FINANCIAL SECTOR REFORMS AND THE ROLE OF DEVELOPMENT BANKING IN

THE SMALL AND MEDIUM SECTOR BY DAS SIR 8961556195

INTRODUCTION
Financial sector is the backbone of any economy and it plays a crucial role in the mobilisation
and allocation of resources. The constituents of the financial sector are Banks, Financial
Institutions, Instruments and markets which mobilise the resources from the surplus sector and
channelise the same to the different needy sectors in the economy. The process of increasing
capital accumulation through institutionalisation of savings and investment fosters economic
growth. The main objectives of the financial sector reforms are to allocate the resources
efficiently, increasing the return on investment and accelerated growth of the real sectors in the
economy. The measures initiated by the Government of India under the reform process are
meant to increase the operational efficiency of each of the constituent of the financial sector.
The discussion of the present text has been restricted to the role of the development banks in
the era of reforms.

ROLE OF DEVELOPMENT BANKING

Traditionally, commercial banks were the main source of finance during the pre-independence
era. After Independence, the Government of India announced the Industrial Policy in 1948 with
a view to build a sound industrial base and a strong village and small industry sector. The
enactment of the State Financial Corporation Act in 1951 and the consequent establishment of
the different development banks acted as a positive step to ensure balanced growth of industry
throughout the country. The development banks supply capital, knowledge and enterprise, the
three major ingredients of development, for business enterprises. These enterprises in turn by
augmenting their productivity can help the nation to develop rapidly. These institutions extend
longterm finance to the small and medium scale units under different schemes and their lending
operations are supplemented with promotional and developmental activities to facilitate
entrepreneurship. The development banks are of two types; namely, the all India level
institutions like IFCI, ICICI, IDBI, SIDBI, NSIC and the State Level Institutions like the State
Financial Corporations (SFCs), State Industrial Development Corporations (SIDCs) and the State
Industrial Investment Corporations (SIICs).

The all India level financial institutions like IFCI, IDBI, ICICI extend financial assistance to the
medium and large sectors whereas institutions like SIDBI and the NSIC cater to the need of the
Small Scale Industry (SSI) sector. The State level institutions provide financial support to the
small and the medium sectors. Besides the lending, these corporations act as the implementing
agency of the various government sponsored schemes in order to ensure a fair distribution of

wealth. The total value of the financial assets of SFCs over the years is about Rs. 10,999 crores
(upto 1996-97) which is quite encouraging.

PERFORMANCE OF THE SMALL AND MEDIUM SCALE SECTOR

The Small and the Medium sector in India covers a wide spectrum of industries ranging from
small, tiny and cottage segments to modern production units with significant investments.
These sectors account for around 98% of the industrial units in India and contribute 65% of the
output in the manufacturing sector. It has generated employment opportunities to an estimated
22 million persons in the country. The criterion for defining an industry as SSI or Medium Scale
Industry (MSI) depends on the investment limit which is fixed by the government from time to
time. This sector has acquired a prominent place in the socio-economic development of the
country as it not only acts as a nursery for the development of the entrepreneurial talent, but
also produces a wide range of products. Industrial policies relating to the SSI sector in India were
hitherto largely based on policy measures of a protective nature such as reservation, fiscal
concession and preferential procurement by the government etc. The concession granted to the
medium sector is comparatively less as the investment limit of this type of units are higher and
also the entrepreneurship skill of the promoter are assumed to be better. The overall industrial
growth of the Indian industries during the period 1989-90 is 7.2% and 6.5% during the period
1997-98. The lower growth after the liberalisation indicates that the industries are yet to avail
of the benefit of liberalisation. The average growth of the Small and Medium sector during the
period 1998-99 was 7%, whereas the overall industrial growth was only 5%.

It has been observed that the average growth of the Small and Medium sectors is higher than
the overall industrial growth of the country in the consecutive years. It is expected that these
sectors will act as prime mover in realising not only the estimated industrial growth but also in
giving a boost to the overall economic growth in the years to come.

IMPACT ON THE REFORM MEASURES

The broader objectives of the financial sector reform process are to formulate the policy for
improving the financial health and to strengthen the institutions. As part of the reforms process
many private banks were granted licence to operate in India. This has resulted into a
competitive environment in the banking industry which in turn has helped in using the resources
more efficiently. Traditionally the industrial units were sanctioned term loan by the
development banks and working capital by the commercial banks. The reform process has
changed the pattern of financing and now both the institutions are willing to extend long term
loan as well as working capital loan. But there is some difference in the mode of operation.

This has enabled the industrial units to avail credit facilities from a single institution. Despite
the fact that the banks provide both the term loan and the working capital loans, the industrial
units prefer the development banks for the following reasons.

It provides equal support to the new as well as existing industries.

The period of repayment of loan is comparatively longer.
Besides providing financial assistance, it acts as the implementing agency for the different
government sponsored schemes. Hence the industrial units can avail of both the financial
assistance as well as the incentives offered under various development schemes through a
Single Window System.
As lending is the prime activity of these institutions, it acquires specialisation in this field and
can share its expertise with the industrial units.
As part of the reform process the Central as well as the State Governments have devised various
schemes for the development of suitable infrastructure to encourage the growth of SSIs and
MSIs. The programme for the establishment of industrial estates was started in the year 1955,
which envisages the acquisition of land and construction of factory sheds etc. The
establishment of the Export Processing Zones (EPZ) at various parts of the country and the
special incentives offered to these units undertaking operation therein came as a boon to the
government. The financial sector reform witnessed the reorganisation of different
development banks like abolition of cross holding by the different financial institutions and the
delinking of ownership of SIDBI from IDBI. The reform process has also stressed the need of
applying the prudential norms on the developmental banks which were hitherto exempted from
the same. This will improve the health of the development banks and dependence on the
government will be reduced. But considering the social objective of these institutions, it is felt
that the application of stringent norms may vitiate the very purpose of the objective.
FUTURE ROLE OF THE DEVELOPMENT BANKING

In the context of the emerging scenario of liberalisation and the financial sector reforms the
development banks need to gear themselves to meet the varied requirements of the small and
medium scale sector. They need to create new product that are relevant and impactful. In the
new economic scenario, the role of technology has emerged as a strategic variable influencing
manufacturing systems of the industrial units who need to reorient their strategies to meet the
challenges of the competition. With the upward revision of the investment ceiling, much
potential has now been created for technological upgradation and the vertical integration of the
industrial units so as to derive advantage from economies of scale.

The liberalisation regime has also opened the doors for a large number of entrepreneurs to
embark upon the setting up of venture with innovative technologies and their commercial

applications with a high risk high return profile, which requires assistance through the venture
capital route. Many development banks have, therefore, taken steps to provide sector specific
Venture Capital funds to the small and the medium sectors. Various State Governments have
already launched the Venture Capital fund scheme for the targetted sectors.

Another thrust area of the development bank is the marketing finance which hitherto the
promoters had to bear. Marketing is the crucial area in the present competitive market and the
development banks need to help the industrial units to market their product and/or encourage
entrepreneurs to develop the common marketing infrastructure.

It has been suggested by the different industry associations to extend the merchant banking
services to the small and medium scale units which hitherto were available mainly for the large
scale units.

CONCLUSION
The economic reforms have favoured the need for shifting the policy objective from protection
to promotion of industries and the creation of more integrated infrastructural facilities. The
employment potential of the SSIs and MSIs is also a pointer to the government to take adequate
steps to ensure a smooth start of these units. Among them, the timely and adequate
availability of credit is the crucial one, and the development banks have a major role to ensure
the same. As the banks are generally unwilling to extend credit facilities at the initial stage of
an industrial unit, the major portion of the financial assistance of the development banks are
availed by the new unit/ new generation entrepreneur at liberal terms. Hitherto, the social
objectives acted as the backdrop of the major policies of the development banks and hence the
profit earning motive was treated secondary. This has adversely affected the financial health of
the development banks as there is always an inherent risk of failure lies in the financing the new
units/new generation entrepreneur. The reform process has suggested for the restructuring of
the development banks and making them abide by the prudential norms, but the same is
difficult to achieve as the social objectives and the prudential banking cannot go hand in hand.
Hence, steps should be taken to ensure the smoother flow of funds to these development banks
who in turn will channelise the same to the needy sectors of the society in order to foster
balanced economic growth.

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