Budget 2021: The Return Of DFI Could Expose The System’s Inadequacies
A worker welds bracing while working at the National Highway 24 road widening and bypass project near the Indirapuram township in Ghaziabad, Uttar Pradesh, India (Photographer T. Narayan/Bloomberg)

Budget 2021: The Return Of DFI Could Expose The System’s Inadequacies

India will soon set up a new development financial institution to raise funds for infrastructure. But that won't be enough. According to experts, it requires an easier regulatory framework and ability to raise money a lower cost to succeed and more.

A DFI is an agency to fund infrastructure projects of national importance that may or may not conform to commercial return standards.

Finance Minister Nirmala Sitharaman said in her Budget 2021 speech that the new DFI will start with a capital base of Rs 20,000 crore and will aim to have a loan book of Rs 5 lakh crore in three years. “A professionally managed development financial institution is necessary to act as a provider, enabler and catalyst for infrastructure financing.”

Later, in an interview with CNBC-TV18, she said the government is not planning to stop with just one such institution. “The amendments that I have to bring in to existing laws during the parliamentary session will have to have a provision for private DFIs to come in. With that I want the private DFIs, the government backed DFI, all to compete.”

While the initial capital base is lower than the Rs 1 lakh crore expected by the market, Vinayak Chatterjee, founder chairman at Feedback Ventures, said it won't be tough for it to raise funds. “For one project, the bullet train, the country was able to raise Rs 1 lakh crore. So for a 100% sovereign backed institution it would not be difficult to raise Rs 5-10 lakh crore.”

Experts BloombergQuint spoke with said the approach needs to go beyond financing to avoid mistakes of the past.

Funding Costs

India’s first DFI, Industrial Finance Corporation of India Ltd., was set up in 1948. It was followed by multiple state financial corporations in 1951, ICICI Ltd. in 1955, IDBI Ltd. 1964 and many more.

Till the early '90s, these institutions flourished as they received cheap financing from the government, multilateral and bilateral agencies. The DFIs were also allowed to raise funds by issuing bonds.

Bulk of the financing came from long-term operations conducted by the Reserve Bank of India, which provided cheap funds, according to KP Nair, former deputy managing director at IDBI Bank. The RBI’s National Industrial Credit (long-term operations) provided long term funds to DFIs at a low cost.

“After liberalisation, the RBI’s window was closed and the DFIs had to depend on market borrowings to fund their business," Nair told BloombergQuint. "Banks also started competing with DFIs for infrastructure financing due to their low cost of funding. This is why you saw ICICI and IDBI convert to banks, while others suffered.”

While avenues to raise funds have risen significantly in the 30 years since liberalisation, the realities of the infrastructure sector haven't changed. They still have a long gestation period. And India's political and judicial uncertainties can make that even longer, causing cost overruns.

The new DFI would have to focus on providing credit enhancements and earn returns for its investors by selecting good quality projects, rather than just lending, said RK Bansal, chief executive officer at Edelweiss Asset Reconstruction Company Ltd. and an IDBI Bank alumnus.

“This way, the bonds issued by the DFI can get a AA rating and it can raise money from pension funds and insurance companies," Bansal said. "But getting any kind of sovereign guarantee on infrastructure projects is always a difficult proposition.”

Regulatory Gaps

Till the early 2000s, the RBI’s guidelines on recognition of bad loans and provisioning were not as stringent as they are today. DFIs could continue to work with a higher delinquency rate and still manage their profitability, said Nair.

As the new DFI intends to have a book of Rs 5 lakh crore within three years, the chances of higher default rates also go up.

“If you were to regulate a DFI with the rules governing bank books now, it would be very difficult to run a profitable venture,” he said. These institutions, he said, would have to be governed with a fundamentally different regulatory approach.

During the heyday, DFIs could afford to offer a two-year moratorium on principal repayments to infrastructure projects. Interest payments, too, would become part of the project cost as the institution would deduct it from the monthly disbursement sent to the promoter, Nair said.

“This kind of structure is difficult to implement today because any long-term moratorium is considered loan restructuring,” he said.

Currently, a bank is required to recognise a loan account as non-performing asset if dues are not repaid within 90 days of the due date. In the first year of an account becoming an NPA, banks must set aside 15% of the loan amount as provisioning from its quarterly profits. The provisioning rate goes up as the NPA ages, reaching 100% if the dues are unpaid for four straight years.

The regulator does provide some leeway for infrastructure projects considering the potential for delays. The date for commencement of commercial operations for infrastructure and real estate projects may be extended by up to one year under RBI norms without attracting a 'restructured account' tag.

“The RBI may need to consider relaxing the one-year extension period in case of DFIs because they have much longer sources of funding and can withstand some delays in project completion,” Bansal said.

Lack Of Talent

A good infrastructure financing institution will need a strong bench of specialists who can look through proposals and select the best possible borrower.

“It is not just about knowing how to read the balance sheets. Back in the day at IDBI, we used to hire specialists who knew their respective sectors inside out," Nair said. "Apart from knowing the company’s financials, a good appraisal process also requires a review of the sector itself and the potential to grow.”

In the last 10 years, as banks have slowly moved away from project financing, the available bench strength in the market has gone down significantly. In 2019, ICICI Bank shut down its project finance division and merged its staff with the corporate finance division. Most other banks have also completely stopped financing green field projects, sticking mostly to top-rated corporates for their needs.

“The talent pool in the past was built over decades of infrastructure financing done through DFIs," Nair said. "Nobody is doing this kind of lending anymore. After a prolonged pause, you will find it difficult to staff the DFI with good project appraisers.”

According to Bansal, the new DFI could consider hiring sectoral experts, like DFIs used to do in the past. But the people, he said, will also need to know how to work with central and state governments to have a profitable business.

“Since the government is the counterparty in a lot of infrastructure projects, the DFI would need to ensure that different departments work together and do not cause undue delays in the completion of the project.”

Also read: Budget 2021: We Spent, Spent, Spent, Says Nirmala Sitharaman. Did They?

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