Introduction :  

At the initiative of COSIDICI, the Government of India, Ministry of Finance (Banking Division), had effected large-scale amendments to the SFCs Act, 1951, to remove restrictive provisions in the Act to enable SFCs to enjoy a level-playing field with commercial banks and other institutions and provide them functional autonomy and operational flexibility. The SFCs (Amendment) Act, 2000, had come into force with effect from 6th September, 2000. The Ministry of Finance (Banking Division), had simultaneously constituted a Committee under the Chairmanship of Shri G.P. Gupta, the then Chairman and Managing Director, IDBI, to look into the functioning of State Financial Corporations and make recommendations for their re-structuring and re-vitalisation. The terms of reference of the Committee were quite comprehensive which, inter alia, included financial and organisational re-structuring, re-capitalization and re-vitalization of SFCs, measures for containment of non-performing assets, etc. The Govt. of India had nominated chief executives of two of our Member Corporations on the Committee, viz., Dr. Vishwapati Trivedi, IAS.., Managing Director, MPFC, and Shri A.K.D. Jadhav, IAS., Managing Director, SICOM. The President COSIDICI, Smt. Yasmin Ahmed, IAS, was subsequently co-opted on the above Committee by the Govt. of India. The Committee had submitted its report to the Govt. of India, Ministry of Finance (Banking Division), on 30th January, 2001. The genesis of this Committee dates back to 4th February, 1999, when a delegation from COSIDICI held a meeting with Dr. Bimal Jalan, Governor, RBI, regarding the problems faced by SFCs. The Governor RBI, while appreciating the problems of SFCs, had suggested that a Committee of Specialists may be constituted to look into the whole gamut of issues presented by the Council and make suitable recommendations. Since then COSIDICI had been vigorously following up with CMD IDBI and the Banking Division of the Ministry of Finance for setting up of such a Committee. During the course of discussions a delegation from COSIDICI held with the Special Secretary (Banking) in January, 2000, he assured that the Govt. of India would certainly constitute a Committee after the SFCs Act had been amended. The setting up of this Committee was, therefore, the result of the relentless efforts and vigorous follow-up made by COSIDICI. 

2. Committee's Report - in two Parts : 

2.1. The report of the Committee is divided into two parts. In the present Report (which is Part-I of the Report), the Committee has set out macro level broad strategy for restructuring and recapitalisation of SFCs with the recommendation that future course of action for each SFC might be best decided after detailed discussions with its stake-holders and the State Govt. concerned in the light of the overall recommendations and broad modalities suggested by the Committee in Part-I of the Report.This approach was adopted by the Committee for it was neither possible nor prudent to arrive at a common and uniform restructuring formula for all the 18 SFCs, which are individually so different and saddled with their own peculiar problems.  

2.2. The Committee has, therefore, decided to finalise SFC-specific recommendations for restructuring and recapitalisation in Part - II of its Report, after interacting with the SFC, concerned State Government and the others concerned. The Part - II of the Report will be submitted by the Committee within a period of six months.  

SUMMARY OF MAJOR RECOMMENDATIONS OF THE COMMITTEE (Part I of the Report)  

Macro Strategy for Restructuring and Recapitalisation of SFCs : 

1. It is a recognised fact that any restructuring/recapitalisation programme, which is not comprehensive and taken up in `Bits and Pieces' is bound to fail. Thus, the Committee keeping the principles and modes of restructuring in mind has recommended `Macro Strategy' for their restructuring together with suitable recapitalisation. Part-I of the Report sets out the Macro Strategy giving main principles and broad parameters of the programme and estimates of the total fund requirement for their recapitalisation and funding pattern thereof.  

2. The recommendations for restructuring of SFCs take the dimensions of (i) operational, (ii) managerial, (iii) organisational, (iv) human resource and (v) financial strategies.  

3. It is assumed that restructuring and recapitalisation would be taken up only from FY2002 onwards. Hence the Committee has worked out the requirement of funds for recapitalisation of SFCs after taking into account the estimated loss, at the level of loss incurred in FY2000 for the subsequent two years i.e. FY2001 and FY2002. Also in view of further expected tightening of norms by RBI, the recapitalisation requirement has been worked out to reach 11% CAR. Accordingly, the funds requirement has been estimated at Rs. 3,335 crore.  

Recapitalisation of SFCs : 

4. SFC-wise position has prompted Committee to group them for recapitalisation/restructuring in two broad categories as under :  

Category-I : SFCs having moderate to good potential for revival :  

4.1. Under this category, for 14 SFCs, a total sum of Rs.2,450 crore has been estimated for recapitalisation, VRS and provision for contingencies. The Committee has worked out the requirement of funds of Rs.2,170 crore for eleven SFs in this category (excluding DFC, GSFC and KFC) to reach 11% CAR. Additionally, funds have been provided to strengthen the capital base of DFC, GSFC and KFC equivalent to about 25% of their respective net worth, amounting to an aggregate Rs.100 crore. Thus, the Committee recommends that in fourteen SFCs mentioned below, the infusion of funds aggregating Rs.2,270 crore might be phased over a period of four years.  

4.2. The Committee is aware that the SFCs would need to undertake staff rationalisation programme by offering VRS to their employees only after assessing manpower requirements. Tentatively, it has estimated a requirement of funds at Rs.130 crore for this purpose. Also, to take care of any unforeseen contingencies, it has felt necessary to provide for an amount of Rs. 50 crore.  

4.3. Thus, the total fund requirement SFC-wise for the fourteen SFCs at Rs.2,450 crore will be as under:  
 

 
Category-II : SFCs having less than moderate potential for revival  

4.4. Four SFCs viz. AFC, BSFC, J&KSFC and OSFC fall into this category, with their CAR ranging from (-) 1809% (BSFC) to (-)56% (OSFC); as estimated on March 31, 2002. They require recapitalisation of Rs. 1,065 crore (32% of the aggregate requirement of Rs.3,335 crore) to reach 11% CAR. Also, an estimated requirement of Rs.35 crore would be needed towards VRS. A provision of Rs.50 crore is expected to take care of any contingency. Thus, the aggregate requirement of Rs.1150 crore may be spread over, during FY-2002 to FY-2005, as given below :  

The suggested funding pattern for above requirement of Rs.1150 crore is as under : 
 

4.6. The Committee while identifying the requirement of funds for recapitalisation/restructuring of SFCs has taken into consideration the underlying principles : 

• The cost of recapitalisation might be shared by all the stake-holders.
• The financial burden of recapitalisation should be phased out.
• GoI and RBI, being the Central Bank of the country, as has been the experience in restructuring of the SFCs world-over, should lend a helping hand, while not giving the impression to other intermediaries in the financial sector of encouraging financial profligacy.
• The infusion of funds should be linked to implementation of a MoU to be entered into amongst the State Govt. , SFC and SIDBI (also on behalf of IDBI, RBI and GoI) to ensure that operational, organisational and financial restructuring is undertaken concurrent to infusion of funds to ensure that discipline and financial health is restored to SFCs on sustained basis.

(i) The funds for recapitalisation to be shared, on 1:1 basis, amongst State Govt. and IDBI/SIDBI on the one hand and GoI/RBI on the other. The funds between State Govts. and IDBI/SIDBI be also shared on 1:1 basis. Accordingly, it is envisaged that GoI/RBI might contribute Rs.1,800 crore and the balance might be shared between IDBI/SIDBI (Rs. 450 crore each) and State Government (Rs. 900 crore). 

(ii) IDBI/SIDBI should convert part of their outstanding refinance into 20 year cumulative preference share capital to provide support by way of Tier-I capital. This is part of RBI guidelines in this regard and should be made applicable to SFCs, if not already done so. The coupon on the preference shares might be fixed at 9% for the period of 4 years i.e. period of recapitalisation during FY2002-05. Thereafter, the coupon might be enhanced to 10%.  

(ii) The network of SFCs was created to serve the respective States for industrialisation under an Act promulgated with the approval of Parliament. The structure, though not necessarily functioning efficiently, is an important link in bringing about the strengthening the federal system. While the Committee is aware of the fact that SFCs are not central subject, the question remains that looking into their importance, whether they should be allowed to languish for want of funds? It is, therefore, essential that GoI steps into arranging for funds. In this regard, it may be mentioned that though RBI had stopped making future contributions to NIC (LTO) fund, keeping in consideration the extraordinary circumstances in which SFCs are working, the Committee recommends that RBI might be permitted by GoI to divert these funds out of the scheduled repayments of existing NIC (LTO) liabilities of IDBI towards recapitalisation/restructuring of SFCs. 

The repayment schedule of the outstanding funds of NIC (LTO) from IDBI to RBI is as under : 

The Committee, however, understands that RBI in keeping with its present policy, would not like to directly contribute towards recapitalisation of SFCs and would pass on the amount to GoI. GoI may, thereafter, decide and finalise the modalities of extending this contribution to SFCs. It may be appreciated that the above proposal would not result in any fresh outgo from NIC (LTO) fund.  

(iv) Being the state-owned corporations, it is the prime responsibility of the State Government to recapitalise the SFCs. The State Governments may channelise funds from their revenues by way of sales tax, excise duty, any other cess leviable on SSI sector as also tap their pension funds and small savings to partly fund the requirement of SFCs. If required, the State Governments may also be allowed to float tax-free bonds to meet the requirement of recapitalisation for SFCs. 

(v) Further, the contributions from the State Governments and those from RBI/GoI might be infused by way of subordinated debt (forming Tier II capital), the interest on which be repaid as per the rate of equity dividend and in the year when the dividend is declared, as had been done for capitalisation of Infrastructure Development Finance Company Ltd. (IDFC). This is also being suggested with a view to avoiding balooning of the SFCs' equity base. 

(vi) The Committee emphasizes that successful implemention of the recapitalisation/restructuring programme singularly depends on the initiative taken by the State Governments, including bringing in their share of recapitalisation, in the first instance, followed by the support from other concerned agencies. This would catalyse the process of putting the SFCs back to their health.  

4.8. In the above context, the Committee recommends that GoI also examines the avenues of arranging funds from international/multilateral agencies on the strength of sovereign guarantee and earmarking the same for recapitalisation of SFCs, as was done for the public sector banks. In the recent past, there have been instances when multilateral agencies like IBRD, ADB, etc. extended lines of credit directly to the States. Incidentally, SIDBI's Board has also resolved to the effect that necessary funds for recapitalisation might be raised from IBRD.  

The Committee's recommendations on four SFCs under Category II  

4.9. As mentioned earlier, the CARs of AFC, BSFC, J&KSFC and OSFC have been substantially eroded. The operations of these SFCs are moribund and the financial position, critical. In this scenario, the Committee recommends as follows :  

(i) The recapitalisation/restructuring of these SFCs is undertaken in the normal course, as applicable to other fourteen SFCs.  

(ii) Alternatively, the State Governments might promote separate new corporate entities which would fulfil the objectives of financing the SSIs in their respective States. This was suggested by a few State Governments also. The existing SFCs would continue to exist but dormant with focus on recoveries and settlement of NPAs. These four SFCs alone may need estimated funds for VRS of Rs.100 crore (on the assumption that the new corporate entity would resort to fresh recruitment and the existing staff of Govt. SFCs would be phased out) as given below :  

(iii) In order to meet the capitalisation requirement of the proposed new corporate entities, funding might be availed of from GoI/Government-owned Institutions/banks, besides the respective State Governments. On the basis of requirement of Rs.100 crore each, equity for promoting four new companies, the aggregate need of Rs.400 crore be funded on the similar pattern, as has been prescribed above for recapitalisation/restructuring of above 14 SFCs. The equity share capital of the new companies can be subscribed by the State Govts. (26%), IDBI/SIDBI (24%) and public/banks/insurance companies/investment companies (50%). This will be in keeping with the new emerging pattern in the financial system.  

(iv) Notwithstanding the above, these SFCs would have to repay the refinance extended by IDBI/SIDBI as also redeem the shareholding of IDBI in these SFCs (excluding loans in lieu of capital) as the same are guaranteed by the State Governments. These repayments/redemption can be made from the recoveries against dues from their clients. 
 
Resources for sustained operations of SFCs.  
 
4.10. The Committee makes following observations and recommendations in regard to resource raising strategy of SFCs for sustained operations :  

• The C-D ratio of commercial banks in certain States is quite low. The banks may be advised to extend lines of credit to each SFC at 2% below PLR depending on the shortfall of their priority sector lending in that State. This could be on the lines of Rural lending in that State. This could be on the lines of Rural Infrastructure Development Fund (RIDF) operating through NABARD. In the present context, such a fund could be operated by SIDBI and passed on to SFCs as soft loans for financing infrastructure projects belonging to SSI sector. 
• The commercial banks may subscribe to the bonds floated by SFCs. Such bonds may be guaranteed by the concerned State Govt. and should carry a coupon equivalent to the GoI securities. 
• To enable and facilitate the State Governments to make the requisite contributions towards restructuring and recapitalisation of SFCs, the Committee recommends that additional market borrowings be permitted to the State Governments as a part of their annual plan by the Planning Commission. In case of any re-schedulement of refinance by IDBI/SIDBI, RBI might be requested to consider relaxation in the criteria for classification of assets not amounting to NPAs. 
• The SFCs may also explore the possibilities of securitisation of their assets with a view to augmenting their resources. 
• While the above measures may help in restoring the CAR to desired levels, the SFCs would need to follow strict discipline and take steps for their restructuring on priority. The Committee thus strongly recommends that the MoU be executed amongst State Governments, SFC and SIDBI (also on behalf of IDBI, RBI and GoI). The Committee emphasizes that the recapitalisation programme would be taken up after the State Government/SFC initiates steps for restructuring, covering aspects such as (i) managerial (ii) organisational, (staffing including VRS) (iii) reducing NPAs and improving recoveries, etc., besides bringing in the funds earmarked against the State Government, in particular. The funds for recapitalisation should flow from GoI/RBI as well as IDBI/SIDBI, only after the above pre-conditionalities are fully complied with. SIDBI would act in the `lead' for supervising and monitoring the attainment of milestones prescribed in MoU towards effective implementation of recapitalisation/restructuring programme. SFC-wise recommendation regarding recapitalisation and restructuring programme and the draft MOU to be entered into would be submitted in Part II of its report.

(a) Converting SFCs into Corporate entities  

In the ever-competitive financial sector where SFCs are required to compete with banks (both in public and private sectors), it is imperative that the SFCs must have operational flexibility and ability to raise resources in a cost-effective manner. The Committee, therefore, recommends that the SFCs after recapitalisation may be converted into companies under the Companies Act, 1956. 

In this context, the Committee would prompt the SICOM Model to be considered by the SFCs for the purpose.  

(b) Disinvestment of State Govt. holding  

In consonance with the emerging pattern of corporatisation, it would be desirable to bring down Govt.'s holding in the corporatised- SFCs, say to the level of 33% by disinvestment to public. During the process of reduction in the State Governments' equity; initially the commercial banks, insurance companies, etc. may contribute towards the capital and once the financial health of the SFCs improves substantially, participation from public in the equity be invited through divestment/additional infusion of capital.  

(c) Converting corporatised-SFCs into NBFCs  

SFCs would then be converted into NBFCs with provisions of raising resources from the public. This will place them in better and competitive situation resource-wise and would provide them with edge to compete with commercial banks. Additionally, the converted SFCs into NBFCs may continue to subserve the cause of SSIs in addition to entering into newer profitable business areas.  

(d) Converting NBFCs into Banks  

In tune with the pattern of changes in the financial system world over including India, some of the corporatised SFCs into NBFCs may at an appropriate time, transform themselves into banks. 

5. Operational Issues :  

• The Committee concurs with widely-held view that SFCs should continue playing the role of credit/service provider to SSI sector 
• SFCs have largely remained a "Single Product" provider extending term loan assistance to SSIs. With the onset of process of liberalisation and competition pushing the process of disintermediation aggressively across various players in the financial system, SFCs would need to provide diversified product/services. Overall, the provisions of diversified bouquet of products/services should ward off the untoward and adverse impact of a particular activity on the health of the SFCs. 
• SFCs should have a judicial mix of advances to SSIs and others including medium scale industry which would help them to improve their viability. In this regard, the Committee also recommends that the maximum limit on accommodation per unit might be removed and the Boards of SFCs be authorised to fix exposure limits per unit, industry-wise, based on the prevailing and emerging industrial climate in the State. 
• SIDBI, as at present, should continue to fill up the credit gaps and play supplementary and complementary role vis-à-vis SFCs in the area of direct financing and empower SFCs to face competition from various players in the liberalised environment. 
• SFCs should take up more non-fund activities. 
• SFCs should completely re-design their business processes and enhance the corporate culture with pro-active client relationship approach. 
• There is widespread perception that the credit dlivery process in SFCs is rather slow with excessive centralisation in decision-making. The SFCs would need to empower their officials by adequate decentralisation of discretionary powers coupled with accountability. The Committee also feels that there is need to have better co-ordination amongst the appraisal, follow-up and recovery functions in SFCs, which calls for strong Management Information System (MIS). 
• There is need for installation of more efficient and effective risk assessment mechanism as well as close monitoring of loan portfolios. Providing on-line data on their operational aspects through strengthening of the IT infrastructure is important and may be attended to by SFCs. 
• In order to increase composite loan portfolio of SFCs, it is suggested that SFCs might insist on the units to open `No lien accounts' with their banks. This will help SFCs to monitor the accounts closely. 

Considering the present shareholding pattern and the prevailing constraints in inviting wider public participation in their shareholdings, the Committee is in agreement with the present composition of the Board of Directors as enshrined in the SFCs (Amendment) Act, 2000. However, the Committee makes following recommendations in this context :  

• To ensure continuity at MD's level, the power to appoint the MD may continue to vest in and be exercised by the State Government. It should, however, be invariably ensured that the services of MD-designate, be made on contract basis for a minimum fixed period of three years without any recourse to recall. 
• The overriding powers vested with the State Governments to dismiss the entire Board are perceived as an `impediment' especially when the current thinking is towards inviting wider participation from public as shareholders. The Committee suggests that this provision be repealed. 
• To effectively guide the SFCs, the nominees of SIDBI, FIs and banks be drawn from a pool of appropriately senior executives, preferably not below the rank of General Manager.
• The second line of management should invariably be developed and such positions be filled by appointing professionals with relevant experience as Executive Directors. 

7. Organisation and MIS  

• The Committee is of the view that unless the organisational changes are brought about, SFCs might not respond to the new business environment. 
• Regarding merger of the state level institutions (SLIs), the Committee is of the view that the mergers, if any, might be considered amongst SIDCs/SIICs and SFCs only, because both these agencies are primarily concerned with term financing. The merger of SFCs with SSIDCs might not be compatible because SSIDCs are concerned with distribution of raw materials, extending marketing support, development of infrastructure, etc.
• With regard to amalgamation of the SFCs across the States, the Committee observes that though it might result in better economies of scale, the proposal might not address the regional aspirations with focus on distinct character of the State. Hence, the Committee feels that the State-specific role of SFCs might not be altered.
• SFCs are saddled with large number of staff in the non-officer category. Also, the level of professionalisation amongst officers is low. With a view to rationalising their staffing pattern, the Committee recommends that SFCs offer VRs to their staff equivalent to one month's pay for every completed year. Each SFC would need to devise its specific scheme for rationalisation of staff.
• The Committee also recommends that SFCs take a realistic assessment of their branch network treating each of them as "Profit Centre", besides looking at the objective of providing the service with better geographical spread. Unviable branches must be closed without delay.
• The Committee suggests following information/data to be computerised on on-going basis : 

(i) Comprehensive corporate planning process; 
(ii) Loan policy and operations manual; 
(iii) Internal budgeting; 
(iv) Appraisal and risk assessment techniques; 
(v) Seamless coordination between disbursement and recovery; 
(vi) Monitoring system to ensure coordination of disbursement; schedules with actual cash flow needs of the funded projects; 
(vii) Benchmarking data on firms in various industries; 
(viii) Annual review of portfolio and projects to spot variances with projections; 
(ix) Internal audit findings;

• Use the upgraded IT and efficient MIS, compatible with the requirement of a technology-driven banking environment.
• The skill and specialisation level of staff need upgradation. Training of staff be accorded priority. SIDBI may consider funding IT requirements of SFCs by way of loans.
• SIDBI should take steps to strengthen its internal monitoring and administrative mechanism with regard to SFCs.

• The Committee broadly concurs with the views expressed by COSIDICI that keeping in mind the crucial role played by SFCs in fulfilling some of the critical social obligations, erosion of their owned funds was largely due to accumulation of bad debts resulting from high risk areas (priority sector) in which SFCs had been operating. A good portion of NPAs is attributable to the over-riding socio-economic programmes, Govt. sponsored programmes and directives of the State Govts.
• The Committee notes that the provisions under Sections 29 to 32 G of the Act, providing certain powers to SFCs for sale of assets or recoveries through arrears of land revenue, etc. have provided limited help to SFCs in containing the NPAs. This is partly due to external pressure, political interference and long drawn litigation process.
• To overcome the delays in recoveries, the State Government may set up special courts for disposal of applications made under Section 32 of the SFCs Act. SFCs are permitted to approach Debt Recovery Tribunals (DRTs) if the claim amount exceeds Rs.10 lakh in each case. The Committee recommends that the special courts be set up by the State Governments which might exclusively deal with recovery applications filed by SFCs.
• Simultaneously, expedite recovery of NPAs either through legal means or entering into OTS with the borrowers. The settlement of their dues is fraught with risks such as jurisdiction of vigilance agencies etc. SIDBI should come out with Ots guidelines for SFCs, on the lines of guidelines issued by RBI on July 27, 2000 to commercial banks which would provide a simplified non-discretionary and non-discriminatory mechanism for recovery of their NPAs. SFCs should then not fight shy in implementing OTS vigorously.
• The State Governments might bring in special legislation for setting up Asset Reconstruction Companies (ARCs). After vigorous OTS duly prescribed by SIDBI, remaining NPAs may be transferred to ARCs with powers of Section 29 to 32G of the SFCs Act. The ARCs may issue bonds in favour of SFCs on the realisable value of the assets transferred to them by SFCs. The State Govts. should grant exemption, if required, of stamp duty and registration charges. Alternatively, the SFCs might transfer the NPAs to a Special Purpose Vehicle (SPV) which will securitise the assets and issue pass-through certificates (PTCs) for raising resources. The bonds will be redeemed out of the sale proceeds recovered from the securitised assets. Besides above measures for containment of NPAs, there is need to closely monitor the quality of new assets. Also, the recoveries need to be made on sustained basis. In this regard, the Committee recommends that :
• The quality of addition of new assets should be closely monitored. Based on the predomination of particular industrial sector in the State, each SFC should fix certain sectoral exposure limits. Also limit should be fixed on client/company basis. A strict vigil must be kept on new accounts entering into NPA category.
• Improve recoveries by hiring the services of factors and deploying own staff, especially trained in recovery. Rehabilitation package should be worked out, wherever feasible.
• The Committee is of the view that the guidelines for income recognition, provisioning and asset classification would need to be different from those applicable to commercial banks owing to special circumstances in which SFCs operate. COSIDICI on behalf of SFCs might take up this issue with RBI/SIDBI.

• The SFCs are carrying huge closing cash and bank balances. This indicates poor cash management. The SFCs need to invest these cash balances profitably in short term investments.
• Asset-Liability Management is an important aspect of effective resource management. The Committee observes that this aspect has been, by and large, ignored by the SFCs in their day-to-day functioning and the system is conspicuous by its absence. It is, therefore, recommended that 
• Asset Liability Management Committee (ALCO) be formed in each SFC for this purpose. It would ensure that SFCs in future do not borrow short and lend long and thereby avoid asset liability mismatches.
• It is noted that some SFCs are not adopting uniform accounting standards. In this regard, SFCs might be advised to immediately adopt uniform accounting standards.

Keeping in view the factors and constraints coming in the way of SFCs' smooth functioning and leading to their present deteriorated health, the Committee suggests that the SFCs in future should consider desisting from : 

(i) large scale concentration in a few industries; 
(ii) introducing new products (like working capital, bills discounting, leasing, etc.) without taking into consideration their operational hazards and the impact on the overall profitability; 
(iii) external influences in taking investment profitability; 
(iii) creating unduly large mismatches between their assets and liabilities;  
(v) expand branches and recruit non-professional staff without considering their impact on operations; 
(vi) depending on the traditional avenues of cheap resources, the channels of which are drying up, etc.