DEVELOPMENT BANKS AND EUROPEAN CRISIS
Giuseppe Pennisi
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.
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