World Economic Forum – Financing for Development Workshop - Hong Kong

SINGNIFICANCE OF LOCAL DEVEOPMENT FINANCIAL INSTITUTIONS IN DEVELOPING COUNTRIES

Relevance, Role & Suggested Framework Presented by

Dr. Sailendra Narain

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Financing 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 Proposal

  The proposal is either to Restructure existing Development Financial Network with more local / regional flavour without government’s intervention - OR Setup Local DFIs with new face as Public-Private Partnerships (PPPs) or Joint-Venture Companies (JVCs) without government ownership.

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 3

The Benefits

Local DFIs will :  Stimulate sustained flow of FfD particularly for SMEs and other important segments;  Ensure adequate private finance and investments, crucial to economic growth; and  Help attaining Millennium Development Goals 4

Who needs to do what ??

(A) Government

For mobilising private finance and investments, Government must create an enabling environment for  Good Governance  Private Sector Development  Regional integration for competitiveness 5

Who needs to do what ??

(B) Donors, Bilateral and Multilateral Agencies

Should help:     Improving aid effectiveness for capacity building Capacity building through technical, financial assistance and business development services (BDS) Improving synergies between international investment funds and private finance Becoming strategic partners by investing in equities, promoting suitable capital market and new financial instruments for mitigating investment risks, such as co financing and joint venture funds, export and risk guarantees, etc. 6

Suggested Framework for Local DFIs Central theme of this presentation is :

  How to restructure Regional DFIs ….. ?? or How to setup Local DFIs with new face so as to better leverage multilateral agencies, fund banks, bilateral donors, national governments and aid agencies ……??

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Suggested Framework

    Awareness must emerge that: “FfD” is different from commercial banking and for which Local DFIs are the most suitable institution. National governments should take necessary steps to recapitalize/restructure ailing DFIs, [like State Financial Corporations (SFCs) and State Industrial Development Corporations (SIDCs) in India], which are nearer the ground and have wider reach. The Local DFIs should be promoted as NBFCs, PPPs or JVCs in the private sector on commercial lines. Government should only be facilitators and not the administrators/owners 8

Suggested Framework

   Governments and Central Banks to ensure that Local DFIs have "level playing field" for raising resources including Open Market Borrowings. Multilateral and Bilateral donor agencies might become co-promoters and also extend financial support to the Local DFIs. Assistance towards Business Development Services (BDS) by DFIs should come as technical support.

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

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Suggested Framework

   SMEs the backbone of any developing country, should be encouraged to corporatise. This will help them to play effectively in Local Capital markets and have less reliance on institutional borrowings. Efforts should be to promote second tier Stock Markets for the SMEs. New and innovative financial instruments should be promoted and active equity markets be developed rather than heavy reliance on debts only.

Special Development Funds like Technology Development and Innovation Funds, Modernization Fund, Risk Capital and General Fund, Small Equity Fund etc., to be co-promoted or jointly set up by the government and multilateral agencies, which might go a long way in promoting economic development. 10

Suggested Framework

   Subsidized formal finance has failed. Connect informal lending agencies i.e. – Micro Finance with Local DFIs Despite its popularity and potential, informal finance has many drawbacks Difficulties may be overcome through links between informal and formal Local DFIs, but much remains to be learned about these linkages.

(World Development Report 1990)

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Obstacles & 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 & Limitations

       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 / development finance.

Innovative instruments like equity, promoters’ contribution, start-up loans, venture capital, R&D and innovation finance, technology up-gradation, etc. are beyond reach and capacity of commercial banks system. Banks borrowing Short can not lend Long (Asian Crisis) Bank finance to SMEs in Latin America (Argentina, Brazil, Chile, Colombia, Mexico & Peru) during 1998-2002 indicates that large banks have neglected SMEs & development finance. 13

Development Finance Matrix - INDIA -

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)

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- INDIA Long term loans by commercial banks Amt (in Crs) 160,000 % of Tot. Credit 35.00% 140,000 30.00% 120,000 100,000 25.00% 20.00% 80,000 60,000 15.00% 10.00% 40,000 20,000 5.00% -

Source : RBI Website

Mar-90 Mar-95 Mar-00 0.00% Mar-02

Amt(Crs) % of Tot. Credit

Year Long term loans by AIFIs 140000 120000 100000 80000 60000 40000 20000 0 Mar-90

Source: RBI website

Mar-95 Mar-00

LT Credit

Mar-02

% to totalcredit

90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 180,000 160,000 140,000 120,000 100,000 80,000 60,000 40,000 20,000 Mar-90

Source: RBI website

Comparative Chart – in Rs cr Banks Mar-95 AIFI Mar-00 Comparative Chart - in % Rs in crores Mar-02 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Mar-90

Source: RBI website Banks

Mar-95

AIFI

Mar-00

15

Mar-02

80.0

60.0

40.0

20.0

0.0

-20.0

-40.0

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

Bank + AIFIs Term Loan Growth rate IIP (Gen) Growth rate 16

Common Problems of DFIs

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 17

New Agenda for ‘FfD’

      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’ 18

Thanks from

Dr. Sailendra Narain

Chairman : Centre for SME Growth and Development Finance (Mumbai, India) Regional Adviser : SDC-CESMED South Asia-South East Asia Multilateral Economic Co-operation Program.

Email: [email protected]

Web: www.cesmed.org

(Views expressed in this presentation are entirely personal)

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