What Do Development Banks Do?

Manila Bulletin, February 6, 2013 | Go to article overview

What Do Development Banks Do?


In a 2011 paper for the Harvard Business School, Lazzarini, Musacchio, Bandeira-de-Mello, and Marcon posed this article title's question and looked at evidence from Brazil. This column will not report the Brazil evidence but will draw from the paper key questions on the role of development banks with the end view of searching for useful lessons appropriate to the Philippine setting.

The paper has an excellent review of literature, especially how development banks can both be a positive and negative force for the economy.

Primarily, development banks help solve market imperfections that would leave either profitable projects or projects that create positive externalities without financing. Development banks can alleviate capital scarcity and promote entrepreneurial action to boost new or existing industries. Development banks do more than just lending to build large infrastructure projects; they also lend to companies that would not have undertaken the project without the capital support. The banks may thus require specific conditionalities on operations and performance as a prerequisite for funding. Hence, the firms who borrow from development banks increase capital investment and overall profitability after the loan. In short, the overall economy performs better. This is the industrial policy view.

Various authors highlight the importance of development banks in promoting industrial catch up. Without public participation, lack of trust would inhibit a deepening of credit market. Value-enhancing projects would remain unfunded. Development banks should be ready to finance the "riskier" undertaking, solving failure in credit markets that inhibit industrial growth. State induced savings and credit would be critical to spur value-added productive investments. Such institutions not only infuse long-term capital in industry, but also serve as a mechanism to screen good private projects, establish well defined performance targets and monitor the execution of investments.

Critics of development banks however cite the political view which argues that the lending can lead to misallocation of credit. One argument is development banks tend to bailout companies that would otherwise fail. The other, more common, complaint is the rent-seeking hypothesis which cite how politicians use state-owned banks to engage in patronage deals with politically-connected industrialists. Thus, some studies have in fact revealed that financing can be influenced by political factors such as election cycles and campaign donation.

Given these theoretical constructs, how can we ensure that our development banks indeed solve market failure leading to suboptimal productive investment. …

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What Do Development Banks Do?
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