“Closing down term finance institutions was a mistake and that we need to revive these in order to facilitate long term financing”. - C Rangarajan (RBI Governor)

1. DO WE NEED TERM FINANCE
INSTITUTIONS?
Name: Jitho Monachan
MBA(Banking & Finance)
Amity University, Mumbai

2. “Closing down term finance institutions was a mistake and that we need to revive these in order
to facilitate long term financing”. - C Rangarajan (RBI Governor)
• According to the Reserve Bank of India’s (RBI) report of the working group on development finance
institutions (DFIs) has made it categorical that these entities have a future only as banks or non-banking
finance companies (NBFCs).
• The three development financial institutions (DFIs) that focused on term finance, namely, IFCI, ICICI
and IDBI. Commercial banks confined themselves mainly to providing working capital.
• The idea that working capital and long-term finance should happen under one roof took hold.
• The finance ministry and the RBI discussed how the recommendations of the Narasimham-II committee
could be taken forward.
• The Narasimham Committee-II had suggested that these institutions should either convert themselves
into banks or non-banking financial companies (NBFCs).

3. • The reasons for separating the two roles:
1. 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.
2. 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.
• The committee recommended that DFIs could evolve as universal banks offering a range of financial
services. Jalan discussed the report with his deputy governor, Y V Reddy, and given the latter’s
reservations, sought the views of a retired chief economist of the Asian Development Bank on the Khan
Committee report. Reddy’s argument was that the transition should be in the form of either pure
commercial banks or as NBFCs.
• His point was that the evolutionary path for each of these institutions ought to be towards emerging as
banks.

4. • The RBI was not entirely convinced. In a discussion paper published in January 1999, the RBI warned,
“Drastic changes in their (DFIs’) respective roles at this stage may have serious implications for
financing requirements of funds of crucial sectors of the economy.”
• Nevertheless, the RBI chose to fall in line with the Narasimham committee recommendations it is often
said, under pressure from the international agencies that had provided structural adjustment loans.
• The RBI advised the three DFIs to convert themselves into banks or non-banking financial
companies (NBFCs).
• ICICI and IDBI opted to merge with their banking subsidiaries.
• IFCI muddled along and eventually became an NBFC.

5. • The proposed term-finance institutions would have a minimum capital requirement of 1,000 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 a
minimum of, say, 10 crore.
• They would be exempt from cash reserve ratio (CRR) requirement for funds raised through
infrastructure bonds.
• These funds would also need to be exempted from SLR requirements in line the relaxation given to
commercial banks.

6. CONCLUSION
• If the proposed term-finance institutions are to raise finance entirely from the markets, it will make their
loans far too expensive.
• Term-finance institutions may not be viable as long as they face higher borrowing costs than banks.
• To be viable, 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 subsidised funding in effect, a new avatar of IDBI.

7. THANK YOU!!