Wholesale Banks And The History Of Dead Ends

Why would there be a discussion on a new big bank when credit offtake is at a historic low?

Wholesale Banks And The History Of Dead Ends

It is yesterday once more. The Reserve Bank of India (RBI) has put forth an old solution for a perennial problem. It has suggested, through a discussion paper, the need to create ‘Wholesale & Long-Term Finance Banks’.

The discussion paper argues that with the “deepening of the financial sector” there is a need to evolve a structure where apart from universal banks, “differentiated banks provide services in their areas of competitive advantage”. The thesis is that this would enable fulfilling long-term financing needs of the growing economy.

That there is a need for long-term financing is indisputable.

The question is whether wholesale banks are the answer to the problem of filling the gap in long-term financing.

The fact is, the solution suggested does trigger a sense of déjà vu.

Phase-I: Pre-Liberalisation

To appreciate how familiar this solution sounds, we need to go back to the early years of independent India.

  • In July 1948, the government of India created the Industrial Finance Corporation of India (IFCI). The rationale: India’s capital market was underdeveloped, there was significant demand for new capital and commercial banks were not equipped to provide long-term finance. The IFCI was created and provided low-cost funds through RBI’s Statutory Liquidity Ratio (SLR) which enabled loans to borrowers at concessional rates.
  • In 1955, following the advice of the World Bank, the government created the Industrial Credit and Investment Corporation of India (ICICI) as a public limited company under the Indian Companies Act. The rationale: India needed development financing and ICICI would play the role of developing medium and small industries of the private sector.
  • In February 1964, the government sponsored the creation of the Unit Trust of India (UTI) under the Unit Trust Act of India 1963. The rationale: To encourage and pool the savings of the middle and low-income groups and to enable savers to share the benefits and prosperity of the industrial development in the country
  • In June 1964, the Industrial Development Bank of India (IDBI) was established by an Act of Parliament. It was regarded as a Public Financial Institution under Section 4A of the Companies Act, 1956. The rationale: With an authorized capital of Rs 2,000 crore it would function as the principal financial institution coordinating the working of institutions engaged in financing industry.
  • In April 1990, the Small Industries Development Bank of India (SIDBI) was created under an Act of Parliament. The rationale: To facilitate and strengthen credit flow to micro, small and medium enterprises and to coordinate with institutions similarly engaged to address both financial and developmental gaps in the micro, small and medium enterprises (MSME) eco-system.

Phase-I Track Record

ICICI and IDBI have amalgamated with their banking outfits. IFCI, the original development finance institution was converted from a statutory corporation to a company and has morphed several avatars in recent times. It is designated by Government of India as the venture capital fund under the social sector to promote entrepreneurship among Scheduled Castes and authorized agency under the Scheme of Credit Enhancement Guarantee for SC entrepreneurs. The UTI, hit by a scam, is a shadow of itself. The larger point is each of the original three development finance institutions has switched roles. Ostensibly there was, and is a good reason for the altered landscape.

Phase-II: Post-Liberalisation

Be that as it may, it is not as if successive governments have not looked at the issue of long-term financing. Every few years finance ministers have articulated the need for long-term finance and pushed the creation of new programmes and new entities.

  • In July 1996, Finance Minister P Chidambaram said “infrastructure needs long-term finance, typically 15-20 year financial instruments. It has not been possible to float such instruments. Hence I am proposing the establishment of an Infrastructure Development Finance Company (IDFC).”
  • In 1998, to enable funding of private sector infrastructure projects, Finance Minister Yashwant Sinha announced that “up to 10 percent of the new accretion of provident funds to be invested in private sector equities” to enable growth in infrastructure.
  • In 1999, Prime Minister Atal Bihari Vajpayee announced the creation of the National Highways Development Project. Funding was enabled through sharing of cess on petrol and diesel sales.
  • In 2002-03, an institutional mechanism to coordinate debt financing of large infra projects was created under IDFC along with IDBI and ICICI.
  • In 2004-05, the State Bank of India, the Life Insurance Corporation of India (LIC), Bank of Baroda and Punjab National Bank were roped into the group to make Rs 40,000 crore available for infrastructure funding.
  • In 2005, Finance Minister P Chidambaram announced the creation of a special purpose vehicle to provide funds of long-term maturity. It was called the Scheme for Financing Viable Infrastructure Projects (SIFTI).
  • In 2006, SIFTI was converted into India Infrastructure Finance Company Ltd. (IIFCL), a wholly owned Government of India company.
  • In 2007, the government announced the launch of a $5 billion infrastructure financing initiative by Citigroup, Blackstone, IDFC and IIFCL.
  • In 2008, the government mooted deploying a part of the foreign exchange reserves for funding the external commercial borrowings, for capital expenditure of large infrastructure projects.
  • In 2011, to enhance the flow of funds to infrastructure sector the government raised the foreign institutional investor (FII) limit for investment in bonds with a maturity of over five years, issued by companies building infrastructure.
  • In July 2014, Finance Minister Arun Jaitley announced the creation of Infrastructure Investment Trusts (InvITs) for infrastructure projects to reduce pressure on the banking system.
  • Also in Budget 2014, banks were allowed to extend long-term loans for infrastructure with flexible structuring – now known as the 5/25 scheme.
  • Budget 2015 saw the creation of the National Investment and Infrastructure Fund (NIIF) with annual flows of Rs 20,000 crore to invest in infrastructure finance companies like Indian Railway Finance Corporation (IRFC) and the National Housing Bank (NHB).

Phase-II Track Record

How have the plans panned out? IDFC, launched in 1997, has successfully transitioned into a full-fledged bank. Many of the ideas – FII limits, coordinating banks, tax breaks et al have played out. In the past decade, banks have emerged as the second biggest lenders to infrastructure projects and the discussion paper recognises this. It is also no mystery that a major chunk of bank non-performing assets (NPAs) and the bulk of large restructured loans are in the infrastructure space.

That the RBI is discussing a new wholesale bank is an indicator of the fact that the 5/25 scheme is flailing.

What about IIFCL? How has it done? IIFCL went into operation around 2007. Between 2007 and 2016, it has disbursed a total of Rs 48,832 crore. That is roughly Rs 4,800 crore a year.

What about NIIF? Clearly, it is still on the drawing board. Earlier this month, Shaktikanta Das, the Secretary of the Department of Economic Affairs revealed, “the NIIF is working to bring in other investors, who would become partners of Government of India in setting up this fund.” The InvITs are yet on the runway.

The idea of wholesale financing has been in the bake for some time – since 2007 as an RBI technical paper. It does make one wonder why the RBI would put this up for discussion now?

Why would there be a discussion on a new big bank when credit offtake is at a historic low, when those who lent monies are unable to recover?

Consider the landscape of long-term finance in India.

  • The National Bank for Agriculture and Rural Development (NABARD) does agricultural finance,
  • Rural Infrastructure Development Fund (RIDF) does rural infrastructure funding,
  • Power Finance Corporation (PFC) does power project financing,
  • The National Highways Authority of India (NHAI) partially addresses road project funding,
  • IRFC looks at railway financing, and
  • LIC, apart from enhancing credit mechanism, is the go-to lender for government.

The long-term strategic question is about the many issues that haunt the infrastructure sector – from land to clearances. The immediate question is whether the context allows for another species of a bank. Is size the issue? Is the nature of ownership a determinant? Have private entities that are funding infrastructure projects done better than public sector ones?

Remember the catchment area for raising money is the same as it is for existing banks and infrastructure players and the deployment zone is the same troubled zone.

And then what happens to the income profile of large banks if the cheese is moved away?

RBI Lists More Arguments Against Than For

The discussion paper has done a kind of SWOT analysis of the proposal for wholesale banks. It lists four points as “pros” and eight as “cons”. Clearly, the negatives outweigh the positives. The last negative listed as “con” says “given the constraints and limited scope for raising long-term funds without sovereign guarantees, financing of infrastructure and commercial projects could be a challenge for the WLTF [wholesale and long-term finance] banks and their viability could be an issue for debate.”

Why enter a debate where negatives outweigh positives in the SWOT analysis?

The jury is still out on whether the idea of so-called bad banks will take off now or ever. If they do take off, will asset reconstruction companies be far behind?

Yes, there is a need for a rethink on how the landscape can be reorganised.

  • Is it possible to merge the smaller banks into an entity to enable balance sheet size?
  • Can IIFCL, for instance, be an instrument or a vehicle that banks can hawk bad loan books to?
  • Can the existing portfolios of renewable projects be placed with the Shanghai-based New Development Bank to create headroom for new lending?

The landscape of the political economy is littered with ill-conceived notions and institutions. The discussion paper affords an occasion to debate solutions. It would be a good idea to examine what can be done in the current context – how existing entities can be leveraged for solutions. That makes more sense than peeping into what could be a possible dead end.

Shankkar Aiyar, political-economy analyst, is the author of Accidental India: A History of the Nation’s Passage through Crisis and Change.

The views expressed here are those of the author’s and do not necessarily represent the views of BloombergQuint or its editorial team.