Development banks

Arriving at a concrete definition of development banks is surprisingly tricky, as they have existed in many parts of the world in different forms for centuries. Yet development banks can be broadly defined by their ownership, how they source their funding, and how funding is distributed. Development banks in almost all cases are owned by the State. Unlike private banks, which are created in order to generate profit, development banks are created as macroeconomic policy institutions. This dynamic is not limited to develop- ing countries, or even to central governments. The socialization of finance through devel- opment banks has occurred in many forms under governments of different size, location, historical period, and political leaning.

While the criterion of ownership is a necessary element in defining development banks, it can also create confusion. Many State-owned financial entities that were not created to be development banks have in diverse times and places assumed roles typically assigned to development banks: central banks and State-owned commercial banks have in many instances channelled government funds to specific economic activities gener- ally considered to be part of economic development. Yet the ownership criteria can also make things clear. Institutions that are officially dedicated to economic development, such as the Asian Development Bank, the Inter-African Development Bank, and the Inter-American Development Bank, are not owned by the States in whose territory they operate. These banks were originally created in the post-war period to support foreign currency financing for developing countries, yet their institutional operations have since changed considerably.

The second criterion to define development banks - the sourcing of their funds - is likewise variable. Development banks can operate much like a commercial bank in taking deposits and giving loans directly to their constituency of eligible lenders, generally defined by the type of economic activity in which they are engaged. Interest rates may or may not be subsidized by the State. Development banks may also operate exclusively as second-tier institutions in essentially two forms. The first is for them to guarantee selected assets in the financial system. A government can select borrowers and projects in a much more direct fashion under the second modality, in which government revenue is channelled through a development bank to specific lenders. Development banks can therefore operate much like private banks in the sense that they can act as simple financial intermediaries that channel savings into investments, or they can eschew this temporal constraint by ex-nihilo credit creation.

The third criterion defining development banks - to whom this socialized finance is directed - also differs widely, as development banks tend to closely follow the position of the government that controls them. Historically, common mandates have been to promote exports, agricultural activity, and infrastructure projects. In more recent times, small and medium-sized enterprises have also been prominent beneficiaries of public support.

During the golden age of capitalism, in which some aspects of Keynesian thinking, like the socialization of finance, were put into practice, development banks became the financial engine of the only sustained period of progress towards economic development in many countries' history. In recent decades, as the neoliberal paradigm has become dominant, the concept and practice of socialization of finance has fallen out of favour with policy makers. Among developing countries, State-owned banks controlled almost 70 per cent of total bank assets in 1970, a number that had fallen to below 50 per cent by 1995 (see Inter-American Development Bank, 2004). Latin America witnessed the most pronounced decline. Under various programmes of privatizations, closings and reduc- tions in operating scopes, banking assets in the hands of development banks have fallen to much lower levels in much of the region.

A common refrain in the containment of development banks was that they represent "unfair competition" to their private sector peers. This criticism is closely related to the more generalized criticism regarding the role of the State in the economy, which holds that development banks increase public debt and destabilize the economy. A further cri- tique centres on the cost-benefit relationship, and claims that this type of bank has high bureaucratic costs and is vulnerable to corruption.

Indeed, development banks have often been considered as superior competitors with regard to private banks. As State-owned entities, development banks face only politi- cal limits, as their economic or financial limits are merely those of the State. Therefore, unlike private banks, they cannot be bought by competitors or go bankrupt. Yet history has shown that development banks have been mainly beneficial to private banking. In many poorer countries, financial systems were non-existent before the establishment of publicly-owned banks, and where these banks have been closed, declines in economic activity have likewise diminished the sources of private bank profit. Likewise, public banks have provided support to financial systems in times of crisis, thereby indirectly aiding their private peers.

If a country does fall into a systemic financial crisis, State-owned banks are relatively immune to market forces during moments of financial instability, as these institutions can operate at a loss for indeterminate periods of time. The relative permanence of State- owned banks allows these institutions to extend credit when market pressure does not allow their private-sector peers to do so, and can even act as custodians of failed banks until market conditions improve.

Despite the various criticisms of development banks in particular, and the socializa- tion of finance in general, such institutions have in different times and places acted as financial engines for economic development.

See also:

Finance and economic growth; Financial crisis; Financial instability; Money and credit.