Development Banking, Objective, Features, Types, Sources of Funds

Development banking refers to specialized financial institutions that provide medium-term and long-term credit for industrial, infrastructure, and agricultural projects, particularly in sectors where commercial banks hesitate to lend due to high risk or long gestation periods. Unlike commercial banks (which focus on short-term working capital and trade finance), development banks (DFIs or Development Financial Institutions) prioritize economic development over immediate profitability. In India, key development banks included IDBI (Industrial Development Bank of India), IFCI (Industrial Finance Corporation of India), ICICI (Industrial Credit and Investment Corporation of India), NABARD (agriculture and rural development), SIDBI (small industries), EXIM Bank (export-import finance), and NHB (housing). However, most DFIs have now either converted into universal banks (IDBI, ICICI) or been restructured. NABARD, SIDBI, EXIM Bank, and NHB continue to operate as specialized DFIs, while commercial banks, NBFCs, and the IBC framework fill the project finance gap. Development banking played a crucial role in India’s industrialization (1950s-1990s) by financing heavy industries, power projects, and infrastructure.

Objectives of Development Banks:

1. Promoting Industrial Development

The primary objective of development banks is to promote industrial development, particularly in priority sectors such as heavy engineering, chemicals, infrastructure, power, and telecommunications. Unlike commercial banks that focus on short-term working capital, development banks provide medium-term and long-term finance (5-25 years) for setting up new industrial projects, expansion, modernization, and diversification. They finance capital-intensive industries where gestation periods are long and commercial banks hesitate to lend. By funding such projects, development banks create productive assets, generate employment, and enhance the country’s industrial output. In post-independence India, development banks like IFCI, IDBI, and ICICI drove the establishment of basic and heavy industries that formed the foundation of industrial self-reliance.

2. Accelerating Economic Growth

Development banks aim to accelerate the overall economic growth of the country by directing financial resources into sectors with high backward and forward linkages (steel, power, transport, communication). Industrial growth stimulates agriculture (through inputs like fertilizers, tractors) and services (banking, logistics, trade). Development banks also fund infrastructure projects (roads, ports, power plants) that reduce transaction costs for all sectors. By focusing on GDP growth rather than short-term profitability, development banks tolerate higher initial risks and longer gestation periods. In India, development bank financing contributed significantly to the high growth rates of the 1960s-1980s (Hindu rate of growth) and later to the post-liberalization expansion. This objective aligns with national planning priorities rather than individual profit maximization.

3. Promoting Balanced Regional Development

Development banks aim to reduce regional disparities by directing credit to less industrialized states and backward districts. Commercial banks naturally prefer lending to already developed regions (Mumbai, Delhi, Chennai, Bengaluru, Gujarat, Maharashtra) where infrastructure exists and risks are lower. Development banks, through policies like concessional interest rates, longer repayment periods, and relaxed collateral norms, encourage industrial projects in underdeveloped regions (Eastern UP, Bihar, Odisha, North-Eastern states, Rajasthan, Madhya Pradesh). They also fund special purpose vehicles (SPVs) for industrial clusters in such regions. For example, IDBI’s backward area development programs and SIDBI’s North-East development fund. Balanced regional development prevents mass migration, reduces social tensions, and ensures that the benefits of economic growth reach all citizens.

4. Supporting Small-Scale and Medium-Scale Enterprises (SMEs)

While commercial banks prefer large corporate clients (lower transaction costs per rupee lent), development banks specifically target micro, small, and medium enterprises (MSMEs) that face difficulty accessing institutional credit. Small industries lack collateral, credit history, and technical expertise—making them unattractive to commercial banks. Development banks like SIDBI (Small Industries Development Bank of India) and the small-scale industry windows of IDBI, IFCI, and ICICI provide: term loans for machinery, working capital, equipment leasing, and venture capital. They also offer technical consultancy, marketing support, and skill development. By supporting SMEs, development banks promote entrepreneurship, employment, and decentralized industrialization. Over 40% of India’s manufacturing output and 35% of exports originate from SMEs, justifying this objective.

5. Providing Long-Term Finance (Project Finance)

Unlike commercial banks that typically lend for 1-5 years (working capital, trade finance, consumer loans), development banks specialize in project finance—long-term loans of 5-25 years for capital-intensive projects (power plants, steel mills, refineries, ports, highways, housing projects). Project finance involves evaluating future cash flows of the project rather than the borrower’s existing balance sheet. Development banks also use innovative instruments: deferred payment guarantees (helping importers buy machinery), underwriting of equity shares (assuring capital raising), direct subscription to shares/debentures, and rupee and foreign currency loans. This objective addresses the critical gap in capital markets where long-term funding is scarce. Without development banks, infrastructure projects would remain unimplemented or rely on expensive, short-term commercial debt leading to frequent rollovers.

6. Promoting Export-Oriented Industries

Development banks aim to boost exports by providing finance to export-oriented units (EOUs), special economic zones (SEZs), and export-import (EXIM) financing. EXIM Bank of India (1982) was established exclusively for this purpose. Development banks offer pre-shipment credit (working capital to manufacture goods for export), post-shipment credit (bridging gap after shipment until payment received), term loans for export capacity expansion (factories, quality testing labs), financing for import of technology and machinery, and overseas investment finance. They also provide export credit insurance (covering political/commercial risk), advisory services on foreign markets, and lines of credit to foreign governments (tied to import of Indian goods). Export promotion earns foreign exchange, creates jobs, and helps achieve a favorable balance of payments.

7. Financing Infrastructure Development

Infrastructure projects (power, roads, ports, airports, telecommunications, railways, urban transport, water supply, and sanitation) have long gestation periods (5-10 years), high upfront capital costs, uncertain returns, and externalities (benefits not captured as revenue). Commercial banks are reluctant to finance infrastructure for maturities beyond 5-7 years. Development banks fill this gap by offering long-term infrastructure debt (10-25 years) along with takeout financing (selling loans after initial years to other lenders). IDBI, IDFC (Infrastructure Development Finance Company, now a bank), and the now-restructured India Infrastructure Finance Company Limited (IIFCL) have been key players. They also structure public-private partnerships (PPPs) with viability gap funding (government grants to make projects financially viable). This objective enables the creation of physical assets essential for economic growth.

8. Undertaking Entrepreneurial Development and Technical Assistance

Beyond mere financing, development banks aim to build entrepreneurial capacity in less industrialized regions and disadvantaged communities. They provide technical assistance: conducting feasibility studies, preparing project reports (detailed project reports or DPRs), identifying suitable technology and machinery suppliers, arranging technical collaboration with established firms, and providing management consultancy for turnaround of sick units. Development banks like SIDBI and NABARD run entrepreneurship development programs (EDPs) for first-generation entrepreneurs, women, scheduled castes/scheduled tribes, and rural artisans. They also fund skill development and vocational training. This objective recognizes that lack of technical knowledge and project management capability, not just lack of funds, is a barrier to industrial growth. Financial inclusion is incomplete without advisory inclusion.

9. Reviving Sick Industrial Units

Industrial sickness (units making losses with negative net worth) leads to loss of employment, waste of capital, and bad debts for banks. Commercial banks lack the specialized skills to diagnose causes of sickness (poor management, obsolete technology, marketing failure, labour problems) and implement revival plans. Development banks aim to revive viable sick units through: restructuring existing loans (extending tenure, reducing interest rates, converting interest into funded term loans), providing additional working capital, changes in management (appointing turnaround professionals), technical upgradation funding, and arranging mergers with healthier units. IFCI, IDBI, and ICICI historically had specialized rehabilitation departments. The Board for Industrial and Financial Reconstruction (BIFR, now abolished and replaced by IBC) worked with development banks. This objective preserves employment, saves capital, and reduces NPAs in the banking system.

10. Mobilizing and Allocating Long-Term Savings

Development banks aim to mobilize long-term savings from institutional sources (insurance companies, provident funds, pension funds, commercial banks’ statutory liquidity ratio or SLR funds) and channel them into productive long-term investments. They issue bonds and debentures (tax-free infrastructure bonds, deep discount bonds) attractive to long-term investors. They also access government refinance (from RBI, NABARD, or central government) and foreign currency loans from multilateral agencies (World Bank, IFC, ADB, JBIC). This objective addresses a capital market failure—mismatch between the long-term needs of industry and the short-term preferences of savers. By intermediating long-term savings (insurance premiums, provident fund contributions often held for 20-30 years) into long-term loans, development banks also provide savers with returns while making industrial investment possible. Without them, long-term savings would be underutilized.

11. Acting as Catalysts for Capital Market Development

Development banks aim to deepen and broaden India’s capital markets (stock exchanges, bond markets, mutual funds) by underwriting public issues, acting as merchant bankers, and promoting investor education. When a company wants to raise equity from the public, development banks underwrite the issue—guaranteeing to buy unsubscribed shares. This reduces risk for retail investors and ensures the company gets the required capital. Development banks have also set up or promoted: stock exchanges (OTCEI, NSE indirectly), credit rating agencies (CRISIL, ICRA, CARE), asset management companies (mutual funds), and the National Securities Depository Limited (NSDL). By demonstrating that long-term industrial investment can be profitable, they encourage private sector participation in capital markets. Over time, developed capital markets reduce dependence on development banks themselves (a form of institutional extinction or transformation).

12. Coordinating with Government Development Plans

Development banks in India (IFCI, IDBI, ICICI, NABARD, SIDBI, EXIM Bank) were established as instruments of national planning. Their objective is to align credit allocation with the government’s five-year plan priorities. For example, early plans prioritized heavy industries (steel, heavy electricals, fertilizers, petrochemicals), later plans focused on exports, information technology, infrastructure, and renewable energy. Development banks implement priority lending by offering subsidized interest rates (via government interest subvention), relaxed collateral norms, and technical assistance for plan-preferred sectors. They also finance state financial corporations (SFCs) and state industrial development corporations (SIDCs). This coordination ensures that scarce institutional credit is not misallocated to consumption, speculative activities, or luxury industries but directed toward national development goals as defined by the Planning Commission (now NITI Aayog).

Features of Development Banks:

Types of Development Banks in India:

1. Industrial Finance Corporation of India (IFCI)

Established in 1948, IFCI was India’s first development financial institution, created to provide long-term finance to the industrial sector in the post-independence era. It played a pioneering role in financing heavy industries such as steel, cement, textiles, and engineering. IFCI provided term loans, underwrote public issues, and offered guarantees to help industrial projects raise capital. However, following the 1991 financial sector reforms, the DFI model became outdated due to high-cost funds and asset-liability mismatches. Unlike IDBI and ICICI which successfully converted into commercial banks, IFCI remained a DFI and faced financial difficulties. Today, IFCI is a shadow of its former self, classified as a public financial institution but with significantly reduced lending operations. Its historical importance lies in demonstrating the need for institutional long-term industrial credit in a capital-scarce economy.

2. Industrial Development Bank of India (IDBI)

IDBI was established in 1964 as a wholly-owned subsidiary of the Reserve Bank of India to coordinate the activities of all financial institutions in the country. It served as the apex development financial institution, providing direct project finance, refinancing to other DFIs (IFCI, ICICI, State Financial Corporations), and undertaking promotional activities for industrial development. Throughout the 1970s to 1990s, IDBI was the dominant player in infrastructure and heavy industrial lending. However, with declining profitability due to high borrowing costs and the rise of commercial bank lending, IDBI was transformed into a commercial bank in 2004-2005. Today, IDBI Bank Ltd is a full-service commercial bank with the government and Life Insurance Corporation of India as major shareholders. Its conversion marked the end of the traditional DFI era in India, reflecting the policy shift toward universal banking.

3. Industrial Credit and Investment Corporation of India (ICICI)

ICICI was established in 1955 with World Bank assistance to provide long-term project finance to Indian industry, particularly in the private sector. Unlike IDBI and IFCI which focused on public sector and heavy industries, ICICI specialized in corporate lending, foreign currency loans, and investment banking. It pioneered many financial innovations in India, including leasing, venture capital, and retail finance. Following financial sector reforms, ICICI strategically converted into a commercial bank in 2002, becoming ICICI Bank. This was the first and most successful DFI-to-bank transformation. Today, ICICI Bank is one of India’s largest private sector banks. ICICI’s legacy demonstrates that development banking functions can be absorbed by universal banks, provided they maintain long-term focus while diversifying into retail deposits for cheaper and stable funding.

4. Export-Import Bank of India (EXIM Bank)

EXIM Bank was established in 1982 as an All India Financial Institution exclusively focused on financing exports and imports. Its primary functions include providing pre-shipment and post-shipment credit to exporters, term loans for export capacity expansion, foreign currency loans for import of technology and machinery, and lines of credit to foreign governments (tied to import of Indian goods). EXIM Bank also offers export credit insurance, advisory services on foreign markets, and financing for overseas joint ventures by Indian companies. It does not accept retail deposits but raises funds through bonds and from RBI. EXIM Bank plays a critical role in India’s trade policy by supporting export-oriented sectors (textiles, pharmaceuticals, engineering goods, services) and helping Indian companies enter challenging markets through government-backed credit facilities.

5. National Bank for Agriculture and Rural Development (NABARD)

NABARD was established in 1982 (replacing the Agricultural Credit Department of RBI and the Agricultural Refinance and Development Corporation) as the apex development bank for agriculture and rural development. Its primary functions include providing short-term refinance (crop loans) to cooperative banks and Regional Rural Banks (RRBs) through State Cooperative Banks, and long-term refinance (5-20 years) for investment credit such as land development, irrigation, farm mechanization, and rural infrastructure. NABARD also conducts inspections and supervises cooperative banks and RRBs, sets performance benchmarks, administers the Rural Infrastructure Development Fund (RIDF), and implements financial literacy programs. It raises funds through bonds, government allocations, and borrowings from RBI. NABARD also supports self-help groups (SHGs), watershed development, and rural livelihoods, making it unique among development banks for its multi-pronged developmental role beyond pure lending.

6. Small Industries Development Bank of India (SIDBI)

SIDBI was established in 1990 as the principal development financial institution for micro, small, and medium enterprises (MSMEs). It provides direct and indirect financing to MSMEs through: term loans for machinery and equipment, working capital, equipment leasing, venture capital, and micro-finance. SIDBI also refinances banks and NBFCs that lend to MSMEs and provides credit guarantee coverage through the Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE). Beyond finance, SIDBI conducts entrepreneurship development programs, skill development, technology upgradation assistance, and marketing support for small industries. It does not accept retail deposits but raises funds through bonds, government allocations, and from RBI. SIDBI plays a critical role in formalizing India’s vast informal MSME sector by providing institutional credit to first-generation entrepreneurs, women-owned enterprises, and units in backward districts.

7. National Housing Bank (NHB)

NHB was established in 1988 as the apex development bank for housing finance, with the primary objective of promoting affordable housing in India. Its functions include providing refinance to housing finance companies (HFCs), commercial banks, cooperative banks, and other primary lenders for housing loans to individuals and developers. NHB also registers and regulates housing finance companies (HFCs) under its supervisory powers granted by the RBI (after the 2019 transfer of HFC regulation to RBI, NHB retains limited regulatory functions). NHB issues tax-free bonds to raise funds, administers the Rural Housing Fund (for subsidized housing loans in rural areas) and the Urban Housing Fund, and implements the Credit Linked Subsidy Scheme (CLSS) under the Pradhan Mantri Awas Yojana (PMAY). It also conducts research and sets technical standards for housing and mortgage-backed securitization.

8. National Bank for Financing Infrastructure and Development (NaBFID)

NaBFID was established in 2021 as India’s newest development financial institution, created to address the large and growing financing gap in infrastructure projects (power, roads, ports, airports, railways, urban transport, telecommunications, water supply, sanitation). It provides direct long-term project finance (10-25 years), takeout financing (selling loans after the initial high-risk years to other lenders), and refinance to commercial banks for their infrastructure debt. NaBFID also plans to develop a deep corporate bond market for infrastructure by underwriting and investing in bonds issued by project special purpose vehicles. It raises funds through bonds (including green bonds), government allocations, and multilateral agency borrowings. NaBFID’s establishment acknowledges that commercial banks (facing asset-liability mismatch) cannot adequately finance infrastructure alone. It aims to complement NABARD (rural infrastructure) and SIDBI (small enterprises) in the large infrastructure space.

9. State Financial Corporations (SFCs)

State Financial Corporations (SFCs) are development banks established under the State Financial Corporations Act, 1951, operating at the state level to promote medium and small-scale industries within their respective states. Each state has its own SFC (e.g., Gujarat State Financial Corporation, Tamil Nadu Industrial Investment Corporation). SFCs provide term loans (5-10 years) for land, building, and machinery, working capital (in limited cases), equipment leasing, and underwriting of equity/debentures. They also offer technical assistance and entrepreneurship development programs. SFCs access funds from SIDBI (refinance), state government allocations, and bonds. Many SFCs have become financially weak due to high NPAs (politically influenced lending), inadequate recovery machinery, and outdated technology. The Narasimham Committee recommended merging weaker SFCs with stronger ones or closing them, but politically they remain because states view them as instruments of regional industrial promotion.

10. State Industrial Development Corporations (SIDCs)

State Industrial Development Corporations (SIDCs) are state-government owned entities that focus on promoting large industrial projects within their state, as distinct from State Financial Corporations which focus on MSMEs. SIDCs develop industrial areas (land acquisition, water supply, power, roads, drainage), provide term loans and equity participation to industrial units, and sometimes operate their own industrial units (hotels, sugar mills, cement plants). Examples include Maharashtra Industrial Development Corporation (MIDC), Andhra Pradesh Industrial Development Corporation (APIIC), and Karnataka Industrial Areas Development Board (KIADB). Unlike development banks at the central level (IDBI, ICICI), SIDCs focus on industrial infrastructure creation (land, utilities) and attracting private investment to their state. Their performance varies widely across states—industrially advanced states have effective SIDCs, while less industrialized states have weak, loss-making SIDCs often serving as extension of government departments rather than dynamic development institutions.

Sources of Funds for Development Banks in India: