Expectations of the Proposed Development Bank in Ghana

By Julius Opuni Asamoah (BSc MBA CA)

Governments all over the world are working towards the development of their nations and growth of their economies as well. The areas of economic growth straddle poverty eradication, education for all, full employment, reduced inequality and accelerated development of infrastructure. The truth is that economic transformation is critical to make these socioeconomic goals achievable and sustainable. Ghana’s recent strides in development provide a good illustration of the nexus between transformative growth and social goals. The Ghanaian economy keeps growing but this growth does not create jobs as expected. In reality, Ghana’s growth has been based on the expansion of the services sector, to the detriment of manufacturing. With these challenges to the Ghanaian economy, the government of Ghana proposed to the World Bank about the establishment of a development bank in Ghana. So on the 29th day of October 2020, the World Bank approved in Washington, the United States, US$250 million from International Development Association to support the establishment of the Development Bank of Ghana to increase access to long term finance and boost job creation in key sectors including agribusinesses, manufacturing and high value services. This is supposed to form part of the integral part of government’s efforts to promote sustainable growth and development in Ghana. 

Economic transformation requires long-term investment to support the expansion of productive capacities, as well as infrastructure development that underpins industrial activities and reduces bottlenecks. Rapid and transformative growth will also require a more autonomous development strategy, in the light of the fragile world economic recovery and uncertainty about foreign direct investments. There is a rationale behind the role of development banks in promoting long-term development. Such banks have been a major feature of the development finance architecture for many years and in many countries. The post-Second World War era saw the emergence of the World Bank and regional banks. Since their creation, these banks have played a fundamental role in funding global and regional public goods, and in providing long-term finance to developing countries. It has been hoped that they will continue to do so by helping address the financing needs of developing nations, together with other sources of financing for development, such as grants and other financing assistance, which are part of global development finance. 

To ensure rapid economic development, especially in the area of infrastructure, a development bank is needed to bridge finance from end-savers to development projects. Such bridging should be done by a development bank at all levels, in order to provide the financing needed in Ghana’s development. A development bank can, thus, be the key player for development by providing long-term financing directly from their own funding sources, by tapping into new sources and by leveraging additional resources, including private, through the co-financing of projects with other partners.

Time is ripened to promote a development bank in Ghana. The recent financial crisis has opened space for national policymakers to support pro-development finance initiatives. There is a new momentum of initiatives for the creation of a development bank, which could tap into global savings. Taking advantage of such opportunities is fundamental to supporting future development of the nation. 

A standard argument for why a development bank should be promoted is that such a bank can fill the gaps left by private financial institutions, which are often geared towards commercial activities. The main gap is usually insufficient finance for economic transformation. The latter typically involves large-scale projects with long maturation periods, which require long-term finance and thus imply risks that commercial banks are unwilling to undertake. In addition, many large-scale projects generate positive externalities and therefore social returns are greater than private returns, so it is often economic imprudent for commercial banks to finance such projects. The provision of long-term finance in Ghana is also lacking due to the funding of financial institutions, which is often short-term. That is, long-term finance requires maturity transformation, which involves a risk that banks usually prefer to avoid. For these reasons, development banks are designed and mandated to fulfil this role. At the national level, development banks can be instrumental not only in addressing market failures, such as the lack of provision of long-term finance due to the risks and uncertainties involved, but as a critical tool in supporting a proactive development strategy.

Moreover, a development bank provides finance for long-term investment in capital intensive industries. In addition, such a bank provides both lending and equity participation, meaning that they have a clear interest in the close monitoring of projects, thus developing a special form of relationship banking. That is, the banks have a hands-on approach whereby they not only provide close project monitoring but also are in a position to nominate directors to the boards of the companies to which they lend and in which they have an equity stake. Moreover, developing banks have in-house technical expertise that allows them to participate in decisions involving choices of technology, scale and location. Development banks can also help raise capital elsewhere by underwriting the issuance of equity securities. Development banks can leverage resources by attracting other lenders that do not have the same technical capacity to assess a project’s viability and potential, as well as by providing guarantees. In addition, development banks can play a countercyclical role, helping sustain overall investment levels and protect the productive structure of a country during economic downturns. Protecting existing industries is important in facilitating a more rapid recovery and because doing so facilitates the emergence of new and innovative industries critical for economic transformation, given the complementarities between new and established industries.

Practitioners define a development bank as a bank or financial institution with state-owned equity that has been given an explicit legal mandate to reach socioeconomic goals, sector or particular market segment. Another school of thought on public development banks define development banks as financial institutions from the State whose mandate consist of promoting socioeconomic development through the financing of activities, sectors or specific economic segments. 

In practice, a development bank is a financial institution that has a clear mandate to support developmentally oriented projects and a funding base whose liabilities are predominately long term and thus aligned with bank mandates. Development banks extend loans to social ends or, more recently, in providing countercyclical financing in a number of developing countries in the wake of the global financial crisis. In the discussions on country experiences, the banks under analysis are often, but not in every case, those that are publicly owned; have a funding mix in which long-term liabilities often dominate the funding base; can resort to central bank financing to address liquidity needs arising from maturity mismatches; and have a clear mandate to support long-term projects that generate both economic and social benefits. 

France and Germany, have greatly benefited from their development banks that provided not only capital but also entrepreneurial skills and technological expertise. These constituted vital elements in their process of industrialisation. In France, Credit Mobilier, founded by the Pereire brothers, played that role while, in Germany, universal banks became heavily involved in the country’s industrial development by providing maturity transformation and other services. During periods of liquidity problems, due to their maturity transformation activities, these banks had access to last-resort lending from the German Central Bank. The universal banks were private, joint-stock banks that were also instruments of the State, acting on its behalf in return for large-scale liquidity support. The role these banks played was hugely transformative. They supported the build-up of thousands of miles of railroads, drill mines, factories, canals and ports. Above all, these banks conceived far-sighted plans, decided on major technological and locational innovations and arranged for mergers and capital increases.

Development banking, in addition to having played a major role in the past when countries were experiencing industrial take-off, continues to play such a role. That is, such institutions do not necessarily disappear once development crosses a certain threshold. A clear example is that of the publicly owned Kreditanstalt fur Wiederaufbau (KfW) in Germany, established in 1948 to support the reconstruction of the country. Despite its initial mandate, KfW has evolved as an important component of long-term financing for infrastructure and has continuously revised the focus of its activities. Currently, KfW is a promotional bank for the German economy and a development bank for developing countries. In its initial years, KfW was geared to meeting the financing needs of large firms in core industries, and was responsible for financing 15% of net real capital formation in 1950. However, as industrialisation gained momentum, and banks once again took on their financing role, the attention of KfW shifted to small and medium-sized industries. 

In developing countries, development banks have emerged and evolved over time to play a similar role, namely providing long-term capital to support growth and economic transformation. That is, such banks are key in those countries embarking on accelerated economic growth and thus facing challenges in terms of financing for capital-intensive projects and maintaining institutions that can anticipate new needs, overcome technical and entrepreneurial limitations and help coordinate multiple investments taking place simultaneously. However, although in most cases such banks have shared such common goals and functions, they can be seen as a diverse group in terms of ownership, funding structure and the types of projects and activities they specifically support.

The quality of loans to infrastructure and other projects should be an important priority for a development bank, as it will maximise the developmental impact of such projects and minimise the risk of default. The latter can help a development bank obtain a good rating and improve it over time. Moreover, the ability to earn profits will help a development bank expand its capital base and therefore increase lending in the future. Another important issue is related to the degree of financial sophistication of the instruments used. The more complex the products, the longer they take to be designed and implemented. While plain vanilla loans can be issued more quickly than more complicated loan structures, transactions involving equity take even longer, although they have desirable features, such as capturing part of the upside if projects are profitable. Therefore, it might be desirable to start with simple products, since these can help build a portfolio of assets more quickly. 

In terms of ownership, development banks tend to be fully owned by the State, yet in a significant number of cases, the private sector owns up to 49% of the total shares of such banks and, in a few cases, over 50%. In Brazil, the country’s main development bank, Banco Nacional de Desenvolvimento Economico e Social, has always been fully owned by the State. At the other end of this continuum of degree of ownership, the Industrial Development Bank of Turkey has from the start been fully owned by the country’s private banking system although, the Government had, at least initially an important role in influencing its functioning. The Industrial Development Bank of Turkey, which is wholly privately owned, is the largest development bank in Turkey. The bank, established in 1950 with World Bank support, was initially owned by six commercial bank funds. During Turkey’s First Five-Year Development Plan (1963 –1967), the Industrial Development Bank of Turkey accounted for as much as 12% of private capital formation in the manufacturing sector. As did many other development banks, the Industrial Development Bank of Turkey both provided loans and invested in the equity of the private firms that it supported.

Furthermore, the Industrial Development Bank of Turkey is closely linked to the Turkish State, deriving resources from the government and World Bank, and making loans and investments based on consultations. Interest rates on such loans are kept low, and the Industrial Development Bank of Turkey is not permitted to accept deposits and could not issue bonds in the market, since that would imply a mismatch between the cost of funds and the interest charged on its loans. This makes the Industrial Development Bank of Turkey largely a vehicle to implement the State’s polices of promoting manufacturing and influencing the allocation of investment, despite the fact that, as noted, it is not publicly owned.

The funding structures of such banks is diverse and can take different forms, such as the following: deposit-taking from the public; resources from financial institutions, including multilateral organisations; debt issuance in national or international capital markets; equity issuance; institutional savings; and government transfers. The establishment of a development bank is a timely and welcome initiative, not only for the reasons indicated above but also for its potential role in strengthening a network of development banks at different levels and of helping fill the financing gap for infrastructure and development more broadly. It is timely, given the current levels of global liquidity available as a result of asset purchase programmes by the central banks of advanced countries and, more fundamentally, due to the large amount of foreign reserves held by China and other emerging economies, savings that are partly placed in sovereign wealth funds and invested in low-yield assets from developed countries. 

Development banks may have specialised mandates. Those with broad mandates often provide finance for a wide range of sectors and activities that are in line with their mandate of supporting a country’s socioeconomic development. Within their broad mandates, such banks are able to diversify risk over time and build technical expertise in different areas. Specialised banks focus on specific sectors, such as agriculture or export activities, or on specific market segments, such as Small and Medium-sized Enterprises (SMEs). Their exact funding mix greatly influences the way in which their resources are mobilised, that is, the kinds of projects they fund and the interest rates they charge on their loans. Banks that have a greater reliance on market sources of finance tend to give greater weight to market considerations when funding projects, and less so to their social and developmental benefits.

In conclusion, a development bank can play a critical bridging role between savings and financing needs and thereby contribute significantly towards the achievement of the Sustainable Development Goals. Unlike commercial financial institutions, geared towards short-term projects and returns, development banks are by design providers of long-term finance. Their funding is predominantly in the form of long-term liabilities, they have technical expertise to take a leading role in the design and execution of development projects and they have the financial means to attract other players to co-financing. In future, they should continue to be a key feature in the development finance landscape. In addition to long-term finance, development banks can provide countercyclical lending, thereby making economies more resilient to shocks and downturns. In doing so, they can help countries protect their productive capacities for their next expansionary phases. Over the years, national development banks have been key levers for national economic transformation and, in particular, for industrialisation. Brazil, Republic of Korea, India and China, are most currently among the largest development finance institutions in the world. They therefore have considerable firepower to ignite the creation of new industries and provide support to a more inclusive development strategy. Therefore, if Ghana wants to pursue real growth and development across all sectors of the economy, it is very apt for the government to establish a development bank and live to its core activities.