K C Chakrabarty: Transformation of DFIs into commercial banks - the
case of the IDBI and the role of employee unions
Special address by Dr K C Chakrabarty, Deputy Governor of the Reserve Bank of India, at a
Seminar on "IDBI's role as Development Financial Institution" organised by the United Forum
of IDBI Officers & Employees, Kolkata, 27 September 2013.
* * *
1. Shri Basudeb Achariya, Hon'ble MP, Lok Sabha; Comrade Rajen Nagar, President,
AIBEA; Shri B.P. Kanungo, Regional Director for West Bengal and Sikkim, Reserve Bank of
India; Shri Samir Ghosh, General Secretary, All Indian Reserve Bank Employees
Association; Principal office bearers of the United Forum of IDBI Officers and Employees;
officers and employees of IDBI and other delegates to the seminar; ladies and gentlemen! I
am pleased to note that the United Forum of IDBI Officers and Employees has taken this
initiative to organize a seminar on the subject of "IDBI's role as Development Finance
Institution for the Social and Economic Development of the Country" in commemoration of
the Golden Jubilee of IDBI.
2. I observe that there is lot of confusion and misconception about the role of Development
Finance Institutions (DFIs) not only in India but also across the globe, especially in the post
reform period. In fact, there is a feeling among the public that in the post reform period,
regulators and policymakers are not encouraging the role of financial institutions as
developmental agents and have oriented their policies towards a market led economy by
sacrificing the developmental role, whereas, the fact is that policymakers and regulators in
India continue to have a firm belief that the role of finance is to encourage development and
that the financial institutions must promote this basic role. The objective of developmental
finance, thus, continues to remain the same and only the outer cover in the form of the
institutional structure needs to undergo a change from time to time.
3. I am extremely happy to be here to address the delegates to this important seminar in this
historic city of Kolkata which has always been the nerve centre of the all types of movements
in the country - be it the freedom movement, the labour movement, the trade union
movement or any other movement related to financial sector or politics. I am sure, befitting
the glorious traditions of this historic city, this seminar would also throw up pertinent
issues/challenges and actionable ideas in the important area of developmental role of
finance, thereby justifying the organizing of this seminar in the city of Kolkata.
4. Let me begin by congratulating IDBI and all its employees on completing 50 years of
glorious existence. Occasions such as Golden Jubilees are not just reasons for celebration
for the organization, but also a moment of joy for the foot soldiers who have put their heart
and soul into building the institution and seeing it through the initial teething phase. Hence,
my warm wishes are also due to the Union and to the present and past employees of IDBI
Bank.
5. Though there is little doubt that DFIs, in general and IDBI, in particular, have made
immense contribution in the economic growth of the country in the post-independence era,
overtime, especially in the post-reform period , they have lost their relevance due to certain
structural changes that have taken place in the banking and financial system in the country. I
thought it apt to use this occasion to share my perspectives on the role of DFIs in India's
economy and the path they should look to traverse following their transition to full-fledged
commercial banks. In my address today, I would also briefly reflect on the context for setting
up of DFIs, trace their history and their relevance in the modern day.
What are Development Finance Institutions?
6. A DFI is defined as "an institution promoted or assisted by Government mainly to provide
development finance to one or more sectors or sub-sectors of the economy". The institution
distinguishes itself by a judicious balance between commercial norms of operation, as
adopted by any private financial institution, and developmental obligations. DFIs adopt the
"project approach" - emphasizing the viability of the project to be financed - against the
"collateral approach". Apart from provision of long-term loans, equity capital, guarantees and
underwriting functions, a development bank normally is also expected to upgrade the
managerial and the other operational pre-requisites of the assisted projects (Scharf and
Shetty, 1972).
7. Thus, the basic emphasis of a DFI is on long-term finance for industrial and infrastructure
projects and on assistance for activities or sectors of the economy where the risks are higher
than what the other traditional financial institutions like banks may be willing to assume. In
fact, in the olden days, banks were only meeting the short term working capital needs of
trade and business and were generally averse to lending for the long term. The risk aversion
of banks primarily stemmed from the repayment of project loans being contingent upon
performance of the project and cash flows arising from it over a long period of time. The
project could go wrong for a variety of reasons like technological obsolescence, market
competition, change of Government policies, natural calamities, poor management skills,
poor infrastructure, etc. Naturally, the risk premium on the long gestation projects was
substantially higher which not only resulted in creating a scarcity of finance for the long term
projects, but also raised the finance cost thereby rendering the project financially unviable. It
was precisely to overcome the twin problems of scarcity and high-cost of finance for the long
term projects that the DFIs were established almost exclusively under Government
ownership. Importantly, these institutions were also expected to develop requisite expertise
on project appraisal and risk management in long term lending and complement private
financial lending entities.
Genesis of Development Finance Institutions
8. As I mentioned earlier, the DFIs were mostly established as special financial institutions
for promoting and supporting national economic development agenda. They have, indeed,
played a catalytic role in the socio-economic development across the globe. In Europe, the
advent of development finance can be traced back to the mid-nineteenth century when these
institutions were established primarily to meet the increased demand for medium to
longterm capital by new and emerging enterprises during the industrial revolution. In France, long
term finance institutions were set up in the late 1840s for giving impetus to the industrial and
infrastructural development. In the developed economies, DFIs were also established
because of external developments like war, etc. DFIs in Continental Europe, in fact, played a
major role in reconstruction of the war-ravaged economies.
9. In the post-colonial era, the emerging economies faced the challenge of evolving an
appropriate mechanism for channelizing resources into the development effort. Many of them
had inherited capital starved, primitive financial systems. Such systems could not be relied
upon to allocate resources among competing demands in the economy. The task of
institution building was too important to be left to the mercy of the market forces, which
themselves were at a nascent stage of development. Besides, the markets and traditional
financial institutions were generally averse to lending for the long-term as such lending would
be characterized by uncertain outcomes. Facing such a scenario, several governments in
Europe and East Asia decided to establish institutions specifically to cater to the
requirements of financial resources for long term developmental efforts.
International experience
10. Having seen the context in which the DFIs were set up, let me now give you some global
perspective on the DFIs. Two distinct models of development financing have been followed
internationally. At one end of the spectrum is the Anglo-American model, which is purely
market based with financial markets playing an important role in allocating resources for
competing uses, including the industry and long term projects. At the other end is the model
adopted by Continental Europe and South East Asian Economies, in which financial savings
were channelized and allocated through financial intermediaries like banks and DFIs. The
DFIs played a very significant role in the rapid reconstruction and industrialization of
Germany and Japan after the 2nd World War by providing long-term credit. In Japan, the
government owned Japan Development Bank was established in 1951 for reconstruction of
the economy. In Korea and Singapore also DFIs were set up in 1960s with the main aim of
rapid industrial development. The emergence of DFIs in the then developing economies also
coincided with a period when the capital market, as a source of long term funding, was yet to
stabilize. Based on the European model, the success of the DFIs in the overseas territories
provided strong impetus for creation of DFIs in India after independence.
11. The initial mission for which the DFIs were set up in the developed economies were
complete by the 1980s and most of them have since been wound down or their roles have
been redefined. Most of the surviving DFIs now operate in niche segments of financial
market where the entry barriers are relatively very stringent. India has also witnessed several
structural changes in the banking and financial system, especially in the post reform period
which has undermined the objectives for which the DFIs were established. Commercial
banks, which traditionally refrained from lending for the long term or infrastructure projects
gradually improved their project appraisal skills, their risk management capabilities and
slowly developed appetite for long term lending. The stable retail deposit base built by the
banks also aided their asset-liability management function. Further, the development of the
bond markets also enabled commercial banks to raise long term funds from the insurance
and pension funds. These structural changes in the economy meant that the DFIs lost their
competitive edge in the long term finance market and started facing challenges on solvency
and liquidity fronts. The non-performing assets started to grow while the profitability
subsided. In a contemporaneous development, following liberalisation in the Indian Economy
during the 1990s, there was an increasing clamour for reduced Government ownership and
involvement in the financial institutions mainly from efficiency, accountability and moral
hazard perspectives. I would return to some of the problems faced by the DFIs in India a little
later in my address. In essence, since the DFIs were no longer in a position to meet the
objectives for which they were set up in an efficient and transparent manner, they were given
an option of transitioning into a universal bank.
Establishment of IDBI
12. The desire to promote rapid economic development and to be self-reliant in industrial
output led to the establishment of several DFIs to finance industrial/infrastructure projects in
the post-independence India. IFCI was the first DFI to be set up in 1948, which was followed
by ICICI in 1955 and other State Finance Corporations under various Acts with the specific
objective of providing long-term finance to industry. IDBI was set up in 1964 as a subsidiary
of RBI by an Act of Parliament. I must compliment you for being a part of an institution which,
for over 40 years, played a key role in nation building as an apex DFI (between July 1, 1964
and September 30, 2004). You must be proud of the fact that as a DFI, the erstwhile IDBI
stretched its canvas beyond mere project financing to cover an array of services that
contributed towards balanced geographical spread of industries, development of identified
backward areas, emergence of a new spirit of enterprise and evolution of a deep and vibrant
capital market. The role of IDBI as an institution builder is also laudable in light of the fact
that EXIM Bank and SIDBI, two of the vibrant development finance institutions of the day,
were carved out of IDBI.
Indian experience
13. As I mentioned earlier, in several economies, having attained their developmental goals,
the DFIs were either restructured or repositioned or they just faded away from the scene.
The Indian experience has also more or less traversed the same path. Although the
developmental goals cited as the primary reasons for setting up of DFIs in India have not
been achieved yet, the Government's fiscal imperatives and market dynamics has forced a
reappraisal of the policies and strategies with regard to the role of DFIs in the system. The
commercial banks have now taken over the mantle of agents of development from the
erstwhile DFIs.
14. Let me now return to the problems faced by the DFIs in India. The DFI concept in the
Indian context suffered from some inherent structural infirmities. As the DFIs were set up as
public sector enterprises, the market perceived the borrowings made by them as having
implicit government guarantee. This induced a sense of profligacy in the behaviour of the
DFIs while borrowing. Further, in the absence of a competitive environment for project
lending, the entities became quite complacent and disregarded the viability of the projects
financed, while pricing. The crossholding of shares amongst the DFIs also led to a contagion
effect in creating NPAs. The slower development of the capital markets also did not help
matters as in several instances, the promoters failed to raise equity from the market after the
DFIs had made the initial disbursements. The DFIs received low cost funds from National
Industrial Credit (Long Term Operations) Fund from RBI under concessional terms and
through government guaranteed bonds in the beginning. However, these were subsequently
withdrawn, leading to a spike in their borrowing cost. Post the reforms programme launched
in the early 1990s, the DFIs had to contend with increased competition from banks, which
were also allowed to undertake project financing. Despite a significant increase in their cost
of funds, the DFIs were forced to lend at very competitive rates, which resulted in a decline in
their spread and profitability. The cumulative effect of all these developments was that the
operations of the DFIs became increasingly unsustainable, at the turn of the century and they
gradually lost their distinct identity as a vehicle for providing long term funding for industrial
and infrastructural purposes.
15. Following the recommendations of the Narasimham Committee II and publication of the
RBI Discussion Paper on "Harmonising the Role and Operations of Development Financial
Institutions and Banks" released in January 1999, Reserve Bank announced its regulatory
approach for the DFIs in the annual policy statement of April 2000. It was decided to allow an
option to any DFI which wished to convert into a commercial bank, provided the prudential
norms applicable to the banks were fully satisfied. This paved the way for conversion of the
DFIs into commercial banks. The GOI in the Mid-Year Review, 2002 also categorically
announced that "financial sector reforms, involving interest rate deregulation, increased
competition from banks, and lack of concessional funds have rendered the business models
of development financial institutions (DFIs) unsustainable". Specifically for IDBI bank, the
percentage of Gross NPAs between 1999 and 2003 ranged from 14.07% to 16.86% of total
advances and the Net NPAs ranged from 11.64% to 14.82% of net advances.
16. It was in this background that the Government repealed the IDBI Act in 2003 and
converted IDBI Limited into a Banking company (as Industrial Development Bank of India
Limited) for undertaking the entire gamut of banking activities. In view of the tough emerging
competitive scenario in the Indian financial sector, the managements of ICICI Limited and
ICICI Bank had already merged their operations in 2002 to pursue a universal banking
strategy.
Where does IDBI bank go from here?
17. Having seen the history of DFIs and the gradual progression of IDBI from a DFI into a
commercial bank, let me now focus on the challenges that the bank is facing in its new
avatar and what contribution can the unions make in helping the institution regain its primacy
amongst the financial institutions of the country? Before I go any further let me quote former
RBI Governor, Dr. Bimal Jalan who aptly captured the thought process behind the
conversion of DFIs into universal banks. Dr. Jalan said "the move towards universal banking
would not provide a panacea for the endemic weaknesses of a DFI or its liquidity and
solvency problems and/or operational difficulties arising from under-capitalization,
non-performing assets, and asset liabilities mismatches etc. The overriding consideration
should be the objectives and strategic interests of the financial institution concerned in the
context of meeting the varied needs of customers, subject to normal prudential norms
applicable to banks".
18. That brings us to the question what objective has IDBI Bank set for itself and how is it
geared to achieve it? It is been around a decade since you became a commercial bank. Are
you satisfied with your performance? Following conversion of the DFIs into banks, the mantle
of leading the developmental agenda has fallen on the commercial banks. With years of
experience in developmental banking behind it, your institution was in a perfect position to
lead this agenda. How do you view your achievement vis-à-vis the expectations the society
has of you? Here, I would like to remind that as unions, there is an onerous responsibility
cast on you to help your institution fulfill this social agenda. While I would leave it upon all of
you to dispassionately evaluate your performance over the years, let me, on my part, delve
into some of the key areas in which I believe IDBI Bank has huge opportunities which, if
properly exploited, would benefit the bank no end, going forward.
19. An immediate goal which you must focus is on spurring your financial inclusion initiatives.
There are vast untapped areas in India's hinterland where banking services are yet to reach.
Even after implementation of our first round of Financial Inclusion Plans by banks, close to
three and a half lakh villages remain unserved by banks. The exclusion is not only limited to
rural areas but also to select pockets in the urban/ metropolitan centres. According to World
Bank Findex Survey (2012), only 35% of Indian adults had access to a formal bank account
and 8% borrowed formally in the last 12 months. Remember the alternate cost of funds for
this segment of borrowers is extremely high. Against this backdrop, it is beyond
comprehension why the commercial banks do not find enough viable business propositions
for growth. I must warn you that it is this most 'creamy' layer of customers that the new banks
would be looking to tap and therefore, it is in your own interest to capture this vast customer
base before others do so. For a bank which has one of the lowest NIMs in the industry, I do
not know why you should not pursue this agenda actively.
20. In a scenario where Government of India is implementing transfer of benefits and
subsidies through direct benefit transfers to the bank accounts in order to plug the leakages
in the system, you must look to open as many customer accounts as you can. Remember,
whosoever acquires the customers initially will be the winner in the longer run. As you are
aware, the bank can use a combination of physical branch network and Business
Correspondents for providing banking services to geographically dispersed areas. Therefore,
the lack of a large number of physical braches can also not be considered as a constraint for
reaching out to the masses. You should look to leverage technology and build a cost-efficient
business delivery model to attain maximum penetration into the unbanked areas and seek to
offer innovative products and services to customers at an affordable price. As employees of
the bank, all of you need to play a pivotal role in bringing about this focus on financial
inclusion.
21. I also observe that IDBI Bank has been unable to achieve the Priority Sector Lending
targets and worryingly, its performance on this front has been falling. This is despite the
merger of a primarily rural focused bank like United Western Bank. The system of Priority
Sector Lending has been introduced mainly to ensure easier access of credit to those
deserving sectors and people, who otherwise, do not receive adequate credit. Moreover, RBI
has freed the pricing of products under PSL; therefore, banks should not have any inhibition
in lending to this segment. Please remember that the banks who do not meet their PSL
targets have to contribute funds to the RIDF, the returns from which are quite less
remunerative, may be lesser than your cost of funds. The bank also needs to take up
financial literacy campaigns to educate the potential customers on high interest charged by
the informal credit channels and wean them away from money lenders.
22. I have also observed an increasing trend in the Gross NPA and restructuring of standard
advances in the banks which reflects deficiencies in the appraisal and risk management
standards. You have to work with the Top Management in acquiring the necessary skills and
upgrading the Credit Risk Management system and initiate necessary steps to arrest this
disconcerting trend.
Role of employee unions
23. Let me now turn specifically to the responsibility that you have, as unions, in ensuring
that IDBI Bank attains its true potential in its role as a full service bank. You must appreciate
the new operating environment that exists today and must realize that in this highly
competitive market, no longer would the corporate chase you. For most of your members
who have cut their teeth in an era when IDBI was a DFI with limited competition and a small
universe of customers to deal with, the transition to commercial banking might be difficult, but
remember, if you wish to survive as an institution in this new avatar, you must be willing to
change. What is, in fact, needed is a change in mindset and you, as responsible union, have
to oversee a smooth transition among the employees. Retail banking is a customer centric
business and hence, you would need to develop the passion, compassion and grace to deal
with customers. In my opinion, IDBI had a great opportunity to leverage upon the relationship
it had built over the years with big corporate/ public sector enterprises and could have got the
salary accounts of staff of these organizations with the bank. This would have given you
access to a stable and low cost fund. It is unfortunate, however, that this has not happened.
24. Employee productivity and efficiency, especially in the public sector banks, remains at
abysmally low levels. I do not know how many of you have gone through the speech I
recently made at a FICCI - IBA event. I have given detailed statistics on the productivity and
efficiency parameters of Indian banks and more so, the PSU banks vis-à-vis their
counterparts in rest of the world. If you peruse them closely, you would be note that we are
not only doing badly vis-à-vis our counterparts in the developed world but also against
developing countries and emerging markets in Asia and elsewhere. I have also argued that
though some productivity and efficiency gains have happened in Indian banks, they have
happened at the cost of compromising on the allocational efficiency. The society at large has
not benefited from the operational efficiency gains that the banking sector has seen and
there is no perceptible cost reduction for the customers in general. I would say the only
saving grace for us is that we are virtually at the lowest ebb and our performance can only
improve from here on. As banking community, we need to change and very quickly at that, to
remain relevant to the society.
25. It is in this context that the ability of the unions to influence employee behavior becomes
very important. Not for a single moment, I mean to undermine the role that IDBI has played,
in its initial role as a DFI. Along with the other development financial institutions, IDBI has
significantly contributed to economic prosperity of the country during the initial plan periods;
but in a liberalized economy and in an era of universal banking, role of DFIs as specialized
financial institutions has certainly diminished. It is for the unions, through seminars/interactive
sessions like these, to sensitize their members about the changed ground realities. As I said
earlier, for you to be able to compete in the tough existing environment, you need to veer
away from preset rigidities and be willing to change.
Conclusion
26. In sum, I would like to mention that for all economies, development is necessary and
finance has a central role in facilitating that. The soul of the DFI has to remain intact in a
developing economy. The structural changes in the financial system have, however, blurred
the boundaries between the DFIs and the commercial banks, in terms of areas of operation.
The DFIs do not hold any competitive advantage over banks and hence the compulsion to
tag institutions as DFIs to enable them to pursue development finance, no longer exists. I
feel that commercial banks are in a perfect position to fulfill the objectives which were
originally intended for the DFIs.
27. Your institution has inherited the soul of a DFI from IDBI Limited. What is required is a
transformation in the mindset of the employees to see through this period of transformation. I
strongly believe that rather than seeking any reversal of status for your institutions as a DFI,
the management and the unions of IDBI Bank should look ahead to the future. As
responsible unions, you have a very constructive role in motivating the employees of your
institution. Rather than resting on past laurels, you have to gear up to face the future. The
achievements over the past 50 years should only be used for drawing inspiration and
motivation for the hard work that you have to do in the next 50 years. As employees, all of
you have to update yourselves with the latest skills, technology, etc. to be able to deliver up
to the optimum level. The Management and the unions have to collectively strive to ensure
that the impressive legacy that the institution has inherited is sustained even in its new avatar
as a commercial bank. There is enough scope for commercial banking in the country, if the
interest for new bank license despite some of the onerous requirements on capital, financial
inclusion, PSL is anything to go by. The need for the bank is to identify the available
opportunities and apply your collective might towards attaining it. IDBI is a well reputed brand
which does not need any introduction. Going forward, you must look to leverage upon your
brand and broaden your customer base before new banks poach them.
28. You may have to unlearn and relearn few new things to succeed in the even more
competitive business environment that is likely to unfold shortly. It is imperative for the Top
Management and for the employees to work collectively for the progress of your institution. I
am sure the able leadership of the United Forum of IDBI Officers and Employees would
ensure that the staff is motivated to handle new challenges and the institution can retain its
glorious tradition in perpetuity.
29. I thank you for inviting me on this occasion and giving me a patient hearing. I wish you all
the very best for all your future endeavors.