Banking, Uncategorized

Role of Development Finance Institutions

Financing of long gestation projects is very different from short and medium term lending that a commercial bank is best suited for and each calls for very different skill sets to manage and operate. This was the logic behind India setting up development finance institutions (DFIs) like Industrial Credit & investment Corporation of India (ICICI), Industrial Development Bank of India (IDBI) and Industrial Finance Corporation of India (IFCI). Each of them had well-defined and slightly different goals and each of them targeted a different clientele.

When in 1994 and soon after, ICICI and IDBI both promoted commercial banks, they kept the distinction between project financing and commercial banking separate. The ICICI Bank and IDBI Bank both recruited and staffed themselves with experienced commercial bankers, with a lot of hard core banking background, and they both succeeded in establishing themselves.

With different profiles and skills needed for each of these organisations, it became logical to recruit Engineer MBAs in DFIs as they seemed to have the required skills to appraise long gestation, large capital projects and monitor lending to such projects effectively. The commercial banks however needed those with entirely different skillsets – graduates and post-graduates in commerce or similar backgrounds who could be recruited and trained.

ICICI and IDBI meanwhile continued their project financing activity but they were facing tremendous pressure – political and otherwise – to keep lending to manufacturing and infrastructure projects which were facing problems. Asset provisioning norms were far more lax at that time, and taking advantage of that, DFIs went on lending to projects that were in trouble under the mistaken hope that they could be revived. For sure, some projects were revived and did well, many others did not.

ICICI and IDBI were also facing scarcity of resources as repayments were not coming in on time. ICICI had been permitted to float tax-savings bonds on which interest they paid was almost equal to that paid by commercial banks on their term deposits. Commercial banks on the other hand, had access to low cost demand deposits. Discussions were therefore floated to merge the two DFIs and their respective commercial banks. This per se would not have been a problem if, after the merger, the basic difference between project finance and its management, was kept separate from commercial short and meium term lending. Also it was necessary to keep the skill sets separate and maintain that distinction in the merged entities. This did not happen in practice.

Once the mergers actually happened, the MBAs who came from the DFI with a larger asset base were placed in positions of authority over the experienced commercial bankers and began to interfere in their domain. This obviously led to severe HR issues and the experienced bankers started to leave their organisations and look for other opportunities. The MBAs obviously had no clue as to how a commercial bank was to be run and tried to implement processes and ways of doing business more attuned to project financing leading to complete confusion.

Meanwhile with the distinction between project lending by DFIs and commercial lending by banks no longer there, other commercial banks also started to get requests from their clients for project lending, something they were not really competent to properly appraise and monitor. With the freeze on hiring, and inability to pay market related salaries, PSBs were constrained from recruiting the right staff who may have better been capable of appraising larger projects In a holistic way.

The blurring of roles made a mess of the asset quality of both the newly merged ICICI Bank and IDBI Bank, as well as the larger PSBs. The experienced commercial bankers who were first recruited into ICICI Bank when it was first set up, and formed the bedrock of its successful foray into commercial banking, started to get side-lined, and quit in droves through sheer disgust. The few who remained were treated as people of no consequence and obviously felt no compulsion to contribute much more than just what they needed to survive. IDBI Bank, being in the public-sector, treated their experienced bankers far better, and therefore they are in a much better position in terms of banking talent, although they have other problems like corruption and below par efficiency to contend with.

If this situation is to be rectified, there is an urgent need to go back to the original position of maintaining a separation between project lending and commercial banking. While a de-merger of the erstwhile DFIs in not an option, what can be done is to reinstate separate divisions in IDBI Bank and ICICI Bank which will focus on their role as project financing specialists. The PSBs and the rest of ICICI/IDBI Banks can then go back to what they do best, that is commercial banking.

The bad loans relating to project lending should also be assigned to the project finance divisions to manage. This includes bad loans related to project lending by PSBs. It is time to recognise that each bad loan needs to be looked at separately and distinctly, if any serious attempt is to be made to recover then. Setting up a general bad bank will not solve the problem, and it is good to see that this proposal seems to be no longer on the table.


Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s