Term lending institutions and capital market

NP Srinivasan and S Sreenivasa Murthy

November 1992

Of late, the Indian capital market has exhibited greater dynamism – the kind of which was never witnessed before. In fact, no facet of the Indian economy has changed so dramatically in the past few years as capital market. The growing number of issues, continuous diversity of financial instruments launched, tremendous growth of investor population, incredible turnover of shares in the stock exchanges and increase in the number and amounts of term loans sanctioned and disbursed by term lending institutions clearly manifest the all-round development of the Indian capital market.

The funds mobilized during the Seventh Plan were Rs 26000 crore when compared to Rs 477 crore raised during the Sixth Plan. The amount of capital raised by the corporate sector was Rs 5716 crore when compared to Rs 3153 crore in 1988-89. Together with the funds raised by the public sector units by way of bonds, the total resources raised from capital market were above Rs 10000 crore during 1989-90. Such a development has been greatly facilitated by two major factors, i.e., the various policy measures adopted by the Government of India and the emergence of a well-integrated structure of the organized sector of the capital market.

The Indian capital market consists of the organized and unorganized sectors. The former mainly includes the banking industry, stock markets, specialized financial institutions, government and international financial agencies; and the later consists of mainly money lenders, small traders and indigenous bankers. The Government of India, consistent with its policy of playing an active promotional role in the balanced economic development took initiative in creating a network of term lending financial institutions, such as, IDBI, IFCI, ICICI, IRBI, SFCs, NIDC, SIDC, UTI, etc.

These term lending institutions greatly contribute to the development of capital market through sale of their own obligations in the capital market, placement of their industrial security holdings, underwriting the issue of new securities; and inducting investors to participate in their own financial operations. In addition, they can help mobilize savings in the form of public deposits, assist stock markets to function efficiently and float new forms of instruments to suit different sectors of the investing public.

All Indian financial institutions took several steps for strengthening the capital markets through its operations. The assistance sanctioned increased from Rs 2294 crore in 1980-81 to Rs 20118.8 crore in 1990-91. The cumulative sanctions up to March 1991 aggregated Rs 99866 crore of which Rs 69285.2 was disbursed. The disbursements in 1990-91 alone amounts to Rs 12097.9 crore. Assistance by way of underwriting, direct subscription gone up by 23.1 per cent to Rs 2002.8 crore during 1989-90. Major portion of such assistance by all Indian development banks was for equity/preference shares, while in the case of investment institutions it was debentures.

Under the new guidelines issued for investor protection, it is mandatory for companies raising project finance through debenture issues to have their projects appraised by the financial institutions even if they do not seek assistance from institutions.

The financial institutions will have to recast their lending and borrowing strategies, appraisal norms and disbursement policies in the present context of policies of decontrol, liberalization and increased competition sweeping the financial and industrial sectors of the country. As rightly pointed by Kenneth Arrow, the noble laureate in Economics, in his moral hazard problem, that where there is no specific accountability, resources will be misused. This has become a common phenomenon in Indian public sector and more precisely in the nationalized financial sector. The government in tune with the liberalization policies cleared the proposal to disinvest 50 per cent of the government equity holding in the term lending institutions in about three years. For the time being it has proposed disinvestments of government equity up to 20 per cent. The Narasimham Committee Report, if considered in to, will have far-reaching implications on the term lending institutions. In the light of these developments, the role to be played by the term lending institutions in capital market development needs special consideration.

The following issues are highlighted in this regard:

Directional change

The development banks provided development finance for a considerably long period and it is time for them to acquire the character of commercial bodies engaged in term lending activity.

However, as rightly pointed out by the World Bank team (in connection with the $ 1 billion credit to be sanctioned to these institutions, i.e., IDBI, IFCI AND ICICI), if these institutions want to continue their role as development financial institutions, it is better if they restrict the development finance to the extent of concessional funding from the government. It is not advisable on the part of the financial institutions to extend any concessional financial assistance with costly money borrowed at commercial rates.

Lending criteria

The term lending institutions should give priority to financially viable units rather than for those often taken over for social and other considerations. It is noted that the larger portion of sticky loans of these financial institutions are with the public sector units like the National Textile Corporation (NTC) or the Cement Corporation of India.

It is obligatory on the part of the FIs to provide financial support to all projects (even if highly risky) once they have been given license and that too on concessional rates. This type of lending has resulted in increased bad debts. The Narasimham Committee has suggested for freeing the financial institutions from such imposing obligations. This will force the corporations to reduce their reliance on debt financing.

Inter-locking up of directors

In the present set up, the chairman of the each of the three institutions (IFCI, IDBI and ICICI) is on the boards of the other institutions. Even though it is presumably meant to encourage competition among institutions. Due to the presence of other two chairmen in the board, the institution cannot maintain any privacy and it may some time affect its independent functioning.

Consortium lending

Likewise, as rightly emphasized by the World Bank, it is better if these institutions discontinue the policy of consortium mode of financing. The competition among institutions improves the quality of its assets. Because of the wave of decontrol, liberalisation and increased competition, the CRISIL points out that, IDBI is likely to face deterioration in its assets quality.

Under the New Industrial Policy, for the first time, the financial services and financial institutions have been brought under the MRTP Act. This will avoid the FIs from resorting to consortium lending. Ultimately, there will be competition among the financial institutions and end result would be increased efficiency.

Shortage of resources

The term lending institutions are facing acute shortage of funds quite often. To overcome this, they are permitted now to issue Certificates of Deposits (CD) for mobilizing funds like commercial banks. In addition the term lending institutions are exempt from maintaining statutory deposit requirements with Reserve Bank of India. FIs, in order to mobilize more resources may securities their debts. Recently, HDFC has successfully introduced this scheme and mobilized more than Rs 100 crore.

Sources of funds

The term lending institutions must approach public for fresh capital rather than depending on government. At present only ICICI has private holding in its capital besides its convertible debenture issue. IFCI Act has been abolished and IFCI has been incorporated under the Indian Companies Act. This will enable IFCI to go public for mobilizing capital. IDBI also has come up with three series of bonds to raise Rs 300 crore from the capital market. The over subscription of issues by many times shows that the market is ready to absorb any amount of public issue.

Bad debt syndrome

The ever-increasing magnitude of bad debts is the worst problem faced by financial institutions as it not only affects the re-circulation of funds and income, but also threatens the very survival of the institution. The recovery of principal and interest formed 51 per cent and 42 per cent of the amount due between 1981-82 and 1984-85 in the case of IDBI. The figures for IFCI were 41 per cent and 32 per cent respectively for the period 1981-82 and 1983-84. The development financial institutions take this in a lighter manner and are not perturbed as long as interest is paid on time even if the installments are not paid. In fact, the defaulters were positively rewarded in many cases, with DFIs writing off penal interest and occasionally even normal interest as part of special rehabilitation packages.

The wide difference between the interest rates charges on term loans and those on working capital borrowings often acts as an inducement to default. It is impressive to attack the problem of default before it affects the operational performance of DFIs.

CRISIL points out that, the steep increase in interest rates on term lending will enable healthier clients to borrow directly from investors through the capital market reducing the availability of lower risk assets to IDBI, the apex financial institutions.

As suggested by the Narasimham Committee, the creation of Asset Reconstruction Fund (ARF) would solve the major problem of maintaining the non-performing assets within the asset portfolio of banks and FIs. A serious consideration should be given to this idea immediately.

Promotional and innovative schemes

The term lending institutions must come up with many innovative schemes for providing capital to needy entrepreneurs. Some of the schemes, which are already in operation, are:

a) Constitution of Technical Development Fund

b) Soft Loan Scheme

c) Seed Capital Assistance

d) Risk Capital Assistance

e) Concessional Assistance Scheme for manufacture and installation of renewable energy system

f) Concessional Assistance Scheme for development of no industry districts and other backward areas

g) Bills Discounting Scheme

h) Leasing

i) Merchant Banking

The OTC market

The term lending institutions have taken the initiative of setting up Over-The-Counter (OTC) Exchange of India Ltd., to facilitate trading in equity shares of small/new companies. In June 1990, UTI set up the UTI Institute of Capital Markets with a view to promote advanced professional education, training and research in the field of capital markets.

Mutual funds

Mutual funds have emerged as a strong influence on the capital markets raising substantial amounts from the public. While UTI takes the lead, other mutual funds have raised estimated Rs 3100 crore during 1990-91 as against Rs 1068 crore during 1989-90. Life Insurance Corporation (LIC) and General Insurance Corporation (GIC) have also started mutual fund operations. IDBI has decided to float an offshore mutual fund to be managed by a subsidiary set up in joint sector. These mutual funds have to function more effectively in order to withstand the competition likely to arise with the entry of private mutual funds.

Project appraisal

The development financial institutions have evolved certain techniques and parameters while evaluating the projects, but that seem to have outlived their use. The excessive importance attached to the debt-service coverage ratio and IRR have to some extent, failed to reach desired results. Extensive market evaluation and sensitivity analysis should be allowed to play a major role in determining the viability of a project.

Role of State Financial Corporations

The SFCs also must gear up to mobilize funds from public rather than depending on financial institutions for refinancing. Then they can function independently without bias in their decisions and the political interference can be minimized to some extent. They can start mutual funds to cater to the needs of small investors and also to tap the rural market.

Stabilisation of capital market

Term lending institutions play a crucial role in avoiding the capital market crash. The 1987 Black Monday (New York Stock Exchange) crash affected all stock markets in the world except Indian stock market, because of the timely intervention of financial institutions.

Considering the current bull phase seriously, on March 4, 1992, HM Kothari, President Bombay Stock Exchange sent and SOS to the Finance Minster expecting the intervention of financial institutions and mutual funds to stabilise the market and contain speculative trend. He cautioned that if this were not done, the market would go out of control and later on crash driving away the investors.

Securities scam

There are different views on what should be done following the recent stock market scam. Of course, all the views converge on the basic issue – the need for greater surveillance by all financial institutions. But for the rest, one view is that it is high time that the Government pressed forward with implementation of the Narasimham Committee recommendations.

Thus, it is needless to say that the term lending institutions have to play a crucial role in capital market. To bring out some radical shifts they need to get clearance from Union Government that may take some time. But, in the meanwhile these institutions must have a close watch on the capital market developments to act accordingly.