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Indian Financial System

Notes Development banks are expected primarily to fill in the gaps in the supply of financial services
that are not normally provided by the banking institutions. Such development institutions are
generally specialised in provision of medium and long-term financing of projects, which require
specialised skills and focus, and may carry higher credit risks or market risks due to the longer
investment tenures. In some cases, the mandated roles of the development banks include the
promotion and achievement of Government's specific social and economic objectives.
The Development banks have in varying degrees contributed to the development and growth of
the targeted industries and strategic sectors of the economy.
The Development banks are expected to provide support to these sectors without resulting in
losses or incurring a direct cost to the Government. To enable them to perform these functions,
such development banks have generally been accorded special benefits in the form of funding at
lower rates, implicit Government guarantee to the institutions' debts, special status for their
debt instruments and favourable tax treatment.

8.6.4 Growth of Development Banks in India

In many countries, development banks have been major conduits for channeling funds to
particular firms, industries and sectors during the latter's process of development. In India,
development banks have been a more important source of long-term funds (mainly debt) for
industry than bank loans or other sources of debt. Using data from the Indian corporate sector,
we evaluate the role of development banks in India for the period 1989-97 by examining how
firms' investment decisions are affected by their ability to access development banks. We find
that firms that had prior access to development banks continue to receive funds from these
sources only if they can be classified as a priori more financially constrained. Access to
development banks for funds spurs investment. These results suggest that development bank
lending is not governed by considerations of lobbying, precedence or even to sponsor particular
types of projects that might be socially desirable but not privately profitable. Rather, the primary
role of development banks has been to reduce financial constraints faced by firms. We also find
that the drastic contraction of long-term bank lending to industry in India in the early nineties
had adverse consequences for firms that were particularly bank-dependent, but only if these
firms could be classified as a priori more financially constrained. Together, these results support
the view that in contrast to firms in well-developed capital markets, in emerging markets, firms
with growth potential are likely to rely significantly on debt financing, especially debt that is
channelled through financial intermediaries.

Structure and Working of Development Banks

Not only developed countries, but several underdeveloped countries in Asia, Africa, and Latin
America established special financial institutions to hasten the pace of industrialisation and
growth.
The International Bank for Reconstruction and Development (IBRD) known as the World Bank
and the International Monetary Fund (IMF) are examples of development banks at the
international level. The major objective of the World Bank is to promote world development
and perform the task of transfer of enormous financial and technical resources from the developed
to developing nations. The IMF performs a special function of providing financial assistance to
private sector projects in developing countries.
Development Financial Institutions in India: The need for development financial institutions
was felt very strongly immediately after India attained independence. The country needed a
strong capital goods sector to support and accelerate the pace of industrialisation. The existing
industries required long-term funds for their reconstruction, modernisation, expansion and

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