All-India Industrial Development Banks in India – (Main Features and Evaluation) !
It will be tedious, highly space-intensive, and less revealing is we study various features of the organization and working of individual development banks in detail. Also these banks belong to one broad class of financial institutions already identified as industrial development banks for large industries.
Therefore, we take a consolidated view of all of them put together and study the main features of their operations. The figures given below have been rounded off liberally and are intended to give only rough orders of magnitudes involved. Most of the time, amounts outstanding are those at the end of March or June 1995.
1. Total Finance:
At the end of March 1991, the total financial resources (liabilities or assets) had amounted to about Rs. 70,000 crore. For 1994-95, the total new financial assistance sanctioned and disbursed by these banks was about Rs. 41,000 crore and Rs. 20,000 crore. In comparison, during 1994-95, all non-governmental companies had raised through new issues total capital of Rs. 26,400 crore only.
The IDBI as the apex bank occupies dominant position, followed by the ICICI and the IFCI. In comparison, the IRBI is very small. In the total financial resources of about Rs. 70,000 crore in their hands at the end of March 1995, about Rs. 38,000 crore were with the IDBI, about Rs. 19,600 crore with the ICICI and about Rs. 11,200 crore with the IFCI. (The resources with the IRCI were only Rs. 1,300 crore).
In the total financial assistance sectioned by the three large development banks of Rs. 41,000 crore during 1994-95, the share of IDBI was Rs. 20,000 crore, that of ICICI Rs. 15,000 crore and of IFCI Rs. 6,000 crore. The respective disbursement was Rs. 11,000 crore, Rs. 7,000 crore and Rs. 3,000 crore. The outstanding total financial assistance as at March-end 1995 was Rs. 33,000 crore from the IDBI, Rs. 31,000 crore from the ICICI and Rs. 15,000 crore from the IFCI.
2. Sources of Finance:
The key point to note here is the difference in the sources of finance of development banks on the one hand and other financial institutions such as banks, insurance companies, and the UTI on the other hand. The latter class of institutions raise funds by mobilising saving’s of the public through their sale of deposits, insurance policies and units. But the financial resources of development banks in India have been raised, not directly from the public, but, in the main, from the Government of India, the RBI, other financial institutions, and foreign sources (mainly the World Bank and its affiliates, the International Finance Corporation, IFC and International Development Association, IDA).
The forms in which this is done are two:
(i) Subscriptions to their share capital and debentures and
(ii) Borrowings from the RBI/IDBI.
For example, the entire share capital of (Rs. 1,000 crore) of the IDBI has been provided by the Government of India. The former, in turn has subscribed to the share capital of the IFCI, which is its 50 per cent subsidiary, and the IRBI. The remaining share capital of the last two institutions is in the hands of the LIC and nationalised banks. The share capital of ICICI is owned by banks, insurance companies and foreign financial institutions. The total share capital amounted to only about Rs. 550 crore and reserves were another Rs. 730 crore.
The two most important sources of finance for development banks are bonds/debentures and borrowings from the RBI. At the end of March 1991 they had contributed something like Rs. 17,000 and Rs. 3,700 crore, respectively. Bonds are marketable securities. Therefore, one may possibly infer that their proceeds are collections from the public. But this is not correct.
The key feature of the bond issues of IDBI and the IFCI is that they are guaranteed by the Government of India, as to both principal and interest. For all practical purposes, this makes these bonds equivalent to Government of India Bonds.
The ICICI bonds, though not guaranteed by the government, are treated as ‘trustee securities’ for purposes of investment by financial institutions. This and the status of ICICI make them comparable with government bonds. Consequently, the rate of interest on the development bank bonds is also (roughly) the same as that on the Government of India bonds of comparable maturity.
The RBI co-ordinates these bonds issues with the issues of government bonds. For illustration, we may only note that it has created a Development Assistance Fund out of which loans are made to the IDBI. The line of credit from the International Development Association (IDA, a soft-loan affiliate of the World Bank) is also used to make loans to the development banks. The total foreign loans outstanding at the end of the March 1995 were of the order of Rs. 7,400 crore.
Most of the Reserve Bank credit is extended through the IDBI. This credit is made available from the National Industrial Credit (Long-Term Operations) Fund of the RBI which was created along with the setting up of the IDBI in July 1964 with the objective of providing loan funds to the IDBI.
The RBI has been contributing to this Fund every year from its profits. At the end of June 1995, this Fund stood at about Rs. 5,675 crore and other sources of finance were like this foreign currency loans Rs. 4,200 crores, out of which loans of Rs. 2,600 crores had been raised by the ICICI and the rest by the IFCI. The funds derived from other sources were about Rs. 6,600 crores.
This shows that the development banks are financial intermediaries mainly for the allocation of term finance. They do nothing to raise funds directly from the public as do banks, insurance companies, and the UTI.
This kind of arrangement has provided large industry with cheap, organized, assured, large and growing amount of term finance. No wonder this sector of industry has become over-dependent on development banks for term finance. Loans, as preferred form of finance, have encouraged very high debt-equity ratios and low rate of interest on loans has encouraged high capital-intensity in industry.
3. Allocation of Funds:
As financial intermediaries, the main function of development banks is as allocators of funds (and not as mobilisers of savings from the public). Therefore, their degree of success must be judged on the quality of their performance of this role.
Two questions are important here:
(i) The form of financial assistance, equity, debentures, or loan capital and
(ii) To whom finance is provided. On both counts, the development banks have not worked to the satisfaction of social objectives, which have themselves been never clearly specified. Consider first the form of financial assistance.
The bulk of this assistance has been provided in the form of debt capital, predominantly in term loans. This form of loan financing has, no doubt, assured the development banks a steady return on their funds, without involving them into difficult managerial problems equity participation would entail. But, this (apparent) security has been bought at a high price.
First, it has distorted the capital structure of the borrowing industrial enterprises in favour of loan capital. Their debt-equity ratios in most cases have assumed values which are considered too high by generally-accepted standards even in industrially-developed countries. In the case of new enterprises, this is especially serious, because right from inception, their financial health is weak. The burden of fixed interest payments is much too heavy on them. Consequently, the default rate is also high, as we have already noted in the case of the IFCI finance. This is one source of growing industrial sickness in the country.
Second, the government loses potential corporation tax, because, for tax purposes, interest is treated as a cost item in arriving at corporate profits. All income earned by the IDBI, including interest income, is tax-free, so that in its case interest does not get taxed even when it is received by the IDBI. This encourages the IDBI to resort excessively to debt financing, rather than equity financing of enterprises. In the case of other development banks, interest income earned by them is, no doubt, taxable.
But the government would presumably gain more tax revenue if the financing was more in the form of equity capital than in the form of debt capital. For, the income from equity capital would be taxed in the hands of industrial companies as profits and then again when a part of it is distributed as dividends.
Other important consequences are the socially adverse distribution of asset ownership in the corporate sector, slow development and spread of industrial entrepreneurship in the economy, and tardy growth of the developmental role of development banks.
The bulk of debt capital is provided in the form of term loans. Debentures are marketable security, whereas loans are not. Companies prefer the latter to the former, because though the interest cost on both the kinds is usually the same, the servicing cost of raising term loans is much lower than the cost of a debenture issue. Much more importantly, default on loans is easier than on debentures. Defaults on loans can be directly negotiated with the lending agencies and payments rescheduled without much difficulty.
The danger of foreclosure on collaterals is also minimal to defaulting parties, because the development banks, as a matter of policy, resort to this step only sparingly. Also, defaults generally are not made public. In the case of debentures, all these facilities will be absent, especially if they are openly traded in the market and not closely held by a few lending agencies.
The defaulting companies would lose a lot of market goodwill, and it would be very difficult for them to raise new funds in the market. The prices of their equities would also suffer. Loan capital protects companies against this kind of healthy market discipline. It tends to breed and has actually bred soft or weak companies, which fall on the sick list at the first opportunity.
Given the relatively small equity base and very much smaller proportion of promoters’ equity, the total atmosphere of corruption and false manipulations, it is easy enough for unscrupulous persons to show losses in the companies under their control and let the lending agencies bear the burden, without suffering any loss of their own investments and profits. Such a climate is fast spreading in the industry. The irony is that the soft lending policy adopted by the development banks has made no “lean contribution to it.
As a by-product of the lending policy of the development banks, the corporate bond market has not developed much in the country. In the first instance, very small amounts of corporate bonds or debentures are issued. And whatever is issued are generally bought and held closely by the financial institutions themselves. There is very little active trading in them. Thus, their prices (or yield rates on them) are not formed by the forces of demand and supply in the market.
Consequently, companies do not get differentiated in terms of their borrowing power and all are able to borrow at the same rate of interest. Little wonder that there is so little concern on the part of so many corporate borrowers to manage their affairs more efficiently. Our observations would, of course, apply only to large-sized corporate borrowers and neither to small public limited companies nor to private limited companies or co-operative societies.
Who are the beneficiaries of the financial assistance provided by the development banks? What is the size-distribution of enterprises and projects assisted? Are they new enterprises or expansion and diversification projects of existing concerns? Are the new enterprises promoted by new entrepreneurs/technocrats or by existing business houses? Are the latter big monopoly houses? Do the beneficiaries fall in the category of MRTP (Monopolistic Restriction of Trade Practices) companies? Are the assisted companies healthy or sick? What is their export performance? What is the industry wise distribution of financial assistance? What is the geographical distribution of this assistance? How far have backward areas been helped? The list of questions can be lengthened further.
This indicates that the allocation of financial assistance has many dimensions. In this book, satisfactory answers to all these questions cannot be provided or even attempted. For such answers, a full-scale independent study will be required. The purpose of posing the questions was to make the readers aware of the several aspects of the allocation role of the development banks.
Yet, a few very brief answers must be given. As a matter to government policy, the development banks under study have been designed to serve large industries. Both the IDBI and the ICICI cater to the needs of relatively large enterprises. A part of the assistance provided by the IFCI goes to medium enterprises also. (The smaller enterprises are supposed to be assisted by the SFCs).
The beneficiaries are a mixed bag of new and old enterprises, (a few of the new enterprises have been promoted by technocrats too), healthy as well as sick, those run by monopoly houses as well as others, and some falling in the category of backward areas. The distribution of assistance over industries is getting diversified over time. In the absence of clear-cut guidelines and well-developed criteria of evaluation, it is difficult to pass a summary judgment or accord marks.
4. Cost of Funds and other Terms and Conditions:
Apart from providing large blocks of funds to large companies (a very important help in itself), the development banks render them assistance in other forms, too. The normal rate of interest of 14 per cent per year (since March 1981), at which development banks make loans is on the low side in a capital-scarce country like India. It is much lower than what would be determined by the capital market, if the large companies were to raise the same amounts of funds in the open market. Then, the IDBI provides concessional finance for specified purposes, such as, for units in specified backward areas. The IDBI provides refinance to banks and others at concessional rates with the stipulation that their primary lender’s rate does not exceed appropriate ceilings.
All these concessions put together, coupled with the easy availability of term finance amount to pampering of private large-scale industry by public financial institutions, constitute excessive subsidisation of this sector, and have bred soft industrial enterprise with low overall efficiency. The low cost of funds (in relation to the true social cost of capital in the capital-scarce economy of India) has encouraged the adoption of highly capital-intensive technology and thus contributed to the problem of growing unemployment in the country.
5. Building Up of a Technical-Managerial-Consultancy Service Complex:
As development banks, the promotional and consultancy service role of the banks is no less important than the provision of term finance, especially for new entrepreneurs. In this context three things are worthy of note.
First, trained personnel are needed in good number for the servicing of their financing activities, viz., for project appraisal, requiring evaluation of the technical and managerial feasibility and financial projections of the projects submitted for assistance, project supervision and follow-up activities, careful scrutiny of periodic progress reports, and competent persons to serve as nominee-directors on the boards of directors of assisted companies. With the growth in total business and its increasing diversity, increasing amount of trained human input is required. The shortfalls in quantity and quality in this field cannot be ruled out.
Second, to map the industrial potential in the country, the development banks have conducted Industrial Potential Surveys of all the backward states and union territories. Much more remains to be done at district levels. Much is not known about the follow-up action. This will necessarily take its own time.
Third, Technical Service Organizations (TCOs) have been organized for the promotion of industrial activities. Their stated objectives are a package of services under one roof to entrepreneurs, in particular to the small and medium entrepreneurs, from the stage of project identification to successful implementation. These services are said to include preparation of feasibility studies and project reports covering technical, market, commercial, financial and economic aspects of a project, and various kinds of services to existing entrepreneurs facing problems and planning expansion or diversification. A successful working of the TCOs will require adequate professional staff which they at present lack.
All told, there is urgent need for developing further and fast the human factor (including consultancy services) needed for a balanced and equitable industrial growth of the country a task which the development banks have paid much less attention to as compared to the provision of term finance.