Confusion on roles

The finance minister has reaffirmed IDBI's status as the country's lead development finance institution.

The rationale for the decision was spelt out in the Budget speech: "The current economic growth pattern requires continuous and added investment. For this, finance has to be made available timely, at reasonable rates and in a coordinated manner. Since the restructured IDBI has the requisite expertise, also experience in project appraisal, funding and coordination, it has been decided to designate IDBI as the lead developmental finance institution. Government will provide necessary support to IDBI for this task."

This brief statement leaves IDBI's status unclear. If it is a development finance institution, then will it be allowed to do other banking business, such as working capital lending and treasury operations?

What is the nature and amount of "necessary support" that the government will provide? Will the Infrastructure Development Finance Corporation cede its premier role in infrastructure financing to the IDBI?

These questions will doubtless be answered in due course. But the underlying position is clear "" there is no alternative to development finance. Perhaps, but then why was ICICI in such a hurry to reinvent itself as a retail bank?

And why has the IDBI brass been in favour of converting the institution into a commercial bank? The reasons are perfectly clear "" the reason DFIs were viable was because they had access to low-cost long-term funds from the government.

When that supply dried up, and banks were freed to go in for project finance, the DFIs had to tap the market for their funding, while the lower cost of funds enabled banks to undercut them on lending. At the same time, their term loans to uncompetitive industries turned into non-performing assets.

All this led to a severe impairment of DFI balance sheets, and it's no wonder that ICICI took the very first opportunity to turn itself into a commercial bank, and a hard-core retail one at that.

The finance minister's assertion that there is no alternative to development finance is well taken.

But in a market economy, that finance can be provided by banks and other agencies at competitive rates, or through the bond market, provided the project is viable.

The problem at its core is not so much a lack of funds but a lack of good projects. And so far as lending to the second-rung of corporates is concerned, all that is needed is to remove the roadblocks that impede this lending.

The implementation of the foreclosure law, now stuck in the Supreme Court, will probably do far more in this regard than any DFI. Moreover, it is the government's demand for money to fund its deficit that crowds the smaller borrower out of the market.

Also, in an environment where windfall capital gains can no longer be made and external borrowings have been made easy, there will be no alternative for banks but to lend.

In this scenario, keeping IDBI as a DFI will be a misfortune for that institution. There is no reason why a model that has not succeeded so far will succeed now.

Then again, the finance minister's statement may be more rhetoric than a precursor to action, and perhaps IDBI will also function as a bank in addition to its "developmental" role.

But even that will needlessly tie the hands of the IDBI management. It is far better to emulate ICICI's shining example, to turn IDBI into a bank and then privatise it.