From Monterrey to Addis: the return of development banks

23 July 2015

This week saw the formal launch of the New Development Bank (aka the ‘BRICS Bank’), to sit alongside the recently established Asian Infrastructure Investment Bank (AIIB) in the new multilateral development finance architecture. The outcome document from the 3rd International Financing for Development (FfD) Conference that concluded in Addis Ababa last week refers to development banks thirty-three times in as many pages. The corresponding document from the last FfD Conference at Monterrey in 2002 gave development banks six mentions.

UN Secretary General Ban Ki Moon speaking at the opening of the 3rd Financing for Development conference in Addis Ababa, Ethiopia. Credit: UN Photo/Eskinder Debebe - Flickr (CC BY-ND 2.0)

The Monterrey Consensus (PDF) also defined development banks very narrowly. All six references, for example, were to the World Bank and Regional Development Banks (RDBs). As well as incorporating the new multilateral institutions described above, the Addis outcome document also gives considerable space to the potential of national public development banks. The scope of potential activities is also much larger.

At Monterrey, the financing activities proposed for development banks was very limited. As much or more attention was given to convening and advisory activities, or support for regional integration, or the implementation of national development plans. As well as being far more ambitious, the Addis document is much more specific.

Some headlines from the 3rd Financing for Development conference on development banks

  • On the scope of lending activities:

“We note the role that well-functioning national and regional development banks can play in financing sustainable development, particularly in credit market segments in which commercial banks are not fully engaged and where large financing gaps exist, based on sound lending frameworks and compliance with appropriate social and environmental safeguards. This includes areas such as sustainable infrastructure, energy, agriculture, industrialization, science, technology and innovation, as well as financial inclusion and financing of micro, small and medium-sized enterprises

  • On the ($1.5 trillion) annual developing country infrastructure gap:

"Development banks can play a particularly important role in alleviating constraints on financing development, including quality infrastructure...We welcome the launch of new infrastructure initiatives aimed at bridging these gaps, including the Asian Infrastructure Investment Bank, the Global Infrastructure Hub, the New Development Bank...we call for the establishment of a global infrastructure forum building on existing multilateral collaboration mechanisms, led by the multilateral development banks."

  • On the potential to dampen booms and busts (i.e. behave counter-cyclically):

“We acknowledge that national and regional development banks also play a valuable countercyclical role, especially during financial crises when private sector entities become highly risk-averse. We call on national and regional development banks to expand their contributions in these areas, and further urge relevant international public and private actors to support such banks in developing countries.”

  • And on combating financial exclusion:

“National development banks, credit unions, and other domestic financial institutions can play a vital role in providing access to financial services.”

Why the striking change in attitude towards development banks?

There are four principal reasons for this shift.

First, the 2007-8 financial crisis made it untenable for anyone to argue that commercial banks alone could deliver on financing for development objectives, opening up a space for public development banks.

Second, the historical record of national development banks was reassessed. Before 2008 a consensus had emerged that public ownership of financial institutions was an inherently bad thing, encouraging corruption, inefficiency and a misallocation of resources. To be sure, there were plenty of examples to support this view, but more sophisticated analysis showed that what mattered was the quality of the institutional framework in which development banks operated, not whether they were publicly owned. Many examples of ‘good’ development banks were belatedly ‘discovered’.

Third, some large national development banks, such as BNDES in Brazil and the CDB in China, performed a valuable counter-cyclical role after the crisis, stepping in when private finance dried up, and limiting downturns relative to countries where this did not happen. By definition, commercial banks cannot undertake this vital stabilising function.

Fourth and finally, frustrated by their continuing lack of influence in institutions like the World Bank and IMF, the BRICS countries and other rising powers decided to set up their own multilateral development banks. This fundamentally and permanently changing the global development finance landscape.

Where development banks were once seen as a relic of the past, they have now been invested with a good share of our hopes for the future

This is greatly to be welcomed, as the case for development banks is very strong.

It is also crucial, however, that the development banks we have, and the new multilateral and national institutions that are likely to be founded, support the achievement of the Sustainable Development Goals (SDGs) as effectively as possible.

On this question, our research on the historical experience of development banks suggests ten basic principles for effective development banks:

  1. Secure a source of stable, long-term , low-cost finance at significant scale
  2. Be large enough to be able to conduct effective counter-cyclical policy
  3. Have a transparent governance structure, independent from political interference
  4. Have a legitimate mandate and clear strategy which balances economic, social and environmental objectives, and protects and balances the interests of all groups
  5. Incentivise staff to maximise sustainable development impacts, and generate returns at a level compatible with this goal (i.e. seek to maximise development not financial ‘returns’)
  6. Develop a portfolio of financial instruments suited to the achievement of different goals
  7. Allocate capital strategically by sector to maximise impacts, and reassess regularly
  8. Evaluate impact on mandated sustainable development goals and revise strategy as a result
  9. Implement rigorous loan approval process to manage risk
  10. Forge partnerships with other financial institutions (both private and public) to enhance sustainable development impacts

On this last principle, the Addis outcome document rightly calls for cooperation between multilateral institutions, old and new. Cooperation between multilateral and national development banks is equally important, however.

The remaining principles certainly do not mean a ‘one size fits all’ approach to development banking. Quite the opposite. Different national and multilateral institutions will answer these and other challenges in their own ways, hopefully continuing the recent increase in diversity in development banking.

This is important. An increasing plurality of institution, bringing a range of skills and experience to the table and cooperating effectively is essential if the potential of development banks is to be realised in the post-MDG era.

Image: UN Secretary General Ban Ki Moon speaking at the opening session of the 3rd Financing for Develpoment conference in Addis Ababa. Credit: UN Photo/Eskinder Debebe - Flickr (CC BY-ND 2.0)

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