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Presented byDr. Sailendra Narain

SINGNIFICANCE OF LOCAL DEVEOPMENT FINANCIAL INSTITUTIONS IN DEVELOPING COUNTRIES

Relevance, Role & Suggested Framework

World Economic Forum – Financing for Development Workshop - Hong Kong

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Financing for Development (FfD) : Which Way To GoFinancing for Development (FfD) : Which Way To Go

Over the year, Development Financial Institutions (DFIs) have played significant role in economic growth.

DFIs are however, now converting themselves into Universal Banks mainly affected by ‘Cost of Resources’

The World Bank had in late 1980s observed :

‘DFIs have no future’ ‘DFIs to Universal Banks’ ….. Is it the only alternative

to sustain FfD…..???

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The ProposalThe Proposal

Restructure existing Development Financial Network with more Restructure existing Development Financial Network with more local / regional flavour without government’s intervention local / regional flavour without government’s intervention

Setup Local DFIs with new face as Public-Private Partnerships Setup Local DFIs with new face as Public-Private Partnerships (PPPs) or Joint-Venture Companies (JVCs) without government (PPPs) or Joint-Venture Companies (JVCs) without government ownership.ownership.

The proposal is either to

The cardinal principles for both the forms being

Less or no reliance on government’s support, donors’ grants and concessional funding; and

Self-reliance mainly on local resources, domestic and later international capital markets, in due course

- OR -

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The BenefitsThe Benefits

Local DFIs will : Local DFIs will : Stimulate sustained flow of FfD particularly for Stimulate sustained flow of FfD particularly for

SMEs and other important segments;SMEs and other important segments; Ensure adequate private finance and Ensure adequate private finance and

investments, crucial to economic growth; and investments, crucial to economic growth; and Help attaining Millennium Development GoalsHelp attaining Millennium Development Goals

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Who needs to do what ??Who needs to do what ??

For mobilising private finance and investments, For mobilising private finance and investments, Government must create an enabling environment forGovernment must create an enabling environment for Good Governance Good Governance Private Sector Development Private Sector Development Regional integration for competitivenessRegional integration for competitiveness

(A) Government(A) Government

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Should help:Should help: Improving aid effectiveness for capacity building Improving aid effectiveness for capacity building Capacity building through technical, financial assistance and Capacity building through technical, financial assistance and

business development services (BDS)business development services (BDS) Improving synergies between international investment Improving synergies between international investment

funds and private finance funds and private finance Becoming strategic partners by investing in equities, Becoming strategic partners by investing in equities,

promoting suitable capital market and new financial promoting suitable capital market and new financial instruments for mitigating investment risks, such as co-instruments for mitigating investment risks, such as co-financing and joint venture funds, export and risk financing and joint venture funds, export and risk guarantees, etc. guarantees, etc.

Who needs to do what ??

(B) Donors, Bilateral and Multilateral Agencies(B) Donors, Bilateral and Multilateral Agencies

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Suggested FrameworkSuggested Frameworkfor Local DFIsfor Local DFIs

How to restructure Regional DFIs ….. ?? How to restructure Regional DFIs ….. ??

or or How to setup Local DFIs with new face so as to How to setup Local DFIs with new face so as to

better leverage multilateral agencies, fund banks, better leverage multilateral agencies, fund banks, bilateral donors, national governments and aid bilateral donors, national governments and aid agencies ……??agencies ……??

Central theme of this presentation is : Central theme of this presentation is :

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Suggested FrameworkSuggested Framework

Awareness must emerge that: “FfD” is different from Awareness must emerge that: “FfD” is different from commercial banking and for which Local DFIs are the commercial banking and for which Local DFIs are the most suitable institution. most suitable institution.

National governments should take necessary steps to National governments should take necessary steps to recapitalize/restructure ailing DFIs, [like State Financial recapitalize/restructure ailing DFIs, [like State Financial Corporations (SFCs) and State Industrial Development Corporations (SFCs) and State Industrial Development Corporations (SIDCs) in India], which are nearer the Corporations (SIDCs) in India], which are nearer the ground and have wider reach. ground and have wider reach.

The Local DFIs should be promoted as NBFCs, PPPs or The Local DFIs should be promoted as NBFCs, PPPs or JVCs in the private sector on commercial lines. JVCs in the private sector on commercial lines.

Government should only be facilitators and not the Government should only be facilitators and not the administrators/ownersadministrators/owners

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Suggested FrameworkSuggested Framework

Governments and Central Banks to ensure that Local Governments and Central Banks to ensure that Local DFIs have "level playing field" for raising resources DFIs have "level playing field" for raising resources including Open Market Borrowings. including Open Market Borrowings.

Multilateral and Bilateral donor agencies might become Multilateral and Bilateral donor agencies might become co-promoters and also extend financial support to the co-promoters and also extend financial support to the Local DFIs. Assistance towards Business Development Local DFIs. Assistance towards Business Development Services (BDS) by DFIs should come as technical Services (BDS) by DFIs should come as technical support.support.

Restructuring / recapitalisation of Regional DFIs Restructuring / recapitalisation of Regional DFIs should be assisted by Multilateral agencies. Multilateral should be assisted by Multilateral agencies. Multilateral agencies should increasingly become co-promoters of agencies should increasingly become co-promoters of such ventures and withdraw in phased manner.such ventures and withdraw in phased manner.

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SMEs the backbone of any developing country, should be SMEs the backbone of any developing country, should be encouraged to corporatise. This will help them to play effectively encouraged to corporatise. This will help them to play effectively in Local Capital markets and have less reliance on institutional in Local Capital markets and have less reliance on institutional borrowings.  Efforts should be to promote second tier Stock borrowings.  Efforts should be to promote second tier Stock Markets for the SMEs. Markets for the SMEs.

New and innovative financial instruments should be promoted New and innovative financial instruments should be promoted and active equity markets be developed rather than heavy and active equity markets be developed rather than heavy reliance on debts only.reliance on debts only.

Special Development Funds like Technology Development and Special Development Funds like Technology Development and Innovation Funds, Modernization Fund, Risk Capital and Innovation Funds, Modernization Fund, Risk Capital and General Fund, Small Equity Fund etc., to be co-promoted or General Fund, Small Equity Fund etc., to be co-promoted or jointly set up by the government and multilateral agencies, which jointly set up by the government and multilateral agencies, which might go a long way in promoting economic development. might go a long way in promoting economic development.

Suggested FrameworkSuggested Framework

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Suggested FrameworkSuggested Framework

Subsidized formal finance has failed. Connect Subsidized formal finance has failed. Connect informal lending agencies i.e. – Micro Finance with informal lending agencies i.e. – Micro Finance with Local DFIsLocal DFIs

Despite its popularity and potential, informal finance Despite its popularity and potential, informal finance has many drawbackshas many drawbacks

Difficulties may be overcome through links between Difficulties may be overcome through links between informal and formal Local DFIs, but much remains informal and formal Local DFIs, but much remains to be learned about these linkages. to be learned about these linkages. (World Development Report 1990)(World Development Report 1990)

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Obstacles & LimitationsObstacles & Limitations

Development finance with longer gestation period, have significantly contributed to various development programmes. However, of late, DFIs role is fast changing.

DFIs are at cross - roads

“Project investments may see big fall in FY04: RBI: The Reserve Bank of India (RBI) has said that fixed capital investments by corporates could be much lower in ’03-04, with no large projects sanctioned in the last two years. Accordingly to a recent RBI study, aggregate capital expenditure on projects in the current year in unlikely to be anywhere close to the previous years figure of Rs. 37.154 crore”.

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Obstacles & LimitationsObstacles & Limitations

Under-capitalised DFIs like in Latin America-Under-capitalised DFIs like in Latin America-Mexico. Private debt averages less than 15% of GDP. Large banks apathy encouraging small players to come in like

BBVA-Bancomer and Serfin-Santander in Mexico. Large banks in search of alternative channels for small loans / Large banks in search of alternative channels for small loans /

development finance.development finance. Innovative instruments like equity, promoters’ contribution, Innovative instruments like equity, promoters’ contribution,

start-up loans, venture capital, R&D and innovation finance, start-up loans, venture capital, R&D and innovation finance, technology up-gradation, etc. are beyond reach and capacity of technology up-gradation, etc. are beyond reach and capacity of commercial banks system. commercial banks system.

Banks borrowing Banks borrowing Short Short can not lend can not lend Long Long (Asian Crisis)(Asian Crisis) Bank finance to SMEs in Latin America (Argentina, Brazil, Bank finance to SMEs in Latin America (Argentina, Brazil,

Chile, Colombia, Mexico & Peru) during 1998-2002 indicates Chile, Colombia, Mexico & Peru) during 1998-2002 indicates that large banks have neglected SMEs & development finance. that large banks have neglected SMEs & development finance.

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AII-India Dev. Banks(IDBI, IFCI,ICICI,IIBI,IDFC,SIDBI)

Specialized Financial Institu(Exim Bank, & NABARD)

Investment Institutions(LIC,GIC,NIC,NIA,OIC,UII,UTI)

Others:(NEDFi, NSIC, KVIC,TFCI, ICICI Venture, IVCF)

State level Institutions-State Financial Corporations-SFCs- 18)

- State Industrial Development Corporations- SIDCs- 28)

-State Small Industries Development Corporations- SSIDCs-17)

-Technical Consultancy Organisations –TCOs-18)

Development Finance Matrix- INDIA -

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-

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

Mar-90 Mar-95 Mar-00 Mar-02

Year

Amt (in Crs)

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%% of Tot. Credit

Amt(Crs) % of Tot. CreditSource : RBI Website

0

20000

40000

60000

80000

100000

120000

140000

Mar-90 Mar-95 Mar-00 Mar-02

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

LT Credit % to totalcreditSource: RBI website

-

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

180,000

Mar-90 Mar-95 Mar-00 Mar-02

Banks AIFI

Rs in crores

Source: RBI website

Long term loans by commercial banks Long term loans by AIFIs

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

Mar-90 Mar-95 Mar-00 Mar-02

Banks AIFI

Source: RBI website

Comparative Chart – in Rs cr Comparative Chart - in %

- INDIA -

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-40.0

-20.0

0.0

20.0

40.0

60.0

80.0

1991

-92

1992

-93

1993

-94

1994

-95

1995

-96

1996

-97

1997

-98

1998

-99

1999

-200

0

2000

-01

2001

-02

2002

-03

Bank + AIFIs Term Loan Growth rate IIP (Gen) Growth rate

-INDIA-Trend in Growth Rate of Banks & AIFIs Term Loan & IIP

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Liberalised economic policy regime led to blurring of DFIs and commercial banks roles

Commercial banks now lend long term loans

Unhealthy competition to win the limited clients

Limited access to low-cost retail deposit

Difficulty in pricing lending products at competitive rates

Paucity and higher cost of resources made sustainability of viability difficult

Virtually term-loan dominated DFIs portfolio did not keep pace with the market changes & new demands

Common Problems of DFIs

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Specialised development financing channel for any developing economy is a Must

Whether “DFIs to Universal Banks” …. necessary? International experiences have shown that suitable

restructuring can give DFIs a Strong foot-hold Major factor in survival of DFIs is the ‘Cost of

Resources’ as compared to commercial banks : Is Government / Central Bank ready to address this issue

in favour of DFIs.or leave it to market forces..?? Answer is : Retain Local DFIs with ‘Levels playing field’

New Agenda for ‘FfD’

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Email: snpn@vsnl.net Web: www.cesmed.org

Thanks from

Chairman : Centre for SME Growth and Development Finance (Mumbai, India)Regional Adviser : SDC-CESMED South Asia-South East Asia

Multilateral Economic Co-operation Program.

Dr. Sailendra Narain

(Views expressed in this presentation are entirely personal)