Development Finance Institutions in India: From IDBI to NaBFID

A commercial bank is funded by money that can be demanded back tomorrow. That single fact limits how long it can lend, and it explains why every industrialising country has at some point built a separate class of institution to supply long money for projects that take fifteen years to pay for themselves. India built an elaborate system of such institutions, dismantled most of it between 1997 and 2004 when the subsidised funding that made it work was withdrawn, and then, in 2021, built one again.

1. What a development finance institution is

A development finance institution is a specialised lender, ordinarily created by statute, that supplies medium and long term finance to a sector that the ordinary credit market does not serve adequately. It is distinguished from a bank by two features.

1. It does not take retail deposits. Its liabilities are bonds, borrowings from the Government, from the Reserve Bank and from multilateral agencies, and lines of refinance. Because those liabilities are long, its assets can be long.
2. It often lends through others. Much of what these institutions do is refinance: they put money into banks, cooperative banks and other lenders who make the actual loans, which gives them reach without a branch network.

Because they do not take deposits they are not banks, and the Banking Regulation Act, 1949 does not govern them. They are financial institutions within the meaning of Chapter IIIB of the Reserve Bank of India Act, 1934, and the Reserve Bank regulates and supervises the principal ones as All India Financial Institutions under Section 45L of that Act, which empowers it to call for information and give directions.

Figure 1: The development banks and what each one covers

2. The four established institutions

Figure 2: Four statutes, four sectors

The National Bank for Agriculture and Rural Development

• Established under the National Bank for Agriculture and Rural Development Act, 1981 and operational from 12 July 1982, on the recommendation of the Committee to Review Arrangements for Institutional Credit for Agriculture and Rural Development.
• It took over the refinancing functions of the Reserve Bank's Agricultural Refinance and Development Corporation and the rural credit functions of the Reserve Bank itself.
• It refinances state cooperative banks, district central cooperative banks, regional rural banks and commercial banks for agricultural and rural lending.
• It inspects and supervises state and central cooperative banks and regional rural banks, which is why the inspection of those institutions does not lie with the Reserve Bank. Urban cooperative banks are inspected by the Reserve Bank itself.
• It administers the Rural Infrastructure Development Fund, into which banks falling short of their priority sector targets contribute and from which State Governments draw for rural infrastructure.

The Small Industries Development Bank of India

• Established under the Small Industries Development Bank of India Act, 1989 and operational from 2 April 1990, initially as a wholly owned subsidiary of the Industrial Development Bank of India.
• It is the principal financial institution for the promotion, financing and development of micro, small and medium enterprises and for coordinating the functions of the institutions engaged in similar activities.
• It works mainly through refinance to banks and other lenders, with direct lending reserved for gaps the system leaves, and it runs credit guarantee and venture funding arrangements for the sector.

The Export-Import Bank of India

• Established under the Export-Import Bank of India Act, 1981 and operational from 1 January 1982, wholly owned by the Central Government.
• It provides financial assistance to exporters and importers, and functions as the principal financial institution for coordinating the working of institutions engaged in financing the export and import of goods and services.
• Its distinctive instruments are lines of credit extended to overseas governments and financial institutions, under which Indian exporters are paid in India while the foreign buyer repays over time, and buyer's credit supported by the national export insurance account.

The National Housing Bank

• Established under the National Housing Bank Act, 1987 and operational from 9 July 1988, as a wholly owned subsidiary of the Reserve Bank of India.
• Its object is to promote housing finance institutions, to provide them with financial and other support, and to refinance housing loans.
• Its ownership was transferred from the Reserve Bank to the Central Government in 2019, removing a second instance of the regulator owning a regulated institution.
• The regulation of housing finance companies moved from the National Housing Bank to the Reserve Bank by the Finance (No. 2) Act, 2019, which amended the National Housing Bank Act and the Reserve Bank of India Act. The National Housing Bank retains its supervisory and refinancing roles.

3. Why the model declined

The older generation of development banks, the Industrial Finance Corporation of India established in 1948, the Industrial Credit and Investment Corporation of India in 1955 and the Industrial Development Bank of India in 1964, worked because they were given money cheaply. They drew on the Reserve Bank's National Industrial Credit Fund, on government guaranteed bonds that banks were obliged to hold, and on concessional multilateral lines. Liberalisation removed all three.

1. Once these institutions had to raise money at market rates and lend long to industrial projects, the spread no longer covered the risk, and the asset quality deteriorated sharply through the late nineteen nineties.
2. The Narasimham Committee's recommendation was conversion: a development bank should become a bank, so that it could fund itself with deposits. The Industrial Credit and Investment Corporation of India reverse merged into ICICI Bank in 2002, and the Industrial Development Bank of India was converted into a banking company in 2004 by a repealing and amending statute.
3. The result was that between 2004 and 2021 India had no development bank of the old kind for infrastructure. Specialised lenders such as India Infrastructure Finance Company Limited, set up in 2006, filled only part of the gap, and the rest was filled by commercial banks lending long against short deposits. The asset liability mismatch that followed is a substantial part of the explanation for the stressed asset problem of the following decade.

4. The return of the model: the NaBFID Act, 2021

The National Bank for Financing Infrastructure and Development Act, 2021 establishes a new development financial institution as the principal institution for infrastructure financing. It is a deliberate return to a model that had been given up, with the funding problem addressed in the statute itself.

Objects

• Financial objectives: to lend to, invest in, or attract investment for infrastructure projects located wholly or partly in India, in the sectors notified by the Central Government.
• Developmental objectives: to develop the markets for infrastructure bonds, loans and derivatives, to attract private and institutional investment including foreign participation, to facilitate the resolution of disputes with government authorities, and to provide consultancy.

Capital, funding and support

• Authorised share capital of one lakh crore rupees. The Central Government initially holds the whole of the share capital, and its holding may not fall below twenty six per cent. Other permitted shareholders include multilateral institutions, sovereign wealth funds, pension funds, insurers, financial institutions and banks.
• The Central Government is to provide a grant of five thousand crore rupees by the end of the first financial year.
• The institution may raise money by loans, bonds, debentures and other instruments, in rupees or in foreign currency, and may borrow from the Central Government, the Reserve Bank, scheduled commercial banks, mutual funds and multilateral institutions.
• The Central Government may guarantee its borrowings, including those from multilateral institutions, sovereign wealth funds and other foreign funds, at a concessional rate, and may reimburse part or the whole of the cost of hedging foreign exchange, which is the statutory answer to the funding problem that destroyed the earlier generation.

Governance and protection

• The Board comprises a Chairperson appointed by the Central Government in consultation with the Reserve Bank, a Managing Director, up to three Deputy Managing Directors, two nominees of the Central Government, up to three directors elected by shareholders, and independent directors.
• No investigation into an offence alleged to have been committed by an employee may be begun without prior sanction: of the Central Government in the case of the Chairperson or a director, and of the Managing Director in the case of any other employee. A court may not take cognizance without that sanction either.
• The Act also provides for the licensing of other development financial institutions by the Reserve Bank, so that the new institution need not be the only one.

5. Quick Revision

1. A development finance institution lends long because it does not fund itself with demand deposits.
2. Refinance, not direct lending, is the characteristic instrument.
3. NABARD inspects and supervises state and central cooperative banks and regional rural banks; the Reserve Bank inspects urban cooperative banks.
4. The National Housing Bank supervises and refinances housing finance companies, but the Reserve Bank now regulates them.
5. The old model failed when concessional funding was withdrawn, and the answer adopted was conversion into banks.
6. Banks funding long projects with short deposits produced the asset liability mismatch behind much of the stressed asset problem.
7. The NaBFID Act answers the funding problem with a government guarantee at a concessional rate and reimbursement of hedging cost.
8. Prior sanction is required before investigating an employee of the new institution.

6. Frequently Asked Questions

Why is a development finance institution not a bank?

Because it does not accept deposits of money from the public, repayable on demand or otherwise and withdrawable by cheque, draft, order or otherwise, which is the definition of banking in Section 5(b) of the Banking Regulation Act, 1949. Its funding comes from bonds, government and multilateral borrowing and refinance lines. That is not merely a technical classification. It is the reason the institution can lend for fifteen years without the liquidity risk that would destroy a bank doing the same thing, and it is the reason it needs no licence under Section 22.

If NABARD supervises cooperative banks, what does the Reserve Bank do?

The two roles are divided rather than duplicated. The Reserve Bank is the regulator: it licenses a cooperative bank under Section 22, issues the prudential norms and directions that govern it, and exercises the powers over management, capital and resolution that the Banking Regulation (Amendment) Act, 2020 strengthened. NABARD is the supervisor and refinancier for state cooperative banks, district central cooperative banks and regional rural banks: it conducts the statutory inspection and feeds the findings to the Reserve Bank, and it supplies the refinance those institutions lend on. Urban cooperative banks are inspected by the Reserve Bank itself.

Was converting the development banks into banks a mistake?

The question is genuinely contested and a good answer should give both sides. The case for conversion was that an institution forced to borrow at market rates and lend long cannot survive, and that access to deposits was the only sustainable source of cheap money; on that view conversion saved two institutions that would otherwise have failed. The case against is that it left the economy with no lender structurally equipped for long gestation projects, so commercial banks took on maturity risk they were never designed to carry, with consequences that appeared a decade later as stressed infrastructure assets. The enactment of the NaBFID Act, 2021 is in substance an acknowledgement that the gap was real, though it addresses the funding problem differently, through guarantees and hedging support rather than through directed investment.

Can the new infrastructure bank be privatised?

Only partly. The Act permits the Central Government's shareholding to be reduced, but not below twenty six per cent, and the other shareholders contemplated are multilateral institutions, sovereign wealth funds, pension funds, insurers, banks and financial institutions rather than the general public. The design is for a government anchored institution with institutional co-investors, which is what allows the Central Government to guarantee its borrowings at a concessional rate without the guarantee operating as a subsidy to private shareholders.

How does an All India Financial Institution differ from a non-banking financial company?

Both are financial institutions under Chapter IIIB of the Reserve Bank of India Act, 1934, and neither is a bank, but the resemblance ends there. A non-banking financial company is an ordinary company that must obtain a certificate of registration under Section 45-IA, maintain net owned funds and comply with the scale based regulatory framework. An All India Financial Institution is created by its own statute, is owned largely or wholly by the Central Government, carries a developmental mandate written into that statute, and is supervised by the Reserve Bank under Section 45L through the power to call for information and issue directions. The institutions presently supervised in that character are NABARD, the Small Industries Development Bank of India, the Export-Import Bank, the National Housing Bank and the National Bank for Financing Infrastructure and Development.

What is refinance, and why does it matter so much here?

Refinance is lending to a lender. A cooperative bank makes a crop loan to a farmer and then draws an equivalent sum from NABARD against that loan, so the cooperative bank's money is replenished and NABARD carries the funding. The instrument matters because it solves two problems at once. It gives a development institution nationwide reach without a branch network, since the lending relationship stays with the local institution that knows the borrower. And it lets the development institution direct credit to a sector by pricing and rationing the refinance, which is a far lighter instrument than lending directly. The cost is distance: the refinancier does not appraise the underlying loan, so the credit judgement remains with the institution whose capital is thinnest.

Why does the new infrastructure bank need a government guarantee?

Because the mismatch that destroyed the earlier generation was a funding mismatch, not a lending mistake. An institution lending for fifteen years must borrow for fifteen years, and the Indian bond market has very little appetite at that tenor at a rate that an infrastructure project can bear. A guarantee from the Central Government at a concessional rate, which the Act expressly permits, lowers the cost of that borrowing to something close to the sovereign's own, and the reimbursement of hedging cost does the same for foreign currency borrowing, where the exchange risk would otherwise consume the interest saving. The statute therefore addresses in its own text the problem that the Industrial Development Bank and its contemporaries were left to solve on their own, and could not.

7. Related Topics and Provisions

• Reserve Bank regulation of non-banking financial companies and payment systems
• Regional Rural Banks and the sponsor bank relationship
• Cooperative banks and the problem of dual control
• Non-performing assets, stressed assets and the prudential framework
• Priority sector lending and the Rural Infrastructure Development Fund
• Public sector banks and the statutes that constitute them