The gap fillers objectives of DFIs and reforms in Indian financial system in post- independence

At the early stage of independence, there were no long-term financing institutions in India. The role of commercial banking at that time was limited to working capital financing on a short-term basis. Therefore, the role of DFIs was to recognize the gaps in institutions and markets in our financial sector and act as a gap-filler which was made due to the incapability of commercial banks to finance big infrastructure projects for the long term and support them to attain growth and financial steadiness. The thrust was therefore to establish Development Financial Institutions (DFIs) for long-term finance to the industry and infrastructure sector in India.  Govt. of   India set up specialized DFIs in India to fulfill long-term project financing requirements of industry and agriculture such as the Industrial Finance Corporation of India (IFCI) in 1948, (Read: Role of IFCI). Industrial Development Bank of India (IDBI) in 1964 (Read:  the role of IDBI),, National Bank for Agriculture and Rural Development (NABARD) in 1982 (Read the role of NABARD), EXIM Bank 1982 Read Role of, EXIM Bank, National Housing Board (NHB) in 1988 Read the role of  National Housing Bank (NHB), and  SIDBI with functions relating to the micro, medium, and small industries sector was separated from IDBI in 1989, with majority ownership of the RBI were launched to meet the long-term financing needs of industry and agriculture in India for driving growth in our economy post-independence. The National Bank for Financing Infrastructure and Development (NaBFID/NBFID) was established as an infrastructure-focused development financial institution (DFI) under the National Bank for Financing Infrastructure and Development Act, 2021 to support the development of long-term non-recourse infrastructure financing in India including the development of bonds and derivatives markets necessary for infrastructure financing and to carry on the business of financing infrastructure. NaBFID, is the nation’s 5th All India Financial Institution (AIFI), aimed at fostering long-term non-recourse infrastructure financing. (To Know more read: NaBFID). There have been three phases in the evolution of DFIs in India. The above financial institutions in India were set up under the full control of both Central and State Governments. The Government used these institutions for the achievements in planning and development of the nation as a whole.

The pre-reform period of 1990 was characterised by administered interest rates, industrial licensing and control dominant public sector, and limited competition, the Indian financial system consisted of unorganised sector. It was a shallow market with the public sector playing a dominant role. It lacked efficiency in the secondary market. The 1991 reform aimed at removing all these barriers for better development of the financial system of India.

As DFIs did not have low-cost deposits in the form of current and saving accounts like commercial banks in India, they were not able to provide low-cost finance to the priority sector for the long term they were mainly surviving on State funding. The system lacked a continuous flow of funds due to a lack of institutions and foreign investments. The 1991 reform aimed at increasing competitive efficiency in the operation of the Indian financial system, making it healthy and profitable and imparting operational flexibility and autonomy for working efficiently. Another objective was to make the Indian financial system much wider by increasing the number of financial instruments and financial institutions. This would result in a greater accumulation of capital funds. It is felt that the developed financial institutions were in a position to raise resources at interest costs that were much lower than if they had relied on market sources. This also allowed them to lend at rates that were rational from the point of view of industry and the infrastructural sectors. That made them the first choice for finance for Indian business, which did considerably benefit from the financial support provided by the government, in the years before the 1990s. But Govt. after 1991 reforms that reduced public funding in these DFIs were responsible for their decline in India. Therefore, there are various ways in which the gap created by the transformation of development finance was filled. There was a shift towards bank credit and external commercial borrowing. There was improved reliance on internal resources and a growing role for external commercial borrowing & private equity in corporate financing.

Other notable developments in the reform era:

Many financial institutions in public were privatized to increase the competitive efficiency of the system. Institutional structures in many PSUs are reorganized. The Financial Market was permitted to integrate with the global market and foreign investments in India were accepted. Protections are provided to investors by various regulatory reforms. The licensing system for various industries was abolished. The Foreign Exchange Regulation Act (FERA) was an act to regulate dealings in foreign exchange and foreign securities with the objective of the conservation of foreign exchange resources of India and its proper utilization in the economic development of India. The Government repealed FERA in 1998 and replaced it with the Foreign Exchange Management Act (FEMA), which liberalised foreign exchange controls and restrictions on foreign investment. The MRTP Act aimed to control monopolies and restrictive trade practices. It was replaced by the Competition Act, which established the Competition Commission of India to prevent anti-competitive practices and protect consumer interests in a liberalized market. The MRTP lacked the dynamic nature that was necessary in such a dynamic economic environment. Indian trade markets were moving toward a more global economy, and the MRTP was not able to keep up with the New Economic Policy. Hence, it was bound to become obsolete. The Monopolies and Restrictive Trade Practices Act, 1969 [MRTP Act] repealed and is replaced by the Competition Act, 2002, with effect from 01st September 2009 [Notification Dated 28th August 2009].

Hence, there were various ways in which the gap created by the transformation of development finance was filled. There was a shift towards bank credit and external commercial borrowing. There was improved reliance on internal resources and a growing role for external commercial borrowing & private equity in corporate financing.

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