Old Problem, Older Solution

Business Standard     15th January 2021     Save    

Context: While the Government is planning to create new Development Finance Institutions (DFIs) to focus on long-term capital financing, it will have the same problems as the Public Sector Banks (PSBs).

Rationale behind the development of new DFIs

  • Developing a deep and liquid corporate bond market: At present, the corporate bond market is stunted due to reasons like heavy government borrowing.
  • An alternate way to channel long-tenure capital: because of the weakness of the non-banking financial sector (NBFC) and the revenue crunch faced by the government.

Problems with state-controlled DFIs: they also face problems similar to the PSBs.

  • Development of cronyism and favouritism towards particular borrowers.
  • It will have room to be manoeuvred by politicians and bureaucrats: Similar was the case with State-controlled banks. (Government may use DFI to manage the economy and achieve its ends)
    • DFIs will end up being dictated: For e.g. A government with coal-fired power plants facing closure due to new regulations might force a DFI to provide project finance to that sector.

Way forward:

  • Change the focus of DFIs: to equity financing.
  • Create sector-specific institutions: with a minority stake and no control for the government will be more effective than state-owned DFIs.
  • Deepen the corporate bond market: by reducing banks’ dependence on holding government securities and improving policy and legal certainty for long-term finance.
  • Improving policy and legal certainty for long-term finance: through protection against arbitrary judicial action.