What is concept of development financial institution?
The economic development of any country depends on the extent to which its financial system efficiently and effectively mobilizes and allocates resources. These functions are performed mainly by banks and financial institutions.
This unit mainly deals with the financial institutions that provide medium and long-term financial assistance and is engaged in the promotion and development of industry, agriculture and other key sectors. These are known as Development Financial Institutions.
Table of Contents
- 1 What is concept of development financial institution?
- 2 Features of Development Financial Institution
- 3 Role of Banks in Economic Development
- 4 Present Structure of Development Financial Institutions in India
- 4.1 Development Institutions at the All India level
- 4.2 State Level Development Institutions
Development Institutions are unique financial institutions that act as dynamic agents in promoting the balanced development of a country. These institutions provide funds to new and upcoming businesses and economic development projects in the form of equity capital or loan capital.
They provide finance to both the private and public sectors. They also provide development and promotional services that can aid in the accelerated growth of an economy. Its primary objective is to promote economic development by promoting investment and entrepreneurial activity in a developing economy. It encourages new and small entrepreneurs and seeks balanced regional growth.
Features of Development Financial Institution
- A development financial institution does not accept deposits from the public.
- It is a specialised financial institution that provides medium- and long-term lending facilities. Therefore, these institutions are also known as term lending institutions.
- It provides financial assistance to both the private sector and public sector undertakings. iv. The objective of these institutions is to serve the public interest rather than earn- ing profits.
- The major role of developing financial institutions is to fill the financing gap, in the existing financial facilities. Therefore, it does not compete with the normal channels of finance, that is, finance already made available by the banks and other conventional financial institutions.
- Development financial institutions normally have high debt to equity ratio.
- To monitor the activities of borrowing firms, DFIs resort to a special form of banking known as “Relationship Banking”. It involves nominating directors on the board of the company who then have an insider view of the functioning of the companies involved. It leads to taking corrective actions on time in case of any sign of errors.
- Development financial institutions also provide technical assistance in drawing up project plans, identifying technology and implementing a project.
Development Financial Institutions are the component of financial structure that can ensure that lending leads to productive investments that accelerate growth and make such lending sustainable.
Role of Banks in Economic Development
They play a vital role in the economic development of a country as follows:
- Help in Rapid Industrial Growth
- Employment Generation
- Development of Backward Areas
- Filling Gaps
- Development of Infrastructural Facilities
- Facilitating Small and Medium Sector
Help in Rapid Industrial Growth
The industrial sector is a very important sector of the Indian economy, and it contributes to the generation of employment and income in the country. Development banks provide financial support to those who wish to start a new business venture or expand and diversify their business in a new sector, which ultimately results in the industrial development of the country.
Development banks create direct employment by appointing many persons in their offices. These institutions also create employment indirectly by financing new and existing industrial units. They also help in creating employment opportunities in backwards areas by encouraging the setting up of units in such areas.
Development of Backward Areas
Some areas remain neglected because facilities that are needed for setting up new units are not available there. Entrepreneurs tend to set up new units in places that are already developed. This causes an imbalance in the economic development of some areas.
To help the development of backward areas, financial institutions pro- vide special assistance to entrepreneurs for setting up new units in these areas. The IDBI, IFCI and ICICI give priority in offering assistance to units that are set up in backward areas and even charge lower interest rates on lending. Such efforts certainly tend to encourage entrepreneurs to set up new units in backward areas.
It is impossible for commercial banks to finance all needs of all customers. Hence, these institutes fill financing gaps by providing long-term funds to industries where the gestation period may be longer and commercial banks are not able to fulfil these requirements.
Development of Infrastructural Facilities
The economic development of a country is linked to the availability of infrastructural facilities. There is a need to have good roads, water supply, sewage systems, communication facilities, electricity, etc. Financial institutions prepare their investment policies by giving utmost importance to national priorities. These institutions invest in these areas with the aim to enhance the development of the country.
Facilitating Small and Medium Sector
SMEs are the backbone of economic development in developing countries like India. The Small Industries Development Bank of India (SIDBI) works towards the Promotion, Financing and Development of the Micro, Small and Medium Enterprise (MSME) sector and for Co-ordination of the functions of the institutions engaged in similar activities.
Present Structure of Development Financial Institutions in India
Development institutions were started with the motive of increasing the pace of industrialisation and agricultural development. Traditional financial institutions have limitations and could not take up this challenge.
To help the all-around development of the economy, development institutions were made multipurpose institutions. Besides financing, they were assigned promotional work also. The major development institutions in India can be classified into various categories based on their focus on different sectors of the economy as follows:
Development Institutions at the All India level
In India, there are specialised financial institutions at the central level. There are a wide variety of financial institutions that offer various financial services. These specialised financial institutions in India are not only committed to offering financial services to their clients but are also devoted to attaining certain missions that aid in the economic development of the country.
The major financial institutions of India are as follows:
- Small Industries Development Bank of India (SIDBI)
- National Bank for Agriculture and Rural Development (NABARD)
- National Housing Bank (NHB)
- Export-Import Bank of India
Small Industries Development Bank of India (SIDBI)
This was established in October 1989. SIDBI commenced its operation in April 1990 with its Head Office in Lucknow, as a development bank, exclusively for small-scale industries. It is a principal financial institution for the promotion, financing and development of the Micro, Small and Medium Enterprise (MSME) sector.
It is a central government undertaking and a wholly-owned subsidiary of the IDBI. The Mission of SIDBI is “To facilitate and strengthen credit flow to MSME and address both financial and developmental gaps in the MSME eco-system.” SIDBI is also working with the vision to emerge as a single window for meeting the financial and developmental needs of the MSME sector to make it strong, vibrant and globally competitive.
National Bank for Agriculture and Rural Development (NABARD)
This is the apex development institute for rural and agricultural development in India. NABARD was established on 12 July 1982 by an Act of the Parliament to promote sustainable and equitable agriculture and rural prosperity through effective credit support, related services, institutional development and other innovative initiatives.
NABARD performs a wide range of functions that can be broadly classified into:
- Financial functions
- Development functions
- supervisory functions.
National Housing Bank (NHB)
This is a wholly-owned subsidiary of the Reserve Bank of India (RBI) and was set up by an Act of Parliament in 1987. The NHB is an apex financial institution for housing. It commenced its operations on 9 July 1988.
The NHB has been established with a view to operate as a principal agency to promote housing finance institutions at both the local and regional levels and to provide financial and other support incidental to such institutions and for matters connected therewith.
Export-Import Bank of India
This is the premier export finance institution in the country. It commenced operations in 1982 under the Export-Import Bank of India Act, 1981. The GOI launched the institution with a mandate to not only enhance exports from India but also to integrate India’s foreign trade and investment with the overall economic growth.
The Exim Bank of India has been both a catalyst and a key player in the promotion of cross-border trade and investment. Commencing operations as a purveyor of export credit, like other Export Credit Agencies in the world, the Exim Bank of India has evolved into an institution that plays a major role in partnering with Indian industries, particularly Small and Medium Enterprises.
This has been achieved through a wide range of products and services offered at all stages of the business cycle, starting from import of technology and export product development to export production, export marketing, pre-shipment and post-shipment and overseas investment.
State Level Development Institutions
There are two important development agencies constituted at the state level that provide financial assistance for setting up industrial projects in small and medium scale sectors. These institutions are also a part of the modernisation, expansion and diversification programmes of the existing units.
The area of operation of these state-level institutions is limited to the respective state.
State Financial Corporation (SFC)
A Central Industrial Finance Corporation was set up under the Industrial Finance Corporations Act, 1948, to provide medium- and long-term credit to industrial under- takings that are outside the normal activities of Commercial Banks. The State Governments expressed their desire that similar corporations be set up in States to supplement the work of the Industrial Finance Corporation.
To implement the views expressed by the State Governments, the State Financial Corporation Act came into existence on 28 September 1951. This act empowered the state government to establish financial a corporation to operate within the state.
The authorised capital of a State Financial Corporation is fixed by the State government within the minimum and maximum limits of Rs. 50 lakhs and Rs. 5 crores and is divided into shares of equal value. These shares were taken by the respective State Governments, the Reserve Bank of India, scheduled banks, cooperative banks, other financial institutions such as insurance companies, investment trusts and private parties.
State Industrial Development Corporations (SIDCs)
SIDCs were established under the Companies Act, 1956, as wholly-owned State Government undertakings for the promotion and development of medium- and large-sized industries. SIDCs act as catalysts for industrial development and provide an impetus to further investment in their respective States.
SIDCs provide assistance by way of providing term loans, underwriting and direct subscription to shares/debentures and guarantees. They undertake a variety of promotional activities such as preparation of feasibility reports, conducting industrial potential surveys, encouraging entrepreneurship development programmers and developing industrial areas/ estates.
SIDCs are also involved in setting up medium and large industrial projects in the joint sector in collaboration with private entrepreneurs or as wholly-owned subsidiaries. The activities of SIDCs have now widened to include equipment leasing, providing tax benefits under the State Government’s Package Scheme of Incentives, merchant banking services and setting up of mutual funds.
Some of the SIDCs also offer a package of developmental services such as technical guidance, assistance in plant location and coordination with other agencies.
In the last category of development financial institutions, all the institutions that have been constituted as companies under the Companies Act 1956 are included. The details of some of the main companies classified under this category are described below:
- Tourism Finance Corporation of India Ltd. (TFCI)
- Power Finance Corporation Ltd. (PFC)
- Rural Electrification Corporation Limited (REC)
- Indian Railway Finance Corporation Ltd. (IRFC)
- Export Credit Guarantee Corporation of India Ltd. (ECGC)