The Neoliberal Transformation of Development Banking: The Indian Experience
Why development banks?
Development banking, or the use of specialised financial institutions to finance lumpy, long-gestation investment projects, has been ubiquitous in developing market economies seeking to accelerate growth, especially since the Second World War. Most often state-owned or sponsored, such institutions were created because developing countries are characterised by an absence of markets for long-term finance. Two factors explain that absence. The first is that given the greater uncertainty associated with the outcome of investment decisions in backward economies, savers are unwilling to directly finance and lock their capital in long-duration projects through investments in equity or bond markets. Such markets tend for long to be limited in size and relatively illiquid. The second is that while banks dominate the financial sector in these countries, they are often too weak and fragile to bear the burden of the liquidity and maturity mismatches associated with transforming deposits by savers, who expect their holdings to be withdrawable on demand, into financing for investments in long duration and relatively illiquid projects.
Because these features are typical of developing market economy environments, the presence of specialised institutions serving as vehicles of long-term financing has not been restricted to countries where, and periods when, governments were pursuing dirigiste strategies, with emphasis on state intervention and planning. Rather even with the onset of liberalisation, the role of such institutions in some form has been recognised. That is development banking has not been discarded altogether. But in some contexts, such as India, the institutions engaged in and the methods adopted for development financing have changed with the adoption of measures of “economic reform” that privilege the market mechanism as opposed to state action and regulation. This chapter is concerned with examining the nature of the transformation of development banking that occurred in India when it moved from a state-directed industrialisation strategy to market-led development, and the relative efficacy of the alternative means of long financing in the two contexts (see also Chandrasekhar, C. P. (2016).
The creation of a development banking infrastructure in India
After Independence in 1947 when the Indian government declared its intention to launch on a state-led development strategy within the framework of a ‘mixed economy’ with a significant role for the private sector, an important component of its industrialisation thrust was the creation of a development banking infrastructure. The process started immediately, with the setting up of the Industrial Finance Corporation (IFCI) in July 1948 to undertake long-term term-financing for industries.1 In addition, State Financial Corporations (SFCs) were created under an Act that came into effect from August 1952 to assist state- or provinciallevel, small and medium-sized industries with credit. In January 1955, the Industrial Credit and Investment Corporation of India (ICICI), the first development finance institution in the private sector, came to be established, with encouragement and support of the World Bank in the form of a long-term foreign exchange loan and backed by a similar loan from the US government financed out of PL 480 counterpart funds.- Two other major steps in institution building were the setting up of IDBI as an apex term-lending institution and the Unit Trust of India (UTI) as an investment institution, both commencing operations in July 1964 as subsidiaries of the Reserve Bank of India.
That the development banks were special institutions was reflected in the role the central bank had in the development-financing infrastructure. An Industrial Finance Department (IFD) was established in 1957 within the Reserve Bank of India (RBI) and the central bank began administering a credit guarantee scheme for small-scale industries from July 1960. With a view to supporting various term-financing institutions, the RBI set up the National Industrial Credit (Long-Term Operations) Fund from the year 1964—1965. Finally, the IDBI, which served for long as the apex development finance institution was owned by the Reserve Bank of India.
A range of other specialised financial institutions were, over time, set up as part of the development banking infrastructure. These included the Agriculture Refinance Corporation (1963), Rural Electrification Corporation Ltd., Housing and Urban Development Corporation (HUDCO), National Bank for Agriculture and Rural Development (NABARD, 1981), EXIM Bank (1982), Shipping Credit and Investment Company of India (1986) (later merged into ICICI Ltd. in 1997), Power Finance Corporation, Indian Railway Finance Corporation (1986), Indian Renewable Energy Development Agency (1987), the Tourism Finance Corporation of India (1989), and the Small Industries Development Bank of India (SIDBI), with functions relating to the micro, medium and small industries sector taken out of IDBI (1989).
The RBI’s Working Group on DFIs classified them as functionally consisting of
- (i) term-lending institutions (IFCI Ltd., IDBI, IDFC Ltd., IIBI Ltd.) extending long-term finance to different industrial sectors, (ii) refinancing institutions (NABARD, SIDBI, NHB) extending refinance to banking as well as non-banking intermediaries for finance to agriculture, SSIs and housing sectors, (iii) sector-specific / specialised institutions (EXIM Bank, TFCI Ltd., REC Ltd., HUDCO Ltd., IREDA Ltd., PFC Ltd., IRFC Ltd.), and (iv) investment institutions (LIC, UTI, GIC, IFCI Venture Capital Funds Ltd., ICICI Venture Funds Management Co Ltd.).
- (RBI 2004: Section 1.4.3)
There were, in addition, State-/regional-level institutions such as various SFCs and State Industrial Development Corporations.
As institutions were established, the scope of development banking in India increased. The average annual assistance provided by the leading development financial institutions rose from Rs. 29 million during 1948—1952 to Rs. 137 million during the following five years (1953—1957) and Rs. 450 million during 1958—1962. This growth then accelerated to take the annual average assistance to Rs. 1,088 million during 1963-1966 and Rs. 1,442 million during 1967-1971 (Kumar 2013). But even in 1970-1971 disbursements by all major financial institutions (including investment institutions such as the Life Insurance Corporation [LIC], Unit Trust of India [UTI| and General Insurance Corporation [GIC]) amounted to just 2.5% of gross fixed capital formation.
It was after the mid-1970s that the DFIs gained substantially in importance, with the assistance disbursed by them amounting to 10.7% of Gross Fixed Capital Formation (GFCF) in 1990-1991 and 15.5% in 1994-1995. Then, matters began to change. The ratio of disbursals to GFCF hovered just below the 1994—1995 level for a few years and collapsed to 10% in 2001-2002, 4.6% in 2002-2003 and 2.3% in 2004—2005. Though there was a marginal revival towards the end of the decade, the figure slipped back to its low levels. What is more telling is the ratio of disbursals to fixed capital formation in the private corporate sector, which was the main beneficiary of DFI loans and equity investments. DFI disbursals rose from 24% of fixed capital formation in the private corporate sector in 1970-1971 to an average of 54% over the decade ending 1985-1986 and 58% in the following decade. That figure then fell to less than 15% over the decade ending 2015-2016.