RBI Governor C Rangarajan, have long argued that closing down term finance institutions was a mistake and that we need to revive these in order to facilitate long term financing (given that bond markets have not taken off).

1. “Closing down term finance institutions was a mistake in India”
By
ASHISH VINOD PAWAR
MBA-IB, II YEAR, AMITY BUSINESS SCHOOL, MUMBAI
A Financial institution is an intermediary between consumers and the capital or
the debt markets providing banking and investment services.
The proposed term-finance institutions would have minimum capital
requirement of 1000 crore, higher than the 500 crore stipulated for commercial
banks. They cannot have savings accounts but they can have current accounts
and term deposits with minimum of 10 crore.

2. • In early 2000’s three term financial Institutions in which ICICI and IDBI were converted
into banks and IFCI changed into an NBFC later. All three institutions suffered huge
NPA’s in 1990s due to variety of reasons.
• Financial sector reforms in the mid-1990s meant that concessional funding was out.
Banks were allowed to venture into long-term funding. DFIs were then reeling under
the impact of bad loans of the past.
• Narasimham Committee on Financial Sector reforms noted that in a market driven
economy, the substance of DFIs may not be viable, since these institutions may be
rising funds at the current market rates and lending to businesses with a long
gestation and often high risk of failure, therefore incurring high credit cost. These
institutions cannot function as pure commercial entities unless adequately supported
by the government.

3. • Now, in a discussion paper, the RBI moots the idea of creating term finance
institutions. Many, including former RBI Governor C Rangarajan, have long argued
that closing down term finance institutions was a mistake and that we need to
revive these in order to facilitate long term financing
• In today's conditions, only a government-owned institution with access to
concessional finance will be practical.
• There were reasons for separating the two roles. Banks’ funds are mostly short-term
in nature. So their getting into term finance results in long-term assets being
financed by short-term funds. This exposes banks to interest rate and liquidity risks.
• Secondly, providing project finance requires appraisal skills of a different sort from
those required for providing working capital. Working capital is backed by assets
that are easily liquidated. Not so project finance. You have to depend on cash flows
to service the debt. This makes the evaluation of risk far more challenging.

4. • Term-finance institutions have to rely on long-term funds. This means more
expensive funding and hence costlier loans. The DFIs could get around this
problem because they were given access to low-cost funds — from the RBI and
through bonds guaranteed by the government and that qualified as statutory
liquidity ratio (SLR) securities.
• The RBI discussion paper seems to acknowledge as much. It argues that, in recent
years, bank lending to the services sector, industry and small and medium-sized
enterprises (SMEs) has suffered thanks to the bad loans on their books. It says that
banks lack the expertise necessary for term finance.
• If the proposed term-finance institutions are to raise finance entirely from the
markets, it will make their loans far too expensive. Banks may be doubting today of
financing projects at the outset.
• However, once a project is close to completion, they are happy to refinance loans
at lower rates. This is happening with power projects, for instance.

5. • Term-finance institutions may not be feasible as long as they face higher
borrowing costs than banks. To be feasible, they will need to access concessional
funding through government guaranteed bonds and low-cost funds from the
international agencies.
• So, yes, there is room for a term finance institution but only one that is promoted
by the government and gets subsidized funding — in effect, a new avatar of IDBI.
Will the government have the stomach for an initiative that looks distinctly
antireformist?
Would it want to promote a new financial institution at a time when it wants to
shrink the numbers of those that obtain today?

6. Conclusions-
• Financial Institution is essential part of financial system.
• Financial institution plays a vital role in economic development.
• Indian financial institutions are very strong but sometimes operations are not up
to the mark.
• Indians make very good plans but in implication sometimes we are lacking in
somewhere.
• We have full range of financial institutions but again sometimes we cannot use in
effective manner.