. Specialized development financial institutions (DFIs) such as the IDBI, NABARD, NHB and SIDBI, etc., with majority ownership of the Reserve Bank were set up to meet the long term financing requirements of industry and agriculture. To facilitate the growth of these institutions, a mechanism to provide concessional finance to these institutions was also put in place by the Reserve Bank. The first development bank In India incorporated immediately after independence in 1948 under the Industrial Finance Corporation Act as a statutory corporation to pioneer institutional credit to medium and large scale. Then after in regular intervals the government started new and different development financial institutions to attain the different objectives and helpful to five-year plans. The early history of Indian banking and finance was marked by stronggovernmental regulation and control. The roots of the national system were in the State Bank of India Act of 1955, which nationalized the former Imperial Bank of India and its seven associate banks. In the early days, this national system operated alongside of

a large private banking system. Banks were limited in their operational flexibility by the governments desire to maintain employment in the banking system and were often drawn into troublesome loans in order to further the governments social goals. The financial institutions in India were set up under the strong control of both central and state Governments, and the Government utilized these institutions for the achievements in planning and development of the nation as a whole. The all India financial institutions can be classified under four heads according to their economic importance that are: All-India Development Banks Specialized Financial Institutions Investment Institutions State-level institutions Other institutions

Definition of Development Banks The definition of the term 'development banks' can be stated as follows, 1. In General sense, "Development banks are those financial institutions whose prime goal (motive) is to finance the primary (basic) needs of the society. Such funding results in the growth and development of social and economic sectors of the nation. However, needs of the society vary from region to region due to differences seen in its communal structure, economy and other aspects." 2. As per banking subject (mainly in Indian context), "Development banks are financial institutions established to lend (loan) finance (money) on subsidized interest rate. Such lending is sanctioned to promote and develop important sectors like agriculture, industry, import-export, housing and allied activities."

Features of development bank: A development bank has the following features or characteristics: 1) A development bank does not accept deposits from the public likecommercial bank s and other financial institutions that entirely depend upon saving mobilization. 2) It is a specialized financial institution which provides medium term and longterm lending facilities. 3) It is a multipurpose financial institution. Besides providing financial help it undertakes promotional activities also. It helps an enterprises from planning to operational level. 4) It provides financial assistance to both private as well as public sector institutions.

5) The role of a development bank is of gap filler. When assistance from other sources is not sufficient then this channel helps. It does not compete with normal channels of finance. 6) Development banks primarily aim to accelerate the rate of growth. It helps industrialization specific and economic development in general. 7) The objective of these banks is to serve public interest rather than earning profits. 8) Development banks react to the socio-economic needs of development.

OBJECTIVES OF DEVELOPMENT BANKS Every country felt the need to accelerate the rate of development in post-world war era. Some countries were directly involved in war while many others were indirectly affected by it. There was a need for reconstructing economics at a faster speed. The existing machinery for developmental activities was not sufficient to the requirements of industry. There was a need to set up such institutions which would take up promotional activities besides financing. In this background developmental banks were needed for the following reasons: 1. Lay Foundations for Industrialization A number of countries got independence from colonial rule. Their economies needed to be rehabilitated. Other underdeveloped and developing countries too needed to accelerate the pace of industrialization. To lay a solid foundation for growth, establishment of certain key industries such as cement, engineering, machine making, chemicals, etc. is essential. Private entrepreneurs were not forthcoming to invest in these vital' areas due to risk involved and long gestation period in those industries. The governments of under developed countries set up development and institutions to fill the vacuum. 2. Meet Capital Needs 1'nere was a dearth of capital needed to foster industrial growth in underdeveloped countries. Owing to the low level of income of the people there were no sufficient surpluses for capitalization. There was a need for institutions which could meet this gap between demand and supply for capital. 3. Need for Promotional Activities Besides capital needs, underdeveloped countries suffered from lack of expertise, managerial and technical know-how. Developmental banks could take up the job of and joint sectors and provide managerial and resources and skills and of channeling them into approved fields under private auspices are needed in these countries.

4. Help Small and Medium Sectors' The large scale was, to some extent, able to meet its needs. There was a need to mitigate sufferings of small and medium size industries which form a sizeable sector of the industrial economy. Despite the important role played by these sectors they experience scarcity of capital owing to the apathy of investors to invest their savings because of their credit worthiness and profitability. There was a need for special institutions to help these sectors in playing vital role in the industrialization of developing and under developed countries.

FUNCTIONS OF DEVELOPMENT BANKS Development banks have been started with the motive of increasing the pace of industrialization. The traditional financial institutions could not take up this challenge because of their limitations. In order to help all round industrialization development banks were made multipurpose institutions. Besides financing they were assigned promotional work also. Some important functions of these institutions are discussed as follows:

To promote and develop small-scale industries (SSI) in India. To finance the development of the housing sector in India. To facilitate the development of large-scale industries (LSI) in India. To help the development of agricultural sector and rural India. To enhance the foreign trade of India. To help to review (cure) sick industrial units. To encourage the development of Indian entrepreneurs. To promote economic activities in backward regions of the country. To contribute in the growth of capital market. Now let's discuss each important function of development banks one by one.

1. Small Scale Industries (SSI) Development banks play an important role in the promotion and development of the small-scale sector. Government of India (GOI) started Small industries Development Bank of India (SIDBI) to provide medium and long-term loans to Small Scale Industries (SSI) units. SIDBI provides direct project finance, and equipment finance to SSI units. It also refinances banks and financial institutions that provide seed capital, equipment finance, etc., to SSI units.

2. Development of Housing Sector Development banks provide finance for the development of the housing sector. GOI started the National Housing Bank (NHB) in 1988. NHB promotes the housing sector in the following ways: It promotes and develops housing and financial institutions. It refinances banks and financial institutions that provide credit to the housing sector. 3. Large Scale Industries (LSI) Development banks promote and develop large-scale industries (LSI). Development financial institutions like IDBI, IFCI, etc., provide medium and longterm finance to the corporate sector. They provide merchant bankingservices, such as preparing project reports, doing feasibility studies, advising on location of a project, and so on. 4. Agriculture and Rural Development Development banks like National Bank for Agriculture & Rural Development (NABARD) helps in the development of agriculture. NABARD started in 1982 to provide refinance to banks, which provide credit to the agriculture sector and also for rural development activities. It coordinates the working of all financial institutions that provide credit to agriculture and rural development. It also provides training to agricultural banks and helps to conduct agricultural research. 5. Enhance Foreign Trade Development banks help to promote foreign trade. Government of India started Export-Import Bank of India (EXIM Bank) in 1982 to provide medium and longterm loans to exporters and importers from India. It provides Overseas Buyers Credit to buy Indian capital goods. It also encourages abroad banks to provide finance to the buyers in their country to buy capital goods from India.

6. Review of Sick Units Development banks help to revive (cure) sick-units. Government of India (GOI) started Industrial investment Bank of India (IIBI) to help sick units. IIBI is the main credit and reconstruction institution for revival of sick units. It facilitates modernization, restructuring and diversification of sick-units by providing credit and other services. 7. Entrepreneurship Development Many development banks facilitate entrepreneurship development. NABARD, State Industrial Development Banks and State Finance Corporations provide training to entrepreneurs in developing leadership and business management skills. They conduct seminars and workshops for the benefit of entrepreneurs. 8. Regional Development Development banks facilitate rural and regional development. They provide finance for starting companies in backward areas. They also help the companies in project management in such less-developed areas. 9. Contribution to Capital Markets Development banks contribute the growth of capital markets. They invest in equity shares and debentures of various companies listed in India. They also invest in mutual funds and facilitate the growth of capital markets in India.

LENDING PROCEDURES OF DEVELOPMENT BANKS (OPERATIONAL ACTIVITIES) Development banks follow a procedure for evaluating a proposal for a project. The basic objective is to check whether the applicant fulfills various conditions prescribed by the lending institution and the project is viable. The acceptance of a wrong proposal will result in the wastage of scarce resources. These banks adopt the following procedure for lending: 1. Project Appraisal and Eligibility of Applicant Every financial institution serves a particular area of activity or there are certain limits prescribed beyond which they cannot go. Before processing the application, it is important to find out whether the applicant is eligible under the norms of the institution or not. The second aspect which is looked into is to determine whether the enterprise has fulfilled various conditions prescribed by the government. In case some license is required from the government. It should have been taken or an assurance is received from the licensing authority. After satisfying these preliminary issues the project is appraised by a team of technical financial and economic officers of the institutions from various discussions with the promoters and clarifications sought on various points. The bank institution considers financial assistance in the light of (I) Guidelines for assistance to industries issued by the government or others concerned from time to time(ii) Guidelines issued by the bank(iii) Policy decisions of the Board of Directors of the bank. 2. Technical Appraisal A technical appraisal involves the study of: 1) Feasibility and suitability of technical process in Indian conditions.2) Location, of the project in relation to the availability of raw materials, power: water, labour, fuel, transport, communication facilities and market for finished products.3) the scale of operations and its suitability for the planned project.4) the technical soundness of the projects.5) Sources of purchasing plant and machinery and the reputation of suppliers. etc.6) Arrangement for the disposal of factory affluent and use of bye products, if any.7) the estimated cost of the project and probable selling price of the product. 8) The programmer for completing the project.

3. Economic Viability The economic appraisal will consider the national and industrial priorities of the project export potential of the product employment potential, study of market. 4. Assessing Commercial Aspects The examination of commercial aspects relates to the arrangements for the purchase of raw materials and sale of finished products. If the concern has some arrangement for sale then the position of the party should be assessed. 5. Financial Feasibility The financial feasibility of a new and an existing concern will be assessed differently. The assessment for a new concern will involve:1)The needs for fixed assets, working capital and preliminary expenses will be estimated to find out its needs.2)The financing plans will be studied in relation to capital structure, promoters' contribution, debt-equity ratio. 3) Projected cash flow statements both during the construction and operation periods. 4) Projected profitability and the like dividend in near future. If a project is already in operation and is undertaking expansion or diversification, the financial feasibility will be different. The analysis of existing capital structure, contribution of owners, debt-equity ratio, past financial performance results shown by profit and loss accounts and balance sheets, the sources of raising funds, likely needs .of the concern, future debt-equity ratio (after extending financial help), debt service coverage, internal rate .of return, in the financial position of the concern and viability for

6. Managerial Competence The success .of a concern depends up on the competence of management. Proper application of various policies will determine the Success of an enterprise. A lending institution would see the background, qualifications, business experience of promoters and other persons associated with management.

7. National Contribution Besides commercial profitability, national contribution .of the project is also taken into account. The role of the project in the national economy and its benefits to the society in the form of good quality products, reasonable prices, employment generation, helpful in social infrastructure etc. should be assessed. Development banks aim at the overall welfare of the society. 8. Balancing of Various Factors Various factors should be balanced against each other. The circumstances .of the individual project will help in weighing various factors. Some factors may be strong as their in-depth analysis should be avoided. In case a project is profitable, there will be no need to assess cash flow. Weaknesses located in certain areas may be .offset by the good points in the .other. An experienced management and sound economic outlook may compensate some weakness in financial positions. The responsibility of lending bank lies in balancing judiciously different considerations for arriving at a consensus. 9. Loan Sanction After the appraisal report on the project is prepared by the bank's officers, it is placed before the advisory committee consisting of experts drawn from various fields of the particular industry. If the advisory committee is satisfied tile proposal then it recommends the case to the Managing Director or board of Directors along with its own report. When the assistance is sanctioned hen a letter to this effect is issued to the pay giving details of conditions. 10. Loan Disbursement The loan is disbursed after the execution of loan agreement. The execution of documents of security or guarantee etc. should precede the disbursement of loan. In case some property is pledged to the bank then title deeds of such property are properly scrutinized. The fulfillment of various conditions proceeding to disbursement will determine the time of paying the money to the party.

11. Follow up The job of a lending bank does noted by disbursing the assistance. It has first to see whether the construction .of the project is as per schedule decided earlier. In case some delay is taking place in executing the plans then the reasons for it should be determined. Later during operations, the result should be properly followed. It should be seen whether the revenue earned by the concern will be sufficient to meet its obligations or not so a proper follow up by the bank will enable it to follow the progress of the unit.