Types of Development Bank
Content
TYPES OF DEVELOPMENT BANK: 1. IFCI: the government established The Industrial Finance Corporation of India (IFCI) on July 1, 1948, as the first Development Financial Institution in the country to cater to the long-term finance needs of the industrial sector. The newlyestablished DFI was provided access to low-cost funds through the central bank's Statutory Liquidity Ratio or SLR which in turn enabled it to provide loans and advances to corporate borrowers at concessional rates. 2. SIDBI: Small Industries Development Bank of India is an independent financial institution aimed to aid the growth and development of micro, small and medium-scale enterprises in India. Set up on April 2, 1990 through an act of parliament, it was incorporated initially as a wholly owned subsidiary of Industrial Development Bank of India. It is an apex body and nodal agency for formulating, coordination and monitoring the policies and program for promotion and development of small-scale industries. 3. IDFC: The Infrastructure Development Finance Company Limited (IDFC) is India's leading integrated infrastructure finance player providing end-to-end infrastructure financing and project implementation services. 4. SIDC: It is responsible for the development of industries in the state by formulating policies that help industry growth, and also by establishing Industrial Estates. 5. NABARD: National Bank for Agriculture and Rural Development (NABARD) is an apex development bank in India based in Mumbai, Maharashtra. It has been accredited with "matters concerning policy, planning and operations in the field of credit for agriculture and other economic activities in rural areas in India". NABARD was established on the recommendations of Shivaraman Committee, by an act of Parliament on 12 July 1982 to implement the National Bank for Agriculture and Rural Development Act 1981. 6. EXIM: Export-Import Bank of India is the premier export finance institution of the country, set up in 1982 under the Export-Import Bank of India Act 1981. Government of India launched the institution with a mandate, not just to enhance
exports from India, but to integrate the country’s foreign trade and investment with the overall economic growth. 7. NHB: The Sub-Group on Housing Finance for the Seventh Five Year Plan (198590) identified the non-availability of long-term finance to individual households on any significant scale as a major lacuna impeding progress of the housing sector and recommended the setting up of a national level institution. 8. DFHI: Discount and Finance House of India Ltd. (DFHI), a unique institution of its kind, was set up in April 1988. The discount has been established to deal in money market instruments in order to provide liquidity in the money market. Thus the task assigned to DFHI is to develop a secondary market in the existing money market instruments. The establishment of a discount House was recommended by a Working Group on Money market. The main objective of DFHI is to facilitate the smoothening of the short term liquidity imbalances by developing an active money market and integrating the various segments of the money market. PROCESS OF ALM: 1. Measurement of risk: The first step in ALM is to decide or measure the risk. The appropriateness of risk measurement parameters depends upon different factors. There are various methods used to measure interest rate risk. They are as follows: Gap method: Gap analysis also known as reprising model, is essentially a book value accounting cash flow analysis of repricing gap between the interest revenue earned on assets and interest paid on liabilities over some particular period. RSG = RSA RSL RSG: rate sensitive gap RSA: rate sensitive assets RSL: rate sensitive liabilities A ratio of 1 indicates perfect match of assets and liabilities. If ratio is greater than 1 higher income is produced if less than 1 the bank is making
losses. Duration Method: This measurement technique calculates price sensitives across different instruments and converts them to a common denominator. Duration analysis can estimate the impact of interest rate changes on the present value of the cash flows generated by a financial institution portfolio. E.g. if the modified duration of a security is 5, the price of a security will decrease by 5%, if the related yield increases by 1%. Simulation: This method attempts to analyze the impact of changes in the interest rate on the net income under different interest rate, market income and market price scenario. It requires forecasting the asset liability picture under different scenarios, ascribing probabilities to them and choosing the most optimal model. Value at risk: In its most general form, the Value at Risk measures the potential loss in value of a risky asset or portfolio over a defined period for a given confidence interval. Thus, if the VaR on an asset is $ 100 million at a one-week, 95% confidence level, there is a only a 5% chance that the value of the asset will drop more than $ 100 million over any given week. 2. Enhancement of long term profitability: The next stage of ALM is identification of favourably priced assets or liabilities and off balance sheet items so as to enhance long term profitability for a given level of risk. The management has to build up core business and create assets and liabilities for the bank. 3. Management of risk: the third stage in the ALM is effective management of market risk. The directors should formulate overall investment policy, liquidity policy and the policy regarding financing. It should also determine the acceptable level of risk in terms of the parameters chosen.
TECHNIQUES USED FOR THE PURPOSE OF DECISION MAKING: The following techniques can be used for the purpose of decision making: Risk adjusted discount rate: In the risk adjusted discount rate (RADR) method for valuing early stage companies, an expected future cash flow is converted to present value by applying a discount rate that reflects both the time value of money and riskiness of the expected future cash flow using the following equation:
Where the present value, PV, of an investment is the expected future cash flows from that asset, and rt is the risk adjusted discount rate appropriate for computing the present value of an expected future cash flows at time t. Certainty equivalent coefficient: Yet another common procedure for dealing with risk in capital budgeting is to reduce the forecasts of cash flows to some conservative levels. For example, if an investor, according to his “best estimate” expects a cash flow of 60000$ next year, he will apply an intuitive correction factor and may work with 40000$ to be on safe side. There is a certaintyequivalent cash flow. In formal way, the certainty equivalent approach may be expressed as: Net present value = (the risk adjusted factor X the forecasts of net cash flow) / (1 + Risk free rate) Sensitive analysis: It provides the information about cash flows under three assumptions – pessimistic, most likely and optimistic outcomes associated with the project. It explains how sensitive the cash flows are under these different situations. The larger is the difference between the pessimistic and optimistic cash flows, the more risky is the project and vice versa. Decision Tree analysis: Decision Tree Analysis provides a tool to study and decide on various choices available at a given point of time. It uses models of decisions which help to study the possibility of an occurrence of a particular
consequence. Decision Tree Analysis also studies the cost of resources, utilities, and the chances of event outcomes. Standard deviation: It is a measure of dispersion. It is a square root of squared deviation calculated from the mean. A project having a larger standard deviation will be more risky as compared to a project having smaller standard deviation. Probability assignment: This approach gives a more precise estimate about the likely cash flows as compared to those estimated without assigning probabilities. Probability means the likelihood of happening of an event. It may be objective or subjective.
exports from India, but to integrate the country’s foreign trade and investment with the overall economic growth. 7. NHB: The Sub-Group on Housing Finance for the Seventh Five Year Plan (198590) identified the non-availability of long-term finance to individual households on any significant scale as a major lacuna impeding progress of the housing sector and recommended the setting up of a national level institution. 8. DFHI: Discount and Finance House of India Ltd. (DFHI), a unique institution of its kind, was set up in April 1988. The discount has been established to deal in money market instruments in order to provide liquidity in the money market. Thus the task assigned to DFHI is to develop a secondary market in the existing money market instruments. The establishment of a discount House was recommended by a Working Group on Money market. The main objective of DFHI is to facilitate the smoothening of the short term liquidity imbalances by developing an active money market and integrating the various segments of the money market. PROCESS OF ALM: 1. Measurement of risk: The first step in ALM is to decide or measure the risk. The appropriateness of risk measurement parameters depends upon different factors. There are various methods used to measure interest rate risk. They are as follows: Gap method: Gap analysis also known as reprising model, is essentially a book value accounting cash flow analysis of repricing gap between the interest revenue earned on assets and interest paid on liabilities over some particular period. RSG = RSA RSL RSG: rate sensitive gap RSA: rate sensitive assets RSL: rate sensitive liabilities A ratio of 1 indicates perfect match of assets and liabilities. If ratio is greater than 1 higher income is produced if less than 1 the bank is making
losses. Duration Method: This measurement technique calculates price sensitives across different instruments and converts them to a common denominator. Duration analysis can estimate the impact of interest rate changes on the present value of the cash flows generated by a financial institution portfolio. E.g. if the modified duration of a security is 5, the price of a security will decrease by 5%, if the related yield increases by 1%. Simulation: This method attempts to analyze the impact of changes in the interest rate on the net income under different interest rate, market income and market price scenario. It requires forecasting the asset liability picture under different scenarios, ascribing probabilities to them and choosing the most optimal model. Value at risk: In its most general form, the Value at Risk measures the potential loss in value of a risky asset or portfolio over a defined period for a given confidence interval. Thus, if the VaR on an asset is $ 100 million at a one-week, 95% confidence level, there is a only a 5% chance that the value of the asset will drop more than $ 100 million over any given week. 2. Enhancement of long term profitability: The next stage of ALM is identification of favourably priced assets or liabilities and off balance sheet items so as to enhance long term profitability for a given level of risk. The management has to build up core business and create assets and liabilities for the bank. 3. Management of risk: the third stage in the ALM is effective management of market risk. The directors should formulate overall investment policy, liquidity policy and the policy regarding financing. It should also determine the acceptable level of risk in terms of the parameters chosen.
TECHNIQUES USED FOR THE PURPOSE OF DECISION MAKING: The following techniques can be used for the purpose of decision making: Risk adjusted discount rate: In the risk adjusted discount rate (RADR) method for valuing early stage companies, an expected future cash flow is converted to present value by applying a discount rate that reflects both the time value of money and riskiness of the expected future cash flow using the following equation:
Where the present value, PV, of an investment is the expected future cash flows from that asset, and rt is the risk adjusted discount rate appropriate for computing the present value of an expected future cash flows at time t. Certainty equivalent coefficient: Yet another common procedure for dealing with risk in capital budgeting is to reduce the forecasts of cash flows to some conservative levels. For example, if an investor, according to his “best estimate” expects a cash flow of 60000$ next year, he will apply an intuitive correction factor and may work with 40000$ to be on safe side. There is a certaintyequivalent cash flow. In formal way, the certainty equivalent approach may be expressed as: Net present value = (the risk adjusted factor X the forecasts of net cash flow) / (1 + Risk free rate) Sensitive analysis: It provides the information about cash flows under three assumptions – pessimistic, most likely and optimistic outcomes associated with the project. It explains how sensitive the cash flows are under these different situations. The larger is the difference between the pessimistic and optimistic cash flows, the more risky is the project and vice versa. Decision Tree analysis: Decision Tree Analysis provides a tool to study and decide on various choices available at a given point of time. It uses models of decisions which help to study the possibility of an occurrence of a particular
consequence. Decision Tree Analysis also studies the cost of resources, utilities, and the chances of event outcomes. Standard deviation: It is a measure of dispersion. It is a square root of squared deviation calculated from the mean. A project having a larger standard deviation will be more risky as compared to a project having smaller standard deviation. Probability assignment: This approach gives a more precise estimate about the likely cash flows as compared to those estimated without assigning probabilities. Probability means the likelihood of happening of an event. It may be objective or subjective.
