Over the past two decades, successive governments have given major impetus to infrastructure growth. Due to the lack of other options, funding for this largely came from banks. Infrastructure projects in India are infamous for cost overruns and delays. Such delays in the implementation of projects, whatever the reasons, led to the “NPA overload”, making banks reluctant to lend to this sector. September 7, 2020 The commercial standard reported that “the finance ministry may soon set up a development finance institution as banks struggle to finance infrastructure projects.” The government had already released a pipeline of 6,749 projects that required more than $ 1.7 trillion in funding over 5 years, according to the article. A few months earlier, in July 2020, the governor of the RBI had asked India Inc. to find another source of financing for infrastructure loans, pointing out that the financing needs of $ 4.5 trillion estimated by NITI Aayog for the infrastructure sector could not be reached by banks alone. “The excess bad debt had made banks risk-averse and quite limited in the kind of exposure they would want to take on their books. Banks are barely recovering from the consequences of excessive exposure to infrastructure, ”he added.

Among other things, the 2021 budget was the subject of a few announcements for the first time, such as the privatization of two banks and the creation of a National Asset Reconstruction Company Ltd (a bad bank). These are undoubtedly bold initiatives. The bad bank will clean up banks’ balance sheets and make them attractive to private investors. But if these balance sheets are to remain attractive, banks will need to closely monitor their asset-liability mismatches. One of the most critical reasons for the high level of NPAs in banks was the huge exposures they had taken to stalled infrastructure projects, a mistake they cannot afford to repeat. Although the irrational exuberance of 2006-2008 may have led to risk-taking, and the political paralysis of 2012-14 may have added to the already latent problem of the NPA, the decision taken in the 1990s had created a banking business’ failing model, which involves accepting shorter-term liabilities to create longer-term assets. This played a major role in creating the NPA mess. Such an economic model cannot be viable in the long term. That is why we have to look for other options, which the governor of the RBI referred to.

After independence, as India embarked on an ambitious industrial development program, a separate category of DFIs (Development Finance Institutions) was promoted, owned and assisted by the government. The combined asset base of all DFIs was Rs 1.58 lakh crore in 1998-99. These institutions were dedicated lenders to Indian industry. DFIs also had access to low cost funds from the National Industrial Credit Long Term Operation Fund (LTO). This fund was created from the profits of the RBI, whose bonds were considered SLR (statutory liquidity ratio) securities. These bonds had takers because they helped the banks maintain the SLR, which was quite high at the time. As part of the banking sector reforms initiated in 1991, the level of CRR, SLR and other pre-empted funds declined, and with it, banks’ appetite for LTO bonds. With the window for cheap funds closing, DFIs found themselves raising funds through short-lived liabilities to create longer-dated assets. This asset-liability asymmetry was unsustainable and DFIs were forced to change their game. Several DFIs, in particular ICICI and IDBI, joined the universal banking movement and reinvented themselves as retail banks with operations of allied insurance.

After the disappearance of these DFIs, the planned commercial banks were invited to intervene to finance long-term projects. If this model of financing long-term assets with short-term liabilities had failed for DFIs, it was unwise to expect it to be successful for planned commercial banks. Listed banks, at the time, dealt primarily with retail and working capital loans, which had shorter moratorium periods and usually came with ready collateral. It was now necessary to reinvent oneself, to face the financing of projects, which had longer gestation and balance periods without the expertise or the support of the balance sheet. In addition, over time, the country’s infrastructure sector has grown rapidly and with it the long-term financing needs of commercial banks. With the increase in NPAs and severe liquidity mismatches at banks, the flow has stalled as banks lost their appetite for long-term credit.

The pandemic has exposed our creaky infrastructure. The next few years will see a lot of momentum given to this sector and the infrastructure pipeline is sure to grow. A plausible solution of financing these projects without burdening the planned commercial banks is the need of the moment. Setting up a DFI will not solve the problem. The revival of the concept of DFI and the creation of a greater number of institutions of this type to grant only long-term credits will allow the banks to remain viable. Now that the government has decided to consolidate the banking sector with the bank merger, can any of these banks be converted into DFIs? We only need the banks for long term credit.

The writer is President (Banking and Financial Services), TA Pai Management Institute, Manipal

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