Old Problem, Older Solution

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.