THE ROLE AND FUNCTIONS OF DEVELOPMENT BANKING

Introduction

Development Banks or Development Finance Institutions (DFI’s) as these are normally called in
the financial world are a post World War II phenomenon. Their establishment in Africa, Asia
and other developing countries in most cases coincided with the attainment of independence.
Their mission being “to expedite the pace of development in accordance with the national
priorities and aspirations of the people”.
DFI’s fall into two broad categories viz. national DFI’s and regional DFI’s. Most of the national
DFI’s in the developing world have been in existence for two to three decades. They were
established to serve as handmaidens of their governments in the implementation of their
development plans.
In places like India, a majority of the applicants for financial assistance from the DFI’s in the
initial stages were existing large industrial houses, or Managing agency firms. These institutions
had resources of men, material and money and were therefore, able to conceive, plan and
implement new or expansion projects successfully. Therefore, there was no problem of arrears.
In the wake of socialist policies pursued by these newly independent states, further growth of
large industrial houses and managing agency firms through DFI assistance was considered
monopolistic and exploitative of the majority by the minority. These were conceived as
institution reminiscent of the former British regime. This attitude led to a greater intervention of
the state in the regulation and operation of DFI’s, which in almost all cases were state owned.
FRESH ORIENTATION IN OPERATIONS

In pursuit of the socialist policies, there was need for a redefinition of guidelines to be followed
by DFI’s in extending credit to their clients. The new guidelines placed greater emphasis on
encouraging new entrepreneurs, technocrats, educated unemployed, professionals, and small-
scale enterprises and above all upon balanced regional development. All these were aimed at
fulfilling socially desirable objectives. This was a beginning of a new phase in the operations of
DFI’s, and called for fresh orientation. It entailed relaxation in a number of aspects like
sponsors’ contribution, security margin, longer gestation period etc. Inadequate resources and
absence of any fall back reserves of the new category of sponsors and their insufficient
managerial skills were manifest soon. Pursuit of new guidelines exposed DFI’s to greater risks,
resulting in widespread sickness of the enterprises. Starting at a moderate level, the problem
assumed great dimensions over a period of time, although it did have a spin off in the form of a
new breed of successful entrepreneurs.
Regional DFI's
Regional DFI's were established as part of the economic cooperation of blocks of neighbouring
states in Africa. Their main role being to facilitate the process of accelerating regional
integration process.
These included East African Development Bank (EADB), which was established at the time
when the East African Community was one of the strongest unions in the whole of Africa.
EADB was set to promote the economic development in the region and to act as a catalyst in
promoting balanced economic development amongst member countries.

Among the regional DFI's are African Development Bank (ADB), Preferential Trade Area Bank
(PTA), Arab Bank for Economic Development of Africa (BADEA) and Islamic Development
Bank (IDB). In a bid to strengthen the operations of DFI's, umbrella organisations were created.
These include The Association of African Development Finance Institutions (AADFI),
established in 1975 in Abidjan (Côte d'Ivoire) under the auspices of the ADB.
Its objective being to serve as a medium for technical exchange and cooperation between the
continents' DFI's and to promote economic ties between African countries with a view to
accelerating the regional integration process. These objectives were to be achieved by the
dissemination of technical data through publications, seminars, conferences, round-tables and
meetings. The membership of AADFI comprises 84 members including 64 ordinary members
(national DFI's), 11 special members and 9 Honorary members. The World Federation of
Development Finance Institutions (WFDFI) is an umbrella of sister DFI's from Asia (ADFIAP),
Latin -America (ALIDE) and Europe (ADRM). AADFI is also a member of this organisation.
The Present Scenario
The progressive weakening of the financial position of most of the DFI's and their almost
exclusive reliance on subsidised sources of finance, either from the national governments or from
the external financiers has led to a rethinking on the operations of DFI's in the present-day world,
particularly in market oriented, deregulated economies. This was in light of the fact that, the
conventional differences between DFI's and commercial banks has been gradually disappearing.
Commercial banks have increasingly undertaken development-financing functions. Also, with
development of capital markets and increasing availability of financial instruments to finance
modern business, the DFI's realised increasing competition for the provision of financial
services. DFI's in response are now diversifying into several fields including merchant and
commercial banking either on their own or through their specially created subsidiaries.

A Development Bank is a multilateral development finance institution dedicated to improving

the social and economic development of its member nations. Its primary emphasis is the welfare
of the people. For example the Asian Development Bank's overarching goal is to reduce poverty
in Asia and the Pacific. It helps improve the quality of people's lives by providing loans and
technical assistance for a broad range of development activities.
A development bank's policies or programs center on the following priorities:
Economic growth
Human development
Gender and development
Good governance
Environmental protection
Private sector development
Regional cooperation
Given below are the principal functions of a development bank:
• Extend loans and equity investments to its developing member countries (DMCs) for
their economic and social development.
• Provides technical assistance for the planning and execution of development projects and
programs and for advisory services.
• Promotes and facilitates investment of public and private capital for development, and
• Responds to requests for assistance in coordinating development policies and plans of its
developing member countries.
Formation of Development banks In India:
Development banks were set up in India at various points of time starting from the late 1940s to
cater to the medium to long term financing requirements of industry as the capital market in
India had not developed sufficiently. The endorsement of planned industrialization at the
national level provided the critical inducement for establishment of Development banks at both
all-India and state levels. In order to perform their role, DBs were extended funds in the form of
Long Term Operations (LTO) Fund of the Reserve bank of India and government guaranteed
bonds, which constituted major sources of their funds. Funds from these sources were not only
available at concessional rates, but also on a long term basis with their maturity period ranging
from 10-15 years. On the asset side, their operations were marked by near absence of
competition.
A large variety of financial institutions have come into existence over the years to perform a
variety of financial activities. While some of them operate at all-India level, others are state level
institutions. Besides providing direct loans, financial institutions also extend financial assistance
by way of underwriting and direct subscription and by issuing guarantees. Recently, some DBs
have started extending short term/working capital finance, although long term lending continues
to be their major activity.
Evolution And Growth Of Development
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Evolution And Growth Of Development

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By: Bitti Wadehra, In Business & Finance

Updated: Wednesday, February 04, 2009
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Prior to reforms, DBs operated in an over-protected environment with most of the funding
coming from assured sources at concessional terms. In the wake of financial sector reforms, the
RBI started monitoring the functioning of DBs with a view to impart market orientation to their
operations. In tune with the emerging scenario, their access to low cost funds of the RBI was
discontinued.
On their part, DBs took several steps to reposition themselves and reorient their operations in the
new competitive environment. They have diversified their activities into new areas of business
such as investment banking , stock broking, and other fee and commission based business.
Nevertheless, their business has slowed down and their operations have become less profitable.
The Committee on Banking Sector Reforms (Chairman: M. Narsimham), 1998 recommended
that DBs should, over a period of time, convert themselves into banks or NBFCs (Non- Banking
Financial Institutions). It is noteworthy that ICICI, one of the leading DBs, has merged with the
ICICI Bank.
Historically, the Reserve Bank of India and the Central Government have played a major role in
financing these institutions by subscribing to the share capital , by allowing them to issue
Government guaranteed bonds, and by extending long term loans at concessional terms.
However, with the financial sector reforms in the nineties, concessional lending by the RBI and
the Government was phased out, leaving the financial institutions to rely for financing their
needs on the equity capital and the debt markets. Expansion of their equity base through public
offers and public issues of long term bonds has become an important element of their market
based financing. In order to provide flexibility, the Reserve bank has allowed FIs to raise
resources by way of term deposits. Commercial Deposits and borrowings from the money market
is allowed within the umbrella limit fixed in terms of net owned funds. In order to expand their
scope of business, a large number of them have been entering into various businesses- venture
capital, mutual funds, banking and insurance.