Development Banks Needed to Finance Sustainable Development Jomo Kwame Sundaram and Anis Chowdhury

Public or state development banking will be vital to achieving the Sustainable Development Goals, argues UNCTAD’s Trade and Development Report 2019 (TDR 2019).

Ongoing World Bank led efforts seek to leverage private finance via shadow banking by using public money to guarantee handsome returns managed by giant investment houses. Such financialization introduce new costs and risks to financing investments for sustainable development, decent work and renewable energy.

TDR 2019 is critical of financialization, which encourages speculation at the expense of productive investments in the real economy. Instead, public banking is far more likely to promote productive investments, and should be enabled to do so.

Development banks different

Public banks are different from private banks, and more likely to serve the long-term public interest, investing in sectors and locations that private commercial banks are more likely to ignore.

Unlike other kinds of state-owned financial institutions, such as state-owned commercial banks or insurance companies, public development banks (PDBs) usually have specific mandates to be more than mere financial institutions.

Certain social and economic objectives are identified to guide their operations. Their achievements are typically due to successfully pursuing positive externalities over the medium and long-term, rather than focusing on short-term returns alone.

Thus, PDBs are supposed to generate both financial returns as well as ‘development dividends’. Sustainable development oriented investments generally involve benefits which are not only commercial, which tends to be the main, if not sole criterion of commercial banking.

PDBs also help counteract the pro-cyclical nature of private finance, which typically fails to adequately finance small enterprises, however innovative, infrastructure as well as environmental projects urgently needed to make economies more dynamic, inclusive and sustainable.

Generally successful, but underappreciated

Despite constant discouragement and many PDB closures as well as ‘commercializations’, PDBs survive in many developing countries. In recent years, Southern-led and Southern-oriented banks and funds have added hundreds of billions of dollars to such finance.

A recent book found PDBs in China, Germany, Brazil, Mexico, Chile, Colombia and Peru generally successful. The PDBs studied served as efficient instruments of national development strategies, helping to overcome major ‘market failures’ flexibly.

Researchers have also found that PDBs can be both profitable and efficient while being socially proactive and progressive in appropriate institutional settings. Others have shown that PDBs can better avoid inefficient credit allocation as commercial banks cannot fully internalize benefits from publicly desirable projects.

Potential not realized

UNCTAD notes that most public banks, especially development banks, are insufficiently capitalized to be effective in their publicly assigned roles. Nevertheless, some PDBs are very significant, e.g., the China Development Bank’s outstanding loan portfolio is over 13.4% of China’s GDP, while the Korean Development Bank’s is 10.5% of Korea’s GDP.

But PDBs in other countries — including India, Russia, South Africa, Mexico and Malaysia — have modest loan portfolios amounting to less than 2% of their countries’ GDPs.

Many PDBs’ low loan-to-equity ratios are due to imposed requirements to raise resources in capital markets, both at home and abroad. Thus, the scale of such PDB lending is limited by how markets view them, typically through the credit ratings’ lens.

Appropriate policy support crucial

TDR 2019 argues that greater policy support is necessary to enable public development banking to achieve its potential including by

• Providing development and other public banks with more capital to scale up lending, including through direct financing;
• Supporting development banking with clear government mandates, performance indicators and accountability mechanisms valuing other criteria besides financial ones.
• Preventing PDBs from being subordinated to short-termist commercial criteria, or guaranteeing private investment returns, as recommended by the OECD and World Bank.
• Encouraging sovereign wealth funds, with assets estimated to be US$7.9 trillion, to direct resources in support of PDBs;
• Ensuring that bank regulators treat public banks, especially PDBs, more appropriately; development banks should be regulated suitably, recognizing their distinctive mandates, roles and operations;
• Reconsidering some governments’ insistence that their PDBs achieve high credit ratings; this task should be done by a credible international body of development finance institutions as credit rating agencies cannot be expected to challenge their own criteria;
• Using multilateral development banks to support green investments in developing countries as ‘green credit’ creation (including by quantitative easing’) is unlikely to be feasible in developing countries for fear of provoking exchange-rate and balance-of-payment crises;
• Freeing central banks from their typically narrow focus on price stability, usually by ‘inflation targeting’ in recent decades, to take on bolder, pro-active development roles. This should include creating and directing credit for sustainable development.

(This article was originally published in Inter Press service (IPS) news on October 22, 2019.)