State Development Loan (SDL) – UPSC Economy Notes

State Development Loans (SDLs) are securities issued by State Governments in India to raise loans from the market. Here are key points about SDLs:

1. Nature of SDLs:
   • SDLs are dated securities, similar to bonds, issued through auctions conducted by the Reserve Bank of India (RBI).
2. Auction Process:
   • State Governments conduct auctions to issue SDLs. Investors, including banks, financial institutions, and other market participants, participate in these auctions.
3. Interest Calculation and Payment:
   • The interest on SDLs is calculated at half-yearly intervals, and the principal is repaid on the date of maturity. This structure is common for most bonds and securities.
4. Statutory Liquidity Ratio (SLR) Eligibility:
   • SDLs qualify for inclusion in the Statutory Liquidity Ratio (SLR) requirements of banks. SLR is a mandatory requirement that banks maintain a certain percentage of their Net Demand and Time Liabilities (NDTL) in the form of liquid assets, which include government securities.
5. Collateral for Market Repo:
   • SDLs can be used as collateral for borrowing through market repo (repurchase agreements). In a repo transaction, the borrower sells securities to the lender with an agreement to repurchase them at a later date.
6. Liquidity Adjustment Facility (LAF):
   • SDLs can also serve as eligible collateral for entities borrowing from the RBI under the Liquidity Adjustment Facility (LAF). LAF is a monetary policy tool used by the RBI to manage liquidity in the financial system.

State Development Loans play a crucial role in allowing state governments to meet their funding requirements by tapping into the financial markets. The inclusion of SDLs in SLR and their acceptance as collateral in various financial transactions enhances their attractiveness to investors.

Development Finance Institution (DFIs) or Development Banks:

Development Finance Institutions (DFIs) play a crucial role in providing long-term credit to various sectors, contributing to economic development. Here are key points about DFIs:

1. Geographical Coverage:
   • DFIs can be categorized based on their geographical coverage, including All-India institutions and State/regional-level institutions.
2. All-India Institutions:
   • All-India institutions can be functionally classified into different types:
     • Term-lending institutions: Examples include IFCI Ltd., which extends long-term finance to various industrial sectors.
     • Refinancing institutions: Institutions like NABARD, SIDBI, and NHB provide refinancing to banking and non-banking intermediaries for financing in agriculture, Small-Scale Industries (SSIs), and the housing sector, respectively.
     • Sector-specific/specialized institutions: Entities like EXIM Bank, HUDCO Ltd., IREDA Ltd., PFC Ltd., IRFC Ltd. focus on specific sectors or purposes.
     • Investment institutions: LIC, UTI, GIC, etc., fall into this category.
3. State/Regional Level Institutions:
   • State/regional-level institutions include State Finance Corporations (SFCs), State Industrial Development Corporations (SIDCs), and others.
4. Access to Low-Cost Funds:
   • Historically, DFIs had access to low-cost funds, ensuring that the profits on their lending operations were not under significant pressure.
5. Long-Term Operation (LTO) Funds:
   • DFIs had access to a soft window of Long Term Operation (LTO) funds from the RBI at concessional rates, supporting their long-term lending activities.
6. Reforms and Universal Banking:
   • With economic reforms in 1991 and the opening of capital markets for equity, DFIs such as ICICI and IDBI faced changes in their operational landscape. Many DFIs transformed into universal banks to adapt to the evolving financial environment.

DFIs have historically played a crucial role in channeling funds for long-term projects and sectors critical for economic development. However, changes in the financial landscape have led to transformations and adaptations in the role and structure of these institutions.

Merchant Banks/Investment Banks:

Merchant Banks, also known as Investment Banks, play a crucial role in the financial sector, particularly in dealing with corporations and financial markets. Here are key points about Merchant Banks:

1. Focus on Corporate Clients:
   • Merchant Banks primarily deal with companies and corporate clients rather than the retail public.
2. Management and Underwriting:
   • Their main functions include managing financial transactions and underwriting. Underwriting involves guaranteeing the purchase of shares in a new issue (Initial Public Offering – IPO) or rights issue that is not fully subscribed by the public.
3. Advisory Role:
   • Merchant Banks advise corporate clients on various financial matters, including fund-raising strategies. They play a crucial role in guiding companies through the process of issuing new securities to raise capital from the public.
4. Investment Banking in the U.S.:
   • In the United States, institutions with similar functions are often referred to as investment banks. These entities provide a wide range of financial services, including investment banking, equity trading, research, investment management, private equity, and private banking.
5. Global Examples:
   • Globally, notable examples of investment banks include Lehman Brothers (bankrupt since 2008), Goldman Sachs, and Morgan Stanley. These institutions are involved in various financial activities such as investment banking, equity trading, research, investment management, private equity, and private banking.
6. Existence in India:
   • Merchant Banks and Investment Banks also operate in India, providing similar financial services to corporate clients.

Merchant Banks play a pivotal role in facilitating financial transactions, supporting companies in their fund-raising endeavors, and contributing to the overall efficiency of financial markets. Their activities are crucial for the functioning and growth of the corporate sector.

Nidhi Company:

A Nidhi company is a specific type of company in the Indian non-banking finance sector, governed by Section 406 of the Companies Act, 2013. Here are key features of Nidhi companies:

1. Core Business:
   • The primary business activity of a Nidhi company revolves around borrowing and lending money among its members. Members typically consist of individuals who have joined the company for mutual benefit.
2. Alternative Names:
   • Nidhi companies are known by various names, including Permanent Fund, Benefit Funds, Mutual Benefit Funds, and Mutual Benefit Company.
3. Regulation:
   • These companies fall under the regulatory purview of the Ministry of Corporate Affairs in India. The Ministry oversees their operations and compliance with relevant regulations.
4. Deposit Acceptance Activities:
   • While their core activity is related to borrowing and lending among members, the Reserve Bank of India (RBI) has the authority to issue directions concerning their deposit acceptance activities.
5. Geographical Distribution:
   • Nidhi companies are more prevalent in South India, with a significant concentration in Tamil Nadu. Approximately 80% of these companies are located in this region.

Collective Investment Scheme (CIS):

A Collective Investment Scheme (CIS) is an investment arrangement where multiple individuals pool their money to collectively invest in assets. Key points about CIS include:

1. Definition:
   • CIS refers to an investment scheme where a group of individuals contributes funds, which are then invested collectively. The returns generated from these investments are shared among the participants.
2. Exclusion of Mutual Funds:
   • It’s important to note that CIS excludes mutual funds. Mutual funds operate under a separate regulatory framework.
3. Regulation by SEBI:
   • CIS is regulated by the Securities and Exchange Board of India (SEBI), which is the regulatory authority for securities and investment markets in the country.

Collective Investment Schemes provide a platform for individuals to pool their resources, diversify investments, and share in the benefits and risks associated with the collective investment strategy. SEBI’s oversight ensures transparency and investor protection within these schemes.

Alternative Investment Funds (AIFs):

Alternative Investment Funds (AIFs) represent a new category regulated by the Securities and Exchange Board of India (SEBI). AIFs are entities established or incorporated for the purpose of pooling capital from both Indian and foreign investors in India. Here are some key points:

1. Pooling Capital:
   • AIFs are designed to pool funds from a diverse range of investors, both domestic and foreign, to invest in various asset classes.

Real Estate Investment Trusts (REITs):

SEBI also regulates Real Estate Investment Trusts (REITs), which operate in a manner similar to mutual funds. Key features of REITs include:

1. Capital Pooling:
   • REITs pool money from investors and issue units in exchange. The funds collected are invested in completed commercial properties that generate income.
2. Registration and IPO:
   • REITs must get registered with SEBI and raise funds through an Initial Public Offer (IPO). There are minimum requirements for asset sizes and the size of the initial public offer.
3. Market Trading:
   • Similar to stocks, investors can buy units of REITs in both primary and secondary markets, providing a way to invest in commercial real estate without directly owning the assets.

Mutual Funds:

Mutual funds, regulated by SEBI, operate by raising money from the public and investing it in various securities such as stocks and bonds.

Hedge Fund:

Hedge funds, regulated under the Alternative Investment Fund (AIF) framework by SEBI, share similarities with mutual funds but employ more complex investment strategies. They are known for their less transparent nature.

Venture Capital:

Venture capital involves financial institutions investing in startups with the potential for significant economic contributions. These investments typically come with inherent risks, and venture capitalists play a crucial role in supporting the growth of emerging businesses.

In summary, SEBI’s regulatory framework covers a spectrum of investment vehicles, each serving specific purposes and catering to different risk profiles and investor preferences.

Angel Investors:

An angel investor, commonly known as an angel, is an affluent individual or firm that provides capital for a business start-up, typically in exchange for convertible debt or ownership equity. Unlike venture capitalists who invest public money, angel investors use their own funds. Here are key aspects of angel investors in the Indian context:

1. Origins and Popularity:
   • Angel investors gained popularity, particularly with the rise of web-based enterprises in the 1990s.
2. Encouraging Entrepreneurship:
   • The Securities and Exchange Board of India (SEBI) recognized the role of angel investors in encouraging entrepreneurship. In 2013, SEBI notified norms for angel investors, allowing them to be registered as Alternative Investment Funds (AIFs).
3. Investment Restrictions:
   • SEBI imposed certain restrictions to ensure the genuineness of investments by angel funds. Notable norms include:
     • Investments limited to companies incorporated in India.
     • Funds must be invested in a firm for a minimum of three years.
     • Investments made in companies not older than three years.
4. Corpus Requirement:
   • Angel funds are required to have a minimum corpus of ₹10 crore.
5. Minimum Investment:
   • Investors are required to make a minimum investment of ₹25 lakh.
6. No Family Connection:
   • SEBI stipulated that the fund must not have any family connection with the investee company.
7. Encouraging Start-ups:
   • The introduction of these norms aimed to encourage entrepreneurship by providing funding to small start-ups that may face challenges obtaining funds from traditional sources like banks and financial institutions.
8. Government Initiatives:
   • In 2016, the Government of India introduced a start-up policy, creating an environment that could benefit from the support of angel investors.

In summary, angel investors play a crucial role in fostering innovation and supporting the growth of start-ups, particularly in sectors like technology and digital enterprises. SEBI’s regulatory framework ensures transparency and genuine investments while providing the necessary boost to early-stage businesses.

FAQs

1. What is a State Development Loan (SDL)?

• A State Development Loan (SDL) is a type of bond issued by state governments in India to raise funds for various development projects and infrastructure initiatives within their respective states.

2. Who issues State Development Loans?

• State governments in India issue State Development Loans (SDLs) through auctions conducted by the Reserve Bank of India (RBI) on behalf of the respective states. These bonds are typically issued to finance state-specific projects and initiatives.

3. What is the tenure of State Development Loans?

• The tenure or maturity period of State Development Loans (SDLs) varies, typically ranging from 5 to 15 years. However, some SDLs may have longer tenures depending on the requirements and financial policies of the issuing state government.

4. How are State Development Loans different from Central Government Securities (G-Secs)?

• While both State Development Loans (SDLs) and Central Government Securities (G-Secs) are government bonds, SDLs are issued by state governments, whereas G-Secs are issued by the central government. SDLs are specific to individual states and carry their credit risk, while G-Secs are considered to have lower default risk as they are backed by the central government.

5. What are the key risks associated with investing in State Development Loans?

• The primary risk associated with investing in State Development Loans (SDLs) is credit risk, as the repayment of principal and interest depends on the financial health of the issuing state government. Additionally, SDLs may also be subject to interest rate risk and liquidity risk, depending on market conditions and investor demand. It’s essential for investors to assess the creditworthiness of the issuing state government before investing in SDLs.

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