This article was published in NIN weekly magazine on April 14, 2011
“A banker is a fellow who lends you his umbrella when the sun is shining and wants it back the minute it begins to rain” claimed Mark Twain a long time ago. After greedy and socially irresponsible bankers wreaked havoc around the world in 2008 no wonder this cynical comment by the famous writer is still referred to. On the other side of the coin are people who believe that the only way to keep a borrowed umbrella for as long as you want is to create a state development bank. As always, the truth lies somewhere in between.
As Serbia considers creating its own development bank, it should thread carefully. World experience does not give one much reason for optimism that such banks can become successful agents of economic growth and sustainable development. There have been far more failures, including very costly ones, than successes. Before creating such an institution, it may be worth looking at other possible instruments as an alternative to address existing market failures. However, if the state is decided to create such a financial institution, it may be interesting to look in depth at some of the (very few) successful models.
Most of the poor performance of state development banks is related to the lack of a clear mandate, and a governance system that allows the presence of weak boards of directors and management, which are subject to political interference. Indeed, too many of them proved to be primary source of political patronage, corruption and waste of public resources.
However, some state development banks have been successful and it may be interesting to look at their characteristics. Widely acknowledged as such are KfW which is well known for its active involvement in Serbia, and two others that may not be so widely known: Canada’s Business Development Bank (BDC), and Finland’s Finnvera plc.
What makes these banks successful? First is a clear mandate. Based on a successful experience, it should include at least three components: (i) a target sector; (ii) rules of cooperation with the private sector; and (iii) a minimum level of efficiency.
How the Canadians and Finns do it? In the case of BDC the mandate is to support Canadian entrepreneurship, with particular consideration to the need of small and medium enterprises (SMEs). The mandate of Finnvera is also clearly articulated: to promote and develop SME business, promote and develop the export sector (Finnvera operates also as an export credit agency), and to foster internationalization of Finnish enterprises. Both of these banks have the flexibility to operate with different instruments: loans, guarantees, investments and other contingent liabilities.
Another important feature is that BDC and Finnvera play a role that is complementary to that of private commercial banks. They make feasible certain projects that would otherwise fail without the presence of a lender with longer-term perspective and less risk aversion. Finnvera is rarely the only lender. It typically participates in syndicated lending and provides guarantees. BDC is generally more expensive than the market but it is an attractive source of funding for riskier projects that commercial banks may feel shy to get involved in initially. In this regard, it is interesting to note that many companies initially funded with BDC look for refinancing with commercial banks at cheaper rates later on. Approximately 6.5 percent of BDC’s clients fully prepay their loans every year. While a commercial bank may consider this as a business failure, BDC considers this a success since this means that projects it has initially supported prove successful enough to get funding directly from the market without further dependence on public support.
In these two cases, laws don’t specify they have to be profitable but their governments require a minimum financial return. BDC needs to earn a return on equity at least equal to the Government’s average long-term cost of capital. Finnevra is expected to earn a minimum of a six-month Euribor rate.
One of the trickiest issues is how to cope with political intervention since this proved to be one of the major threats for successful functioning of state development banks. In Canada the law establishes general fit and proper requirements for members of the board of directors and the short list is typically prepared by professional headhunters. No government officials participate on the board of directors of BDC. In addition, BDC made a practice to report through the media any undue pressure it receives from politicians regarding its credit decisions. Since politicians do not generally like their interventions to fund projects that ultimately proved to be unprofitable to be so exposed, this measure has dramatically reduced political interference in BDC credit decisions.
While grassing up may rightly be frowned upon in most cases, maybe to ensure the success of a state development bank this practice is not such a bad idea?