Banking Article, Banking Finance 2022, Banking Finance July 2022

Development Banks: an overview

Development banks are the financial institutions that provide long-term credit for capital-intensive investments spread over a long period and yielding low rates of return, such as infrastructure projects, mining, heavyindustry and irrigation systems.Development Banks are the financial institutions that provide funds and financial assistance tonew and upcoming business enterprises. Development banks like IDBI, SIDBI, and IFCI etc. were setup to meet long term capital requirements of the industry. They help in accelerating industrial and economic growth.

These are the financial institutions concerned with providing all types of financial assistance (medium as well as long-term) to business units, in the form of loans, underwriting, investment and guarantee operations, and promotional activities, economic development in general, and industrial development, in particular. In short, a development bank is a development-oriented bank.

In our country development banks were started with the objective of increasing the pace of industrialization. To help all round industrialization development banks were made multipurpose institutions. Besides financing, they were assigned promotional work also. The traditional financial institutions could not take up this challenge because of their limitations.

An outstanding financial development of the post-independence period has been the rapid growth of development banks in the country. These banks are specialized financial institutions which perform the twin functions of providing medium and long-term finance to private entrepreneurs and of performing various promotional roles conducive to economic development. As the name clearly suggests, they are development-oriented banks. As banks, they provide finance. But they are unlike ordinary commercial banks.

The financial assistance to industry is given in the following four main forms:

  • Term loans and advances,
  • Subscription to shares and debentures,
  • Underwriting of new issues, and
  • Guarantees for term loans and deferred payments.

At present, at the all-India level, there are five industrial development banks,

  • The development banks for the industry are the Industrial Development Bank of India (IDBI),
  • the Industrial Finance Corporation of India (IFCI),
  • the Industrial Credit and Investment Corporation of India (ICICI),
  • and the Industrial Reconstruction Corporation of India (IRCI) for large industries
  • and the National Small Industries Development Bank of India (SIDBI) for small-scale industries.

one agricultural development bank

  • National Bank for Agriculture and Rural Development (NABARD).

and one export-import bank.

  • Export-Import Bank of India (EXIM)

Features of Development Banks

Unlike commercial banks, the development banks do not accept deposits from the public,or they are notjust a term-lending institution. They are essentially development-oriented banks. Their primary objective is to promote economic development by promoting investment and entrepreneurial activity in a developing economy. They encourage new and small entrepreneurs and seek balanced regional growth.Development banks provide financial assistance not only to the private sector but also to the public sector undertakings. They do not compete with the normal channels of finance, i.e. the finance alreadymade available by the banks and other financial institutions. Here themajor role is of a gap-filler, i.e. to fill up the deficiencies of the existing financialfacilities available in the system.The motive is to serve the public interest rather than to make profits. They work inthe general interest of the nation. Development bank is a multi-purpose financial institution.

Objectives of Development Banks:

The main objectives of the development banks are:

  • To promote industrial growth in the country.
  • They promote and develop small-scale industries (SSI) in India.
  • To facilitate the development of large-scale industries (LSI) in India.
  • To help in the development of the agricultural sector and rural India.
  • To finance the development of the housing sector in India.
  • To enhance the foreign trade of India.
  • To improve the capital market in the country.
  • To create more employment opportunities in the society.
  • To generate more exports and encourage import substitution.
  • To encourage modernization and improvement in technology.
  • To promote more self-employment projects.
  • To improve the management of large industries by providing training.
  • To remove regional disparities or regional imbalance.
  • They promote science and technology in new areas by providing risk capital
  • They help to revive the sick industrial units.
  • To encourage the development of Indian entrepreneurs.
  • To promote economic activities in backward regions of the country.

Functions of Development Banks

The functions of development banks depend upon the requirements of the economy and the state of development of the country. They have become well-recognized segments of the financial market. They are playing an important role in the promotion of industries in developing and under-developed countries.

Small Scale Industries (SSI):

Development banks play an important role in the promotion and development of the small scale sector. The Government of India (GOI) started the 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.

Large Scale Industries (LSI):

The development bank promotes and develops large-scale industries (LSI). Development financial institutions like IDBI, IFCI, etc., provide medium and long term finance to the corporate sector. They provide merchant banking services, such as preparing project reports, doing feasibility studies, advising on the location of a project and so on.It promotes and develops housing and financial institutions. It refinances banks and financial institutions that provide credit to the housing sector.

Review of Sick Units:

Development banks help to revive sick-units. The government of India (GOI) started the Industrial Investment Bank of India (IIBI) to help sick units. IIBI is the main credit and reconstruction institution for a revival of sick units. It facilitates modernization, restructuring, and diversification of sick-units by providing credit and other services.

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.

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.

Agriculture and Rural Development:

Development banks like the National Bank for Agriculture &Rural Development (NABARD) help 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.

Enhance Foreign Trade:

Development banks help to promote foreign trade. The government of India started the Export-Import Bank of India (EXIM Bank) in 1982 to provide medium and long-term loans to exporters and importers from India. It provides Overseas Buyers Credit to buy Indian capital goods. Also, encourages abroad banks to provide finance to the buyers in their country to buy capital goods from India. Development banks help to promote foreign trade by providing medium and long-term loans to exporters and importers from India. Development banks would encourage exports which are must to achieve the target.

Regional Development:

The development bank facilitates rural and regional development. They provide finance for starting companies in backward areas. Also, they help companies in project management in such less-developed areas.

Contribution to Capital Markets:

The development bank contributes to the growth of capital markets. They invest in equity shares and debentures of various companies listed in India. Also, invest in mutual funds and facilitate the growth of capital markets in India.

Financial Gap Fillers

Development banks not only provide medium-term and long-term loans butthey also help industrial enterprises in many other ways.It is not possible for the commercial banks to fulfill all financial needs of all the customers. Issue of Non-performing assets, absence of organized capital market, absence of adequate facilities for financing industries arise the problem of slow development. Such development banks fulfill this credit gap. They provide long-term funds for industries and help in growth.

Undertake Entrepreneurial Role:

Developing countries lack entrepreneurs who can take up the job of setting up new projects. It may be due to a lack of expertise and managerial ability. Development banks were assigned the job of entrepreneurial gap filling.They undertake the task of discovering investment projects, promotion of industrial enterprises, provide technical and managerial assistance, undertaking economic and technical research, conducting surveys, feasibility studies, etc. The promotional role of the development bank is very significant for increasing thepace of industrialization.

Commercial Banking Business:

Development banks normally provide medium and long-term funds to industrial enterprises. The working capital needs of the units are generally met by commercial banks.In developing countries, commercial banks have not been able to take up this job properly. Their traditional approach in dealing with lending proposals and assistance on securities has not helped the industry.Development banks extend financial assistance for meeting working capital needs to their loan if they fail to arrange such funds from other sources.

Joint Finance:

Another feature of the development bank’s operations is to take up joint financing along with other financial institutions. There may be constraints of financial resources and legal problems (prescribing maximum limits of lending) which may force banks to associate with other institutions for taking up the financing of some projects jointly.It may also not be possible to meet all the requirements of concern by one institution, so more than one institution may join hands. Not only in large projects but also in medium-sized projects it may be desirable for a concern to have, for instance, the requirements of a foreign loan in a particular currency, met by one institution and under the writing of securities met by another.

Refinance Facility:

Development banks also extend the refinance facility to the lending institutions. In this scheme, there is no direct lending to the enterprise. The lending institutions are provided funds by development banks against loans extended to industrial concerns.In this way, the institutions which provide funds to units are refinanced by development banks. In India, the Industrial Development Bank of India (IDBI) provides reliance against term loans granted to industrial concerns by state financial corporations.

Credit Guarantee:

The small scale sector is not getting proper financial facilities due to the clement of risk since these units do not have sufficient securities to offer for loans, lending institutions are hesitant to extend the loans. To overcome this difficulty many countries including India and Japan have devised the credit guarantee scheme and credit insurance scheme.

Underwriting of Securities:

Development banks acquire securities of industrial units through either direct subscribing or underwriting or both. The securities may also be acquired through promotion work or by converting loans into equity shares or preference shares. So,In India, a credit guarantee scheme was introduced in 1960 with the object of enlarging the supply of institutional credit to small industrial units by granting adegree of protection to lending institutions against possible losses in respect of such advances.

Conclusion

The development banks have a dual objective of contributing to the development as well as earning a financial return on the investment. Hence there is an inherent conflict in the operational objectives of development bank. They have to limit their lending to the financially viable projects, with an acceptable financial rate of return. Also, long term loans represent a higher level of uncertainty and will have higher interest rates than the short term loans.But, these financial institutions are concerned with providing all types of financial assistance, medium as well as long-term. Thus, the role of these institutions in the development trajectories of the developing countries cannot be underestimated.

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