Taking Stock

Infrastructure Financing Leads To Better World Economies

noreply@blogger.com (Prahelika-2011) — Tue, 11 Oct 2011 15:56:00 +0000

Why is financing important?

Financing is the act of providing funds for the development and growth of a business. A company acquires funds for the simple reason of increasing its capacity to spend on its requirements viz. machinery, raw materials, man power etc. The company in this sense increases its working capacity and improves upon its existing operations leading to better working margins. This in turn leads to a higher return on investment for the investors and therefore a better position for company as well. Thus it is a win-win situation for both the investors and the company. However, there are many factors one must consider before investing so as to analyse the level of risk and the expectancy of their returns.

Infrastructure financing

Infrastructure is the basic entity that allows a country or economy to function. Examples of infrastructure include transportation (roads, railways, ports, and airports), telecommunication, water resources, agriculture, energy etc. There is a need for large and continuing amount of investments in almost all areas of infrastructure in India as well as in the whole world. The main question here is “Who” will finance these projects and “How” will these projects get financed. In the past government used to finance these projects as these projects benefitted the entire population of the country and were also used to implement and maintain them throughout. But with the world economy changing so rapidly there is a definite need to externally finance these projects as government financing may not be the best and efficient way in the longer run.

Taking care of the environment

The thing to keep in mind is that large infrastructure projects can have substantial social and environmental impacts in the form of cutting of trees, exploitation of natural resources, relocation of people and construction related impacts on the environment. We have to ensure that people and environment are not being harmed as a result of this financing. Government environmental and social safeguard policies contain provisions to address these impacts. However the areas where it is not possible to avoid impacts, mitigation measures are designed and implemented in a sustainable manner.

Foreign Investments in Infrastructure Need Encouragement

The Government of India has been emphasising on the need for increased FIIs for the forthcoming years and has also eased the regulations for the same. We need to understand that a developing country like India stands to gain from these FIIs coming in from other developing and developed nations.

However it does not mean that the developed countries will comparatively gain less from these investments. It is a matter of inclusive growth and provision of sustainable development of infrastructure requirements of nations. The growth rate for developing nations like India and China stand at a commendable position and it would be in the benefit of the foreign investors to invest in their projects that ensure a growth rate of the projected magnitude. These investments act as a safe parking spot for their money.

The areas where these developed countries require investments can be different to the ones of the developing nations. The developed countries which have a good network of underlying infrastructure viz. road and rail networks, water resources, energy tapping infrastructure etc. also require an increase in the infrastructure investments for future benefits. They can therefore enter into mutual agreements and invest in those infrastructure projects in which developing countries have comparative advantage over them. By entering into such an agreement it can be a win-win situation for both of them.

For example, India has high requirement of infrastructure development in road and energy sectors and country X is efficient in both the sectors. Now the country X has an absolute advantage over India, however when opportunity costs are considered India has a comparative advantage over country X.

Now going by the theory of absolute and comparative advantage both countries stand to gain. They would enter into a mutual investment of projects that they are comparatively superior in leading to a benefit for both the nations.

Also the countries can use the Signalling Information for their benefit and gain from the Infrastructure Financing.

Other sources of infrastructure financing

Apart from foreign investments financing for infrastructure needs can be effectively done through PPP (Public Private Partnerships). In such models large private players invest in projects through which they ensure a long term profitable payback for themselves. In health sector PPPs exist from more than two decades.

Through PPPs in the health sector, the OECD and the BRIC nations will grow by 51% between 2010-2020 amounting to a total of $71 trillion. Such huge numbers are a huge potential for all to tap.

Creating an Infrastructure Bank is the Solution

As Fahrholz (2001) said that “the infrastructure financing needs of developing countries were going to run into the trillions of dollars over the next few decades and public institutions alone would not be able to pick up the tab”. To compete, they must build a competitive infrastructure in a matter of years. The solution to this problem is the creation of the Infrastructure banks in the developing countries. Almost every country in the world benefits from an infrastructure bank to attract the large-scale private capital that is essential to financing domestic economic self-sufficiency, competitiveness, and resiliency. The world today stands at an important crossroads. Infrastructure Banks can contribute to solutions in a difficult time. But the countries cannot rely upon these institutions alone to pay for necessary investments; “Innovative Finance” can surely contribute along with Infrastructure banks for sustainable development. Financial Innovation can be grouped as new products, new services, new production processes or new organizational forms. Of course, if a new intermediate product or service is created and used by financial service firms, it will help in the overall development of the nation.

Submitted By:

Ayush Deep
Vaibhav Garg
2nd Prize winners of Article writing Competition, held across B-Schools

Name of the Institute:

International Management Institute- New Delhi

Infrastructure Financing – Opportunities & Challenges

noreply@blogger.com (Prahelika-2011) — Tue, 11 Oct 2011 15:46:00 +0000

Introduction

Complex, capital intensive, long gestation periods that involve multiple and often unique risks to project financiers are some of the typical characteristics of an Infrastructure project.

Infrastructure projects are further characterized by non-recourse or limited recourse financing, i.e., lenders can only be repaid from the revenues generated by the project. Infrastructure projects are also exposed to several forms of risks like operational risk, completion risk, market risk, infrastructure risk, funding and legal risks. Infrastructure Projects have unique forms of risks due to the public interest nature of the projects. These typical characteristics of Infrastructure projects make Infrastructure Financing a tough challenge.

Government budgetary support and internal resources of public sector infrastructure companies have been the main source of Infrastructure financing for a long period of time. However in the span of last few years private sector has emerged as key cog in the wheel of Infrastructure Financing. However the regulatory policies limit the capacity of the banks and FI’s in meeting the requirements of Infrastructure sector.

RBI Norms for Banks and FI’s for Lending to Infrastructure Sector
Single Company	Group
20% of the capital funds for Infrastructure Projects #	50% of the capital funds for infrastructure projects $


# 25% with board’s approval	$ 55% with board’s approval
Capital Funds Include Tier I and II capital

Constraints are more than one and are not just regulatory in nature. However the biggest hurdle Infrastructure financing is faced with are financial sector constraints.

a.       Equity and Quasi Equity Financing constraints
b.      Restriction on ECBs
c.       Limited use of Takeout Financing
d.      Underdeveloped Bond Market and Lack of Long Term Financing

a. Equity and Quasi Equity Financing Constraints:

Raising adequate equity finance tends to be the most challenging aspect of infrastructure project financing, as equity typically carries the greatest level of operational, financial and market risk. Equity financing offers limited exit options at present which limits equity financing. Other constraints include a shallow capital market (albeit continuously improving), and weaknesses in corporate governance (primarily minority shareholder protection rights).

Mezzanine finance, which is a hybrid of debt and equity, is a debt capital with fixed payment or repayment requirements, but with the right to convert to an equity interest in a company is critical in funding infrastructure projects in developed countries, but is also limited in India. The basic reason for this is:

(i) The lack of a sufficiently large and varied pool of infrastructure projects, which leads to a preference among funding institutions to opt for more straightforward loans (rather than hybrids)

(ii) Interest rate caps on external commercial borrowing (ECBs), which prevent the precise pricing of different debt or quasi-equity instruments (like mezzanine financing)

b. Restriction on ECBs

New ECB guidelines encourage use of infrastructure financing. Despite this external funds are significantly low compared to the needs and the reason for this is the interest rate cap on ECBs (Libor+350 for loans more than 5 years). These caps do not seem commensurate to the risk of infrastructure projects. This also has implication on mezzanine financing as indicated earlier.

Constraint in utilizing foreign currency loans is the lack of a sufficiently deep forwards market in foreign exchange. Infrastructure projects require long tenor loans, and if financed through foreign currency borrowings these need to be adequately hedged against currency risks since few infrastructure projects have FOREX earnings to serve as a natural hedge. Inability to hedge long term currency risk in a market which is limited to one year’s forward cover poses a big challenge to the use of foreign currency loans in these projects.

c. Limited Take-Out Financing

In take-out financing, banks provide long-term infrastructure loans, featuring the loan being extinguished from the books of the financ ing bank within a pre-fixed period by another institution, say in seven or eight years of a loan with a tenor of 15 years to mitigate the possibility of an asset-liability mismatch.

Source: Economic Times, 24^th August 2011

Though takeout financing is not very common, it can give a fillip to infrastructure financing by addressing both the unwillingness and the lack of experience of institutional investors to participate in infrastructure financing. The main factors limiting the use of takeout financing include the following:

First, the presence of excess liquidity in the system reduces the need for banks to quickly circulate their funds, and hence, the appetites for innovative instruments like takeout financing. With limited number of ‘bankable’ projects in the fray and no liquidity crunch, banks have no inclination to sell out these good assets from their portfolio.

Second, high stamp duties reduce the attractiveness of takeout financing and securitization. Excessive rates of stamp duties in some states have stymied the growth in innovative financial instruments such as take-out financing and also securitization

RBI is now unwilling to allow banks to raise bonds to fund infrastructure. It has also not revised group exposure norms or individual borrowing limit. Breaching lending norms would result in constraints on prudential exposure norms. All these factors could boost demand for takeout financing. However, there are sceptics who say that it will be tough for infrastruc ture finance companies to promote take-out financing in a big way as in frastructure lending by banks has started picking up only in the last two three years. Many banks have not exhausted their infrastructure exposure limit. So there is a limited scope to take out big sums now. It will take some more time for recently funded projects to be eligible for takeout financing.

d. Underdeveloped Bond Market and Lack of Long Term Financing

Issues pertaining to development of government securities market, lack of market infrastructure and innovations in the corporate debt market are the basic reasons for the underdeveloped bond market in India.

Limited size of government securities and their trading activity has meant that there is no reliable benchmark yield curve. This is one of the key issues associated with development of government securities. This implies there is a need for the benchmark yield curve for government bonds. Absence of the same has been responsible for the poor development of the bond markets.

Similarly burdensome primary issuance guidelines have affected trading by being responsible for higher costs for raising debt, regulatory compliances’ costs, advertising expenses and intermediation costs to brokers and underwriters. This Market infrastructure also is inefficient in information dissemination leading to information asymmetry, and is also responsible for inefficient clearing and settlement mechanisms. These issues are of extreme importance as they are responsible for making markets illiquid.

In order to give a fillip to the infrastructure financing, India needs to adopt ‘market finance’

approach instead of the prevalent ‘contract finance’ approach. This can be achieved through Privatization and securitization .Private ownership of public investment projects will support a more efficient and successful infrastructure development in the country. Therefore it is imperative to explore the opportunities for securitization for improving the financing for the Indian infrastructure sector.

Submitted By:

Gunjan Sheth

Snehal Punjani

1st Prize winners of Article writing Competition, held across B-Schools

Name of the Institute:

Narsee Monjee Institute of Management Studies & MBA-Core

Enhancing participation of banks, financial institutions (FIs) and large NBFCs in infrastructure financing

noreply@blogger.com (Prahelika-2011) — Wed, 05 Oct 2011 18:27:00 +0000

Banks, FIs and large NBFCs play a vital role in infrastructure financing. But they are likely to face severe resource constraint. Going forward financing infrastructure is going to be a big challenge for the banking sector as projects require huge amount of funds and these Financial Institutions, Banks are restricted in a sense to maintain their asset-liability mismatch. These alternate sources of Finance will also need to hone their skills in appraisal and management of risks inherent in infrastructure lending. Financing of long-gestation infrastructure projects has long been a ticklish issue for project promoters as well as financial institutions.

Renowned banker Mr. Deepak Parekh has given various recommendations to Government of India for enhancing participation of Banks, Financial Institutions and large NBFCs in Infrastructure Financing. He made a two way approach to manage both Asset and Liability side and gave various measures to help the sources of Finance, participate in Infrastructure.

Under Asset side management, recommendation are for Securitization of Loans as it helps transform loans to tradable debt securities, and thereby facilitates financial institutions to not only address the exposure norm constraints, but also distribute risks more efficiently even among those who do not have the skills to appraise them. Further, he gave important recommendations regarding Rationalization of existing exposure norms of Financial Intermediaries. This can be done by relaxing the exposure requirements if intermediary can sell off the exposure in short interval of time, say 6 months. Take out financing for infrastructure projects, at present, conditional take out financing is subject to 100 percent risk weight for provision of capital by both the entities involved simultaneously (with the take-out financier using a credit conversion factor of 50% till the take-out happens), which results in i) maintenance of excess capital, thereby restricting take-out financier’s lending ability and ii) increase in the lending costs.

Under Liability side management of these Alternate Financial Institutions, he made points to enable banks/NBFCs to mobilize sufficient resources of suitable tenor and nature for infrastructure financing. Recommendations were made to allow financial intermediaries such as banks, financial institutions and NBFCs to raise foreign currency borrowings for on-lending to infrastructure sector. There is a dearth of long term resources in the domestic market, but not so in the international market. Since it is difficult for infrastructure companies to directly access foreign markets in view of the projects being sub-investment grade, inter-mediation of foreign funds by domestic financial intermediaries is imperative. Other recommendation was that the resources, whether domestic or foreign, raised by banks for a long tenor (say at least 10 years) by way of bonds/term deposits for investment in infrastructure assets should have no SLR requirement. This will reduce the cost of inter-mediation for infrastructure and hence, induce banks to have a relatively larger exposure to infrastructure than other sectors. In addition, this will encourage banks to use long term funds for long term lending. Further Banks should be allowed to raise long tenor gold deposits which will beused for the purpose of infrastructure financing.

What are Infrastructure Debt Funds:

http://www.youtube.com/watch?v=JnefbBtEi9E&feature=relmfu

Watch out Mr. Deepakh Parekh talking about these Infrastructure Debt Funds; Asset Liability mismatch for Banks:
Part 1

http://www.youtube.com/watch?v=BdSBIx23woI

Part 2

http://www.youtube.com/watch?v=qpwyfk7QNcw&feature=relmfu

The complexity of the investments and their long duration will require the creation of innovative instruments which spread out the risk judiciously among many participants. It is this ability to design instruments best suited to the risk profile of projects and then to allocate the risks to those best able to assume them that will determine the extent to which the specific issues in infrastructure financing will be addressed.

In the absence of specially designed instruments, these characteristics would preclude the effective participation of the banks which typically have a shorter time preference owing to their liability profiles. Further, as long as necessary appraisal skills and detailed knowledge of functioning of infrastructure markets are being developed, many banks may not be willing to participate in infrastructure financing. In this regard, Government and Reserve Bank of India are taking a number of steps. The Finance Minister, in his budget speech for 2011-12, had announced setting up of IDFs to accelerate and enhance the flow of long term debt in infrastructure projects for funding the government's ambitious programmes in the sector. Recently, he Reserve Bank today announced guidelines for permitting banks and Non Banking Financial Companies (NBFCs) to set up Infrastructure Debt Funds (IDFs), to help meet long-term financing for the sector. IDFs would be set up either as Mutual Funds (MFs) or NBFCs

Building and Sustaining of Public-private partnership: India's Perspective

noreply@blogger.com (Prahelika-2011) — Fri, 30 Sep 2011 17:24:00 +0000

Public–private partnership (PPP) describes a government service or private business venture which is funded and operated through a partnership of government and one or more private sector companies. PPP involves a contract between a public sector authority and a private party, in which the private party provides a public service or project and assumes substantial financial, technical and operational risk in the project. In some types of PPP, the cost of using the service is borne exclusively by the users of the service and not by the taxpayer. In other types (notably the private finance initiative), capital investment is made by the private sector on the strength of a contract with government to provide agreed services and the cost of providing the service is borne wholly or in part by the government.

Response of Private sector:
PPP models have grown in popularity around the world in recent years, with governments around the world finding it difficult to finance infrastructure investments through conventional route. Despite the emphasis placed on PPP in the Plan Documents, the private sector response to infrastructure development in India has been lukewarm for a number of reasons:

- Overlapping regulatory jurisdiction

- Improper design

- Appraisal and risk allocation mechanism under PPP

- Bidding transparency issues

- Project costs and time overruns considerations

- Inadequate financial market developments, PPPs in India typically rely on commercial
banks for funding exposing them to risk concentration

Probably a centralised PPP mechanism and a single window clearance of the project under direct investment route are called for at this juncture.

Challenges faced by India in PPP:
Although the government is committed to rely on PPPs significantly in the provision of infrastructure services, it is facing a variety of challenges — big and small — in translating its intent into action. It was noted that, in trying to scale up its program, India was facing the same challenges that other countries have also faced, namely:

- How to marry private sector motivation for profit with public sector concern for public service (the need for inclusiveness)

- How to apportion risk in a manner that is fair, rational and sustainable;

- How to manage the partnership through a tightly-framed concession agreement over a 20–30 year period, in a rapidly changing environment;

- How to develop capacities in the concerned financial institutions so that they are able to
appraise projects which have a life span of 15–20 years, since effective due diligence by
these institutions will be critical for proper screening of PPP proposals brought to them by
developers.

Steps taken by Government:
We hope that proactive steps taken by Government in this regard (see Figure 1) will help us, to overcome all challenges and will give a boost to Infrastructure development in India through PPP. In this regard, the Union Finance Minister, in the Budget speech for the year 2011-12 has announced that It is our endeavour to come up with a comprehensive policy that can be used by the Centre and the State Governments in further developing Public-Private Partnerships.

Pursuant to this announcement, Department of Economic Affairs, Ministry of Finance has prepared the draft National PPP Policy and solicits views / suggestions from all stakeholders by 15th October, 2011.

Click on the link below to know more about draft of National PPP Policy.
http://www.pppinindia.com/draftpolicy.php

Future: The Growing Pool of International Financial Investors
Financial investors, from India as well as abroad, has welcomed the Indian government’s commitment to embrace PPPs, and see this as an exciting business opportunity. India can take advantage of the growth of the heightened global interest in infrastructure assets. In addition to investors from Canada and Australia, who are already active in this segment, investors from Europe, the Middle East and North America are increasingly looking for opportunities in infrastructure. However, in order to be able entice these investors, India’s PPP program should offer a sizeable pool of infrastructure concessions that are up and running, with a reliable stream of cash flows. To be able to do this, it has to first transition from the present state, which is characterized by contractor-led growth and the dominance of trade players. Also, it has to increase the role of financial investors in PPP projects.

Suggestions:
Government could aid private sector participation in PPPs through expeditious awarding of contracts, facilitating land acquisition and ensuring better coordination between the centre and states. In particular, large size PPP projects may be put out for bidding after obtaining mandatory clearances and approvals — say, through a Shell Company/Special Purpose Vehicle (SPV) — as was recently done in the case of the Ultra Mega Power Projects; Information on the development of PPPs, prior to their being bid out, would be appreciated by the private sector, perhaps as part of a national database; The tax regime applicable to dividends paid out by SPVs needs to be rationalized; currently, in cases where a holding company is implementing multiple projects through SPVs, dividends are being taxed twice, first at the level of project-specific SPVs and then at the holding company level; The entry of financial investors will introduce a longer-term perspective than construction-oriented concessionaires, and this can be encouraged by allowing concessions to be more tradable; The government should take measures to deepen debt markets and encourage insurance funds to invest in infrastructure projects. Moreover, four major areas need urgent attention: the country needed a stronger policy and regulatory framework both at the centre and states; it needed appropriate market instruments and the capacity to raise long term equity and debt; the shelf of bankable PPP projects had to be expanded, and the government had to strengthen its capacity to manage PPP projects.

India’s Infrastructure Challenges

noreply@blogger.com (Prahelika-2011) — Mon, 26 Sep 2011 17:59:00 +0000

The Economic Survey 2010 – 2011 talks about robust growth and steady fiscal consolidation of the Indian economy in the year 2010-11 so far. Despite high economic growth, business opportunities in India also present some risks. In order to support this robust economic growth, India will need to improve the road & rail transport, highways public infrastructure and general transportation system.

India’s ability to grow manufacturing sector is being hampered by overcrowded roads and highways, the average productivity of a truck in India being 400 kms a day. When it comes to seaport, India is still using armies of people to unload cargo from trucks and lug it onto ships. According to Shashank S. Kulkarni , Secretary General, Indian Private Port and Terminal Association, around 95% of the total foreign trade is carried out via ports but congestion seems to persist here also on account of delayed evacuation of cargo due to inadequate road and rail capacity. Inadequate and sporadic power supply also lead to heavy wastage and reduced industrial output. In some cities it is not uncommon for power utilities to cut off power supply at least one day a week to relieve pressure from the grid.

Broadly, Infrastructure Problems in India can be classified into two parts:

Urban infrastructure problems in India
Rural infrastructure problems in India

Urban infrastructure problems in India is an age old problem. The Infrastructure problems in India mostly took a back-seat in the economic development policy drafts. The meagre budgetary allocation to arrest infrastructure problems in India has so far proved to be too little to keep pace with other areas of business development in India. Moreover, the tremendous growth of Indian IT, telecommunication, manufacturing, and pharmaceutical industries has consumed the limited world class urban infrastructure available in India.

The Urban infrastructure problems in India are:

Urban residence
Business premises
Power
Urban transport
Water
Sewerage
Airports
Railways
Seaports
Roads
Bridges
Tourism infrastructure
Solid waste management
Projects in SEZ
Health care
Entertainment
Communications

Rural infrastructure problems in India have gone from bad to worse in recent years. However, the government of India has taken some important steps to arrest the age old problems of rural India, such as:

Connecting 66,800 habitations with all weather roads
Construction of 1,46,000 km of new rural roads
Upgrading 1,94,000 km of existing rural roads
Allocation of investment to the tune of ` 1,74,000 crore envisaged under “Bharat Nirman”.
Providing a corpus of ` 8000 crore for Rural Infrastructure Development Fund (RIDF).

With around 600,000 villages and 70% of its population in rural India, the need of the hour for the government is to develop proper rural infrastructure for the masses in India. The immediate focus area should cover but not be confined to the following areas:

Power
Irrigation
Drinking Water
Rural housing
Roads

Health care
Education
Telecommunication

Challenges in Infrastructure Financing:

One of the key constraints in infrastructure financing is the lack of availability of risk capital to support debt raising. Adequate flow of equity capital into infrastructure sectors has not been forthcoming, despite the fact that the domestic equity market is well developed. This underlines the need for developing the market for other forms of risk capital such as mezzanine financing, subordinated debt and private equity. Shortage of risk capital in the domestic market is also grounds for seeking larger FDI into infrastructure, which would not only narrow the risk capital gap, but also usher in requisite skills to implement and monitor projects in line with global best practices.

PPPs presented an opportunity to meet India’s investment needs that can be translated into a win-win situation for all. Elaborating on the challenges that India faces in this regard, four major areas need urgent attention: the country needed a stronger policy and regulatory framework both at the centre and states; it needed appropriate market instruments and the capacity to raise long term equity and debt; the shelf of bankable PPP projects had to be expanded, and the government had to strengthen its capacity to manage PPP projects.

Ways to address infrastructure issue

Some Indian companies with large volume turnover of material work in 2 or 3 shifts to address infrastructure issues. Companies that do not have the option to be located in technology parks choose to operate outside the normal business hours to cope up with the issues of power cut in their areas. In fact, recently Maharashtra Government has proposed to frame a policy to supply power on concessional rates to industries that operate units during the off-peak hours, mainly at night time.

Although work can be carried out in several shifts, the standard operating procedures are consistent and transferable so as to remove any production variances. Therefore, standard such as ISO 9001:2008 is highly critical to enhance the organisational outcome in order to reduce variances of quality on the operational floor and risks associated with quality defect.

When it comes to implementation of quality management system, some companies also adopt the concept of ‘just in time’ system which minimises inventory held by a firm, and can be supplied at convenient time (perhaps even at off peak times). Factories can then ship out smaller quantities, in smaller vehicles with quicker turnaround time. Hence, this helps avoiding time wasted in the traffic jam during peak hours. However, delivering the same consistency, irrespective of how small is the quantity produced and the frequency of their delivery method can be difficult.

This is why world’s leading companies implement an effective management system based on ISO 9001 standard to ensure quality consistency and to also reduce risks associated with production default. Large organisations also ask their suppliers (and in many cases make it mandatory) to be certified to ISO 9001 management system standard in order to reduce chances of product recall or customer grievances. Some researchers also observed that companies with ISO 9001 certification perform better in long term than those who are not certified.

Several other initiatives that can be taken in the regard of Infrastructure financing as a challenge, which are classified under the following major heads.

A. Development of domestic debt capital market

B. Tapping the potential of insurance sector

C. Rationalizing banks’ and NBFCs’ participation in infrastructure financing

D. Fiscal recommendations

E. Facilitating equity flows into infrastructure

F. Inducing foreign investments into infrastructure

G. Utilizing foreign exchange reserves

Infrastructure Development in India Has a "Huge Entrepreneurial Element", says Vikram Limaye

noreply@blogger.com (Prahelika-2011) — Sat, 24 Sep 2011 18:01:00 +0000

Entrepreneurs have played a leading role in this arena, points out IDFC executive director Vikram Limaye in an interview with India Knowledge@Wharton. Limaye believes the private sector's participation in the country's infrastructure development will increase in the coming years, but cautions that India will now have to compete with the rest of the world to attract the necessary investments.

Characteristics and Major Sources of Infrastructure Finance

noreply@blogger.com (Prahelika-2011) — Fri, 23 Sep 2011 18:03:00 +0000

Characteristics of Infrastructure Finance
Choose any point in time in the past 5 years and you’ll find that investment in global infrastructure portfolios have outperformed investment in global equities. What we are witnessing is rise in infrastructure as an attractive asset class that benefit from a supply/demand mismatch.
Infrastructure projects differ in some very significant ways from manufacturing projects and expansion and modernisation projects undertaken by companies.
1. Longer Maturity: Infrastructure finance tends to have maturities between 5 years to 40 years. This reflects both the length of the construction period and the life of the underlying asset that is created. A hydro-electric power project for example may take as long as 5 years to construct but once constructed could have a life of as long as 100 years, or longer.
2. Larger Amounts: While there could be several exceptions to this rule, a meaningful sized infrastructure project could cost a great deal of money. For example a kilometre of road or a mega-watt of power could cost as much as US$ 1.0 mn and consequently amounts of US$ 200.0 to US$ 250.0 mn (Rs.9.00 bn to Rs.12.00 bn) could be required per project.
3. Higher Risk: Since large amounts are typically invested for long periods of time it is not surprising that the underlying risks are also quite high. The risks arise from a variety of factors including demand uncertainty15, environmental surprises16, technological obsolescence (in some industries such as telecommunications) and very importantly, political and policy related uncertainties.
4. Fixed and Low (but positive) Real Returns: Given the importance of these investments and the cascading effect higher pricing here could have on the rest of the economy, annual returns here are often near zero in real terms17. However, once again as in the case of demand, while real returns could be near zero they are unlikely to be negative for extended periods of time (which need not be the case for manufactured goods)18. Returns here need to be measured in real terms because often the revenue streams of the project are a function of the underlying rate of inflation

Major Sources of Infrastructure Finance
The government is unable to fund the increasing demand in infrastructure investment and so the private sector project financing is stepping in to fill the gap attracting investors’ interest at record levels into this emerging asset class, once considered the domain of municipal governments. For project development, several forms of financing can be sought, from initial feasibility and project initiation financing through construction and longer term project operations. Various sources of Infrastructure Financing are Equity, Long-Term Debt Market, Commercial Bank Loans , Fixed-Rate Debt Market , International Capital Market , Supplier Credits , Governmental Assistance , World Bank Loans , Inter-American Development Bank , Local Sources of Capital
Although the emerging markets financial crisis of the past two years has severely affected the volume, flow and risk profile of international investment projects, the elements presented below remain relevant. An overview of various public financing instruments presented, along with a brief discussion of the evolving Asian bond market and its importance in financing Asian growth within the coming decade. Below we discusses seven forms of financing often encountered in project development.

SOURCES & TYPES OF FINANCING
1. Feasibility Studies and Demonstration Projects: Loans or grants provided by governments, such as the US Trade and Development Administration, for financing the costs of preparing feasibility studies, business plans and in limited very defined cases, demonstration projects.
2. Venture Capital & Infrastructure Funds: Start-up financing from traditional venture capital groups for new enterprises is not usually available for international infrastructure projects, due to the high cost of due diligence and limited exit options for these firms. Typically, high rates of return, often 25-50%, are also required. However, a number of special purpose international investment funds have been created by large insurance companies and other major corporations for investing in major infrastructure projects.
3. Non-Recourse or Project finance: Refers to projects financed on the basis of projected cash flows of the project rather than on the credit worthiness of the borrowers or project's sponsors. Understanding and allocating risks among all parties are key components in project finance, and extensive project preparation and documentation regarding purchase or supply contracts and other documentation is required . Also, because lack of collateral, lenders require substantial equity participation by project developers. Large scale infrastructure projects having significant components of exported equipment, such as power generation projects, may have the following typical BOT project financing structure:
4. Corporate Finance: Corporate finance, in contrast to project finance, bases debt and equity financing on a corporations project earnings and balance sheet, with its asset base as collateral for the debt financing. This form of financing is only available to financially strong established companies.
Equity Financing involves providing funding in return for an ownership interest in the project or enterprise. Returns are in dividends on equity shares and in appreciation in share values.Debt Financing involves loans secured by the assets of a corporation or project. Lenders typically require substantially more collateral than their exposure, which usually means that major portions of a project, often 25-50%, be finance through equity.
5. Export Credit Finance: Export credit finance, also termed trade financing, can be available to finance the export of goods and services from countries. It usually requires letters of credit from qualified local banks to assure repayments to the lenders in the exporting country.
6. Public Finance & Bond Funding: Public finance, often termed municipal or special authority borrowing, addresses public sector projects, and increasingly public-private integrated projects. Resulting project debt are usually based on overall tax revenues (general obligation bonds) or targeted revenues streams from specific projects (revenue bonds).
Whereas until recent years the distinction between public and private financing was mostly clear, in recent years integrated public-private revenue and cost-risk sharing arrangements are creating hybrid structures where public or private financing distinctions are not completely separate. (See discussion of Asian bond financing below).
7. Guarantees or Credit Enhancement Programs: Multilateral agencies, national governments and other sponsors often provide insurance, guarantees or other forms of credit enhancement mechanisms such as subordinated debt in order to make projects more attractive to investors or project lenders or investors. These credit enhancement mechanisms help reduce and reallocate project risks among lenders and investors in order to make project more attractive.
Public Finance Instruments: There are many type of public finance instruments. These include: general obligation, tax increment, sales tax and assessment bonds; revenue bonds related to industrial, power supply, water supply-wastewater treatment, airports, ports, solid waste disposal, parking, mass transit and other revenue producing projects or programs.
Other types of public finance instruments include refunding bonds, grant and bond anticipation notes, commercial paper, variable rate demand notes, leveraged leases, sale/leasebacks, lease financing certificates of participation, swaps, instalment sale contracts and other secondary market derivative products.

Investment in Infrastructure: Some facts based on Data

noreply@blogger.com (Prahelika-2011) — Tue, 20 Sep 2011 18:35:00 +0000

In the previous article, we showed the current scenario of Infrastructure in India, the stages various projects in Infrastructure are in, the investments India would need and the deficits we are facing for the same. Let us dig deeper into the issue and find the gap between the planned and actual investments and what measures Government can take in this regard.

India’s infrastructure spending has fallen well short of its economic growth, with the investment ratio (investment as a percentage of GDP to the GDP growth rate) declining from 50 between 1988 and 1997 to 38 between 1998 and 2007. In the Eleventh Five Year Plan, the government committed to increasing gross capital formation from 4 to 9 percent of GDP during the Plan period. The massive target set by the Eleventh Plan (see Fig. 1 below) would amount to 28 percent of the total infrastructure investment planned by emerging markets and is second only to China’s planned investments. Further, much of this investment, about one-fourth in core infrastructure, is expected to come from the private sector. Improving macro-fundamentals, easier access to and attractive fiscal incentives for private and foreign capital, and greater ability to pay user charges as a result of improved economic growth, are boosting private investment in India’s infrastructure. However, structural and regulatory barriers that impede the flow of domestic capital into infrastructure— asset liability mismatch and exposure limit issues for banks; the high pre-emption of funds from the banking system; investment restrictions on long-term savings mobilises, namely insurance, pension and provident funds; the shallowness of the bond market; and constrained supply of External Commercial Borrowings (ECB) will hamper funding to the sector. Further, the global economic slowdown and rising interest rates make project funding for infrastructure more expensive and financial closure more difficult. All these factors will create a shortfall of US$150 billion to US$190 billion in capital available for infrastructure projects. While most of the shortfall will occur in debt capital, equity flows to PPP projects will also be threatened by various structural barriers.

Figure 1

To avert a situation that India can ill afford, the government could consider several policy reforms and interventions to stimulate capital flows into infrastructure. Such measures include various steps to remove bottlenecks to flows from existing sources of capital, for example by allowing banks to raise resources through long- term bonds exempt from statutory reserve requirements, and easing norms for insurance companies and pension funds to invest in infrastructure assets. These measures may also include encouraging new investor groups to invest in emerging infrastructure, such as mutual funds, overseas infrastructure funds and pension funds, and replicating other successful mechanisms to channel funds into the sector. In addition, the government could also consider direct financial participation in infrastructure. This could be through refinance support to infrastructure lending by commercial banks, credit enhancement of infrastructure instruments, or direct investment in hybrid debt or equity issued by infrastructure companies through an Asset Management Company (AMC) structure.

Figure 2

While a combination of these initiatives can significantly reduce the gap foreseen between planned and actual investment, the flow of capital may prove insufficient unless supported by government measures to improve creation, uptake and execution of PPP projects. The government and key nodal agencies must address various challenges to project implementation, including land acquisition, risk allocation and contract enforceability, as a means to improve the risk-return equation for private sector players.

INFRASTRUCTURE FINANCE- BUILDING INDIA

noreply@blogger.com (Prahelika-2011) — Sun, 11 Sep 2011 18:37:00 +0000

The importance of infrastructure for sustained economic development and improving the living standards of the population is well recognized. Yet, millions of people, across the world lack access to roads, transport, electricity, safe drinking water, proper sanitation and communication facilities. Inadequate and inefficient infrastructure not only adds to transaction costs but also prevents the economies from realizing their full growth potential.
With Indian economy moving on a high growth trajectory facilitated by a consistent and steady growth of 8 - 9% in the recent years, there is a critical need to accelerate investments in the infrastructure sector. In fact, infrastructure has emerged as a key driver for sustaining the robust growth of the economy and the government has been focusing on development of infrastructure.

India’s infrastructure build-out envisages investments of close to US$500 billion, with US$430 billion of this in the core transport and utility sectors. About one-fourth of this investment is expected to be met through Public-Private Partnerships (PPP). Successful implementation of this ambitious plan depends on four interdependent factors namely, the creation of adequate projects for tender by government agencies, the uptake of available projects by private sector developers and cash contractors, the financial closure and start of construction, and finally, the execution of projects on-time and within budget. India faces multiple challenges along all these dimensions in its quest to reach the targets set by the Eleventh Plan. To date, India’s success across sectors has been mixed. Capacity under construction or fully constructed relative to the Eleventh Plan (an integrated measure of the first three dimensions mentioned above) reveals that only the power sector is on track, achieving 100 percent of planned capacity, while the ports sector is at 85 percent, the airports sector at 75 percent 2 and the roads sector at 50 percent (including the National Highway Development Program (NHDP) that has achieved only 10 percent of planned capacity).

But even assuming the bottlenecks in project creation, uptake and execution are tackled; India is on course to a deficit of US$150 billion to US$190 billion in financing core infrastructure sectors. Structural impediments in the financial system coupled with the global credit crisis will constrain capital flows to the sector, perpetuating the deficit in core public goods and persistent inefficiencies in the economy. These consequences can be forestalled only by expeditiously reforming the financial sector to eliminate impediments to existing sources of capital, allowing new investor groups into infrastructure projects and adapting innovative mechanisms to channel investment into the sector.

Nevertheless, the infrastructure sector provides a large opportunity for financial sector players, with potential revenues of US$10 billion to US$12 billion between the financial years 2010 and 2014,3 and a revenue pool of US$25 billion to US$29 billion beyond 2014.4 Several project models with different risk-return implications are available for capital participation across all core sectors. Success will lie in building a profitable business model that earns a high sustained return on capital.

Regional Rural Banks: The Way Forward

noreply@blogger.com (Prahelika-2011) — Tue, 26 Oct 2010 14:38:00 +0000

Catalyzed by the growth of the domestic economy, the banking sector in India has come of age. However, the recent slowdown and fears of a global recession have put the Indian economy and the banking sector on the lookout for new avenues of growth. Rural Banking, which has hitherto been a slow growth sector, could prove the next development engine for Indian banks.

The Regional Rural Bank (RRB), an innovative feature of Indian banking, emerged from India’s early aspirations for a stronger institutional arrangement to develop a savings culture in the rural eco-system, provide rural credit and agricultural finance, while enabling poverty elevation. RRBs are usually 50 per cent owned by the Central Government, 15 per cent by a State Government, and 35 per cent by a Sponsor Bank. These banks have been at the centre of controversy for the last few years.

The establishment of RRBs heralded a new era in Indian banking, with the initial expectation that these banks would contribute to bridging the gap between the rural poor and the urban rich. But over the years it has been found that rural credit has been associated with poor recovery and high cost of servicing. Despite multiple attempts by several outstanding economists towards analyzing this problem of rural credit, the problems are far from being resolved. They appear to be compounded in fact.

The total count of RRBs has come down to 82 from the previous figure of 196 as on March 2010. This reduction has resulted due to the amalgamation process of these banks which was introduced by the Reserve Bank Of India (RBI) in 2005, with an objective to strengthen and consolidate the RRBs. Further, the recommendations of the KC Chakraborty-led committee on the financial status of these banks, recommending a recapitalisation requirement of Rs. 2,200 crore for 40 of the 82 RRBs are under examination. Other measures initiated to expand the outreach of these RRBs include a target to open 2000 branches by March 2011, and the requirement to migrate to Core Banking Solution (CBS) by September 2011 (21 RRBs have already achieved 100% CBS status). The Sponsor Banks would provide the required support to the RRBs sponsored by them for this purpose.

The problems plaguing these banks are manifold. An illustrative list would include low recovery, high Non-Performing Assets (NPAs), low business level, low productivity per branch and per staff, high cost structure, poor financial management, and limited areas of
operation, besides a non-viable level of operation in branches located in resource-poor areas. Further, RRBs have also been lagging behind in the use of technology and growingly losing their business to other commercial banks.

While other rural financial services providers like Scheduled Commercial Banks and private banking entrants have robust processes for functions ranging from HR to product development, RRBs are largely insulated in operation and lag behind their commercial counterparts in efficiency and rationalization of processes as well as in governance mandates.

Despite being present for 26 years, the RRBs have been able to establish just over 12000 branches in rural areas. But other public sector commercial banks, although not specifically meant for rural areas, have more than 19000 branches in rural areas. Further, the lack of adequate infrastructure support, which translates into high project preparation costs and risk aversion among sponsor entities, and consequently the inability of most RRBs to retain qualified managers, affect the growth and the discharge of their operations.

At more than 40 per cent for most RRBs, the high ratio of operating expenditure to other expenditure, is another persistent problem that has affected the profitability of RRBs. Salaries and allowances to staff, and maintenance of offices constitute the largest chunk of this expenditure. Though automation of operations can lower the operating expenditure, even elementary mechanization remains a challenge for several of these banks. Basic automation, like the Advanced Ledger Posting Machine, for end-of-day reporting, is yet to reach a significant number of RRBs. Lack of automation also hampers reporting and MIS, which in turn results in poor visibility into business and operational parameters, critical for management-driven business decisions.

Few RRBs are up to the rigours of channel expansion and customer segmentation, mandatory to conduct business in today’s fast changing times. Most RRBs also lack a robust product innovation agenda to deliver relevant offerings, factoring in the need for customer convenience and flexibility, increasingly critical in today’s highly competitive and dynamic rural marketplace.

The failure of these banks has put a question mark on their functioning to an extent that the RRB restructuring has also been debated at length without a resolution of the problems of this sector. All the alternatives, viz., merger with the sponsor bank (Khusro Committee), merger into rural subsidiaries of commercial banks (Narasimham Committee), and the merger of all RRBs into a nation-wide National Rural Bank could not be implemented due to various reasons.

I feel there is a strong case for merging these RRBs with their respective sponsor banks. As pointed out by a report of the Agricultural Credit Review Committee (1987), submitted in August 1989, “Once the RRBs are merged with the commercial banks with their wide range of lending, the scope for internal cross-subsidisation also widens and the losses on account of having to service the weaker sections can be offset by earnings from the higher interest-yielding loan portfolio of the banks.” The merger will result in a covert but desirable transfer of income from the rich to the poor. The commercial banks whose staff is exposed predominantly to an urban culture can benefit immensely from the services of the staff of the RRBs who have exposure to the rural environment, and consequently are familiar with the local people, their peculiarities, and their problems.

Besides, and most importantly, technology can be an enabler. A robust technology solution can help RRBs break through the insular mould, share information, reuse data and business logic, deliver one view of the customer, and sustain fruitful relationships in the long term, thereby enabling them to confront several current market and business challenges.

The one-size-fits-all approach restricting the offerings of the RRBs to a skeletal spread of microfinance for Self Help Groups, and small loans and deposits is no longer feasible. They must cater to the rural market’s need for a comprehensive range of banking and insurance products arising from diverse customer segments ranging from the agri-based sector, the cottage and small scale industry, and artisans. Technology can be leveraged to build a knowledge repository by consolidating knowledge about products, customers, systems, processes, revenue and practices. This would provide the RRBs with an integrated, 360-degree view of themselves. Such consolidated knowledge would serve as intellectual capital which can be realized by proactively sharing it with all stakeholders – both within and outside the bank. It can also form the basis of information sharing between RRBs for mutual risk-mitigation from poor credit and eventual gains. Further, employees will be empowered with the knowledge necessary to sustain and grow business. They will also have the wide-ranging information to match customers with tailored financial products and services that fulfil their needs and enable mapping of processes to the business challenges.

Such an operational environment would make it easy for an RRB to standardize processes for all services, besides introducing the much needed intelligence into the RRB organization, and empowering it to chart a successful and sustainable future road-map, which in turn can strengthen profitability.
Specialized and innovative schemes to improve rural penetration, like no-frills credit cards, franchisee networks, supply chain financing for agriculture, and cross-selling of products, would complement the above. At the core of these initiatives lies sophisticated yet reasonably priced technology - playing a significant role both in effective operations and delivery.
The original mandate of promoting profitable banking with a rural focus will be an enduring phenomenon, only when the RRB is able to deliver customer-relevant products with optimal operational efficiency and ensure the functioning of a sustainable and viable business. With 80% of RRBs in rural India, this would serve the larger cause of financial inclusion as well.

Written By:
Purnima Kataria
PGDM II
International Management Institute

Innovation in Financial Inclusion

noreply@blogger.com (Prahelika-2011) — Thu, 21 Oct 2010 20:09:00 +0000

India’s financial system has developed tremendously in the recent years. Gradual reforms in the sector have held the economy in good stead. The relative immunity of the sector to the global financial crisis is testimony to the good health of India’s financial system. Having said that it, it cannot be ignored that significant bottlenecks exist in the system which need to be urgently dealt with. Financial services remain inaccessible to majority of the population particularly in rural areas. The trickle down approach can clearly not be expected to yield any results in this particular sector as the concerned issue is of accessibility.

Financial inclusion has been the aim of the Central Banking in India for many decades. However it has continued to be only a much coveted end goal with the path towards it not being deliberated enough. Many structured initiatives towards financial inclusion have been seen in the past by the government and the Reserve Bank. Some of these include rural branches for all scheduled commercial banks and sector wise percentage requirement in total loans for agriculture and SSIs. Without undermining the importance of these endeavours it can be claimed that these are not necessarily the ones that would drive financial inclusion in India in the years to come. In a country where adult literacy rate is only 66% (2008, UNICEF) the awareness and understanding of financial services still remains desirable. For majority of the population awareness of a model alternate to the local moneylender is virtually nonexistent.

The prerequisite for an economy with access of the masses to financial services is an adequate level of social and physical infrastructure, the absence of which poses an impediment in the process of financial inclusion. It is too late in the day to wait for our society to first achieve the desired social infrastructure and then move towards financial inclusion. The players in the financial sector including the regulator and all other institutions

The business model of traditional banking is extending loans to individuals and institutions on the basis of credit worthiness. A higher level of credit worthiness implies a lower cost of borrowing and vice versa. The issue for prospective borrowers in rural areas is that low degree of credit worthiness is coupled with an inability to pay a higher cost of borrowing.

Thus commercial banks are sceptical of extending loans to rural clients. The low amount of loan per capita also renders it infeasible to tread the paths of rural areas.

It is in light of such unique challenges that creative models for financial inclusion will have to take precedence over the conventional forms of credit growth that have been prevalent for years. One innovative idea that has become popular in many Asian countries is micro finance where a combination of community pressure and assistance ensures that loans are serviced by the borrowers. Branchless banking is another important initiative which is expected to yield results as access to information and communication technology increases. Third party business correspondents such as other financial institutions are also in branchless banking in handling account opening, conducting transaction etc.

Many other endeavours have been introduced in the recent years. A common thread that runs through all these is that they seek to deal with the either the problem of distribution of credit or disproportionate amount of credit risk for rural areas. Measures possessing scalability in dealing with these issues will help in achieving the target of making economic growth more inclusive for Indian economy.

Technology is the enabler that financial institutions will increasingly use to deal with the issue of distribution. But this will essentially become the point of parity in the long run. It is innovation in dealing with enhancing credit worthiness that will become the differentiating factor and decide the fate of India’s financial development. Transferring credit risk from high risk to low risk entities and eventually to risk aggregators will help in mitigating risk of the ultimate borrower. Some mechanisms for this can be reinsurance and securitization.

Mutual funds that invest some percentage of its portfolio in cooperatives and micro finance institutions will help in transfer of credit risk from high risk small borrowers. It is in implementing such a transfer of risk that an integration of large scale financial institutions with small localized financial institutions assumes importance.

Financial innovation has been popular in the economies of the developed world. Mechanisms of transferring risks away from high risk entities have helped in offering financial services to most segments of the economy. Such a model has also posed magnanimous problems as can be seen in the US Subprime mortgage market in 2007. India and other developing countries have the advantage of having witnessed a model of risk transfer that has failed. It is thus an opportunity to leverage form the lessons learnt by the whole world to develop a model of financial inclusion through our own customized approach of risk transfer and mitigation.

Written by
Aparna Kaicker
PGDM II
IMI, New Delhi

Responsible Lending

noreply@blogger.com (Prahelika-2011) — Tue, 19 Oct 2010 19:40:00 +0000

In a globalised world with a high degree of transparency and information flows, socially and morally appropriate behavior is becoming increasingly important for all market participants. Responsible Lending has become a catchword in financial system development.

International scenario

Over the past few years, the microfinance sector in developing countries has experienced enormous growth rates. Enterprises and the people in general in many developing countries now have significantly better access to financial services. This has contributed to economic growth and greater prosperity, including among relatively poorer groups of the population. Yet, despite these positive impacts, the upward trend has also shown its downside and created new pressures of competition and sharper expectations which must be addressed, to ensure that the sector achieves its potential and the desired growth rates. These include a range of issues associated with the legal and regulatory framework, transparency and fair practices, ownership structures and corporate governance, institutional & operational capacity, sustainability of operations etc.

Indian Perspective

The micro finance sector in India has witnessed exponential growth, particularly in the last two years. Today, the top 10 MFIs account for around 70% of the market share. The growth has created new pressures of competition and sharper expectations to surpass the standards reached by the MFIs. Managing this growth is the need of the hour. Thrust towards Responsible financing and self regulation by all the stakeholders in the sector is undoubtedly a timely and welcome step.

Responsible Finance includes practices designed to create a fair balance of interests between MFIs and its customers, employees and business partners on the one hand and with their shareholders and refinancers on the other hand. Hence, it affects all market players and cannot be reduced merely to the relationship between an MFI and its customers. 2

The four dimensions of responsible finance are-

1. Customers

2. Micro Finance Institutions

3. Regulatory authorities and

4. Donors

1) Customers

Customers meaning the ultimate beneficiaries should be capable of understanding the fundamental aspects of financial services, particularly debt relationship. Hence, educating them and strengthening their confidence in the financial sector becomes imperative
In the microfinance sector, the field level practices employed by MFIs are still weak in some areas. The MFIs need to educate the ultimate beneficiaries about the pricing mechanism in the manner and language which is simple and easily comprehensible

2) Micro Finance Institutions

Amidst growing competition, the sector faces the challenge of matching necessary growth with sound lending practices and good governance which would give confidence to shareholders, donors, governments, regulators and lenders. Effective governance ensures transparent operations and a balanced growth
The MF sector is an emerging industry which is expanding at breakneck speed. The two biggest problems identified are lack of corporate governance and issues related to transparency.

Corporate Governance

The need for governance arises to ensure effective management of MFI and to attract people with much needed skills. MFIs mostly in the Tier 2 and Tier 3 category need to establish high standards of corporate governance in order to sustain the pressures induced by high growth. This would ensure transparent operations and balanced growth
Barring a few MFIs, most MFIs still do not have independent members on their Board. Having a Board with members drawn from diverse fields of 3 expertise would not only help in getting more professional and strategic inputs but would also lend credibility to their entire set-up
Further, with increased scales of operations, MFIs will need to develop impersonal management systems so that the operations are not leader driven, but are systems driven

Transparency

In the micro finance sector given the phenomenal growth rates, it is not surprising that MFIs in India eagerly report their impressive outreach figures – rising numbers of borrowers, greater loan volumes, ever expanding geographic penetration. However, besides a small number of leading Indian MFIs, few institutions follow rigorous accounting and reporting procedures based on international standards resulting in Transparency Deficit
The four most commonly cited sources of weak MFI financial transparency are portfolio quality reporting, loan loss provisioning, donation accounting, and loan liability accounting
MFIs often drastically inflate their profitability by pooling donation revenues together with revenues from their normal operations. To assess an MFI’s long-term sustainability, stakeholders must be able to gauge an institution’s financial performance excluding donation inflows. To achieve this, ideally the income statements of the MFIs should clearly distinguish between operational revenues and non-operational revenues such as grants / donations and should also explain the grant recognition policies
As in other key accounting areas, NGO-MFIs have far more heterogeneous loan liability re-porting practices than their NBFC counterparts. Loan liability accounting and reporting is, therefore, another key driver of the NGO-MFI transparency gap
Also there is an urgent need for sharing information amongst the players in the sector on the growth of the microfinance sector indicating the break-up State-wise/ Region-wise/ district-wise etc. to effectively monitor and channelize the resources to relatively underserved areas

3) Regulatory authorities

The regulatory authorities should ensure effective implementation of policies so as to protect the interests of both the lenders and their clients
Also the accounting and reporting policies must aim at narrowing the transparency gap to reduce the administrative cost to the MFIs and supervisory cost to the regulator.

4) Donors and investors

Keeping in view the large investments in the sector fuelling rapid expansion, donors and investors can contribute by engaging in long-term commitments, promoting good governance and by using their instruments in line with the needs of the institutions they support

In the end it can be concluded by saying that responsible borrowing facilitated by financial literacy and responsible lending by financial institutions will lead to financial stability among the consumers and ensure the objectives of financial inclusion are fulfilled.

Written By

Garima Shukla

PGDM II

IMI, New Delhi

Financial Innovation: A Necessary Evil?

noreply@blogger.com (Prahelika-2011) — Tue, 19 Oct 2010 15:05:00 +0000

Any innovation arises out of a visible need or to improve current standards that can vary from cost reduction to ease of use to make money. Thus by birth, an innovation is not good or bad. It is decided by how it is used in future. It can die unnoticed, serve human mankind or lead to destruction.

Imagine a life without money that in financial terms is known as currency. How will you buy stuff from market? It is impossible to think. Financial Innovation dates back to as early as in 7th Century B.C. with the introduction of coins in the Greek state of Lybia which today in the form of currency we use in our daily lives. Thus, if it were not for that financial innovation we would still be using the barter system.

The last two decades have seen a sudden increase in financial innovation with one of the reasons for it being the more use of Information Technology in the financial world. Some of the beneficial financial innovations had been zero coupon bonds, puttable bonds , Treasury STRIPS etc. With growth of derivatives and other financial tools, the circulation of money in market has increased exponentially and contributed to the development of economies. When junk bonds were introduced in 1980s they were ridiculed by many but today they are lifeline of many start ups and companies who do not get access to capital otherwise. It has lowered the cost of borrowing for firms and helped in building the entrepreneurial culture. Thus, financial innovation is very much important for economic growth and is a lifeline for any progressive system.

Recent recession has aggravated the debate on whether financial innovation is an evil. However, at the same time the recession has put forward a very important question on what should be done to ensure that these kinds of events does not happen again in future. Clearly stopping financial innovation is not a solution. But some measures need to be taken to prevent this to happen again. Clearly, there is a need to scrutinize the financial products more closely in future. Regulations need to be strengthened. Recession also points out to the fact that the policy environment needs an overhaul.

It is easy to declare Financial Innovation as the evil behind the crisis but it is actually a result of a clear policy failure. The risk taking mistakes by the financial managers in the subprime mortgage market were encouraged by the weak policy environment that allowed them to underestimate the risk involved. Credit was made available very easily thus again pointing towards failed policy environment. Rating agencies failed to guide the customers properly. Hence, pointing fingers at financial innovation is running away from the root cause of the problem. In addition, any financial innovation like other innovations is seen by the world with same skepticism and distrust. Thus, just blaming the recession which was more a cause of human greed to the beautiful innovation of CDS is definitely unjustified. The actual idea behind subprime mortgage was to help people who dreamed of owning a home to realize their dream.

Currently the regulatory reforms fail to match the dynamism of the financial sector .The need of the hour is to understand that the economic growth, financial innovation and regulations are linked. Financial innovation and regulations have to keep evolving with time to sustain economic growth. Instead of regulations curbing financial innovation, the regulations should ensure that the innovation does not lead to destruction and actually does what it was intended to do.

One cannot deny that the improper use of financial innovation can lead to harmful consequences. But the same is true for any innovation. But the important point is that the positives of financial innovation do outweigh the negatives and at same time negatives can be controlled with better regulations and policy environment. Thus, stereotyping it as an Evil is completely unjustified and inappropriate.

Written By:

Rahul Bhatia

PGDM II

International Management Institute

Inlcusive Growth, financial inclusion

noreply@blogger.com (Prahelika-2011) — Tue, 19 Oct 2010 14:42:00 +0000

Economic policy formulation is based on ‘ceteris paribus’ assumption — a Latin term meaning “all other things being equal or held constant”. In reality this is never the case, and monetary policy formulation is no exception.
The Reserve Bank of India (RBI) will have to grapple with several imponderables when it formulates its first ever mid-quarter policy, to be detailed on Thursday, to deal with inflation.
The government’s chief statistician TCA Anant and chief economic advisor Kaushik Basu have flagged two factors that are fanning inflation — Prime Minister Manmohan Singh government’s thrust on inclusive growth and financial inclusion.
Both goals are important for sustained high economic growth but the programmes’ off-shoot appears to be high inflation rate, for which there seems to be no short-term solution.
Food inflation is 11.5% (in the week to August 28); wholesale price inflation for all commodities was a wee bit below 10% in July. Inflation beyond 6% is perceived to be outside the comfort zone.
RBI is in an unenviable situation — its monetary action to deal with demand-driven inflation seems to have no control over these hidden pressures.
New inflation growth dynamics
“Inflation in recent years is the flipside of inclusive growth,” Anant said. “In the past, rise in inflation used to be in line with (gross domestic product) growth. But in the last three or four years, inflation trend is different,” he said. “The policy of inclusive growth has pushed up demand for wage goods substantially in rural areas. Supply of these goods has not matched demand,” he said.
The big social sector programmes have raised incomes of the poor and given them some spending power even in the worst of times.This combination of inflation and growth does not mean there is overheating of the economy, which could call for slowdown in GDP growth. In fact, India needs higher growth for faster poverty eradication.
“I don’t see any evidence of overheating…India needs to have high growth,” said Pronab Sen, principal advisor to the Planning Commission.
The imponderables — financial inclusion and inclusive growth — that have entered into the system and difficult global economic scenario have resulted in a peculiar situation that calls for frequent monitoring and policy reviews.
“RBI’s decision to have mini-quarterly policy review is a good thing especially when you have an unusual situation,” Sen said.

Reference : http://www.financialexpress.com/news/inclusive-growth-financial-inclusion-fanning-inflation-say-anant-&-basu/681477/

(Dr Kaushik Basu will be inaugurating the Prahelika 2010)

Microfinance and Microinsurance- An Introduction

noreply@blogger.com (Prahelika-2011) — Mon, 18 Oct 2010 12:40:00 +0000

Microfinance in India started evolving in the early 1980s with the formation of informal Self Help Groups (SHG) for providing access to financial services to the needy people who are deprived of credit facilities. Micro-finance refers to small savings, credit and insurance services extended to socially and economically disadvantaged segments of society. In the Indian context terms like "small and marginal farmers", " rural artisans" and "economically weaker sections" have been used to broadly define micro-finance customers. At present, a large part of micro finance activity is confined to credit only. Women constitute a vast majority of users of micro-credit and savings services.

India has large size and population of 1.3 billion and more than 70% people live in rural areas. More than 500 million poor people lack access to the basic financial services which are essential for them to manage their precarious lives. Demand for microfinance services in India is growing at a rapid pace. Credit on reasonable terms to the poor can bring about a significant reduction in poverty. That’s why microfinance is assuming greater significance in the Indian context.

With globalisation and liberalisation of the economy, opportunities for the unskilled and the illiterate are not increasing fast enough, as compared to the rest of the economy. This is leading to a lopsided growth in the economy thus increasing the gap between the haves and have-nots. It is in this context, the institutions involved in microfinance have a significant role to play to reduce this disparity and lead to more equitable growth.

Microfinance is one of the fastest growing sectors of India and it is spearheading intense competition among the largest players. The microfinance institutions are organised under three models: SHG, Grameen model/Joint liability groups and Individual banking groups as in cooperatives. Indian microfinance market is dominated by SHG bank linkage and MFI model.

Micro-Finance Institutional Structure:
The different organisations in this field can be classified as "Mainstream" and "Alternative" Micro Finance Institutions (MFI). Mainstream MFIs include NABARD, SIDBI, HDFC, Commercial Banks, RRBs, and the credit co-operative societies.
Alternative MFIs include

NGOs, which are mainly engaged in promoting self-help groups (SHGs) and their federations at a cluster level, and linking SHGs with banks
NGOs directly lending to borrowers, who are either organised into SHGs or into Grameen Bank style groups and centres
MFIs which are specifically organised as cooperatives
Mutually Aided Cooperative Thrift and Credit Societies (MACTS) in AP
MFIs, which are organised as non-banking finance companies

Demand for Credit and savings
In terms of demand for micro-credit, there are three segments: At the very bottom in terms of income and assets, and most numerous, are those who are landless and are engaged in agricultural work on a seasonal basis, and manual labourers in forestry, mining, household industries, construction and transport. The next market segment is small and marginal farmers and rural artisans, weavers and those self employed in the urban informal sector as hawkers, vendors, and workers in household microenterprises.

The third market segment is of small and medium farmers who have gone in for commercial crops such as surplus paddy and wheat, cotton, groundnut, and others engaged in dairying, poultry, fishery, etc. Among non-farm activities, this segment includes those in villages and slums, engaged in processing or manufacturing activity, running provision stores, repair workshops, tea shops, and various service enterprises. These persons are not always poor, though they live barely above the poverty line and also suffer from inadequate access to formal credit.

The demand for savings services is ever higher than for credit. Studies of rural households in various states in India show that the poor, particularly women, are looking for a way to save
small amounts whenever they can. The irregularity of cash flows and the small amounts available for savings at one time, deter them from using formal channels such as banks. The poor want to save for various reasons – as a cushion against contingencies like illness, calamities, death in the family, etc; as a source of equity or margin to take loans; and finally, as a liquid asset.

Micro insurance
Micro insurance refers to protection of assets and lives against insurable risks of target populations such as micro-entrepreneurs, small farmers and the landless, women and low-income people through formal, semiformal and informal institutions. Such products are often bundled with micro-savings and micro-credit, thereby allocating scarce resources to micro-investments with the highest marginal rates of return. Micro insurance is the most underdeveloped part of microfinance. Yet various schemes exist that are viable, benefiting both the institutions and their clients. Such schemes have generally served two major purposes: (i) they have contributed to loan security; and (ii) they have served as instruments of resource mobilization. The greatest challenge for micro insurance lies in the combination of viability and sustainability with outreach.

The supply of insurance services to the poor has been increased substantially over the 1990s, and there are a large number of low premium schemes covering them against death, accidents, natural calamities, and loss of assets due to fire, theft, etc. However, the usage is limited by low awareness among the poor. Crop and livestock insurance, however, are quite expensive and their reach to the poor is negligible. Livestock and asset insurance was extended to the poor along with the IRDP subsidised loans, and thus remained scheme driven, with little awareness among the customers.

After the pioneering efforts of the last ten years, the microfinance scene in India has reached a takeoff point. With some effort substantial progress can be made in taking MFIs to the next orbit of significance and sustainability. This needs innovative and forward-looking policies, based on the ground realities of successful MFIs. This, combined with a commercial approach from the MFIs in making microfinance financially sustainable, will make this sector vibrant and help achieve its single minded mission of providing financial services to the poor.

Written By
Shivendu Kumar Singh
PGDM II
IMI, New Delhi