Wholesale and Long-term Finance bank

What is the issue?

After having issued licences for new-age payments and small finance banks, the RBI has now published a discussion paper on the need for wholesale and long-term finance (WLTF) banks.

What is WLTF?

• The idea is that as the financial sector grows, apart from a number of universal banks, it may be useful to have differentiated banks focusing on different areas and developing competence.
• This will reduce the cost of intermediation and lead to better economic outcomes.
• The WLTF banks will focus on lending to the corporate sector, small and medium businesses, and the infrastructure sector.
• They may also offer services in the area of foreign exchange and trade finance.
• Further, they can act as market makers in instruments like corporate bonds and credit derivatives.
• WLTF banks can raise funds through issuance of debt and equity. They may also be allowed to accept term deposits above a threshold.

What are the advantages?

• As specialized institutions, they will be in a much better position compared with commercial banks in evaluating and funding long-term projects.
• It’s not easy for companies to get long-term financing because of the underdeveloped corporate bond market and possible asset liability mismatch in the banking system.
• With specialized banks, NPA risks could possibly be avoided in the future.
• It may also help the rest of the banking sector in the case of joint lending, or by simply getting the project evaluation from these banks.
• Establishment of WLTF banks will also enhance competition, which will lead to more efficient allocation of financial resources.

Does India have prior experience?

• India has tried the development finance institution (DFI) model in the past with limited success.
• After independence, DFIs were established to increase the level of investment in the economy.
• Industrial Finance Corp. of India (IFCI) was the first such institution to be established in 1948.
• This was followed by the establishment of state finance corporations.
• In later years, other institutions like the Industrial Credit and Investment Corporation of India (ICICI) and Industrial Development Bank of India (IDBI) were established.
• However, DFIs struggled with government interference and changes in the economy, and accumulated high levels of NPAs.
• One of the biggest problems facing long-term finance institutions is competing for funds in the marketplace and being able to lend at competitive rates.

What are the factors to be considered?

• As the banking regulator mulls over issuing licences for new-age WLTF banks, there are at least three aspects that will need greater attention.
• First, government participation in setting up WLTF banks should be avoided as it could end up defeating the purpose.
• Government ownership would lead to the same problems that public sector banks are facing at the moment.
• Further, these banks will be highly specialized and will need operational freedom, which is not possible with government ownership.
• Second, licences should only be issued to entities that are able to demonstrate the ability to build such a highly specialized bank, and are in a position to bring in capital to both meet regulatory requirements and run the business on a sustainable basis.
• The central bank may allow industrial houses to participate to the extent that they are not in a position to influence business decisions.
• Third, the RBI will need to design a regulatory architecture that will enable growth with adequate safeguards.
• For example, the regulator may choose to exempt these banks from cash reserve ratio and statutory liquidity ratio requirements.
• These banks will compete directly with the bond market.

Source: Live Mint