DEVELOPMENT BANKS AND EUROPEAN CRISIS
The most recent estimates by 20 research and forecasting private econometric institutes – generally known as the consensus group - point to a slow and fragile exit from the economic and financial crisis that has troubled Europe in the last seven years. According to the ‘average’ forecast of the 20 institutes, in the next two years the euro area will grow by 1-1.5 per cent per annum, as against nearly 3 per cent in the United States and Great Britain. Within this sluggish recovery, unemployment is expected to remain at a high 12 per cent of those willing and able to work. In addition, this average picture conceals a great deal of risks. Twelve of the 20 institutes provide much less positive growth estimates and warn that long term issues and structural problems may make the pale expansion much lower. Furthermore, as European growth is, to a large extent, dependent on exports, a slowdown in international trade may determine a relapse into stagnation. As a part of the overall pictures, there would be major country differences. Namely, in the base scenario built on the average between forecasts, Italy would grow merely by 0.5-0.7 per annum. It is useful to recall that in around 2008- i.e. before the crisis became severe - the research departments of the European Central Bank (ECB), of the European Commission (EC) and of the Organization for Economic and Developed (OECD) published estimates whereby Italy ‘potential growth rate’ would be only 1.3 per cent per year – as against 2.5 per cent per year as estimated and, by and large, realized in the first part of the 1980s. Such a severe drop (almost 50 per cent) in the ‘potential’ growth rate is due to demographic determinants (ageing population) and obsolete industrial structures, as well to socio-economic problems (poor public administration, extremely slow judiciary system, a real Himalaya of contradictory legislations).
Against this backdrop, a battery of instruments of macro-economic and micro-economic policies as well as of major reforms are required. Would development banks help as a tool of such a battery?
This note is addressed to provide a preliminary answer to this question. It is easy to talk about development banks and their usefulness but in most of the literature, and obviously even more in journalistic editorials and reports, the term ‘development banks’ is open to many interpretations.
Thus, let us take the Britannica Encyclopedia definition whereby ‘development banks are national or regional financial institutions designed to provide medium and long term capital for productive investment, often accompanied by technical assistance, in poor countries. Now, the term ‘poor countries’ ought to be revised as in their actual work many development banks have the specific objective to help countries in transition from planned to market economies and in a structural adjustment process. The area of the euro is undergoing a major structural adjustment process, albeit with different intensity in the different member countries because sometime in the final decades of the twentieth century, it has lost the monopoly of technical process it had enjoyed since the end of the eighteenth century; thus, although with different and differing degrees, its member countries need to adjust to a new and rapidly changing world wide environment. Furthermore, for several years a primary purpose of development banks has been to provide access to international capital markets to Government and countries that either were considered too risky by international lenders or featured highly protected economies through trade restrictions and exchange controls with, as a result, exchange rates that did not reflect the economic value of the scarcity of their foreign exchange. Now, because of trade and exchange control liberalization as well as because of international economic and financial integration, neither the World Bank Group nor the major international regional development banks have this function any longer. A recent paper by Devesh Kapur and Arjun Raychaudhury, the Center for Gobal Development Working Paper No. 352, describes quite effectively how the World Bank Group is drastically revising its aims and objectives to ‘fight world poverty’ – a highly challenging task.
The key point is that development banks have the aim of providing medium and long-term capital for productive investment, often accompanied by technical assistance. Also, the productive investments should be identified, appraised and selected with a two-fold set of criteria: in the short term, they should help make full utilization of production factors (and thus increase employment) and in the medium and long term, they will provide physical, financial and technical capital (and thus, increase productivity of the production factors). In short, they should be both Keynesian and neo-classical. This, I would consider as the key note discriminating feature between development banks and other categories of investment banks.
The number of development banks has increased rapidly since the 1950s; they have been encouraged by the success the International Bank for Reconstruction and Development and its affiliates (normally known as the World Bank Group), created in 1944 at the Bretton Woods conference with the primary objective of helping reconstruct countries that had been devastated by World War II. The large regional development banks include the European Investment Bank established as a part of the Rome Treaty in 1957, the Inter-American Development Bank established in 1959; the Asian Development Bank which began operations in 1966; and the African Development Bank, established in 1964, the European Bank for Reconstruction and Development which opened for business in 1991. There are smaller development banks on a sub-regional basis (i.e. the Caribbean, the Andean areas and alike). There is also a large number of national domestic development banks that, in the operational policies and practices, often follow the more established large development banks. I have had the opportunity of having my first career in the World Bank (where I spent 18 years) and also of having spells of work for the Inter-American Development Bank, the Asian Development Bank and the African Development; thus, I have seen the change and the transformation of these institutions from ‘inside’ not merely as an outside onlooker.
Normally, the international and the domestic development banks make loans for specific national or regional projects to private or public bodies or may operate in conjunction with other financial institutions. One of the main activities of the development banks has been the recognition and promotion of private investment opportunities. The efforts of the majority of development banks are directed toward infrastructure and the industrial sector as well as agriculture and human resources at large (education, health). Now, as mentioned in the previous paragraph, the challenge of fighting world poverty is becoming the primary purpose of the major international development banks.
Development banks may be publicly or privately owned and operated, although governments frequently make substantial contributions to the capital of private development banks. The form (share equity or loans) and cost of financing offered by development banks depend on their cost of obtaining capital and their need to show a profit and pay dividends.
International development banks practices have provoked some controversy. Because development banks tend to be government-run and are not accountable to the taxpayers who fund them, there are few checks and balances preventing the banks from making bad investments. Some international development banks have been blamed for imposing policies that ultimately destabilize the economies of recipient countries. Yet another concern centers on ‘moral hazard’—that is, the possibility that fiscally irresponsible policies by recipient countries will be effectively rewarded and thereby encouraged by bailout loans. While theoretically a serious concern, the existence of such moral hazard has not been proved.
An example of a successful private development bank is the Grameen Bank founded in 1976 to serve small borrowers in Bangladesh. The bank’s approach is based on microcredit —small loans amounting to as little as a few dollars. Loan repayment rates are very high, because borrowers are required to join ‘lending circles’. The fellow members of a circle, which typically contains fewer than ten people, are other borrowers whose credit rating is at risk if one of their members defaults. Therefore, each member drives other members to pay on time. The Grameen approach has spurred the creation of similar banks in numerous developing countries.
This general overview is useful to focus on the domestic national development banks in Europe and on the role they have in the exit from the European crisis. The most significant are the Italian Cassa Depositi e Prestiti, the French Caisse des Dépôts et Consignation, the German Kreditanstalt für Wiederaufbau. There are many smaller development banks such as those of Austria, Bulgaria, Croatia, Greece, Poland, Spain, Turkey, the United Kingdom, and other countries.
In 2012 a study by Dalberg Global Development Advisors, an international consulting firm, examined the methods and effectiveness of the national development banks in Europe on a commission by the European Development Finance Institutions (EDFI). The association has fifteen members - all of them are development banks. The concrete goal of the study was to describe the growing role and tasks of the national development banks in Europe and to highlight opportunities and challenges. Because many national development banks are under mandate to finance the private sector, this was given special attention. One of the highest hurdles for local businesses in these countries is the lack of access to financial services. The Dalberg study clearly shows that the private sector is the engine for growth not only in advanced market economies but in developing and transition economies as well, and that, in doing so, it makes a significant contribution to the reduction in poverty. In general, EDFI members act in accordance with three principles: a) They are present where other investors are not (yet); b) They act as catalysts and their presence prompts the involvement of others; c) They operate in a sustainable manner because they reduce dependence on aid payments by relying on employment and growth as sustainable sources for financing developing countries and emerging markets through taxes. In short, the emphasis is not in providing access to international capital markets (the earliest purpose of several development banks) but to help channel savings towards investment with short term Keynesian effect to increase and improve utilization of production factors and, in the medium and long term, to increase and improve productivity and, thus, competitiveness.
According to the study, the fifteen specialized European institutions have succeeded in both prompting positive developmental momentum in developing and transitioning countries and enjoying financial success in numerous projects. The requirement that the projects be economically successful has also kept the infusion of capital from national governments at a moderate level; up to now they have represented only a small part of the financial strength of the national development banks. European countries were also able to credit the work of their national development banks to their progress in achieving the UN-Millennium Development Goals and in part to their respective Official Development Aid quotas. The study summarized by saying that the national development banks have now long established themselves as a third pillar of international development policies along with classical development work and the multilateral development banks.
Italy has a special tradition and role in development banking. A recent study by Amadeo Lepore reviews the history of the Cassa per il Mezzogiorno, the forerunner of many European national development banks, and confirms previous research by Alfredo Del Monte and Adriano Giannola that until the mid nineteen seventies the Cassa operated as one of the best European development banks, was often praised by the World Bank Group and shown as a model to imitate; incidentally, from the end of World War II to 1964, when Italy ‘graduated’ from been eligible for World Bank lending, all the World Bank operations for Italian reconstruction and development were made through lending to the Cassa not to the Government or some of its Ministries. A number of financial development agencies operated along with the Cassa; some of the them were specific small industrial development banks to finance manufacturing in Sardinia and Sicily; others to provide support services in area such as training and project planning. Although since the mid nineteen seventies, the quality of their operations deteriorated and this led to their demise, the Cassa experience is a useful building bloc to identify strength and weaknesses of national development banks for setting Europe back on a growth path.
More recent and more telling is the transformation, in the last ten years, of the Cassa Depositi e Prestiti (CDP) from a department within the Ministry of Economy and Finance to a development bank, with private minority shareholders (banks), offering a full array of services either directly or through specialized funds. CDP maintains its original objective of financing long term investment in infrastructure but also lends and provides equity to strategic and innovative initiatives. In short, it has acquired a range and depth of activities even larger than those of the longer established Caisse des Dépôts et Consignation and Kreditanstalt für Wiederaufbau. With these and others (including non-European) institutions CDP has helped establish a Long Term Investors Club (LTIC) with the specific objectives to channel savings towards well conceived and thoroughly appraised long term investments to promote economic and social development, while providing a decent return to the investors.
This general overview provides a preliminary answer to the question raised in the first paragraph. Development finance corporation and development banks – the difference is only nominal – may help Europe to increase its growth rate and to provide a more equal distribution of growth benefits if they provide lending and equity support to well conceived and well appraised investment in infrastructure and strategic and innovative initiatives. This may very well require harmonization of appraisal parameters and selection criteria, especially when dealing with innovative programs and with projects where attempt is made to factor in equity standards in operations primarily designed to improve factor utilization and productivity.