Do we need term finance institutions

1. FINANCIAL INSTITUTIONS
 Definitions – Business which offer multiple
services in banking and finance
 Services may include saving and checking
accounts, loans, investments and financial
counselling.
 Financial institutions are companies in the
financial sector that provide a broad range of
business and services including banking,
insurance and investment managements

2. 1) DEPOSITORY INSTITUTIONS
DEPOSITORY INSTITUTIONS, SUCH AS BANKS AND CREDIT UNIONS,
COLLECT MONEY FROM DEPOSITORS AND LEND THE MONEY OUT TO
BORROWERS. LENDING HAS RISKS, BECAUSE OF INFORMATION
ASYMMETRY BETWEEN THE LENDER AND THE BORROWER. BORROWERS
KNOW A LOT MORE ABOUT THEIR ABILITY AND WILLING TO PAY THAN
LENDERS DO, WHICH IS WHY IT IS RISKY FOR PEOPLE TO LEND OUT
MONEY DIRECTLY TO OTHERS. DEPOSITORY INSTITUTIONS MITIGATE THIS
RISK BY ASSESSING THE CREDITWORTHINESS OF BORROWERS FOR
POSSIBLE LOANS, MONITORING THE BORROWERS AFTER THE LOAN, AND
COLLECTING ON DELINQUENT ACCOUNTS. THEY ALSO CONVERT THE
SHORT-TIME DEPOSITS THAT MOST SAVERS PREFER TO THE LONG-TERM
LOANS THAT BUSINESSES DESIRE
 TYPES

3. NON DEPOSITORY INSTITUTIONS –
COLLECT MONEY AS PREMIUMS, CONTRIBUTIONS, OR BY SELLING
SECURITIES FOR SPECIFIC PURPOSES, AND THEN INVEST THE MONEY
FOR HIGHER RETURNS. NON-DEPOSITORY INSTITUTIONS INCLUDE
INSURANCE COMPANIES, PENSION FUNDS, SECURITIES FIRMS, AND
FINANCE COMPANIES.
2) Non depository institutions

4. 1. EXPORT-IMPORT BANK OF INDIA (EXIM BANK)
2.SMALL INDUSTRIES DEVELOPMENT BANK OF INDIA (SIDBI)
3.NATIONAL HOUSING BANK (NHB)
4.ACUITE RATINGS & RESEARCH LIMITED
5.LIST OF CMDS OF FINANCIAL INSTITUTIONS
6.INDUSTRIAL FINANCE CORPORATION OF INDIA (IFCI)
Financial Institutions

5. 1.THE FINANCIAL INSTITUTIONS PROVIDE LOANS AND ADVANCES TO THE
CUSTOMERS.
2.THE RATE OF RETURN IS VERY HIGH IN CASE OF INVESTMENT MADE IN
THIS TYPE OF INSTITUTION.
3.IT ALSO GIVES A HIGH RATED CONSULTANCY TO THE CUSTOMERS FOR
THEIR BENEFICIAL INVESTMENTS.
4.IT ALSO SERVE AS A DEPOSITORY FOR THEIR CUSTOMERS.
5.IT CAN ALSO MAKE AN EFFORT TO MINIMIZE THE MONITORING COST OF
THE COMPANY.
6.ALL THE FINANCE RELATED WORK IS DONE BY THE FINANCIAL
INSTITUTION OR ON BEHALF OF THE CUSTOMERS.
Functions

6. Government of India shut down financial institutes and converted in to the banks. For
ex. two of three term finance institutions we had in the early 2000s, ICICI and IDBI,
getting both converted into banks. IFCI changed into an NBFC later. Now, in a
discussion paper, the RBI suggests the idea of creating term finance institutions.
Many, including former RBI Governor C Rangarajan, have long argued that closing
down term finance institutions was a mistake and that we need to revive these in
order to facilitate long term financing (given that bond markets have not taken off).
Several reasons may there for doing so…
In today's conditions, only a government-owned institution with access to
concessional finance will be viable (practical).
The Reserve Bank of India (RBI) has issued a discussion paper that suggests the idea
of long-term finance banks. This would amount to seriously turning the clock back to
the early 2000s.
We then had three development financial institutions (DFIs) that focused on term
finance, namely, IFCI, ICICI and IDBI. Commercial banks confined themselves mainly
to providing working capital.

7. There were reasons for separating the two roles. Banks’ funds are mostly short-term in
nature. so their getting into term finance results in long-term assets being financed by
short-term funds. This exposes banks to interest rate and liquidity risks.
Secondly, providing project finance requires appraisal skills of a different sort from those
required for providing working capital. Working capital is backed by assets that are easily
liquidated. Not so project finance. You have to depend on cash flows to service the debt.
This makes the evaluation of risk far more challenging.
Term-finance institutions have to rely on long-term funds. This means more expensive
funding and hence costlier loans. The DFIs could get around this problem because they
were given access to low-cost funds — from the RBI and through bonds guaranteed by the
government and that qualified as statutory liquidity ratio (SLR) securities.
At their peak in the late 1990s, the three DFIs accounted for nearly a third of gross fixed
capital formation in manufacturing. Most of the loans were made to manufacturing.
Lending to infrastructure accounted for just 15 per cent of the total.
Financial sector reforms in the mid-1990s meant that concessional funding was out. Banks
were allowed to venture into long-term funding. DFIs were then reeling under the impact
of bad loans of the past. These together undermined the DFI model.

8. The idea that working capital and long-term finance should happen under one roof took hold.
The second Narasimhan committee on financial sector reforms (April 1998) and the S H Khan
Working Group (May 1998) both recommended that the roles of DFIs and banks be
harmonized.
The RBI was not entirely convinced. In a discussion paper published in January 1999, the RBI
warned, ―Drastic changes in their (DFIs’) respective roles at this stage may have serious
implications for financing requirements of funds of crucial sectors of the economy. ‖
Nevertheless, the RBI chose to fall in line with the Narasimhan committee recommendations —
it is often said, under pressure from the international agencies that had provided structural
adjustment loans. The RBI advised the three DFIs to convert themselves into banks or non-
banking financial companies (NBFCs). ICICI and IDBI opted to merge with their banking
subsidiaries. IFCI changed along and eventually became an NBFC
In Japan and many East Asian economies too, the role of DFIs was curtailed over time. But this
happened only after certain conditions had been met: A high savings rate, large foreign direct
investment (FDI) flows and considerable growth in domestic capital markets. The Indian
economy had not met these conditions in the early 2000s. Doing away with DFIs at that point
was thus rather premature

9. The RBI discussion paper seems to acknowledge as much. It argues that, in recent
years, bank lending to the services sector, industry and small and medium-sized
enterprises (SMEs) has suffered thanks to the bad loans on their books. It says that
banks lack the expertise necessary for term finance. There is a need for term-
finance institutions to fill these gaps.
The proposed term-finance institutions would have a minimum capital requirement
of 1,000 crores, higher than the 500 crores stipulated for commercial banks. They
cannot have savings accounts but they can have current accounts and term deposits
with a minimum of, say, 10 crores. They would be exempt from cash reserve ratio
(CRR) requirement for funds raised through infrastructure bonds. These funds
would also need to be exempted from SLR requirements in line the relaxation given
to commercial banks.
The key question, which the paper sidesteps, is: How do we ensure viability
(possibility, practicality)?
If the proposed term-finance institutions are to raise finance entirely from the
markets, it will make their loans far too expensive. Banks may be doubting today of
financing projects at the outset. However, once a project is close to completion, they
are happy to refinance loans at lower rates. This is happening with power projects,
for instance. Term-finance institutions may not be feasible as long as they face
higher borrowing costs than banks.

10. CONCLUSION:
 Financial Institution is essential part of financial system.
 Financial institution plays a vital role in economic development.
 Indian financial institutions are very strong but sometimes operations
are not up to the mark.
 Indians make very good plans but in implication sometimes we are
lacking in somewhere.
 We have full range of financial institutions but again sometimes we
cannot use in effective manner.