Development finance institution (DFI): Creation of the National Finance and Development Bank (NaBFID)

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The bill establishing the National Bank for Infrastructure Finance and Development (NaBFID) is now adopted by the Lok Sabha. The bill contemplates the establishment of a new government-owned development finance institution (DFI) to facilitate the flow of long-term funds for infrastructure projects. The objective also includes the issuance of guarantees and the facilitation of the development of a bond and derivative market. The proposed tax breaks will increase resource mobilization in a cost-effective manner.

Infrastructure projects are mainly financed by banks. The shorter-term (liability) resource base of banks, compared to the long gestation period of projects (assets), makes an asset-liability asymmetry endemic in this type of bank financing. The corporate bond market, despite many initiatives, has yet to achieve momentum. The availability of medium / long term funds for infrastructure projects has therefore experienced its fair share of difficulties. An institution providing funds of an appropriate duration is expected to present a viable alternative for infrastructure financing. However, a DFI that focuses exclusively on medium / long term infrastructure lending is likely to face significant operational challenges.

History of DFIs in India

India had set up extremely successful DFIs such as Industrial Finance Corporation of India (IFCI) in 1948, Industrial Development Bank of India (IDBI) in 1964, and Industrial Credit and Investment Corporation of India (ICICI) in 1955. IFCI and IDBI were fully owned enterprises of the Indian government (GoI). The objective of the institution building was to provide medium and long term project finance to Indian industries. Until about the mid-1990s, DFIs were very effective in channeling these funds for industrialization from the country.

India had subsequently set up specialized DFIs to seek medium / long term sector specific credit flows, unlike sector agnostic loans to which the aforementioned DFIs have committed. This includes attempts made twice in the past to create a specialized DFI. for the financing of infrastructure projects. While the first three DFIs played an extremely successful role with wide reach and a positive effect on industrial growth, the specialized DFIs in most cases remained small and had limited impact. Ironically, over the next few years, these three DFIs struggled to survive in their original genre and evolved into commercial banks. Specialized DFIs continue in most cases, but with limited impact. DFIs set up exclusively to finance infrastructure projects have not, however, had the desired impact.

Fundraising activities

The DFIs extended the term loan for the creation of new units as well as for the expansion, modernization and rehabilitation of existing units. There were no sector restrictions (except for the small negative list). DFIs could extend their assistance to any industry, resulting in a well-diversified (less risky) asset portfolio. The duration of aid was generally up to 10 years, with an initial moratorium of up to two years. The mortgage charge on the fixed assets of the assisted business was provided as a loan guarantee. The flaws were insignificant and the security package was found to be acceptable, without being reviewed on the basis of the effectiveness of the application.

Resources

DFIs have been financed by patient equity and preferential market access to raise medium / long term resources. Preferential access has taken the form of channeling multilateral lines of finance, the flow of funds from the Reserve Bank of India’s (RBI) National Long-Term Industrial Credit Operations (NIC (LTO)), issuing a statutory liquidity ratio (SLR) and tax savings. bonds and appropriate catalysts to attract available funds via capital gains and deduction reserves for investment. There were other special provisions in the Income Tax Law, which allowed access to medium / long term funds, which complemented other avenues of fundraising. DFIs were also allowed to mediate the external commercial borrowing (ECB) market for on-lending.

Market exclusivity

This was a simple arrangement, in which DFIs borrowed medium / long term funds at a fixed (specified) interest rate, in the bank / bond market, and lent for medium / long term financing. . In the absence of a refinancing and / or downselling market, DFIs have retained their loan assets to maturity. The maturity profile of the asset and liability portfolio has approached closely. The Credit Authorization System (CAS) has restricted commercial banks to opting for large, long-term loans. Access to the ECB by companies was not allowed. The capital market was narrow and shallow with fewer participants. Activity in the debt market was almost nil. Insurance companies and fund companies were either non-existent or still not supportive of the idea of ​​low-cost refinancing of outstanding DFI loans to completed (mostly performing) projects. It was a period of happiness, during which DFIs granted medium / long term loans to greenfield and / or brownfield projects, with a good interest spread, and held them for a long time until maturity. .

Transition

Progressive decline DFIs started from the mid-1990s, after the era of liberalization. The transition to a banking company took place around the turn of the century. With liberalization, DFIs lost their exclusive status and were unable to adapt and reinvent themselves in the new economic environment. Preferential access to funds has been phased out. The Credit Authorization Program (CAS) has been appropriately relaxed to allow banks to extend large, long-term loans at significantly lower interest rates. The ECB market has been opened to direct business access. With a lower cost of funds, banks aggressively refinanced outstanding loans from development finance institutions (DFIs), resulting in an asset-liability mismatch on the books of DFIs. Insurance companies, with their low cost of financing, have also been aggressive in the refinancing market for corporate credit. With the onset of defaults, DFIs realized that the mortgage collateral was not strong and also difficult to enforce, vis à vis security in the form of receivables / cash flow, available to banks.

Likely challenges of NaBFID

India is today an attractive destination for foreign funds. The debt and equity markets are increasingly dynamic. Insurance companies, fund companies, etc. are active in the repurchase and / or refinancing of loans / bonds, in particular for completed projects. Commercial banks are active lenders. In short, NaBFID is likely to face challenges of intense competition from several players. The necessary condition for sustaining the proposed DFI will be its ability to (a) retain a low cost advantage on an ongoing basis, (b) withstand market competition, and (c) overcome the challenges of asset inflexibility. – exclusively infrastructure.

NaBFID is expected to face fewer challenges in mobilizing low-cost resources from the start with appropriate government support, but it could face significant challenges in maintaining the cost advantage over a period of time, as the resources raised would have a fixed (specified) coupon with a long life. maturity which may not be flexible. It would face competitive pressure in the deployment of resources as well as the retention of assets (refinancing by competitors). The risk of an inflexible portfolio of assets would only add to the aforementioned difficulties.

Structural challenges

The funding environment would continue with strong competitors. Commercial banks are an integrated intermediary for both deposit mobilization and on-lending. As the deposits are of mixed duration and price, the gradual growth of the deposit / liability portfolio guarantees continuous revaluation, which adjusts the average cost and maturity on an ongoing basis. Other competitors are also operating on a favorable low-cost matrix. DFIs, on the other hand, are essentially loan vehicles created with the aim of channeling medium and long-term resources for specific purposes. Resources are raised by DFIs through financial instruments designed to meet their specific needs. This makes resource mobilization more costly and inflexible for a DFI vis-à-vis a bank, with its implication on the relative pricing of products and the institutional asset and liability management (ALM) profile over time. .

In the above context, some suggestions from a risk mitigation perspective are placed below:

  • Refinancing Risk: As loans are refinanced, once the project has started operating / achieved stability, NaBFID may consider stipulating a re-pricing option with appropriate tariff incentives, after implementation. Incentives can be carefully designed to hold / exit the underlying loan, depending on the quality of the assets.
  • Cost / maturity risk: The resources can be mostly raised with a weighted average maturity to cover the period of implementation of the assets of the loan portfolio, and not over the long term, on the basis of the concept of “held until the end of the year. ‘due date “. This would help reduce costs and also give flexibility in average cost and maturity, over time.
  • Security package: NaBFID should have a security right over all present and future cash flows of the assisted business on pari passu base with other lenders, and not be secured by the first charge on fixed assets only.

NaBFID may take a close look and choose to be selective in fund-based lending and focus more on the following activities, which feature prominently in its mandate / objective:

  • Non-fund-based activities: Given NaBFID’s high capitalization and quasi-sovereign status, collateral issued by NaBFID is likely to be well accepted. He can therefore consider having a guarantee / NFB ledger, instead of focusing on financing.
  • Corporate bond / debt market: NaBFID, with its large capital base, government support and systemic importance, may well focus on strategies / modalities for leveraging resources to facilitate the dynamism of the debt market . This would then have a more beneficial long-term impact on infrastructure development than just term loans.

In the past, DFIs had taken steps to put in place an efficient country’s financial architecture, including on-screen transactions and the establishment of depositories and rating agencies, among others. These have facilitated the evolution of the financial market and made it more transparent. The success of NaBFID in the dynamism of the bond / debt market will be an important and positive step in India’s further efforts to develop a solid financial structure.


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