Abstract
The conventional paradigm about development banks is that these institutions exist to target well-identified market failures. However, market failures are not directly observable and can only be ascertained with a suitable learning process. Hence, the question is how do the policymakers know what activities should be promoted; how do they learn about the obstacles to the creation of new activities? Rather than assuming that the government has arrived at the right list of market failures and uses development banks to close some well-identified market gaps, we suggest that development banks can be in charge of identifying these market failures through their loan-screening and lending activities to guide their operations and provide critical inputs for the design of productive development policies. In fact, they can also identify government failures that stand in the way of development and call for needed public inputs. This intelligence role of development banks is similar to the role that modern theories of financial intermediation assign to banks as institutions with a comparative advantage in producing and processing information. However, while private banks focus on information on private returns, development banks would potentially produce and organize information about social returns.
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
Notes
In Latin America, for instance, development banks played a central role in the import substitution strategy in the region.
For a discussion with somewhat contrasting views, see Levy Yeyati et al. (2007) and La Porta et al. (2004).
In Latin America, the rolls of ALIDE, the association of public banks, shrank from 171 to 73 in that period. Liquidations included major banks in Peru, Mexico, Colombia, Venezuela, and Nicaragua among others; many others were downgraded.
Gutierrez et al. (2011), cite a 2009 survey by the Business Development Bank of Canada that surveyed 373 development institutions in 92 countries and found that the six most common target sectors for development banks are (i) start-ups; (ii) SMEs; (iii) international trade; (iv) housing; (v) infrastructure; and (vi) agriculture.
In this paper, we concentrate on development banks and do not consider state-owned financial institutions that operate like private commercial banks and do not have an explicit development mandate. However, the distinction between these two types of institutions is not always clear (de Luna-Martínez and Vicente, 2012).
In order to simplify the exposition, when specificity is not of the essence, “lending” means any financial support, not necessarily a credit operation.
It is worth noting that it is possible to think of several environments in which institutions that work in direct contact with end-users (be enterprises or households) could be endowed with capabilities aimed at uncovering problems and at designing appropriate operations and policies to address these problems. For instance, schools have access to information that could be used to devise policies (that go beyond supplying education) aimed at reducing inequality or improving nutrition. Similarly, utilities could be used to devise and implement climate-friendly policies. In doing so, it would be necessary to find a balance between the desire to improve policymaking and the need of protecting the privacy of end-users. These are important topics that go well beyond the scope of this paper.
Our original intention was to interview 12 banks in Latin America, 2 in emerging market countries outside Latin America, and 2 in advanced economies. However, we were not able to establish contact with all the targeted banks. The interviews were conducted over the phone by Eduardo Fernandez-Arias, Ugo Panizza, Gonzalo Rivas, and Sergio Rodriguez Apolinar. The structured questionnaire and the list of interviews are available from the authors upon request.
A third market failure that was first explored and documented by Micco and Panizza (2007) and dubbed by Levy Yeyati et al. (2007) as the macroeconomic view relates to the fact that private banks do not internalize that increasing lending during a recession may stabilize the economy. Therefore, private banks lend too little during economic crises (recent work by Bertay et al., 2012, corroborates the original findings of Micco and Panizza, 2007). This market failure, however, is more of a justification for state-owned commercial banks than for development banks, and we leave it aside of our analysis.
Da Rin and Hellmann (2002) also point out that conglomerates are an alternative to banks with market power.
A possible alternative is to design a guarantee scheme with some form of participation in the upside.
Outside collateral is collateral that is not financed by the loan itself as in the case of home mortgages or cars. This is a way to force the firm to pledge additional equity into the project, but it imposes a wealth constraint on potential entrepreneurs.
To dispose of its governance responsibilities without creating political problems the development bank could invest in a private equity fund and leave the active management responsibilities to the fund, as has been done by the International Finance Corporation. However, it is important that this delegation be made compatible with the need to generate the economic intelligence which the bank needs.
For instance, Mexico has seven development banks.
This encompasses cases in which the borrower has no access to credit, and therefore, the market rate is infinite.
The same reasoning applies to situations in which a specific segment of the capital market is underdeveloped. For instance, Petersen and Rajan (1994) found that banks with monopoly power are more likely to lend to new and credit-constrained firms because they will be able to extract rents from the firms’ future profits. In this setting, an institution like Canada’s CDC which specializes in lending to new firms but does not maximize profits can improve access to credit to new entrants without the negative effects of monopoly power.
A justification for lower risk aversion comes from Arrow and Lind (1970) who have shown that in public projects the social cost of the risk tends to zero as the population tends to infinity.
Similarly, a state-owned bank may be able to internalize the financial benefits of a “big push” while competitive private banks may not.
This is the case, for example, of Mexico’s Nacional Financiera (NAFIN). In fact, NAFIN’s board targets an average zero real rate of return in an accounting sense.
Colby (2013), for instance, claims that BNDES may be too conservative because the development impact of a loan is hard to evaluate but defaults are easy to measure, and employees can be punished for loans that default. Employees end up being too risk averse and, rather than maximizing the Bank’s development impact, they maximize its financial health.
de Luna-Martínez and Vicente (2012) found that 12% of the institutions covered in their survey operate as second-tier institutions, 36% as first-tier, and the remaining 52% blends first and second-tier operations. Among the banks that are members of the Association of Latin American Development Banks (ALIDE) 47% are first-tier, 34% second-tier, and the remaining 19% are hybrid institutions. However, ALIDE’s membership includes many commercial banks.
This includes conspicuous examples in Latin America, such as COFIDE in Peru, NAFIN in Mexico, and CFN in Ecuador.
This formulation abstracts from agency problems within the state. A more detailed analysis would look at how to structure development bank governance in relation to political power.
As documented for Italian and Pakistani public banks by Sapienza (2004) and Khwaja and Mian (2005)
In this regard, Colby (2013) discusses how the Brazilian Development bank BNDES succeeded in becoming a “silo of bureaucratic efficiency.”
In fact, one manager in our Survey said that co-financing arrangements with private banks are an ideal setting for exploiting the complementarities of public and private sector financial institutions. Armendariz de Aghion (1993) also discusses the merit of co-financing; however, in her model is the development bank that transfers knowledge to the private banks.
In his view it was important to consult with individual entrepreneurs rather than with entrepreneurial associations.
This survey was conducted before the financial scandals associated with the so-called Operation Car Wash in Brazil became known, so it does not include any discussion about BNDES situation concerning them. More generally, the survey did not focus on the risks of capture and corruption in development banks. We understand that there is a debate concerning the role of BNDES in corrupt lending despite the fact that it appears to have emerged unscathed in the investigations of Operation Car Wash (Brazilian Monitor of April 29, 2017). The absence of references to the financial scandals in this Box does not reflect a view on this debate.
When asked whether the structure described above is replicable in smaller development banks, BNDES management replied that size does not really matter and mentioned that most of the research is conducted within the sectorial departments, which often have less than 40 employees. There is an issue related to the fixed costs involved in creating a system for organizing and analyzing different sources of information, but such system does not necessarily need to be country-specific. Development banks located in different countries could possibly share this fixed cost and learn from existing experiences.
References
Anginer D, de la Torre A, Ize A (2014) Risk-bearing by the state: when is it good public policy? Journal of Financial Stability, Volume 10:76–86
Arrow K, Lind R (1970) Uncertainty and the evaluation of public investment decisions. Am Econ Rev 60:364–378
Banerjee AV, Banerji R, Duflo E, Glennerster R, Khemani S (2010) Pitfalls of participatory programs: evidence from a randomized evaluation in education in India. American Economic Journal: Economic Policy, American Economic Association, vol 2(1):1–30
Colby, Seth 2013. Searching for institutional solutions to industrial policy challenges: a case study of the Brazilian development bank. PhD Thesis Johns Hopkins SAIS
Cornick J, Bo ED, Fernandez-Arias E, Rivas G, Stein E (2018) Building capabilities for productive development policies. IDB Book Publication
Da Rin M, Hellmann T (2002) Banks as catalysts for industrialization. J Financ Intermed 11(4):366–397
De la Torre, Augusto, Carlos Gozzi, and Sergio Schmukler 2007. Innovative experiences in access to finance: market friendly roles for the visible hand? World Bank working paper WPS4326, August
de Luna-Martinez, Jose & Vicente, Carlos Leonardo, 2012 .Global survey of development banks. Policy Research Working Paper Series 5969, The World Bank
Duflo E, Kremer M, Glennerster R (2008) Using randomization in development economics research: a toolkit. In: Schultz T, Strauss J (eds) chpt. 15Handbook of development Economics,Vol. 4. Elsevier Sci. Ltd. North Holl, Amsterdam
Fernandez-Arias E, Sabel C, Stein E, Trejos A (2016) Two to tango: public-private collaboration for productive development policies. IDB Book Publication
Gerschenkron A (1962) Economic backwardness in historical perspective, a book of essays. Belknap Press of Harvard University Press, Cambridge
Griffith-Jones S, Ocampo JA (2018) The future of national development banks. Oxford University Press, Oxford
Gutierrez E, Rudolph H, Homa T, Beneit E (2011) Development banks: role and mechanisms to increase their efficiency. In: Policy research working paper series 5729. Bank, The World
Hart O, Shleifer A, Vishny R (1997) The proper scope of government: theory and an application to prisons. Q J Econ 112(4):1127–1161
Holmstrom B, Milgrom P (1991) Multitask principal-agent analyses: incentive contracts, asset ownership, and job design. J Law Econ Org 7:24–52
IDB (2014) Rethinking productive development: sound policies and institutions for economic transformation. Inter-American Development Bank, Washington DC
Inter-American Development Bank (2005) Unlocking credit: the quest for deep and stable bank lending. Inter-American Development Bank, Washington DC
Karlan D, Zinman J (2010) Expanding credit access: using randomized supply decisions to estimate the impacts. Rev Financ Stud 23(1):433–464
Leland, Hayne E and David Pyle, David 1977. Informational asymmetries, financial structure, and financial intermediation. J Financ, 32(2), 371–387
Lewis A (1955) Theory of economic growth. Allen and Unwin Ltd., London
Yeyati L, Eduardo AM, Panizza U (2007) A reappraisal of state-owned bank. Economía 7(2):209–247
Micco A, Panizza U, Yanez M (2007) Bank ownership and performance. Does politics matter? J Bank Financ 31(1):219–241
Murphy KM, Shleifer A, Vishny R (1989) Industrialization and the big push. J Polit Econ 97(5):1003–1026
Rosenstein-Rodan P (1961) Notes on the theory of the big push. In: Ellis H, Wallich H (eds) Economic development for Latin America, St Martin’s New York
Rudolph H (2009) State financial institutions: mandates, governance and beyond. In: Policy research working paper series, 5141. Bank, The World
Schreiner M, Yaron J (2001) Development finance institutions: measuring their subsidy. World Bank, Washington DC
Scott D (2007) Strengthening the governance and performance of state-owned financial institutions. In: Policy research working paper series 4321. Bank, The World
Stiglitz J (1994) “The role of the state in financial markets”. In: Proceedings of the World Bank Conference on Development Economics, World Bank, Washington, DC
World Bank (2013) Rethinking the role of the state in finance, global financial development report. World Bank, Washington, DC
Author information
Authors and Affiliations
Corresponding author
Ethics declarations
Disclaimer
The views expressed in this paper are the authors’ only and need not reflect, and should not be represented as, the views of any of the institutions that the authors are or have been affiliated with.
Additional information
Publisher’s Note
Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.
This paper was prepared for a special issue (edited by Karl Aiginger and Dani Rodrik) on new industrial policy of the Journal of Industry, Competition and Trade.
Appendix
Appendix
1.1 The Experiences of BNDES and KfW
The Brazilian development bank BNDES operates both at a first and second-tier level. BNDES gathers economic intelligence by favoring a continuous exchange of information between project managers in the operational departments and the bank’s research department.Footnote 28 The bank has four main operational divisions and within each operational division there is a small research group that is in close contact with the project managers and then reports to the bank’s main research department, which collects and aggregate information and disseminates it to the rest of the bank. To facilitate this exchange of information, BNDES has developed a uniform methodology to evaluate firms’ capabilities and tangible and intangibles assets that depend on the sector of operation of the ultimate borrower. In order to build quantitative indicators, BNDES has developed sector-specific weights on different capabilities. Developing such a methodology required a large initial investment, but it has allowed BNDES to have a common language and methodological approach for evaluating different firms and activities and quantifying the challenges faced by different sectors of the Brazilian economy.Footnote 29 BNDES uses this internal intelligence to design and adjust its strategy with the ultimate objective to achieve its government-defined mandate. BNDES also manages some venture capital funds that give the bank a unique opportunity to participate in the management of new firms and gain a better understanding of the challenges and opportunities faced by new firms. BNDES has both formal and informal channels for communicating with the government. Bank employees are often consulted by central and local governments. BNDES management has seats in various ministerial-level government committees that provide inputs to the design of the Brazilian industrial and economic policy.
The German development bank KfW is also actively engaged in advising the German government on how to achieve its economic development goals.
As KfW operates as second-tier bank, it does not collect soft information on its ultimate borrowers. However, KfW collects data on all the German small and medium enterprises that have accounts with first-tier banks that receive KfW funding. In collecting these data, KfW is especially concerned in understanding the constraints faced by firms that want to adopt new technologies. KfW also collects extensive data on start-up firms. KfW uses these data to guide its own lending strategy and to provide advice to German policymakers, and it also produces periodical reports which are freely available on the bank’s website. There are many channels through which KfW provides inputs to the design and implementation of economic policy in Germany. First, KfW shapes policy by implementing its own mandate. Second, KfW staff and management often support and provide advice to government officers who conduct bilateral negotiations with the private sector. Finally, KfW staff and management participate in advisory meetings with the Ministry of Finance and the regional governments with the specific objective of providing inputs to the design of federal and regional economic policies.
Rights and permissions
About this article
Cite this article
Fernández-Arias, E., Hausmann, R. & Panizza, U. Smart Development Banks. J Ind Compet Trade 20, 395–420 (2020). https://doi.org/10.1007/s10842-019-00328-x
Received:
Revised:
Accepted:
Published:
Issue Date:
DOI: https://doi.org/10.1007/s10842-019-00328-x