by Professor Stephany Griffith-Jones
20 May 2015
It is very welcome that in paragraph 30 of the zero draft for the Addis Ababa Conference on Financing for Development, it is acknowledged that well-functioning national development banks (NDBs) can play a role in filling major financing gaps. Such large financing gaps exist in areas crucial for sustainable development, including infrastructure, agriculture, industrialization, science, technology and innovation, as well as for financial inclusion. The draft further rightly acknowledges that DBs also play a valuable countercyclical role, especially when private financial institutions sharply reduce their lending. Furthermore, development banks can play a critical role in alleviating constraints on investment in infrastructure and MSMEs. The draft calls on DBs to expand their contribution and urge relevant international public and private actors to support NDBs in developing countries.
The financial sector should help support the real economy. As the IMF Managing Director, Mme Lagarde perceptively said, “We need a financial system that serves society”. To achieve this key role the financial sector needs to encourage and mobilize savings, intermediate them at low cost, and channel them into efficient investment.
In recent decades the private financial system has not performed fully any of these functions. It has been pro-cyclical, over-lending in boom times, and rationing credit during and after crises, limiting working capital and, especially, long-term finance crucial for investment. In both tranquil, but more in turbulent times, it has not funded sufficiently long-term investment in innovation and skills which businesses need to grow and create jobs; key sectors like infrastructure, renewable energy and energy efficiency have been insufficiently funded. Small and medium enterprises get insufficient credit, which is often costly and short-term – problems accentuated in low-income countries.
The limitations of the private financial sector have increasingly drawn attention to the positive complementary role that effective public development banks can play, at national, regional and multilateral levels.
The positive role these DBs (at national, regional and multilateral levels) have played in providing counter- cyclical finance as private finance fell sharply during the North Atlantic crisis, which started in 2007, is increasingly seen as valuable. This happened not just in developing and emerging economies, but also in several developed ones. Furthermore, where the national development banks have relatively significant size, their counter-cyclical impact has been relatively larger.
The greater need for instruments to implement long- term national development strategies has been increasingly recognized. Often, development banks facilitate financing of sectors and investment projects key for future development, that have high uncertainty as to future success. Because of that, they may not be initially funded by the private financial system. Well run development banks can provide the vision- and part of the resources, to do those things that at present are not done at all. This requires good development banks with the expertise and the strategic vision to fund new sectors and technologies. The fact that development banks can provide long-term loans, have a long-term development perspective, as well as require lower returns further facilitates this financing. .
There are therefore four valuable functions that seem crucial for national, regional and multilateral development banks to play: a) providing counter-cyclical finance, especially for supporting investment; b) funding, a dynamic vision and strategy of growth and structural transformation, c) mobilizing broader financial resources, for example by leverage: especially in a world with limited fiscal resources, the leverage which public contributions through paid-in capital can have is significant, as DB lending can be funded in the private markets, and such DB lending can be co-financed by private lending and investing; d) financing public goods. Indeed, development banks are also needed to help fund sectors or activities where important externalities exist, implying that social returns are higher than market returns; this is for example the case with environmental externalities.
Development banks provide benefits of diversification. This may have several advantages. Firstly, it may encourage competition between different types of financial institutions, which should lead to greater efficiency. Secondly, a more diversified financial system could lead to less systemic risk and contribute to financial stability. Thirdly, if different varieties of financial institutions have different strengths, a more diverse system could make it more likely that financial sector functions needed are achieved.
It is key to look at the best ways of building synergies amongst institutions of different types as well as encourage best practice within them. Public development banks co-finance, and increasingly lend, via private banks. Furthermore, much of their lending is done to private firms. The ability to combine private and public resources creatively, ideally working constructively together, is essential for a financial system that serves the needs of inclusive and environmentally sustainable growth. Well-run and well-governed development banks can play an important role in this aim.