Main features of development

banks and other banking

Financial institutions
Development banks and other banking nancial
institutions (BFIs) have distinct features that de ne
their roles in the nancial system. Here are some
main features of each:

Development Banks:

1. Purpose: Development banks are established to

promote industrial and economic growth in a
country.
2. Long-Term Finance: They mainly provide long-term
nance to businesses and industries.
3. Risk-Taking: They often take higher risks in funding
projects compared to commercial banks.
4. Specialized Knowledge: They have specialized
knowledge about the sectors they cater to and assist
projects with expert guidance and technical
assistance.
5. Government Involvement:
Many development banks are either fully or partially
owned by the government.
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 6. Holistic Development: They emphasise not just on
nancial returns, but also on the developmental
impact of their projects.
7. Regional Focus: Some development banks focus
on regional development, serving particular areas in a
country.
8. Reinvestment: Pro ts earned are usually reinvested
in other developmental projects rather than being
distributed as dividends.

Other Banking Financial Institutions (BFIs):

1. Diverse Functions: BFIs include a wide range of

institutions such as commercial banks,
investment banks, savings and loan associations,
and credit unions.
2. Deposit and Lending: Commercial banks, in
particular, accept deposits from the public and use
those funds to provide loans.
3. Short-Term Loans: Unlike development banks,
commercial banks tend to o er short to medium-term
loans.
4. Pro t Orientation: Most BFIs aim to maximize pro t
for their shareholders.
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5. Diverse Services: They o er a variety of nancial
services, including checking accounts, savings
accounts, mortgages, and more.
6. Regulations: BFIs are typically heavily regulated by
national or regional authorities to ensure the stability
of the nancial system.
7. Credit Creation: Commercial banks have the ability
to create credit through the fractional reserve banking
system.
8. Risk Management: BFIs, especially commercial
banks, are typically risk-averse and have strict criteria
for lending to minimize potential losses.

While both development banks and BFIs play crucial

roles in the economy, their objectives and operational
methodologies di er. Development banks focus on
the broader economic and social development of a
region or country, while BFIs primarily cater to the
immediate nancial.

Unregulated credit market in

India
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 The unregulated credit market in India, often referred
to as the informal credit market, consists of lenders
and institutions that aren't supervised or regulated by
the o cial regulatory bodies, like the Reserve Bank of
India (RBI) or other nancial sector regulators.

Here are some key features and elements of the

unregulated credit market in India:

1. Lenders: The informal credit market includes

moneylenders, traders, landlords, friends, family, and
other non-institutional sources.

2. Lack of Documentation: Transactions in the

informal credit market often lack formal
documentation or involve very minimal paperwork.

3. Interest Rates: The interest rates can be

signi cantly higher than those in the formal sector.
Rates are often determined by the lender's discretion
rather than market competition or regulatory
guidelines.

4. Accessibility: The informal market is sometimes

preferred because it's more accessible to those who
may not have the necessary documentation or credit
history to borrow from formal nancial institutions.
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 5. Purpose: Loans from the informal sector can be for
various purposes, including personal emergencies,
agricultural needs, or business capital.

6. Repayment Flexibility: Informal lenders might o er

more exible repayment terms based on personal
relationships and understanding of the borrower's
situation.

7. Risks: Borrowing from the informal sector can

come with risks, such as the lack of consumer
protection mechanisms, the possibility of exploitative
practices, and the absence of formal recourse in case
of disputes.

8. Signi cant Share: Despite the growth and outreach

of the formal banking sector, the informal credit
market still constitutes a signi cant portion of the
credit market in India, especially in rural areas and
among low-income populations.

E orts have been ongoing to bring more people into

the formal nancial system through nancial inclusion
initiatives, thereby reducing the dependence on the
unregulated credit market. However, the informal
sector continues to play a signi cant role due to its
quick accessibility and minimal procedural
requirements.
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Problems between government
and commercial sector
 The relationship between governments and the
commercial sector in the context of developmental
banks and other nancial institutions can sometimes
be fraught with challenges. Here are some problems
that can arise between the two:

1. Regulatory Challenges:
- Governments may impose strict regulations on
banks and nancial institutions to safeguard the
economy and protect depositors. The commercial
sector might perceive these regulations as
burdensome and limiting their ability to operate
e ciently and pro tably.

2. Government Interference:
- In some countries, the government has a
signi cant stake in developmental banks. This can
lead to perceptions or realities of excessive
government interference in day-to-day operations,
lending decisions, or strategy.

3. Policy Inconsistencies:
- Governments might change policies related to the
banking sector frequently, making it di cult for
commercial entities to plan for the long term.

4. Priority Sector Lending:

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 - Governments might require banks to allocate a
certain portion of their lending to priority sectors (e.g.,
agriculture, small scale industries). This can con ict
with the commercial objectives of banks, as these
sectors might be perceived as riskier.

5. Bailouts and Non-Performing Loans:

- If banks face nancial di culties, there might be
expectations from the commercial sector for the
government to intervene and bail them out. This can
lead to moral hazard issues, where banks take
excessive risks believing the government will always
rescue them.

6. Lack of Transparency:
Governments might sometimes in uence banks to
lend to certain projects or entities without clear
transparency, leading to accusations of favouritism or
corruption.

7. Interest Rate Policies:- Central banks, which often

operate with some degree of government oversight,
can in uence interest rates. The commercial sector
might have issues if these rates are perceived as too
high (making borrowing costly) or too low (a ecting
pro t margins on lending).
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 8. Competition with Private Banks:- State-owned
developmental banks might be seen as having an
unfair advantage due to government support. This
can lead to competition concerns with wholly private
commercial banks.

9. Ine cient Operations:

Government-led banks might sometimes be
perceived as less e cient than their private
counterparts due to bureaucracy. This can lead to
concerns about their ability to serve the commercial
sector e ectively.

10.Di ering Goals:

Governments might focus on socio-economic
objectives, such as nancial inclusion, employment
generation, or infrastructure development. In contrast,
the commercial sector is often driven by pro tability.
These di ering objectives can sometimes clash.

Building trust, transparency, and e ective

communication channels between the government
and the commercial sector is crucial to address these
problems and ensure that developmental banks and
nancial institutions serve their intended purpose.

Inter sectoral and inter regional

problems
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 Inter-sectoral and inter-regional issues in the realm of
developmental banks and other banking nancial
institutions (BFIs) can arise due to the diverse and
dynamic nature of economic development. Here are
some of the main challenges:

Inter-sectoral Problems:

1. Unequal Distribution of Funds: Some sectors might

receive a disproportionate amount of funding
compared to others, based on government priorities,
perceived pro tability, or other factors. This can lead
to neglect of certain crucial sectors.

2. Varied Risk Appetites: Di erent sectors carry

di erent risk pro les. Banks might be more inclined to
nance sectors with lower risks, leaving high-risk,
albeit crucial, sectors underserved.

3. Di ering Returns on Investment: Some sectors

o er quicker returns on investments, while others, like
infrastructure or agriculture, might require longer
gestation periods, a ecting banks' lending decisions.

4. Mismatched Expertise: A bank with expertise in

one sector might struggle to evaluate and nance
projects in another, leading to ine cient lending
decisions.
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 5. Technological Disruptions: Rapid technological
changes can make some sectors obsolete, potentially
endangering the investments made by banks in those
sectors.

Inter-regional Problems:

1. Regional Disparities: Developmental banks and

BFIs might focus more on regions that are already
economically advanced, exacerbating regional
disparities in development.

2. Geopolitical Risks: In areas with geopolitical

tensions or territorial disputes, banks might be
hesitant to nance projects, leading to
underdevelopment.

3. Infrastructure Challenges: Regions with poor

infrastructure might not attract as much investment
from banks, further hindering their developmental
potential.

4. Cultural and Local Norms: Di erences in cultural or

local norms can a ect banks' operations in various
regions, potentially leading to misunderstandings or
con icts.
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5. Lack of Regional Expertise: Banks headquartered
in urban centers or in certain regions might lack the
necessary local knowledge to nance and support
projects in other regions e ectively.

6. Migration and Population Shifts: As populations

move, regions that once were thriving might face
decline, a ecting the viability of projects nanced
there. Conversely, rapidly growing regions might face
shortages of essential services and infrastructure.

Addressing these inter-sectoral and inter-regional

challenges requires a nuanced approach.
Developmental banks and BFIs need to diversify their
expertise, collaborate with local stakeholders, and
continuously update their strategies in response to
changing economic landscapes. Governments, on
their part, can play a role by providing clear
guidelines, o ering incentives for investment in
underserved sectors or regions, and fostering an
environment conducive to equitable development.

Problems between small and

large borrowers
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 Developmental banks and other banking nancial
institutions cater to a wide variety of borrowers, from
large corporations to small individual entrepreneurs.
The di erences in the needs and capabilities of large
and small borrowers can sometimes lead to issues.
Here's a brief overview of the problems that arise
between large and small borrowers in these
institutions:

1. Di erential Access to Credit:

Large borrowers often have better access to credit
due to their established credit histories, collateral,
and professional relationships with the banks.
Small borrowers, especially new entrepreneurs or
startups, might nd it di cult to get loans due to their
lack of credit history or collateral.

2. Loan Terms and Conditions:

- Large borrowers can negotiate better loan terms,
including lower interest rates and longer repayment
periods, due to their bargaining power.
- Small borrowers, on the other hand, might have to
accept stringent conditions and higher interest rates.

3. Collateral Requirements:
- Large corporations can o er substantial assets as
collateral, reducing the risk for banks.
- Small borrowers might not have signi cant assets
to o er as collateral, which can limit their borrowing
capacity.
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 4. Perception of Risk:
- Banks may perceive lending to smaller borrowers
as riskier than to larger, established corporations.
- This can result in stricter scrutiny of loan
applications from small borrowers and higher
rejection rates.

5. Customised Financial Products:

- Large borrowers can often get nancial products
tailored to their speci c needs.
- Small borrowers typically have to make do with
standardized loan products which might not suit their
unique requirements.

6. Financial Literacy and Support:

- Large corporations have nancial experts who can
navigate the complexities of banking systems.
- Small borrowers, especially individual
entrepreneurs, might not be well-versed in nancial
matters, leading to potential misunderstandings and
mismanagement of funds.

7. Bias and Favouritism:

- There can sometimes be an implicit bias towards
larger corporations because of their economic
signi cance and potential for generating more pro t
for the bank.
- Small borrowers may feel that they are not treated
with the same importance or priority.
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 8. Time-to-Disbursement:
- Large borrowers, due to their established
relationships, might experience quicker loan
processing and disbursement times.
- Small borrowers might face longer waiting times,
a ecting their ability to use the funds when needed.

9. Feedback and Redress Mechanisms:

- Large corporations might have dedicated
relationship managers who can address their
concerns promptly.
- Small borrowers might not have the same level of
access or responsiveness, leading to feelings of
neglect.

Addressing these problems requires banks and

nancial institutions to develop frameworks and
mechanisms that ensure equitable treatment for all
borrowers, regardless of size.
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