Mains Articles

Development Banks: Let’s return to them [Mains Article]

India’s post-90s shift to commercial banking impacted asset creation. But worldwide, there’s been a trend reversal after 2008.
By IT's Mains Articles Team
August 29, 2019

Content

  • Why it was in News?
  • What are development banks?
  • Difference between Development banks and commercial banks
  • What is Anglo-Saxon financial system?
  • History of Development Banks in India
  • Challenges faced by Development Banks in India
  • China and Germany’s development banks
  • Conclusion

Development Banks: Let’s return to them

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Why it was in News?

  • Indian Finance Minister recently announced a slew of measures to boost the economy and financial market, including setting up of a development bank.

Development-Banks-in-India.-1

What are development banks?

  • Development banks are financial institutions that provide long-term credit for capital-intensive investments yielding low rates of return, such as urban infrastructure, mining and heavy industry and irrigation systems.

Development-Banks-in-India. 2

  • Development banks are also known as ‘term-lending institutions’ or ‘development finance institutions’.
  • Such banks often lend at low intersect rates to promote long-term investments with considerable social benefits.
  • To lend for long term, they require long-term sources of finance, usually obtained by issuing long-dated securities in capital market, subscribed by long-term savings institutions such as pension and life insurance funds and post office deposits.
  • Considering the social benefits of such investments, development banks are often supported by governments or international institutions.
  • Such support can be in the form of tax incentives and administrative mandates for private sector banks to invest in securities issued by development banks.

Difference between Development banks and commercial banks

Difference between Development banks and commercial banks

What is Anglo-Saxon financial system?

Anglo-Saxon financial system

  • It refers to a system having heavy reliance on free-market behavior (lower barriers to trade) and minimal regulation in the financial and labor markets.
  • The capital market (a market where buyers and sellers engage in trade of financial securities like bonds, stocks, etc.) helps commercial banks in providing long-term finance. They are together termed as the Anglo-Saxon financial system.
  • It is a free-market model that emerged from the Chicago School of Economics in the 1970s.
  • Historically, in the U.K. and the U.S., such a debt market funded the expansion of the market economy and colonial investments in the 19th century, such as financing of railways worldwide.
  • Rhine capitalism of Germany (German Model) contrasts with the Anglo-Saxon capitalism.
  • Industrialisation of Europe and Asia was done through German-type universal banks (providing long- and short-term credit) and state-sponsored development banks.
  • For instance, the earliest saving institution (post office bank), channeled national savings into development banks for long-term investments whose social rates of return were higher than the interest rates for depositors.
  • Alexander Gerschenkron famously theorised that the greater the backwardness of a country, the greater the role of the country in economic development, particularly in providing long-term finance to catch up with the advanced economies in the shortest possible time.

History of Development Banks in India

Development-Banks-in-India

  • In the context of the Great Depression in the 1930s, John Maynard Keynes argued that when business confidence is low due to low-interest rates, the government can set up a National Investment Bank to boost the society’s savings.
  • Following this principle, India’s first development bank, Industrial Finance Corporation of India (IFCI), was set up in 1949.
  • In 1955, the World Bank prompted the Industrial Credit and Investment Corporation of India (ICICI) as a collaborative effort between the government and India’s leading industrialists to finance modern and large private corporate enterprises.
  • In 1964, Industrial Development Bank of India (IDBI) was set up as an apex body of all development finance institutions.
  • As the domestic saving rate was low, and capital market was absent, development finance institutions were financed by

(i) Credit from the Reserve Bank of India (some of RBI’s profits were channelled as long-term credit)

(ii) Statutory Liquidity Ratio bonds, into which commercial banks had to invest a proportion of their deposits. In other words, short-term bank deposits were transformed into long-term resources for development banks.

Challenges faced by Development Banks in India:

  • However, development banks got discredited for mounting non-performing assets, allegedly caused by politically motivated lending and inadequate professionalism in assessing investment projects.
  • After 1991, following the Narasimham Committee reports on financial sector reforms, development finance institutions were disbanded and got converted to commercial banks.
  • The result was a steep decline in long-term credit from a tenure of 10-15 years to five years.

China and Germany’s development banks

  • China’s development banks have been at the forefront of financing its industrial prowess.
  • After the global financial crisis, these institutions have underwritten China’s risky technological investments helping it gain global dominance in IT hardware and software companies.
  • Germany’s development bank has been spearheading long-term investment in green technologies and for sustainable development efforts requiring long-term capital.

Conclusion

  • The Finance Minister’s agenda for setting up a development bank is welcome.
  • However, there are questions that still needs to be answered such as how the development bank will be financed.
  • Moreover, foreign private capital is expected to contribute equity capital (funds paid into a business by investors in exchange for stocks), such an option needs to be carefully analysed, especially in the current political juncture.

IT’s Input

There are mainly four types of development banks in India. They can also be subdivided on national and State Level.

  • Agricultural Development Banks e.g: National Bank for Agriculture and Rural Development (NABARD)
  • Housing Development Banks e.g: National Housing Bank (NHB)
  • Export-Import Development Banks e.g: Export–Import Bank of India (EXIM) Bank
  • Industrial Development Banks e.g: ICICI, IDBI, International Bank for Reconstruction and Development (IBRD), Small Industries Development Bank of India (SIDBI)

 

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