ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Changing Scenario

Industrial Finance and Capital Market

Given the current state of the financial institutions and banks, it will take many years before they are integrated into the capital market framework thus bridging the artificial gulf that exists today between the two. The basic function of financial institutions and banks and the financial/capital markets is to facilitate the transfer of funds from the surplus to the deficit pockets. The main thrust of policy now should be to create seamless linkages between DFIs/banks and capital markets to facilitate this process of transfer from the ultimate savers to the ultimate users at minimum cost. Such a policy should also ensure a neutral stance towards banks and the capital markets thus making for an environment where there is efficient resource allocation as well as a certain discipline among users of funds.

In the post-independence period, our country witnessed the birth of a large number of specialised institutions for providing finance to different sectors of the economy. Among these, the well-knit structure of development financial institutions (DFIs) for meeting the requirement of medium and long-term finance of all range of industrial units – from the smallest to the very large ones – occupied the pride of place. As a matter of conscious policy; the RBI and the government nurtured DFIs through various types of financial incentives and other supportive measures. The main objective was to provide the much-needed long-term finance to industry, which, the then existing banking institutions were not keen to provide because of the fear of asset-liability mismatch. Since deposits were short-medium term, extending term-loans was considered to be relatively risky. The five-year development plans envisaged rapid growth of domestic industry to support the import substitution growth model adopted by the national planners. To encourage investment in industry, a conscious policy decision was taken that the DFIs should provide long-term finance at interest rates that were lower than those applicable to working capital loans. In the early years of the post-independence period, various commodity shortages tended to make trading in commodities a more profitable proposition than investment in industry, which carried a higher risk. Partly to correct this imbalance, the conscious policy design was to increase the attractiveness of long-term investment in industry and infrastructure through relatively lower interest rates. To enable the term-lending institutions to finance industry at concessional rates, the government and the RBI gave the DFIs access to low cost funds through bonds with government guarantee, budgetary support and allocating sizeable part of RBI’s National Industrial Credit (Long- Term Operations) funds to IDBI. Through an appropriate RBI fiat, the turf of the DFIs was also protected, until recently, by keeping commercial banks away from extending large sized term loans to industry.

After the opening up of the Indian economy and introduction of financial sector reforms since 1991, the development banks have been deprived of the protective climate in which they operated for long. They have no access to concessional sources of finance and have to compete for business along with commercial banks, whose cost of funds is way below that of the DFIs. Global competition through more liberal imports has adversely affected profitability of several industrial units assisted by the DFIs in the past. Hence the DFIs are now saddled with high level of NPAs. This in turn has adversely affected their fresh business as the demand for term loans has come down sharply. A more liberal policy framework has encouraged mergers, amalgamations, restructuring and rationalisation of production capacities, leading to productivity improvements, and consequently less demand for additional capacities in various industries. Greater import availability, which ensures a much wider range of choices (and often of better quality), has led to the lower demand for term finance from industry.

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