The role of development financial institutions in the new millennium

Are national development financial institutions (DFIs) still relevant? What are the critical factors that make these institutions succeed? What are concrete examples of sound, well-administered and innovative DFIs? Why do they still remain in business in countries with large and sophisticated financial systems? How can we assess their economic and social impact? Have our views on DFIs evolved in the past decades?
 
All these interesting questions were discussed during the Global Symposium on Development Financial Institutions, an event jointly organized by Bank Negara Malaysia and the World Bank Group on September 19 and 20 in Kuala Lumpur, Malaysia. With the theme “Balancing Sustainability and Social Mandate: Development Financial Institutions in a New World” the Global Symposium brought together 500 participants from Malaysia and around the world to discuss the challenges and opportunities faced by DFIs.
 
These are my three main takeaways from the Global Symposium:

Development financial institutions remain relevant. Historically, DFIs have been created by governments around the world to promote economic growth and support social development. They typically provide credit and a wide range of capacity-building programs to households, SMEs, and even larger private corporations whose financial needs are not sufficiently served by private banks or local capital markets. In doing so, they seek to promote strategic sectors of the economy, such as agriculture, international trade, housing, tourism, infrastructure, and green industries, among other sectors.

Although many of the institutions were created several decades ago, data shows that many governments around the world still see them as a relevant instrument to pursue economic goals. It is estimated that around 20% of all development financial institutions currently in operation around the world were created in the past 17 years. A further 33% were set up during the 80s and 90s – the decades in which mass privatizations took place in various parts of the world.

Views towards national development financial institutions have evolved over the years.  For decades, the World Bank Group has worked with development financial institutions in many countries by providing lines of credit, guarantees, and technical assistance programs. Our approach towards these institutions have changed from full support for their establishment during the 60s and 70s to a more cautious approach during the 80s and 90s which saw more closure or privatization of state-owned financial institutions. Since the global financial crisis of 2008, we are seeing a more balanced appreciation of their role and mandate.
 
During the 2008 Global Financial Crisis, development financial institutions played an important countercyclical role in many jurisdictions, by scaling up their lending operations when private financial institutions experienced temporary difficulties in granting credit. Moreover, in the aftermath of the global financial crisis the loan portfolio of more than two thirds of DFIs has continued to expand at double digit growth rates, thus contributing to global economic recovery efforts.
 
Financial sustainability and good governance are critical elements for the success of DFIs. It is a risky activity to finance projects in strategic sectors of the economy where there is insufficient financing from the private sector. To be effective, DFIs need to have business models that ensure long-term financial sustainability.  They also need to have sound risk-management tools and high corporate governance standards that insulate them from undue political interference.

In the past, we have seen multiple examples of poorly performing development financial institutions that have become a heavy fiscal burden. Their poor performance has led to credit market distortions that displace and crowd out private financial institutions. When they’re weak, they also become vulnerable to political interests, resulting in high non-performing loans and wasting of taxpayers’ money.

During the Global Symposium it was clear that we all need to learn lessons from the past. Financial sustainability and good governance of development financial institutions are critical elements that cannot be compromised. To achieve that, the institutions need to have well-defined mandates, be subject to high standards on corporate governance and transparency, and be regulated and supervised with standards applicable to other financial institutions. Moreover, owners of development financial institutions need to have the ability to properly monitor their business activities, assess their social and economic impact, and compare their interventions versus other public policy alternatives.

The timing of this global symposium could not be better. We need to think of innovative instruments to attract and channel new resources to finance our developmental aspirations, as outlined in the 2030 Sustainable Development Goals now more than ever. Reliable and well-administered development financial institutions with a well-defined mandate and sound governance framework will continue to be an important vehicle to accelerate economic and social development. They can create new channels to crowd-in the private sector. Moreover, they can play a catalytical role by generating new knowledge, convening stakeholders, and providing technical assistance to build capacity in the private and public sectors.