The Bill for setting up the National Bank for Infrastructure Financing & Development (NaBFID) is now passed by the Lok Sabha. The Bill envisages setting up of a new government-owned Development Financial Institution (DFI) to facilitate flow of long-term funds for Infrastructure projects. The objective also includes issuance of guarantees and facilitating development of a bond and derivative market. Proposed Tax breaks will enable increasing cost-effective resource-raising.
Infrastructure projects are predominantly financed by banks. Shorter term resource (liability) base of Banks, vis-à-vis long gestation period of projects (assets) makes an asset liability mismatch endemic in such bank finance. Corporate bond market, despite numerous initiatives is yet to attain vibrancy. Availability of medium-/long-term funds for infrastructure projects has, therefore, experienced its fair share of difficulty. An institution to provide funds with commensurate tenor is expected to present a viable alternative for funding infrastructure. However, a DFI that is concentrated exclusively on medium/long-term infrastructure lending is likely to face substantial operational challenges.
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 Government of India (GoI) enterprises. The objective in setting up the institutions were to provide medium- and long-term project finance to Indian industries. Till about the mid-1990s, the DFIs were very effective in channelising such finance for industrialisation of the country.
India had subsequently set up specialised DFIs to pursue medium-/long-term sector-specific credit flow, in contrast to the sector agnostic lending which the aforesaid DFIs engaged in. This includes attempts made twice in the past, to set up a specialised DFI for infrastructure project financing. While, the first three DFIs had an extremely successful role with widespread reach and positive effect on industrial growth, the specialised DFIs in most cases remained small and had limited impact. Ironically, in later years, the said three DFIs faced difficulty in surviving in its original genre and revamped themselves into commercial banks. The specialised DFIs in most cases continue, albeit with limited impact. The DFIs set up exclusively for financing infrastructure projects have, however, not had the desired impact.
The DFIs extended term loan for setting up new units as also for expansion, modernisation, and rehabilitation of existing units. There were no sectoral restrictions (except for the small negative list). The DFIs could extend assistance to any industry, resulting in a well-diversified (less risky) asset portfolio. Tenor of the assistance was usually up to 10 years, with an initial moratorium of up to two years. Mortgage charge over fixed assets of the assisted company, was provided as loan security. Defaults were insignificant and the security package was found acceptable, without it being examined on the bedrock of enforcement efficacy.
The DFIs were funded by patient equity capital and preferential market access for raising medium-/long-term resources. Preferential access was in the form of channelising multilateral funding lines, fund flow from National Industrial Credit-Long-term Operations (NIC (LTO)) of Reserve Bank of India (RBI), issuance of Statutory Liquidity Ratio (SLR) and tax-saving bonds, and suitable enablers to attract funds available through capital gains and investment allowance reserves. There were other special provisions made in the Income Tax Act, which enabled access to medium-/long-term funds, which supplemented the other fund-raising avenues. DFIs were also permitted to intermediate external commercial borrowings (ECB) market for on-lending.
It was a plain vanilla arrangement, wherein DFIs borrowed medium-/long-term funds at fixed (specified) interest rate, in the bank/bond market, and on-lent for medium/long-term funding. In the absence of refinancing and/or down-selling market, the DFIs held their loan assets till maturity. The maturity profile of the asset and liability book approximated closely. The credit authorisation scheme (CAS) restricted commercial banks in going for large ticket long-term lending. Access to ECB by corporates were not permitted. The capital market was narrow and shallow with fewer participants. The activity in the debt market was almost nil. Insurance companies and fund houses were either non-existent or were yet to warm to the idea of low-cost refinancing of the outstanding loans from DFIs to completed (mostly well-performing) projects. It was a period of bliss, in which the DFIs extended medium-/long-term loans to greenfield and/or brownfield projects, with a good interest spread, and held it long till maturity.
Progressive decline of DFIs started from mid 1990s—post the liberalisation era. Transition to a banking company happened around the turn of the century. With liberalisation, the DFIs lost their exclusive status and were unable to adapt and reinvent themselves in the new economic environment. Preferential access to funds was withdrawn in phases. The Credit Authorisation Scheme (CAS) was suitably relaxed to permit banks to extend large ticket long-term loans at significantly lower interest rates. The ECB market was opened up for direct access by corporates. With lower cost of funds, banks aggressively refinanced outstanding Development Finance Institution (DFI) loans, leading to asset-liability mismatch in the DFI books. Insurance companies, with their low fund cost, were also aggressive in the refinancing market, for corporate loan. With occurrence of loan defaults, DFIs realised that mortgage security was not robust and also difficult to enforce, vis-à-vis security by way of receivables/cash flow, as available to banks.
India is today an attractive destination for foreign funds. Debt and equity capital markets are increasingly dynamic. Insurance companies, fund houses, etc. are active in loan/bond buyout and/or refinance, particularly for completed projects. Commercial banks are active lenders. In short, NaBFID is likely to face challenges of intense competition from multiple players. Necessary condition for the proposed DFI to sustain will be its ability to (a) retain low-cost advantage on a continuing basis, (b) withstand market competition, and (c) navigate challenges of asset inflexibility—exclusively infrastructure.
NaBFID is expected to face less challenge in mobilising low-cost resources upfront with appropriate government support, but it could encounter steep challenges in maintaining the cost advantage over a period of time, as the resources raised would have a fixed (specified) coupon with long maturity which may not be flexible. It would face competitive pressure in resource deployment as well as asset retention (refinancing by competitors). Risk of an inflexible asset book, would only add to the aforesaid difficulties.
The funding environ would continue with strong competitors. Commercial banks are an integrated intermediary for both mobilising deposits and also on-lending. As deposits are of mixed tenure and price, incremental growth in deposit/liability book ensures continuous repricing, which adjusts average cost and maturity on an ongoing basis. Other competitors, also operate on a favourable low-cost matrix. DFIs, on the other hand, are essentially lending vehicles created for the purpose of channelising medium- to long-term resources for specific purpose. Resources are raised by DFIs through financial instruments crafted to meet its specific needs. That makes resource raising costlier and inflexible for a DFI vis-à-vis a bank, with its implication on relative product pricing, and institutional asset and liability management (ALM) profile over time.
In the above context, certain suggestions from an risk mitigation outlook, are placed below:
NaBFID may closely review and choose to be selective in fund-based lending and instead concentrate more on the following activities, which are prominently included in its mandate/ objective:
DFIs in the past had taken steps to set up an efficient financial architecture of the country, comprising of screen-based trading, and setting up of depositories and rating agencies, amongst others. These have facilitated evolution of the financial market, and made it more transparent. Success of NaBFID in imparting bond/debt market vibrancy will well be an important and a positive step in continuation of India’s endeavour in developing a robust financial structure.
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Debasish Mallick is the former Deputy Managing Director of EXIM Bank of India and MD &: CEO of IDBI Asset Management Company Ltd (IDBI AMC) ...
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