Project Reports: Method of Financing Very Large Capital Intensive Projects

 Considering the growing use of project finance, we undertook this project with an objective of understanding the salient features of project finance. It is a method of financing very large capital intensive projects, with long gestation period, where the lenders rely on the assets created for the project as security and the cash flow generated by the project as source of funds for repaying their dues. As project financing is adopted by a majority of companies at least once in their lifetime, we decided to study this concept in detail.

Banks as well as non-banking financial companies provide project financing. Banks enjoy a major market share among the borrowers and the NBFC firms are lagging far behind and will slowly loose their market share if adequate steps are not taken. Banks are usually preferred over NBFC firms due to the security aspect and brand name. also the documentation process is one such aspect which the borrowers find lengthy and tiresome in both the banks and NBFC. Awareness regarding the nationalized banks providing project finance is more than the NBFC firms providing the same.

Academic anxiety?
Get original paper in 3 hours and nail the task
Get your paper price

124 experts online

Also a borrower chooses a project finance provider mainly due reference and time frame within which the loan would be approved. The NBFC firms need to take adequate steps to improve their position in the minds of the borrowers so as to stay in the market. The NBFC firms should try to inculcate in the minds of the borrowers that NBFC is as safe as any bank and should try and develop a feeling of security among borrowers with regard to NBFC.

Project financing is generally sought for infrastructure related projects. Its linkages to the economy are mutiple and complex, because it affects production and consumption directly, creates negative and positive externalities, and involves large flow of expenditure. Prior to World War I, private entrepreneurs built major infrastructure projects all over the world. During the 19th century ambitious projects such as the suez canal and the Trans-Siberian Railway were constructed, financed and owned by private companies.

However the private sector entrepreneur disappeared after world War I and as colonial powers lost control, new governments financed infrastructure projects through public sector borrowing. The state and the public utility organizations became the main clients in the commissioning of public works, which were then paid for out of general taxation. After World War II, most infrastructure projects in industrialized countries were built under the supervision of the state and were funded from the respective budgetary resources of sovereign borrowings.

This traditional approach of government in identifying needs, setting policy and procuring infrastructure was by and large followed by developing countries, with the public finance being supported by bond instruments or direct sovereign loans by such organizations as the world Bank, the Asian Development Bank and the International Monetary Fund. Development In the early 1980s. The convergence of a number of factors by the early 1980s led to the search for alternative ways to develop and finance infrastructure projects around the world.

Competition for global markets among major equipment suppliers and operators led them to become promoters of projects to enable them to sell their products or services. Outright privatization was not acceptable in some countries or appropriate in some sectors for political or strategic reasons and governments were reluctant to relinquish total control of what maybe regarded as state assets.

During the 1980s, as a number of governments, as well as international lending institutions, became increasingly interested in promoting the development for the private sector, and the discipline imposed by its profit motive, to enhance the efficiency and productivity of what had previously been considered public sector services.

It is now increasingly recognized that private sector can play a dynamic role in accelerating growth and development. Many countries are encouraging direct private sector involvement and making strong efforts to attract new money through new project financing techniques.

Such encouragement is not borne solely out of the need for additional inancing, but it has been recognized that the private sector involvement can bring with it the ability to implement projects in a shorter time, the expectation of more efficient operation, better management and higher technical capability and, in some cases, the introduction of an element of competition into monopolistic structures. However, the private sector, driven by commercial objectives, would not want to take up any project whose returns are not consumerate with the risks.

Infrastructure projects typically have a long gestation period and returns are uncertain. What then are the incentives of private capital providers to participate in infrastructure projects, which are fraught with huge risks? Project finance provides satisfactory answers to these questions.

Project finance is typically defined as limited or non-recourse financing of a new project through separate incorporation of vehicle or Project Company. Project financing involves non-recourse financing of the development and construction of a particular project in which the lender looks principally to the revenues expected to be generated by the project for the repayment of its loan and to the assets of the project as collateral for its loan rather than to the general credit of the project sponsor. In other words the lenders finance the project looking at the creditworthiness of the project, not the creditworthiness of the borrowing party.

Financing discipline includes understanding the rationale for project financing, how to prepare the financial plan, assess the risk, design the financing mix, and raise the funds. A knowledge base is required regarding the design of contractual arrangements to support project financing; issues fior the host government legislative provisions, public/private infrastructure partnerships, public/private financing structures; credit requirements of lenders, and how to determine the projects borrowing capacity; how to prepare cash flow projections and use them to measure expected rates of return; tax and accounting onsiderations; and analytical techniques to validate the projects feasibility.

Traditional finance is corporate finance, where the primary source of repayment for investor and creditors is the sponsoring company, backed by its entire balance sheet, not the project alone. Although creditors will usually still seek to assure themselves of economic viability of the project being financed so that it is not a drain on the corporate sponsors existing pool of assets, an important influence on their credit decision is the overall strength of the sponsors balance sheet, as well as their business reputation. If the project fails, lenders do not necessarily suffer, as long as the company owning the project remains financially viable. Corporate finance is often used for shorter, less capital-intensive projects that do not warrant outside financing.

The company borrows funds to construct a new facility and guarantees to repay the lenders from its available operating income and its base of assets. However private companies avoid this option, as it strains their balance sheets and capacity, and limits their potential participation in future projects. Project financing is different from traditional forms of finance because the financier principally looks to the assets and revenue of the project in order to secure and service the loan.

In project finance a team or consortium of private firms establishes a new project company to build, own and operate a separate infrastructure project. The new project company to build own and operate a separate infrastructure project. The new project company is capitalized with equity contributions from each of the sponsors. In contrast to an ordinary borrowing situation, in a project financing the financier usually has little or no recourse to the non-project assets of the borrower or the sponsors of the project. The project is not reflected in the sponsors’ balance sheets.

Recourse refers to the right to claim a refund from another party, which has handled a bill at an earlier stage. The extent of recourse refers to the range of reliance on sponsors and other project participants for enhancement to protect against certain projects risks. In project financing there is limited or no recourse. Non-recourse project finance is an arrangement under which investors and credit financing the project do not have any direct recourse to the sponsors. In other words, the lender is not permitted to request repayment from the parent company if borrower fails to meet its payment obligation.

Although creditors security will include the assets being financed, lenders rely on the operating cash flow generated from those assets for repayment. When the project has assured cash flows in the form of a reliable off taker and well-allocated construction and operating risks, the lenders are comfortable with non-recourse financing. Lenders prefer limited recourse when the project has significantly higher risks. Limited recourse project finance permits creditors and investors some recourse to the sponsors.

This frequently takes the form of a precompletion guarantee during a projects construction period, or other assurance of some form of support for the project. In most developing market projects and in other projects with significant construction risk, project finance is generally of the limited recourse type. Merits and Demerits of project financing Project financing is continuously used as a financing method in capital-intensive industries for projects requiring large investments of funds, such as the construction of power plants, pipelines, transportation systems, mining facilities, industrial facilities and heavy manufacturing plants.

The sponsors of such projects frequently are not sufficiently creditworthy ot obtain tr5aditional financing or unwilling to take the risk and assume the debt obligation associated with traditional financing. Project financing permits the risk associated with such projects to be allocated among number of parties at levels acceptable to each party.

The advantages of project financing are as follows:

  1. Non recourse: the typical project financing involves a loan to enable the sponsor to construct a project where the loan is completely “Non-recourse” to the s[sponsor i. . the sponsor has no obligation to make payments on the project loan if revenues generated by the project are insufficient to cover the principle and interest payable on the loan. This safeguards the assets of sponsors. The risks of new projects remain separate from the existing business.
  2. Maximizes leverage: in project financing. The sponsors typically seek to finance the cost of development and construction of project on highly leverage basis. Frequently such costs are financed using 80 to 100 percent debt. High leverage in an non recourse financing permits a sponsor to put less in funds at risk, permits a sponsor to finance a project without diluting its equity investment in the project and in certain circumstances, also may permit reduction in cost of capital by substituting lower cost, tax deductible interest for higher cost, taxable return on equity.
  3. Off balance sheet treatment: depending upon the structure of project financing the project sponsors may not be required to report any of the project debt on its balance sheet because such debt is non recourse or of limited recourse to the sponsor. Off balance sheet treatment can have the added practical benefit of helping the sponsor comply with convenient and restrictions related to the board. Borrowings funds contain in other indentures and credit agreements to which the sponsor is a party.
  4. Maximizes tax benefits: project finance is generally structured to maximize tax benefit and to assure that all available tax benefit are used by the sponsors or transferred to the extent possible to another party through a partnership, lease or vehicle.
  5. Diversifies risk: by allocating the risk and financing need of the projects among a group of interested parties or sponsors, project financing makes it possible to undertake project that would be too large or would pose too great a risk for one party ion its own.

Demerits

  • Complexity of risk allocation: project financing is complex transaction involving many participants with diverse interest. If a project is to be successful risk must be allocated among the participants in an economically efficient way. However, there is necessary tension between the participants. For e. g between the lender and the sponsor regarding the degree of recourse, between the sponsor and contractor regarding the nature of guarantees. , etc which may slow down the realization of the project.
  • Increase transaction cost: it involves higher transaction costs compared to other types of transactions, because it requires an expensive and time-consuming due diligence conducted by the lenders lawyer, the independent engineers etc. , since the documentation is usually complex and lengthy.
  • igher interest rates and fees: the interest rates and fees charged in project financing are higher than on direct loan made to the project sponsor since the lender takes on more risk.
  • lender supervision: in accordance with a higher risk taken in project financing the lender imposes a greater supervion on the mangement and operation of the project to make sure that the project success is not impaired. The degree of lender supervision will usually result into higher costs which will typically have to be borne by the sponsor.

Whether expanding manufacturing facilities, implementing new processing capabilities, or leveraging existing assets in new markets, innovative financing is often at the core of long-term projects to transform a company’s operations. Akin to the underlying corporate transformation, the challenge with innovative financial structures such as project finance is that the investment is made upfront while the anticipated benefits of the initiative are realized years later.

There has been a rise in number of companies that need innovative financing to satisfy their capital needs, in a significant number of instances they have viable goals but find that traditional lenders are unable to understand their initiatives. And so the need emerged for project finance. Project financing is a specialized form of financing that may offer some cost advantages when very large amounts of capital are involved It can be tricky to structure, and is usually limited to projects where a good cash flow is anticipated.

Project finance can be defined as: financing of an industrial (or infrastructure) project with myriad capital needs, usually based on non-recourse or limited recourse structures, where project debt and equity (and potentially leases) used to finance the project are paid back from the cash flow generated by the project, with the project’s assets, rights and interests held as collateral. In other words, it’s an incredibly flexible and comprehensive financing solution that demands a long-term lending approach not typical in today’s market place.

Whether expanding manufacturing facilities, implementing new processing capabilities, or leveraging existing assets in new markets, innovative financing is often at the core of long-term projects to transform a company’s operations. Akin to the underlying corporate transformation, the challenge with innovative financial structures such as project finance is that the investment is made upfront while the anticipated benefits of the initiative are realized years later. Infrastructure is the backbone of any economy and the key to achieving rapid sustainable rate of economic development and competitive advantage.

Realizing its importance governments commit substantial portions of their resources for development of the infrastructure sector. As more projects emerge getting them financed will continue to require a balance between equity and debt. With infrastructure stocks and bonds being traded in the markets around the world, the traditionalist face change. A country on the crest of change is India. Unlike many developing countries India has developed judicial framework of trust laws, company laws and contract laws necessary for project finance to flourish.

Build operate transfer is a project financing and operating approach that has found an application in recent years primarily in the area of infrastructure privatization in the developing countries. It enables direct private sector investment in large scale infrastructure projects. In BOT the private contractor constructs and operates the facility for a specified period. The public agency pays the contractor a fee, which may be a fixed sum, linked to output or, more likely, a combination of the two.

The fee will cover the operators fixed and variable costs, including recovery of the capital invested by the contractor. In this case, ownership of the facility rests with the public agency.

The theory of BOT is as follows:

  • BUILD – A private company (or consortium) agrees with a government to invest in a public infrastructure project. The company then secures their own financing to construct the project.
  • Operate – The private developer then operates, maintains, and manages the facility for a agreed concession period and recoups their investment through charges or tolls.
  • Transfer – After the concessionary period the company transfers ownership and operation of the facility to the government or relevant state authority.

In a BOT arrangement, the private sector designs and builds the infrastructure, finances its construction and operates and maintains it over a period, often as long as 20 or 30 years. This period is referred to as the “concession” period. In short, under a BOT structure, a government typically grants a concession to a project company under which the project company has the right to build and operate a facility.

The project company borrows from the lending institutions in order to finance the construction of the facility. The loans are repaid from “tariffs” paid by the government under the off take agreement during the life of the concession. At the end of the concession period the facility is usually transferred back to the government.

A BOOT funding model involves a single organization, or consortium (BOOT provider) who designs, builds, funds, owns and operates the scheme for a defined period of time and then transfers this ownership across to a agreed party. BOOT projects are a way for governments to bundle together the design and construction, finance, operations and maintenance and potentially marketing and customer interface aspects of a project and let these as a package to a single private sector service provider. The asset is transferred back to the government after the concession period at little or no cost.

The Components of BOOT. B for build The concession grants the promoter the right to design, construct, and finance the project. A construction contract will be required between the promoter and a contractor. The contract is often among the most difficult to negotiate in a BOOT project because of the conflict that increasingly arises between the promoter, the contractor responsible for building the facility and those financing its construction. Banks and other providers of funds want to be sure that the commercial terms of the construction contract are reasonable and that the construction risk is placed as far as possible on the contractors.

The contractor undertakes responsibility for constructing the asset and is expected to build the project on time, within budget and according to a clear specification and to warrant that the asset will perform its design function. Typically this is done by way of a lump-sum turnkey contract.

The concession from the state provides concessionaire to own, or at least possess, the assets that are to be built and to operate them for a period of time: the life of the concession. The concession agreement between the state and the concessionaire will define the extent to which ownership, and its associated attributes of possession and control, of the assets lies with the concessionaire.

An operator assumes the responsibility for maintaining the facility’s assets and the operating them on the basis that maximizes the profit or minimizes the cost on behalf of the concessionaire and, like the contractor undertaking construction and be a shareholder in the project company. The operator is s often an independent through the promoter company.

With a view to improving the credit delivery mechanism and shorten the Turn Around Time (TAT), IDBI has set up Centralized Loan Processing Cells (CLPCs) at major centers across the country. To strengthen the credit delivery process, the CART (Credit Appraisal & Rating Tool) Module developed by Small Industries Development Bank of India (SIDBI), which combines both rating and appraisal mechanism for loan proposals, was adopted by IDBI for faster processing of loan proposals. Recently, a number of products have been rolled out for the SME sector, which considerably expanded IDBI’s offerings to its customers.

Also, the German Technical Co-operation and IDBI entered into an understanding for strengthening the growth and competitiveness of SMEs by providing better access to demand-oriented business development and financial services. Agri Business Agriculture continues to be the largest and the most dominant sector in India, contributing 22 % to the country’s GDP. It provides a source of employment and livelihood to over 60 % of the population. Its linkages with industry are growing with increasing stress on food and agri processing industry on account of changing demand patterns for processed food by consumers.

With this background Corporate India has started finding new opportunities in Agriculture. The emergence of modern economic system has institutionalized agriculture sector on business models. Agribusiness is a broad term that encompasses a number of businesses in agriculture including food production, farming, agrochemicals, farm machinery, warehousing, wholesale and distribution, and processing, marketing and sale of food products. The bank has launched several products catering to the rural and agri community.

Under the Project Finance scheme IDBI provides finance to the corporates for projects. The Bank provides project finance in both rupee and foreign currencies for Greenfield projects as also for expansion, diversification and modernization. IDBI follows the Global Best Practices in project appraisal and monitoring and has a well-diversified industry portfolio. IDBI has signed a Memorandum of Understanding (MoU) with LIC in December 2006 for undertaking joint and take-out financing of long-gestation projects, including infrastructure projects.

It has been a long and eventful journey of almost a century across 24 countries. Starting in 1908 from a small building in Baroda to its new hi-rise and hi-tech Baroda Corporate Centre in Mumbai is a saga of vision, enterprise, financial prudence and corporate governance. It is a story scripted in corporate wisdom and social pride. It is a story crafted in private capital, princely patronage and state ownership. It is a story of ordinary bankers and their extraordinary contribution in the ascent of Bank of Baroda to the formidable heights of corporate glory.

It is a story that needs to be shared with all those millions of people – customers, stakeholders, employees & the public at large – who in ample measure, have contributed to the making of an institution. Personal Banking Services Bank of Baroda believes in the strength and integrity of relationships built with its customers like you. With over 90 years of experience in the banking industry and a wide network of over 2700 branches all over the country, we have always been active in extending financial support and adapting to your changing needs.

Their Deposit Products, Retail Loans, Credit Cards and Debit Cards help you with your growing financial needs. With facilities like Lockers we ensure that your valuables are safe with us. Their countrywide branches offer you convenience and ease in operating your account wherever you are. Their 24-hour ATMs enable you to withdraw cash, check your account balance and request for a new chequebook even after banking hours. Baroda Internet Banking / Baroda Mobile Banking, their latest Internet and Mobile banking initiatives enable you to operate your account just as you would in any of our branches.

You can through the Internet check your balance, request for chequebooks and print account details. Choose from other various products and services, that they sincerely feel will put a smile on your face; an investment we would like to bank on forever. Business Operations The small and medium business enterprise is one of the fastest growing sectors in the country. Bank of Baroda offers various products and services that meet the specific requirements of such enterprises and help them grow.

In addition to tailor-made products, you can depend on the strength of other nation-wide network and facilities that will enable you to conduct your business smoothly, without geographical constraints. Be it Deposits, Loans & Advances, Collection Services, Working Capital Finance, Term Finance, Non-Fund based Facilities, Trade Finance, Merchant Banking or other such aspects of banking, they have a solution to help your business run smoothly and efficiently. Corporate Banking Services As corporations grow they feel the need to expand and invest in new infrastructure.

External finance is one of the most important sources for funding expansion plans. With services ranging from Working Capital Finance, Short Term Corporate Loans, Project Finance to Cash Management and Merchant Banking, Bank of Baroda Corporate Banking offers various options that help fund and enable corporations in their investment and expansion plans. These products also offer merchant banking and cash management solutions. Their global presence, large-scale operability, highly networked systems and local market penetration allow our customers to reap financial benefits to the maximum.

Loans & Advances For immediate financial need in times, Bank of Baroda has a host of loan options for a corporate to choose from. These enable smooth functioning without monitory hassles. Project Finance Bank of Baroda provides its customers with the option of a loan to take care of the needs of an ongoing project, whether it is in Indian or foreign currency. This facility is available for project finance and also for project exports. International Operations Bank of Baroda started its overseas journey by opening its first branch way back in 1953 in Mombassa, Kenya.

Since then the Bank has come a long way in expanding its international network to serve NRIs/PIOs and locals. Today it has transformed into India’s International Bank. It has significant international presence with a network of 70 offices in 24 countries including 45 branches of the Bank, 21 branches of its eight Subsidiaries and four Representative Offices in Malaysia, China, Thailand, & Australia. The Bank also has one Joint Venture in Zambia with 9 branches.

The Bank has presence in world’s major financial centers i. e. New York, London, Dubai, Hong Kong, Brussels and Singapore. The “round the clock around the globe”, Bank of Baroda is further in the process of identifying/opening more overseas centers for increasing its global presence to serve its 29 million global customers in still better way. The Bank has recently upgraded its operations in Hong Kong on 2nd April 2007 and now offers full banking service through its two branches at Central and Tsim Sha Tsui. It would also be upgrading its operations to full banking service in China and through JV in Malaysia shortly.

It is also in process of establishing offices in Canada, New Zealand, Qatar, Bahrain, Saudi Arabia, Mozambique, Russia etc. Besides this, it has plans to extend its reach in existing countries of operations in US and UAE. Treasury operations In the changing economic environment of the country in particular and the globe in general, Bank of Baroda was the premier public sector bank in India to set up a Specialized Integrated Treasury Branch (SITB) in Mumbai and the integrated approach initiated by the Bank in its treasury operations is now being emulated by other peer banks.

Bank of Baroda has consciously adopted a focused approach towards improving efficiency and profitability by successfully integrating the operations of different financial markets, viz. Domestic Money, Investments, Foreign Exchange and Derivatives and has made its mark as an important player in the market-place. The SITB at Mumbai, equipped with the State-of-the-art technology, with modern communication facilities, handles all types of financial transactions, both for managing its resources and deployments and effective compliance of regulatory requirements. Rural Operations

Rural India contributes a major chunk to the economy every year. To give this sector a stronghold on finance and to enable economic independence, Bank of Baroda has special offerings that extend credit facilities to small and marginal farmers, agricultural labourers and cottage industry entrepreneurs. With the objective of developing rural economy through promotion of agriculture, trade, commerce, industry and extending credit facilities particularly to small and marginal farmers, agricultural labourers and small entrepreneurs, Bank of Baroda, over the years, has reached out to larger part of rural India.

They extend loans for agricultural activities and a host of services for farmers well tuned to the rural market, and aim to make a Self Reliant Rural India. [pic] Axis Bank was the first of the new private banks to have begun operations in 1994, after the Government of India allowed new private banks to be established. The Bank was promoted jointly by the Administrator of the specified undertaking of the Unit Trust of India (UTI – I), Life Insurance Corporation of India (LIC) and General Insurance Corporation Ltd. and other four PSU companies, i. e. National Insurance Company Ltd.

The New India Assurance Company, The Oriental Insurance Corporation and United Insurance Company Ltd. The Bank today is capitalized to the extent of Rs. 357. 48 crore with the public holding (other than promoters) at 57. 03%. The Bank’s Registered Office is at Ahmedabad and its Central Office is located at Mumbai. Presently, the Bank has a very wide network of more than 608 branch offices and Extension Counters. The Bank has a network of over 2595 ATMs providing 24 hrs a day banking convenience to its customers. This is one of the largest ATM networks in the country.

The Bank has strengths in both retail and corporate banking and is committed to adopting the best industry practices internationally in order to achieve excellence. It provides an array of services like Personal Banking, Corporate Services, NRI services and Priority Banking. In personal Banking it offers different accounts like EasyAccess Account Senior Citizen’s Account Prime Savings Account Women’s Account Salary Power etc. . It also offers deposits services like Fixed Deposit, Recurring Deposit, and Tax Saving Fixed Deposits. It provides an array of loan services like Home Loan, Car Loan, Personal Loan, Study Loan, Mortgage etc.

It also provides Cash Management Services as in today’s competitive market place, effectively managing cash flow can make the difference between success and failure. Axis Bank offers a wide range of collection and payment services to meet your complex cash management needs. Payments received from your buyers and made to your suppliers are efficiently processed to optimize your cash flow position and to ensure the effective management of your business’ operating funds. [pic] Bank of India was founded on 7th September, 1906 by a group of eminent businessmen from Mumbai.

The Bank was under private ownership and control till July 1969 when it was nationalized along with 13 other banks. Beginning with one office in Mumbai, with a paid-up capital of Rs. 50 lakhs and 50 employees, the Bank has made a rapid growth over the years and blossomed into a mighty institution with a strong national presence and sizable international operations. In business volume, the Bank occupies a premier position among the nationalized banks. The Bank has 2644 branches in India spread over all states/ union territories including 93 specialized branches.

These branches are controlled through 48 Zonal Offices . There are 24 branches/ offices (including three representative offices) abroad. The Bank came out with its maiden public issue in 1997. Total number of shareholders as on 30/09/2006 is 2, 25,704. While firmly adhering to a policy of prudence and caution, the Bank has been in the forefront of introducing various innovative services and systems. Business has been conducted with the successful blend of traditional values and ethics and the most modern infrastructure.

The Bank has been the first among the nationalized banks to establish a fully computerized branch and ATM facility at the Mahalaxmi Branch at Mumbai way back in 1989. The Bank is also a Founder Member of SWIFT in India. It pioneered the introduction of the Health Code System in 1982, for evaluating/ rating its credit portfolio. The Bank’s association with the capital market goes back to 1921 when it entered into an agreement with the Bombay Stock Exchange (BSE) to manage the BSE Clearing House. It is an association that has blossomed into a joint venture with BSE, called the BOI Shareholding Ltd. o extend depository services to the stock broking community.

Bank of India was the first Indian Bank to open a branch outside the country, at London, in 1946, and also the first to open a branch in Europe, Paris in 1974. The Bank has sizable presence abroad, with a network of 23 branches (including three representative office) at key banking and financial centres viz. London, Newyork,Paris,Tokyo,Hong-Kong,and Singapore. The international business accounts for around 20. 10% of Bank’s total business.

The RBI in its latest monetary policy statement has cautioned that NBFCs should be encouraged to exit from public deposits, in essence saying NBFCs should not take public deposits. This is, indeed, extraordinary. The reasons given are that nowhere in the world are private financial institutions allowed to accept public deposits. The fact is that non-bank finance institutions are active in other economies. They accept deposits in developed countries as well as in some developing countries, like Malaysia. The existence of thrift societies in the US and housing societies in the UK is well-known.

Thrift and savings associations are almost omnipresent in the US. Credit unions of employees are, in effect, self-help groups, present in every organization. So are housing societies in the UK. They perform a useful role in garnering public savings and extending credit to those in need. The same is the situation with non-bank finance companies in Malaysia. The position in the US is that as against deposits of $4,391 billion held by commercial banks, thrift institutions and finance companies hold $1,247 billion. These non-banks as a whole hold 28. 4 per cent of the deposits of banks.

In India, however, public deposits of NBFCs are only 0. 003 per cent of banks in India. Non-bank finance institutions in the US are even covered by deposit insurance even as they are subject to supervision by a special office of thrift supervision. These institutions handle a substantial channel of local savings and transfer them as loans to deserving borrowers, besides small and medium-scale industries, as well as housing needs. These institutions are also liberally allowed to access the capital market, where banks subscribe to bonds issued by them. The situation in UK is broadly similar.

Building Societies in the UK have a big share of business compared to their analogues in India, which hold deposits amounting to 18 per cent of total retail deposit balances. They also are entitled to receive compensation from the Financial Services Compensation Scheme in the event of failure in the business of deposit-taking, among others. In Malaysia, non-bank finance companies’ deposits as a percentage of bank deposits amount to 21 per cent. It is, therefore, wrong to argue that non-bank finance companies cannot access public deposits in other countries.

Again, the new-fangled notion of Grameen banks and self-help groups is nothing but thrift societies in another form. Traditionally in India, chit funds have performed the role of collecting deposits from savers and lending money to those who are in need. Constrained as they are by numerous restrictions, they still perform a signal service in funding small and medium business, trade and transport The fact is that NBFCs in India have played a useful role in financing various sectors of the economy, particularly those that have been underserved by the banks.

No business flourishes unless there is a need for it and it fulfils the need efficiently. The success of NBFCs bears testimony to its role. Anywhere in India, the small entrepreneur goes first to an NBFC for funds even before he approaches banks in view of the former’s easy access, freedom from red-tape and quick response. The large expansion of the consumer durable business in India in the last few years would not have taken place if NBFCs had not entered the trade. Similarly, housing activity has also been encouraged by NBFCs.

The role of NBFCs in funding transport activities is well-known. Latterly, some NBFCs have been active in funding infrastructure quite successfully using the securitization of obligations. NBFCs in India have played a useful role in financing various sectors of the economy, particularly those that have been underserved by the banks. The tendency of regulators to deny access to these institutions to public deposit is a confession of inability to see the economic reality, which calls for a flexible and customer-friendly financial intermediary, which is what NBFCs and chit funds are.

The tendency of regulators to deny access to these institutions to public deposit is a confession of inability to see the economic reality, which calls for a flexible and customer-friendly financial intermediary, which is what NBFCs and chit funds are. In fact, many banks are forming NBFCs to take advantage of their greater flexibility in dealing with customers. The fact that some NBFCs were found abusing their position in the 1990s seems to have scared the regulator out of its wits. The answer lay in better regulation, supervision and prudential norms.

The RBI has now strengthened its machinery of registration and supervision and extended prudential norms to NBFCs. Denying access to deposits would seem a case of throwing the baby out with the bathwater. On the contrary, the RBI should apply its mind to strengthening the functioning of NBFCs, if necessary, facilitating better access to the capital market. It is, however, interesting to note that the RBI is thinking of using in some form an instrumentality like the NBFC to extend its credit reach. Observations in recent RBI reports show that the central bank would prefer to use microfinance credit agencies dedicated to serving SME clusters.

The RBI’s Report on Trend and Progress of Banking in India 2004 mentions that “banks should extend wholesale financial assistance to non-governmental organizations/microfinance intermediaries and work as innovative models for securitisation of MFIs’ receivable portfolios. Such micro-credit institutions can take the form of NBFCs funded by individuals or a group of banks, but not permitted to take public deposits”. A strange requirement, indeed, of exclusion from public deposits! The recommendation of setting up an institution in the form of NBFC is significant, although excluding such institutions from deposit-taking is not correct.

NBFCs have, indeed, served a useful purpose as instruments for extending outreach of credit in the Indian countryside. To ignore them but recreate them in the form of microfinance institutions or NGOs of the same kind is being ritualistic. After all, let us recognise that NBFCs have a set of characteristics that have made them an effective form of financial intermediation. It is these characteristics that the RBI wants to incorporate in its version of microfinance groups. The path of wisdom is to incorporate NBFCs as such into India’s financial structure rather than reinventing them in another form.

There are, of course, some persistent problems for NBFCs, apart from deposit-taking. These relate to flexible handling of their capital issues. Both SEBI and the RBI need to revisit their case for relaxations with sympathy, especially since they are rated and supervised. These specific relaxations are more a matter of confidence-building. The requests made by NBFCs deserve sympathetic treatment by both the securities market regulator and the central bank. In short, NBFCs are vitally needed to give the Indian economy a much-needed boost by enabling easier access to credit.

As it is, public and private sector banks are finding it difficult to extend their reach for various reasons. It behooves the RBI and the Government to look at the problems faced by NBFCs with sympathy rather than with a recollection of the past follies of a few institutions. The time has come for the RBI to “make” peace with NBFCs as a class. They are proven instruments of efficient and customer-friendly outreach in the credit space — not only for consumer durables, but also housing and transport, besides infrastructure. These are also critical areas in which the Government is vitally interested as part of boosting economic growth.

This essay was written by a fellow student. You may use it as a guide or sample for writing your own paper, but remember to cite it correctly. Don’t submit it as your own as it will be considered plagiarism.

Need a custom essay sample written specially to meet your requirements?

Choose skilled expert on your subject and get original paper with free plagiarism report

Order custom paper Without paying upfront

Project Reports: Method of Financing Very Large Capital Intensive Projects. (2018, Feb 12). Retrieved from https://graduateway.com/project-reports/