DEVELOPMENT BANKS

DEVELOPMENT BANKS

INTRODUCTION

Development banking is different from simply banking.

 Loans are made not to those who have accumulated wealth

in the past but to those who show promise to become
wealthy in the future.
 Normal banking looks for safety in assets accumulated from
the past; in development banking, possible accumulation of
assets in the future is the true collateral. Thus, while in
normal banking, the collateral is real and tangible, in
development banking, the collateral is a dream;
 Normal banks can afford to be myopic; development banks
should take the long view. For development banks, it is the
trend line and not the current surplus that is important.
 As one development banker blithely explained: "When I see
any risk, I take my money and run away." But that is not
development banking; development banks take risks that
ordinary banks will not.

SAMRITI GOEL
MBA LECTURER
 DEVELOPMENT BANKS

MEANING

 Development banks are the institutions engaged in the promotion and

development of industry, agriculture and other key sectors.

 National or regional financial institution designed to provide medium- and

long-term capital for productive investment. Such investment is usually
accompanied by technical assistance.

 Some development banks are government-owned, while others are private.

Many have been established under the auspices of the World Bank.

 Among the largest are the Inter-American Development Bank, the Asian
Development Bank, and the African Development Bank.

DEFINITION

A.G. Kheradjou: "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".

D.M. Mithani: "A development bank may be defined as a financial institution

concerned with providing all types of financial assistance (medium as well as
long-term) to business units in the form of loans, underwriting, investment and
guarantee operations and development in general and industrial area”.

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MBA LECTURER
 DEVELOPMENT BANKS

A development bank's policies or programs center on the following priorities:

 Economic growth

 Human development

 Environmental protection

 Private sector development

 Regional cooperation

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MBA LECTURER
 DEVELOPMENT BANKS

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 an 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.
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.

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MBA LECTURER
 DEVELOPMENT BANKS

OBJECTIVES OF DEVELOPMENT BANKS

1. Lay Foundations for Industrialization

To lay a solid foundation for growth, establishment of certain key industries such
as cement, engineering, machine making, chemicals, etc. is essential. Private
entrepreneurs were not forthcoming to invest in these vital' areas due to risk
involved and Long gestation period in those industries. The governments of under
developed countries set up development institutions to fill the vacuum.

2. Meet Capital Needs

Owing to the low level of income of the people there were no sufficient surpluses
for capitalization. There was a need for institutions which could meet this gap
between demand and supply for capital.

3. Need for Promotional Activities

Besides capital needs, underdeveloped countries suffered from lack of expertise,

managerial and technical know-how. Developmental banks could take up the job
of joint sectors and provide managerial resources and skills and transform them
into approved fields.

4. Help Small and Medium Sectors'

There was a need to mitigate sufferings of small and medium size industries.
Despite the important role played by these sectors they experience scarcity of
capital owing to the apathy of investors to invest their savings because of their
credit worthiness and profitability. There was a need for special institutions to
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 DEVELOPMENT BANKS

help these sectors in playing vital role in the industrialization of developing and
under developed countries.

FUNCTIONS OF DEVELOPMENT BANKS

Development banks have been started with the motive of increasing the pace
of industrialization. In order to help all round industrialization development banks
were made multipurpose institutions. Besides financing they were assigned
promotional work also. Some important functions of these institutions are
discussed as follows:

1. Financial Gap Fillers

Development banks do not provide medium-term and long-term loans only but they
help industrial enterprises 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 raised from foreign and domestic sources. They also help
'undertakings to acquire machinery from with in and outside the country.

2. Undertake Entrepreneurial Role

Developing countries lack entrepreneurs who can take up the job of setting up new
projects. It may be due to lack of expertise and managerial ability. Development
banks were assigned the job of entrepreneurial gap filling. They undertake the task
of discovering investment projects, promotion of industrial enterprises, provide
technical and managerial assistance, undertaking economic and technical
research, conducting surveys, feasibility studies etc. The promotional role of
development bank is very significant for increasing the pace of industrialization.

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MBA LECTURER
 DEVELOPMENT BANKS

3.Joint Finance

Another feature of development bank's operations is to take up joint financing

along with other financial institutions. There may be constraints of financial
resources which may force banks to associate with other institutions for taking up
the financing of some projects jointly. It may also not be possible to meet all the
requirements of a concern by one institution, 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
a particular currency, met by one institution and under writing of securities met by
another. In case of big projects where substantial financial assistance is needed,
more institutions may form a consortium to meet their needs. The members of the
consortium will undertake joint appraisal of projects and then decide the quantum
of assistance to be provided by each institution.

4. Refinance Facility

Development banks also extend refinance facility to the lending institutions. In this
scheme there is no direct lending to the enterprise. The lending institutions are
provided funds by development banks against loans extended' to industrial
concerns. In this way the institutions which provide funds to units are refinanced
by development banks.

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 DEVELOPMENT BANKS

5. Credit Guarantee

The small scale sector is not getting proper financial facilities due to the element
of risk since these units do 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 guarantee scheme and
credit insurance scheme. In India, credit guarantee scheme was introduced in
1960 with the object of enlarging the supply of institutional credit to small
industrial units by granting a degree of protection to lending institutions against
possible losses in respect of such advances.

6. Underwriting of Securities

Development banks acquire securities of industrial units through either direct

subscribing or underwriting or both. The securities may also be acquired through
promotion work or by converting loans into equity shares 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 in a systematic way which should not influence market prices of
these securities and also should not lose managerial control of the units.

Development banks have become world wide phenomena. Their

functions depend upon the requirements of the economy and the state of
development of the country. They have become well recognized segments of
financial market. They are playing an important role in the promotion of industries
in developing and underdeveloped countries.

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 DEVELOPMENT BANKS

DEVELOPMENT BANKING IN INDIA

The foreign rulers in India did not take much interest in the industrial development
of the country. They were interested to take raw materials to England and bring
back finished goods to India. The government did not show any interest for
securing up institutions needed for industrial financing.

 The “recommendation for setting up industrial financing institutions was

made in 1931 by Central Banking Enquiry Committee but no concrete steps
were taken.

 In 1949, Reserve Bank had undertaken a detailed study to find out the need
for specialized institutions.

 It was in 1949 that the first development bank i.e. Industrial Finance
Corporation of India (IFCI) was established.

 In 1951, Parliament passed State Financial Corporation Act. Under this

Act state governments could establish financial corporations for their
respective regions.

 The IFCI and state financial corporations served only a limited purpose.
There was a need for dynamic institutions which could operate as true
development agencies.

 The Industrial Credit and Investment Corporation of India (ICICI) were

established in 1955 as a Joint Stock Company. Though ICICI was
established in private sector but its pattern of shareholding and methods of

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 DEVELOPMENT BANKS

raising funds gives it the characteristic of a public sector financial

institution.

 Another institution ,Refinance Corporation for Industry Ltd. (RCI) was set
up in 1958 by Reserve’ Bank of India, LIC and Commercial Banks.

 In 1964, Industrial Development Bank of India (IDBI) was set up as an

apex institution in the area of industrial finance, RCI was merged with
IDBI. IDBI was a wholly owned subsidiary of RBI and was expected to co-
ordinate the activities of the institutions engaged in financing, promoting or
developing industry.

 The State Industrial Development Corporations (SIDC's) were established

in the sixties to promote medium scale industrial units.

 The State Small Industries Development Corporations (SSIDC's) were

also set up to cater to the needs of industry at state level.

 The Unit Trust of India (UTI) established in 1964, Life Insurance

Corporation of India (1956) and General Insurance Corporation of India
(GIC) set up in 1973 also finance industrial activities at all India level.

 In 1982 the Export-Import Bank of India (Exim Bank) was established to

provide financial assistance to exporters and importers.

 In order to meet credit needs of agriculture and rural sector, National'

Bank for Agriculture and Rural Development (NABARD) was set up in
1982.

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MBA LECTURER
 DEVELOPMENT BANKS

Role of development banks in financial system

Financial institutions provide means and mechanism of transferring

resources from those who have an excess of income over expenditure to those who
can make productive use of the same. The commercial banks and investment
institutions mobilize savings of people and channel them into productive uses.
Financial institutions provide all type of assistance required for infrastructural
facilities to Institutions or the economic persons who can take the development in
the following ways.

1. Providing Funds

The underdeveloped countries have low levels of capital formation. Due to low
incomes, people are not able to save sufficient funds which are needed for sensing
up new units and also for expansion, diversification and modernization of existing
units. These institutions help large number of persons for taking up some
industrial activity. The addition of new industrial units and increasing the
activities of existing units will certainly help in accelerating the pace of economic
development.

2. Infrastructural Facilities

Economic development of a country is linked to the availability of infrastructural

facilities. There is a need for roads, water, sewerage, communication facilities,
electricity etc. Indian industry and agriculture is facing acute shortage of
electricity. All India" institutions are giving priority to invest funds in projects
generating electricity. Small entrepreneurs cannot spare funds for creating

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 DEVELOPMENT BANKS

infrastructural facilities. To overcome this problem, institutions at state level are

developing industrial estates and provide sheds, having all facilities at easy
installments. So financial institutions are helping in the creation of all those
facilities which are essential for the development of a country.

3. Promotional Activities

An entrepreneur faces many problems while setting up a new unit. One has to
undertake a feasibility report, prepare project report, complete registration
formalities, seek approval from various agencies etc. All these things require time,
money and energy. Some people are not able to undertake this exercise or some do
not even take initiative. Financial institutions make available the expense and
manpower resources for undertaking the exercise of starting a new unit. So these
institutions take up this work on behalf of entrepreneurs. Some units may be set up
jointly with some financial institutions and in that case the formalities are
completed collectively.

4. Development of Backward Areas

Some areas remain neglected because facilities needed for setting up new units are
not available here. The entrepreneurs set up new units at those places which are
already developed. It causes imbalance in economic development of some areas.
In order to help the development of backward areas, financial institutions provide
special assistance to entrepreneurs for setting up new units in these areas. IDBI,
IFCI, ICICI give priority in giving assistance to units set up in backward areas
and even charge lower interest rates on lending. Such efforts certainly encourage
entrepreneurs to set up new units in backward areas.

5. Planned Development

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 DEVELOPMENT BANKS

Financial institutions help in planned development of the economy. Different

institutions earmark their spheres of activities so that every business activity is
helped. Some institutions like SIDBI, SFCI's especially help small scale sector
while IFCI and SIDC's finance large scale sector or extend loans above a certain
limit. Some institutions help different segments like foreign trade, tourism etc. In
this way financial institutions devise their roles and help the development in their
own way. Financial institutions help in the overall development of the country

6. Accelerating Industrialization

Economic development of a country is linked to the level of industrialization there.

The setting up of more industrial units will generate direct and indirect
employment, make available goods and services in the country and help in
increasing the standard of living. Financial institutions provide requisite financial,
managerial, technical help for setting up new units. In some areas private
entrepreneurs do not want to risk their funds or gestation period is long but the
industries are needed for the development of the area. Financial institutions
provide sufficient funds for their development. Since 1947, financial institutions
have played a key role in accelerating the pace of industrialization. The country
has progressed in almost all areas of economic development.

7. Employment Generation

Financial institutions have helped both Direct and indirect employment

generation. They have employed many persons to man their offices. Besides office
staff, institutions need the services of experts which help them in finalizing lending
proposals. These institutions help in creating employment by financing new and
existing industrial units. They also help in creating employment opportunities in

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 DEVELOPMENT BANKS

backward areas by encouraging the setting up of units in those areas, Thus

financial institutions have helped in creating new and better job opportunities.

ALL INDIA DEVELPOMENTS BANKS

In India, various financial institutions were set up after independence only. The
Government of India has taken steps to set up institutions which assist various
sectors of the economy. At present the country has 12 institutions at the national
level and 46 at the state level. The All India Financial Institutions comprise All-
India Development Banks, namely:

 Industrial Development Bank of India,

 Industrial Finance Corporation of India Ltd.,

 Industrial Credit and Investment Corporation of India Ltd.,

 Small Industries Development Bank of India,

 Industrial Reconstruction And Development Bank of India,

 SCICI Ltd,

 NABARD

There are three investment institutions:

 Life Insurance Corporation of India Ltd.,

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 DEVELOPMENT BANKS

 Unit Trust of India and

 General Insurance Corporation of India.

At state level there are 18 State Finance Corporations and 28 state industry
development corporations.

SAMRITI GOEL
MBA LECTURER