With the aim of becoming a $5 trillion economy by 2024-25 and $10 trillion by 2030, India is taking a series of initiatives focused on economic growth. One such initiative is the National Infrastructure Pipeline (NIP), which envisages attracting investments of Rs 111 trillion across different sectors and multiple geographies in the country. Among the key objectives of the NIP is the creation of infrastructure through monetisation.
In this context, development financial institutions (DFIs) have a key role to play. DFIs are institutions established to serve as vehicles for economic development and finance industrial growth, with a specific focus on term finance. They provide long-term credit for capital-intensive investments spread over a long period and have low yielding rates of return. These institutions act as critical intermediaries for channelling the finance required for infrastructure and realising higher economic growth.
India has had experience with DFIs for many years. However, following the 1991 reforms, the major DFIs were converted into commercial banks as they were struggling to compete with new players entering the refinancing market. That left only a few institutions in the country that could take care of industrial or infrastructure development. Later, institutions such as India Infrastructure Finance Company Limited (IIFCL) and the National Investment and Infrastructure Fund emerged with a focus on funding infrastructure.
IIFCL has played an instrumental role in developing innovative financing mechanisms such as credit enhancement, takeout finance and subordinate debt. As of March 2021, IIFCL has participated in around 620 projects with a total outlay of more than Rs 10 trillion, providing financial assistance to over 26 per cent of public-private partnership (PPP) projects in the country. IIFCL’s asset quality has improved significantly over the past years as it was able to bring down its net non-performing assets (NPAs) to 5.4 per cent in 2020-21 from 9.75 per cent in 2019-20. Further, it aims to reduce its NPAs to around 4 per cent in 2021-22. The company’s cash recovery in NPAs increased to more than Rs 6.25 billion in 2020-21, as much as 92 per cent higher than the previous year. The company is planning to capture a higher market share by keeping its pricing competitive and lowering the base rate to attract more business in order to strengthen its portfolio.
Setting up of the NBFID
Realising the importance of long-term financing for infrastructure, the government proposed the setting up of a DFI in the Union Budget 2021-22. The National Bank for Financing Infrastructure and Development (NBFID) will be set up with a corpus of Rs 200 billion and will have a lending target of Rs 5 trillion for three years.
The NBFID will serve both financial as well as developmental objectives. The central government will prescribe which sectors are to be covered in the infrastructure domain. The developmental objectives include facilitating the development of a market for bonds and derivatives for infrastructure financing. The NBFID will be governed by a board of directors. The members of the board will include a chairperson, a managing director, up to three deputy managing directors, two directors nominated by the central government, up to three directors elected by shareholders, and a few independent directors. The NBFID will be set up as a corporate body with an authorised share capital of Rs 1 trillion. Its shares may be held by the central government, multilateral institutions, sovereign wealth funds, pension funds, insurers, financial institutions and any other institution prescribed by the central government. Initially, the central government will own 100 per cent shares of the institution, which may subsequently be reduced to up to 26 per cent.
Lending from NBFCs
The stress in the non-banking financial company (NBFC) segment has continued unabated since Infrastructure Leasing and Financial Services Limited’s default in September 2018. The sector has been facing serious liquidity challenges and mounting bad loans. Due to these reasons, NBFCs have faced difficulties in raising funds from the market.
While it was expected that the situation would normalise in the early part of 2020, the Covid-19 outbreak shifted the focus to asset quality and funding challenges. The NBFC industry experienced a slowdown in infrastructure lending in March 2020. The lockdown compounded this, with credit growth decelerating further in November 2020. The total infrastructure credit by banks and NBFC-infrastructure finance companies (NBFC-IFCs) remained sluggish in the first quarter of 2021-22 due to the disruptions caused by the second wave of the pandemic. However, with the government’s focus on the infrastructure sector, the demand for infrastructure credit is likely to improve over the medium term. The share of IFCs in the total infrastructure credit has continued to increase and stood at 54 per cent as on March 31, 2021; meanwhile, the share of banks slid to 46 per cent from about 61 per cent five years ago, as per a report by ICRA.
The Reserve Bank of India (RBI) and the government have taken several measures to facilitate the flow of funds to the sector and restore overall financial stability. Recently, the RBI has introduced the prompt corrective action framework for NBFCs, which will come into effect from October 1, 2022, based on the financial position of the NBFCs on or after March 31, 2022. Lenders showing a deterioration in performance metrics such as capital, asset quality and leverage have to be restricted with regard to paying dividends, opening branches and incurring capex. The restrictions could be based on the severity of the situation and additional scrutiny could be imposed till the bad phase persists.
Meanwhile, many liquidity enhancing schemes such as targeted long-term repo operations, a special liquidity scheme, the partial credit guarantee scheme 2.0 and refinancing facility for all Indian financial institutions have been introduced. These measures are expected to help alleviate the funding challenges faced by NBFCs and, at the same time, reduce their borrowing costs and improve market confidence.
The way forward
The government’s continued focus on the infrastructure sector augurs well for lenders to the infrastructure sector, especially against the backdrop of the recovery in the balance sheet strength of NBFC-IFCs, which had been significantly impacted. These institutions need to adopt a customer-centric approach by accessing data and building a strong relationship with customers. They can leverage technology-based solutions to reform their functions and develop tight information security controls to ensure safety from the rising number of cyberthreats.
In November 2021, the RBI issued a clarification on the asset classification norms, which brings NBFCs at par with banks in terms of classification norms. As per the norms, NPA classification should be as of end of day and not the month. If an account has to be upgraded from NPA to standard, all the arrears should be paid and not just a part of it. It is expected that the risk of slippages will increase with stricter norms.
DFIs in India will play a significant role in aiding industrial development with the best resources being made available to them. Going forward, the NBFID is likely to begin its lending operations with about 190-200 big infrastructure projects in the railway, road and energy sectors. The ownership and organisation structure are critical and require greater clarity as this would have a bearing on the functioning, flexibility and governance of the institution and its long-term sustainability. It is also important to hire experts with an in-depth understanding of infrastructure, policy, finance and risk management to work with the institution and ensure that borrowers get sufficient time for repayment and other safe side options in case of unusual circumstances. In addition, enhanced transparency will be a top priority to ensure that DFIs are fulfilling their mandates including developmental impact, market building and accountability. Further, periodic reviews will be needed to ensure that DFIs remain relevant by taking into account the changing priorities of the economy and making adjustments according to their role.