National Development Banks in comparative perspectiveC. P. ChandrasekharJawaharlal Nehru University, New Delhi

Why development finance

Late industrialisation requires lumpy investments, with long gestation lags to occur simultaneously in multiple industries.

In most late industrialisers liquidity and maturity mismatches between the expectations of savers and requirements of investors results in the absence of such long –term finance

While government can finance such investments through taxation or borrowing, the private sector often cannot because of the absence of markets for long–term finance.

Besides, if left to markets, come sectors may not be financed because of higher costs or perceptions of risk.

Development banksPresent across the world and mandated to provide credit at terms that render industrial and infrastructural investment viable.

Tend to lend not only for working capital purposes, but to finance long-term investment as well.

Invest in equity as well, resulting in them adopting the unconventional practice of investment in equity in firms they are exposed to as lenders.

Closely monitor the activities of the firms they lend to, with nominated directors on the boards of companies

Technical assistance

Involved in decisions such as choice of technology, scale and location

Provide merchant banking services to firms they lend to, taking firms to market to mobilise equity capital by underwriting equity issues. If the issue is not fully subscribed the shares would devolve on the underwriter, increasing the equity exposure of the bank.

Monitor corporate governance and performance on behalf of all stakeholders.

How common are theyAccording to an OECD estimate there were about 340 development banks in some 80 developing countries in the mid-1960s. Over half of these were state-owned and funded by the exchequer; the remainder had mixed ownership or were private.

According to Nicholas Bruck (1998), there were over 550 development banks worldwide, of which 32 were in the nature of international, regional and sub-regional development banks, leaving around 520 national development banks (NDBs) in 185 countries, or an average of about 2.8 per country.

Latin America and the Caribbean had the largest number of NDBs (152), followed by Africa (147), Asia and the Pacific (121), Europe (49) and West Asia (47).

Characteristics 1Survey conducted by the World Bank in 2009 (Luna-Martinez and Vicente 2012) defined NDBs as “financial institutions with at least 30 per cent state-owned equity”, with “an explicit legal mandate to reach socioeconomic goals in a region, sector or particular market segment”.

Covered 90 DFIs and found that 12 per cent of them had been established before 1946, 49 per cent between 1946 (after the end of World War II) and 1989, and 39 per between 1990 and 2011.

Despite the change in policy orientation after 1990 in most developing countries, governments continued to rely on DFIs.

Characteristics 2

74 per cent of these institutions were entirely government owned and controlled and a further 21 per cent had less than 50 per cent of private equity ownership.

Though 41 per cent of the institutions surveyed reported taking deposits, 89 per cent were borrowing from other financial institutions or issuing debt in local markets, 40 per cent had obtained budgetary transfers from the government, and 64 per cent had benefited from government guarantees of the debt they issued. 18 per cent of the institutions that received transfers declared that if transfers were withdrawn, they would not be able to operate.

Importance of state support

Access to government support allowed development banks to offer credit at subsidised interest rates.

Half of those surveyed reported that practice, two-thirds of which claimed to finance those subsidies with transfers from government. Some reported cross-subsidisation.

53 per cent of the institutions surveyed had specific policy mandates, having been “established to support the agriculture sector (13% of all DBs), SMEs through their lending, guarantee or advisory services (12%), export and import activities (9%), housing (6%), infrastructure projects (4%), local governments (3%), and other sectors (6%).”

Divergent trajectoriesDespite the widespread presence of NDBs, their recent evolution has been very different.

In Brazil, the BNDES has emerged a giant, financing huge projects, serving as a countercyclical instrument during the recession, bankrolling Brazil’s going-out strategy, and spreading its tentacles across Latin America and beyond.

China, which did not have a development bank, established on in 1994 as part of reform.

India, on the other hand, has dismantled its development banking infrastructure.

Historical precedentIn early, late industrialising nations (Germany and Japan, for example) there were components of the financial sector that helped overcome the handicaps that such a nation suffers from.

But here it was the mainstream banking system that was called upon to play the role, especially in the form of the Kreditbanken or universal banks in Germany and the more recent main bank system in Japan.

Original example was of course the Credit Mobilier in France, which however failed.

Gerschenkron’s interpretation

Gerschenkron believed they served as institutional substitutes for crucial “prerequisites” such as prior accumulation of capital or the availability of adequate entrepreneurial skills or technological expertise.

Basing his arguments on the roles played by Crédit Mobilier of the brothers Pereire in France and the ‘universal banks’ in Germany, Gerschenkron argued that the creation of “financial organisations designed to build thousands of miles of railroads, drill mines, erect factories, pierce canals, construct ports and modernise cities” was hugely transformative.

Gerschenkron 2In his view, financial firms based on the old wealth were typically in the nature of rentier capitalists and limited themselves to floatations of government loans and foreign exchange transactions. The new firms, were “devoted to railroadisation and industrialisation of the country” and in the process influenced the behaviour of old wealth as well.

“The difference between banks of the credit-mobilier type and commercial banks of the time (England) was absolute. Between the English bank essentially designed to serve as a source of short-term capital and a bank designed to finance the long-run investment needs of the economy there was a complete gulf. The German banks, which may be taken as a paragon of the type of the universal bank, successfully combined the basic idea of the credit mobilier with the short-term activities of commercial banks.”

Credit Mobilier

Influence by the early-socialist views of Saint Simon, the Pereire brothers established Credit Mobilier in 1852. Besides investments from large promoters, the bank accepted deposits from the public as well.

It funded governments, shipping line, transportation companies and the like. But in 1856 the French government under the influence of the Banque de France refused permission to the CM to issue its own paper.

The failureIn his discussion of the Credit Mobilier, Sraffa reportedly argues that while it began with a wise policy of matching maturities of assets and liabilities, it made a mistake in turning towards financing long-term investment with short-term deposits, which ultimately led to its failure.

This he argued was because CM did not receive adequate state support. He refers to the jealousy it aroused in the Banque of France, which turned hostile, and jettisoned the CM’s requests for government permission to issue long term bonds.

The issue of liquidity

The issue is not really that banks would not be able to call in their long term credits, but that the assets they hold in the form of the securities associated with those credits may not be easily sold and converted to cash to meet demands to pay back deposits.

So lending is possible if an agency exists to provide lines of credit to banks engaged in long term lending to industry when the former are unable to obtain liquidity from elsewhere.

The German exampleThe German universal banks Sraffa argued built on the experience of the Credit Mobilier to serve as banks that (backed by the Reichsbank) financed German industrialisation.

De Cecco summarises Sraffa’s perception of the system as follows: “German Grossbanken, which were heavily involved in maturity transformation, were likely to find themselves periodically stuck in illiquidity situations, and required reliable access to last-resort lending by the Reichsbank. In fact, the whole concept of last-resort lending, which had been developed in the English context, had to be adapted, indeed drastically transformed, to be used in the German one.”

German specificity

The central bank gives security to banks engaged in extending industrial credit by being prepared to help them when they are in temporary difficulty and are unable to sell their securities in the open market.

In all countries on the Continent, Sraffa notes, joint stock banks have recourse to the central bank, directly, whenever they need it. ‘In this respect,’ he writes, ‘the relations of joint stock banks to the bank of issue are very different from those in England.

Social bankingAccording to Sraffa, what was recommended and experimented with on the Continent by Saint Simon, the Pereire brothers and the German universal banks was a form of “active banking” involving close interaction of banks and industry with an element of domination of the latter by the former because of “the superior information banks could gather on industry, being at the crucial node of the economic system.”

Being heavily involved in maturity transformation, they were likely to find themselves periodically stuck in illiquidity situations, and required reliable access to last-resort lending by the Reichsbank.

Role of the ReichsbankThe whole concept of last-resort lending, developed in England, was adapted, or drastically transformed, to be used in Germany.

The German Reichsbank, according to Sraffa, was best thought of as the apex institution of an organically conceived centrally planned economy in which the banking system, headed by the central bank, performed the role of planning office.

This was possible due to the elasticity of its note issue, while the Bank of England is tied to the Bank Act’s rigid note issue.

How was the moral hazard problem

addressed?Long-term relationship and presence of nominated directors on the board gives the banks the ability to better monitor managers on behalf of itself and other stakeholders.

Since the German universal bank closes the gap for finance AND the gap in entrepreneurship and technical capability it was often a part of the decision-making process.

Information asymmetry problem adequately dealt with

Developing country specificity

No guarantee that institutional substitutes or mechanisms such as these that can support late industrialisation will evolve automatically. In any case, the wait may be far too long.

Modern commercial banks were either recent or a colonial implant and were both prone to failure and unlikely to to have the wherewithal to take and manage risk associated with capital intensive investments.

This might require DFIs to be established by the government, even owned by it and supported with significant resources from the budget or the central bank.

Motivation

Make up for the failure of private financial agents to provide certain kinds of credit to certain kinds of clients.

Left to themselves, private financial markets in developing countries usually fail to provide enough long-term finance to undertake the investments necessary for economic and social development.

Alternative institutions needed with objectives other than profitability.

Some implications

NDBs are instruments of state-led or state-supported capitalist development.

There is a priori no reason to believe that this is a requirement only in dirigiste regimes and that liberalisation will imply the end of development banking.

There would be differences in what NDBs do under different regimes.

The Brazilian case

Banco Nacional de Desenvolvimento Econômico e Social (BNDES) in Brazil, established in 1952.

The importance of BNDES support for private investment in Brazil was large and has increased significantly, with a transition in 1965 when BNDES support rose from below 3 per cent of capital formation to 6.6 per cent.

At its peak in 2010 annual BNDES lending amounted to around 70 per cent of long term credit in the country.

Sectoral focus

Initially sectors like transport and power overwhelmingly dominated its lending.

Subsequently there was considerable diversification in support, to sectors such as nonferrous metals, chemicals, petrochemicals, paper, machinery, and other industries.

While in its early years BNDES investments were focused on the public sector, there was a significant shift in favour of the private sector in later years. Financing for the public sector fell from 80-90 per cent in the period 1952-66, to 44 per cent during 1967-71, and then to 20-30 per cent.

Sources of funding

Funding for BNDES activities has come from a range of sources, such as bond issues, resources from multilateral organisations, transfers from the treasury, and deposits from the government of funds from privatisation, for example.

The government has also used various measures such as special taxes and cesses, levies on insurance and investment companies and direction of pension fund capital to mobilise resources for the industrial financing activities of the BNDES

A major changeUnder President Ernesto Geisel (1974-1979), the administration of funds collected through payroll taxes imposed on company profits under the Social Integration Programme (PIS) and the Public Employment Savings Programme (PASEP) that were started in early 1970s was transferred to BNDES.

Changes in the management of PIS-PASEP in the 1988 Constitution led to the creation of the Workers Assistance Fund, 40 per cent of accruals to which had to be mandatorily routed to BNDES for investments in employment generating projects.

In 2007, 10 per cent of BNDES’ funds came from the government’s investment in its equity, and 75 per cent from the government through obligatory investments of FAT (Workers’ Support Fund) resources and special programmes such as the Accelerated Growth Programme (PAG) and the Sustainable Investment Programme (PSA).

SubsidySELIC (Sistema Especial de Liquidação e Custódia or Special System for Settlement and Custody) rate set by the central bank, which serves as the benchmark for the credit system, rules higher than the TJLP (Taxa de Juros de Longo Prazo or Long Term Interest Rate) that governs BNDES’ operations.

Since the government borrows at the SELIC rate and lends to the BNDES at the TJLP, there is an implicit subsidy being paid out to BNDES from the budget and being borne by the tax payer.

To the extent that BNDES offers credit to its borrowers at a rate lower than the SELIC, there is a transfer to the latter as well. The BNDES does indeed lend at rates close to the TJLP.

Implications

As Brazil’s capitalism has changed so has the role played by the BNDES.

It is true that the use of FAT funds for subsidised lending to big corporations cannot be justified on distributional grounds.

But that is not the objective. It is to strengthen Brazilian capital, particularly when it is attempting to spread its wings abroad.

Three phases of development finance in

IndiaThe first began with Independence and extends to 1964 when the Industrial Development Bank of India was established, which was the phase of creation and consolidation of a large development financing infrastructure.

The second period stretched from 1964 to the middle of the 1990s when the role of the DFIs gained in importance, with the assistance disbursed by them amounting to 10.3 per cent of Gross Capital Formation in 1990-91 and 15.2 per cent in 1993-94.

Thirdly, after 1993-94, the importance of development banking declined with the decline being particularly sharp after 2000-01, as liberalisation resulted in the conversion of some development banking institutions into commercial banks and in a decline in the resources mobilised by other firms.

Role of the central bank

An Industrial Finance Department (IFD) was established in 1957 within the Reserve Bank of India (RBI) and the central bank began administering a credit guarantee scheme for small-scale industries from July 1960.

With a view to supporting various term-financing institutions, the RBI set up the National Industrial Credit (Long-Term Operations) Fund from the year 1964-65.

The infrastructureThe industrial finance infrastructure consisted of the Industrial Finance Corporation of India (established in 1948), the State Financial Institutions set up under an Act that came into effect in August 1952, the Industrial Credit and Investment Corporation of India (ICICI), the first development finance institution in the private sector, established in January 1955 with a long-term foreign exchange loan from the World Bank, the Refinance Corporation for Industry (1958) established to channel PL 480 counterpart funds earmarked for lending to the private sector, and the Industrial Development Bank of India (IDBI) established in 1964 as an apex development bank.

Thus, by the end of the 1980s, the industrial development banking infrastructure in India consisted of three all-India development banks (IFCI, ICICI and IDBI), and 18 State Financial Corporations. In 1990, the government established the Small Industries Development Bank of India (SIDBI) as an all-India financial institution for the financing of micro, small and medium enterprises.

OutcomeThe post-1972 period witnessed a phenomenal rise in financial assistance provided by these institutions (including investment institutions).

Given the nature of and the role envisaged for the development finance institutions, the government and the RBI had an important role in providing them resources. In addition, public banks and the LIC and GIC also played a role

Howeever, India turned its back on this legacy in the mid-1990s. By 2011-12, assistance disbursed by the DFIs amounted to just 3.2 per cent of Gross Capital Formation. By 2012 there were only two all-India development banking institutions: the National Bank for Agricultural and Rural Development (established in 1982) and the SIDBI.

The Brazil-India contrast

In Brazil, reform notwithstanding, the BNDES has grown in strength as noted above. This has served Brazil well. The bank’s role increased significantly when private activity slackened in the aftermath of the financial crisis. This countercyclical role helped Brazil face the crisis much better than many other developing countries.

On the other hand liberalisation led to a decline in development banking and the demise of the major development finance institutions in India. The absence of these specialized institutions is bound to limit access to long term capital for the manufacturing sector.

Outcome twoOne result has been that the government has had to use the publicly-owned commercial banks as a means of financing capital intensive investment.

The share of infrastructure in lending to industry by commercial banks in India has risen from less than 5 per cent in 1998 to 32 per cent in 2012, when aggregate credit provided by scheduled commercial banks rose from 21 per cent of GDP to 56 per cent of GDP, with the share of advances to industry falling from around 50 to 40 per cent.

Given the reliance of banks on shorter maturity deposits that are extremely liquid, this exposure to infrastructure implied large maturity and liquidity mismatches. Not surprisingly, defaults have been on the rise and non-performing assets have shot up, leading to balance sheet fragility.

The South Korean caseAmong the factors responsible for Korea’s success with its outward-oriented industrialisation and mercantilist strategy of growth based on rapid acquisition of larger shares in segments of the world market for manufactures, was the role of the state in guiding industry to the segments of the global market that were targeted.

For this to work, the State must through its financial policies ensure an adequate flow of credit at favourable interest rates to firms investing in these sectors, so that they can not only make investments in frontline technologies and internationally competitive scales of production, but also have the means to sustain themselves during the long period when they acquire and expand market share.

The situation after World War II

Korea had a shell of a modern financial system.

Almost all the existing banking institutions were engaged predominantly in a regular commercial banking business consisting essentially of accepting demand deposits and of making short-term loans and advances to primary producers, to businessmen and to Government Agencies.

Korean Development Bank

Established in 1954 with the primary objective of granting medium and long-term loans to industry

Wholly owned by the government and built on the assets and facilities of the Industrial Bank, the KDB came to account by the end of 1955 for over 40 per cent of total bank lending.

At one point, it accounted for 70 per cent of the equipment loans and 10 per cent of working capital loans made by all financial institutions.

Sources of funds

Loans were not based on deposits.

About a third of the loans were supported by aid counterpart funds and two thirds with financing from the Bank of Korea and the government.

In the 1950s, 50 per cent of the funds came from the government fiscal loans programme and another 30 per cent raised by issuing bonds.

Foreign borrowingThe KDB’s charter was revised to allow it to borrow funds from abroad and guarantee foreign borrowing by Korean enterprises.

An interesting feature of industrial finance in Korea was the guarantee system, created largely to privilege borrowing abroad over attracting foreign investment, to keep Japanese capital at bay.

Firms wishing to borrow from abroad obtained approval from the Economic Planning Board. Once that was done the Bank of Korea (BOK) issued a guarantee to the foreign lender and the KDB issued one to the Bank of Korea.

So, while the borrower was committed to repay the loan and carry the exchange risk, that commitment was underwritten by the KDB and BOK, which by guaranteeing against default were ensuring access to foreign borrowing.

Other initiativesThe Korea Development Finance Corporation, established in 1967 with support from the World Bank, was mandated to assist in the development and creation of private enterprises by providing medium and long-term financing and equity participation, as well as technical and managerial consulting services.

With the launch of the Heavy and Chemical Industries (HCI) strategy the National Investment Fund (NIF) was set up in 1974, to direct savings to these industries. The NIF mobilised its resources through the sale of bonds, obtaining loans from the deposit money banks (DMBs) and other savings and investment institutions, and transfers from the government budget.

China Development Bank

Established as part of the reform process in 1994. Three factors that gave CDB a privileged position.

It was established at a time when banks were being restrained from lending to projects that were either capital intensive in nature, with long gestation lags, or were in the infrastructural area.

This was the phase of rapid urbanisation in China, resulting in huge demands for infrastructure.

Much of the investment in infrastructure was being undertaken by provincial governments that did not have the tax revenues needed to finance those expenditures and could not borrow to finance the same because of the 1994 ban. To circumvent the ban they established special local government financing vehicles that became important clients of CDB.

Sources of funds

Not a deposit taking institution, which was limited by liquidity mismatches from investing in capital intensive projects that would yield returns only in the long run, if at all.

Mobilised resources by issuing bonds that were subscribed to by banks that saw these instruments as being safe despite yielding higher returns. In fact, the presumption was that these bonds carried a sovereign guarantee, even though there was no formal commitment.

FinancingBy 2011, the assets of CDB were estimated at $991 billion, as compared with $545 billion for the World Bank group (consisting of IBRD, IDA and IFC), $306 for BNDES (2010) and $132 billion for the Korea Development Bank .

It replaced the government and the commercial banks as lender to the state-owned enterprises.

It lent to the LGFVs to finance the huge infrastructural investments being undertaken by the provincial governments. According to one estimate, as much as one-half of CDB’s loan book could consist of lending to local governments, and the bank may account for as much as one-third of all LGFV loans

New areas

Financing China’s “going out” policy or spread abroad, partly as manufacturing investor in low cost locations in Africa and Latin America but more importantly as acquirer of mineral and oil resources across the globe.

Major investor in China’s wind, solar and telecommunications companies, with Huawei Technologies being the largest beneficiary.

ConclusionOver a significantly long period of time, countries embarking on a process of development within the framework of mixed, capitalist economies have sought to use the developing banking function, embedded in available or specially created institutions, to further their development goals.

With financial liberalisation of the neoliberal variety transforming financial structures, some countries are doing away with specialised development banking institutions on the grounds that equity and bond markets would do the job. This is bound to lead to a shortfall in finance for long-term investments, especially for medium and small enterprises.

The New Development Bank

New Development Bank different because most existing development banks are in terms of shareholding, voting rights and management dominated by one or the other developed country.

Since the NDB is owned and backed by governments in a set of “emerging economies”, it is likely to be able to mobilise substantial resources at reasonable cost from private market.

As the allocation of these resources would be determined by the representatives of the five BRICS countries, it could direct resources to projects that are more in keeping with the requirements of the South.

The terms on which the institution lends could in time reflect “Southern” requirements and sensitivities.

Case for cautionIn the final analysis development banks are instruments of state capitalist development.

Whether even this difference would be material depends on three factors. The first is the degree to which the emergence of the NDB alters the global financial architecture. The second is the degree to which the BRICS bank can differ in its lending practices from the institutions that currently dominate the global development-banking infrastructure. And, the third is the degree to which a development bank set up as a tool of state-guided development by governments can indeed contribute to furthering goals of more equitable and sustainable development.

Constraint

Being a bank, even if a specialised one, it must ensure its own commercial viability. And it must do so when a large part of the resources it lends would be mobilised from the market.

While guarantees from the governments of its shareholding countries would improve the institution’s rating and reduce its borrowing costs, those costs will have to be borne.

Any form of socially concerned lending that does not yield a return adequate to cover costs and deliver at least a nominal profit likely to be ruled out.