One problem is that the FIs no longer have access to cheap funds provided by the Government. Consequently, they have had to finance their loans to projects through public deposits. Since these deposits are short term, there is a risk of severe maturity mismatch. At the same time, banks have muscled their way into termlending. FIs' spreads have been squeezed as a result. Moreover, exposure to capital-intensive projects at a time of restructuring of Indian industry has resulted in burgeoning NPAs, and the markets have given the thumbs down to FI stocks. Hence the demand by FIs that they be allowed to function as banks.

The RBI's fears about industrial development suffering as a result of the demise of DFIs are exaggerated. If a project is viable, there is no reason why universal banks will not finance it. Financial intermediaries, call them what you will, should be free to choose a portfolio of products. That will not only ensure their health, but will also result in funds flowing to their most productive uses.

The issue is not ultimately whether FIs should become universal banks or not. It may so happen that even if the DFIs were allowed to become banks, they would prefer to concentrate on term lending, because that is their area of expertise. The RBI thinks that it, rather than the market, should decide the kind ofassets which financial companies choose to invest in. Given that our experience with strictly segregated financial markets has not resulted in strong financial intermediaries, the RBI's decision to keep the current system going is not defensible. Intermediation costs remain high, and political interference has affected the health of financial institutions. Further, the RBI's refusal to take a view on the ownership of the DFIs shirks a solution to this problem.

The RBI's decision to keep the financial sector compartmentalised may make its regulation task easier, but it would lead to suboptimal outcomes in utilising financial resources.