What do development banks really do?

Thursday August 4 2016

By Samuel Sejjaaka

At this moment, it is urgent to understand what development banks do, and what one must make of the hash tag #Scambailouts which has been trending this past week. Let’s take Kreditanstalt Fur Wiederanfbau or KfW - also known as the (German) Bank for Reconstruction and Development as our benchmark. KfW was started in 1948 after the Second World War and is 100 per cent owned by the German government. In 1949, KfW’s balance sheet size (total assets) was Euro0.3 billion. In 2015, this balance sheet was about Euro503b. The bank employs more than 5,500 people, of whom are over 300 risk experts and is regulated by the Federal Reserve Bank of Germany. Headquartered in Frankfurt, KfW is one of 18 development institutions in Germany. Each federal state has its own development bank, but KfW is the national development institution. It is also the third largest bank in Germany.

So what does KfW do as a development finance institution (DFI), and what is the thinking behind this success? As with other DFIs worldwide, its key roles include (1) Providing long-term finance for development projects which are deemed both economically and socially viable, but for which commercial banks may not have the risk appetite; (2) Avoiding a mismatch between short-term financing and long-term projects and (3) Price determination of development projects using a business (profit) oriented approach; ie ensuring that investments are not made on the basis of political expediency only, but can also be justified economically and socially. Ensuring that development finance is a sustainable business by running profitable operations.

KfW’s business is based on an intermediation model, whereby its funds are lent to deserving projects through commercial banks, at interest rates ranging from 1 per cent to 3 per cent. This model allows the commercial banks to assume the project risks, while KfW assumes the bank risks. The KfW story is not restricted to Germany. It has been replicated in many jurisdictions, both developed and underdeveloped, and the underpinning principle, is matching finance to long-term development objectives.

Back home, we have Uganda Development Bank. When Uganda implemented structural adjustment programmes in the 80s, UDB was classified as a “for sale” institution. In the intervening years, it was mismanaged and forgotten. In the 2000s, it was reclassified as a ‘not for sale’ institution. Efforts have been made to revive it and it has been shown that the bank is sustainable if (and that is a big IF) it is managed on strict business principles. Its share capital is about $30 million, and it has assets under management of about $60 million. Clearly, UDB is not in the major league of DFIs, and is not able (on its own) to address our development challenges. On the balance of the evidence, we have a serious development finance problem.

So what about that trending hash tag #Scambailouts? A lot of angst has been expressed on social media about the request for bailing out distressed businesses. Famed lawyer David Mpanga tweeted (to paraphrase), “how do we avoid the socialisation of business losses, when we didn’t share in the profits of the ailing businesses?”

Is there a case for bailouts? Yes and no. If the stress being felt by businesses is systemic, then government has an obligation to address those stress factors, such as a slowdown in economic activity. This can be done through payment of domestic arrears, reduction of power tariffs and other non-discriminatory measures. (Allegedly, KfW does not pay corporation taxes and Thyssen, Germany’s largest steel maker, does not pay for electricity). But can the government directly bail out businesses? That again is a function of their strategic importance. Are the businesses seeking a bailout strategically important? Generally no. And that is why they created the limited liability company. Business failure is not a sin and it reflects the price of efficiency. In the UK alone, there are over 3,000 insolvencies annually. If a business fails - which we should learn is not necessarily a bad thing; you give it to the undertakers.

So what should or can be done for those who need relief, in light of a depressed market? Funds permitting, a mechanism would be put in place to provide appropriate refinancing for viable and sustainable businesses through a bank like UDB. That would provide for a correction in some of the fatal effects of mismatched finance, and save some jobs. Does the Government of Uganda have those funds? I don’t think so. If it borrowed these funds, it would only manage to cause a new increase in interest rates. But to do nothing is equally dangerous. The government is financed mainly through consumption taxes, and failure to do something means revenue targets would soon be missed. Even the little social services you are receiving will be badly compromised. We are damned if we do something, we are damned if we don’t. Just be careful not to upset the yam cart.

Mr Sejjaaka is country team leader at Abacus Business School.