Development bank


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Roles of development bank

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Development bank

  1. 1. Development Bank Development banks are unique financial institution that act as catalytic agents in promoting balanced development of the country and thereby aid in the economic growth of the country.  Development Bank is a financial institution dedicated to fund new and upcoming businesses and economic development projects by equity capital or loan capital.  Development banks are those financial institutions engaged in the promotion and development of industry, agriculture and other key sectors. Definition “A development bank is like a living organism that reacts to the social-economic environment and its success depends on reacting most aptly to that environment” By A.G. Kheradjou Structure of development banks Industrial development Bank Agricultural Development Bank Export Import Development Bank All India State Level All India State Level Local Level All India SFCs/For Large For small SIDCs/ NABARD SLDBs PLDBs andscale Scale SIICs (formerly branches ofindustries industries ARDC) SLDBs Exim BankIFCI, IDBI, NSICIRBI, ICICI Fig: Structure of development banks
  2. 2. Formation of Development Banks In India:Development banks were set up in India at various points of time starting from the late 1940s to cater tothe medium to long term financing requirements of industry as the capital market in India had notdeveloped sufficiently. The endorsement of planned industrialization at the national level provided thecritical enticement for organization of Development banks at both all-India and state levels.In order to perform their role, Development Banks were extended funds in the shape of Long TermOperations (LTO) Fund of the Reserve bank of India and government guaranteed bonds, whichconstituted main sources of their funds. Funds from these sources were not only available at concessionalrates, but also on a long term basis with their maturity period ranging from 10-15 years.On the asset side, their operations were marked by near absence of competition. A large variety ofeconomic institutions have come into existence over the years to perform a type of financial actions Whilesome of them operate at all-India level, others are state level institutions.Besides providing direct loans, financial institutions also extend economic assistance by way ofunderwriting and direct contribution and by issuing guarantees. Recently, some Development Banks havestarted extending short term/working capital finance, although long term lending continues to be theirmajor activity.Development Banks in India: 1. The Industrial finance corporation of India (IFCI)-1948. 2. The industrial Development Bank of India (IDBI)-1964. 3. The Industrial Reconstruction Bank of India (IRBI)-1971. 4. The Industrial Credit and Investment Corporation Of India (ICICI)-1955 Etc.Features of a development bank.A development bank has the following features or characteristics: 1) A development bank does not accept deposits from the public like commercial banks and other financial institutions who entirely depend upon saving mobilization. 2) It is a specialized financial institution which provides medium term and long-term lending facilities. 3) It is a multipurpose financial institution. Besides providing financial help it undertakes promotional activities also. It helps enterprises from planning to operational level. 4) It provides financial assistance to both private as well as public sector institutions. 5) The role of a development bank is of gap filler. When assistance from other sources is not sufficient then this channel helps. It does not compete with normal channels of finance.
  3. 3. 6) Development banks primarily aim to accelerate the rate of growth. It helps industrialization specific and economic development in general 7) The objective of these banks is to serve public interest rather than earning profits. 8) Development banks react to the socio-economic needs of development. Sources of Fund of Development banks: There are two sources: Long-Term Sources:  Capitals in the form of equity/subordinate debts/debentures/preference shares.  Internal accrual generated out of profits.  Long-term borrowings from financial institutions like NABARD/SIDBI. Short-Term Sources:  Market-linked borrowings from RBI.  Sale of liquid certificate deposits in the open market.  Borrowing from RBI under Repo (Repurchase option).  Short-term borrowings from FIs by way of rated papers placed, etc.FUNCTIONS OF DEVELOPMENT BANKSDevelopment banks have been started with the motive of increasing the pace of industrialization. Thetraditional financial institutions could not take up this challenge because of their limitations. In order tohelp all round industrialization development banks were made multipurpose institutions. Besidesfinancing they were assigned promotional work also. Some important functions of these institutions arediscussed as follows:1. Financial Gap FillersDevelopment banks do not provide medium-term and long-term loans only but they help industrialenterprises in many other ways too. These banks subscribe to the bonds and debentures of the companies,underwrite to their shares and debentures and, guarantee the loans rose from foreign and domesticsources. They also help undertakings to acquire machinery from within and outside the country.
  4. 4. 2. Undertake Entrepreneurial RoleDeveloping countries lack entrepreneurs who can take up the job of setting up new projects. It may be dueto lack of expertise and managerial ability. Development banks were assigned the job of entrepreneurialgap filling. They undertake the task of discovering investment projects, promotion of industrialenterprises, provide technical and managerial assistance, undertaking economic and technical research,conducting surveys, feasibility studies etc. The promotional role of development bank is very significantfor increasing the pace of industrialization.3. Commercial Banking BusinessDevelopment banks normally provide medium and long-term funds to industrial enterprises. The workingcapital needs of the units are met by commercial banks. In developing countries, commercial banks havenot been able to take up this job properly. Their traditional approach in dealing with lending proposalsand assistance on securities has not helped the industry. Development banks extend financial assistancefor meeting working capital needs to their loan if they fail to arrange such funds from other sources. Sofar as taking up of other functions of banks such as accepting of deposits, opening letters of credit,discounting of bills, etc. there is no uniform practice in development banks.4. Joint FinanceAnother feature of development banks operations is to take up joint financing along with other financialinstitutions. There may be constraints of financial resources and legal problems (prescribing maximumlimits of lending) which may force banks to associate with other institutions for taking up the financing ofsome projects jointly. It may also not be possible to meet all the requirements of a concern by oneinstitution, So more than one institution may join hands. Not only in large projects but also in medium-size projects it may be desirable for a concern to have, for instance, the requirements of a foreign loan in aparticular currency, met by one institution and under writing of securities met by another.5. Refinance FacilityDevelopment banks also extend refinance facility to the lending institutions. In this scheme there is nodirect lending to the enterprise. The lending institutions are provided funds by development banks againstloans extended to industrial concerns. In this way the institutions which provide funds to units arerefinanced by development banks. In India, Industrial Development Bank of India provides relianceagainst (term loans granted to industrial concerns by state financial corporations. commercial banks andstate co-operative banks.
  5. 5. 6. Credit GuaranteeThe small scale sector is not getting proper financial facilities due to the clement of risk since these unitsdo not have sufficient securities to offer for loans, lending institutions are hesitant to extend them loans.To overcome this difficulty many countries including India and Japan have devised credit guaranteescheme and credit insurance scheme. In India, credit guarantee scheme was introduced in 1960 with theobject of enlarging the supply of institutional credit to small industrial units by granting a degree ofprotection to lending institutions against possible losses in respect of such advances. In Japan besidescredit guarantee, insurance is also provided. These schemes help small scale concerns to avail loanfacilities without hesitation.7. Underwriting of SecuritiesDevelopment banks acquire securities of industrial units through either direct subscribing or underwritingor both. The securities may also be acquired through promotion work or by converting loans into equityshares or preference shares. So development banks may build portfolios of industrial stocks and bonds.These banks do not hold these securities on a permanent basis. They try to disinvest in these securities ina systematic way which should not influence market prices of these securities and also should not losemanagerial control of the units.Development banks have become worldwide phenomena. Their functions depend upon the requirementsof the economy and the state of development of the country. They have become well recognized segmentsof financial market. They are playing an important role in the promotion of industries in developing andunderdeveloped countries.