India’s new DFI will help achieve big development targets

India has had experience with development finance institutions (DFIs) in the past and they were converted into full-time commercial banks to allow them access to retail deposits. That India needs a DFI once again is well recognized, but its structure and functioning would be of significance in determining its role in shaping a ‘New India’.

This is precisely why the structure of the newly-created National Bank for Financing Infrastructure and Development (NABFID) is so important. One key determinant of the success of any institution is its governance. A company with a sound board, strong governance structures and excellent management will perform consistently well. Companies with weaker corporate governance may also perform well for some time. But over the long-term, their value and wealth creation potential will be adversely impacted by inherent weaknesses in their management. This is particularly true for public sector enterprises, in which shareholder supervision is not as strong as it is in private enterprises. The fact that NABFID is intended to have a professional board that will be half filled by non-official directors, and that people of eminence will serve as its members, be it as its chairperson or non-official directors, is a signal to markets that it has been designed to operate in a professional manner.

Moreover, the institution has also been given the task of developing India’s bond market for infrastructure financing. It is expected to play a major role as both bond seller and market-maker during its initial years of operations. This may appear to be a conflict of goals. But it is important to note that there need to be certain preconditions for a market to emerge. The role played by NABFID in the development of India’s infrastructure financing market would allow those preconditions to be met by ensuring that there is adequate interest among investors right from the start.

It is equally important to highlight the specific provision of a mandatory performance review of the institution once every five years that will be presented publicly. This will ensure accountability and strengthen the institution’s governance. Further, in the past, salaries for the recruitment of talent by such institutions was capped at the level of secretaries in the Union government.

With better-paying private-sector options available to professionals, their decision to work for the public sector would have entailed a significant pay cut. Thus, public institutions could be deprived of competitive talent by salary differentials between the public and private sector. The new institution, however, will have attractive performance-based incentives to help attract talent, which will be crucial for its proper functioning.

Another advantage is the allowing of sovereign wealth funds (SWFs) and other institutions to purchase equity, along with a buy-back option, in NABFID. SWFs are among the world’s well-run institutions and their investment in NABFID would serve to improve its overall governance.

While governance is important, equally crucial is its scale of operations. Notably, NABFID will have an authorized capital of ₹1 trillion, and the Union budget for 2021-22 laid out the government’s ambition for it to have a portfolio of ₹5 trillion within three years. Therefore, in many ways, the new institution will serve as an important instrument for financing the bulk of the country’s infrastructure investment plans.

However, the success of NABFID would depend on its ability to generate adequate investor interest in its instruments. Careful selection, bundling and securitization of projects (or their constituent elements) are matters of detail that could prove crucial in attracting the interest of other financial institutions as well as high net worth individuals.

Also important is the use of tax policies that could make some of these investments attractive for investors. The government has already provided a nudge by granting incentives, such as a 10-year income tax holiday on its bonds, along with other concessions and guarantees. These should help whet investor appetite.

The proposed institutional design reflects a deep understanding of the challenges that such institutions have faced in the past. Thus, the new institution will learn from DFI mistakes that were made in the past, with the overarching objective of creating a truly world-class financing mechanism for the fulfilment of India’s infrastructure and development aspirations.

The institutional structure of NABFID is compatible with the broad objectives of this institution. The approach is geared towards finding a solution to the critical problem of financing long-term infrastructure projects in the country. The push for strong governance structures along with robust management of the newly-created institution is an illustration of how the government envisions a larger role for it that would be in line with our target of spending ₹102 trillion on various projects of the National Infrastructure Pipeline.

Vivek Singh and Karan Bhasin are, respectively, officer on special duty to India’s finance minister and an independent economist.