Development finance institutions are still very relevant

04 Dec 2017
Arshad Rab

Summary

When DFIs have helped to take certain industries to the level that the private financial institutions can come in, it is time for the DFIs to focus on other sectors or segments that are under-served.

Arshad Rab, CEO, European Organisation for Sustainable Development

Arshad Rab, CEO, European Organisation for Sustainable Development, addresses issues of the relevance of African development finance institutions (DFI). He was a keynote speaker at the 2017 CEO Forum of African DFIs. After his presentation, he spoke with Jide Akintunde, Managing Editor, Financial Nigeria, and Director, Nigeria Development and Finance Forum.

Jide Akintunde (JA): African DFIs evolved with post-colonial African states. With many of the countries in their fifth or sixth decade of independence, one may ask – and I am asking – “Are the DFIs still relevant?”

Arshad Rab (AR): African DFIs are as relevant today as they were in the 1960s, 70s and the 80s. The real question, though, is whether they are fulfilling their key mandate, which is to de-risk the sectors that are important for a given country but are currently unattractive for the private financial institutions. Those DFIs that are fulfilling their mandates are playing an important role.
    
The main issue today, however, is that new industry sectors are emerging fast, some older ones are disappearing and others are being totally reshaped as we move towards a new economy.  We are also experiencing comprehensive digitization of manufacturing and as you know the greening of some major industry sectors have started. All these developments are creating a real challenge and at the same time a historic opportunity for the DFIs. If they can serve the requirements of 21st century businesses, de-risk critically important sectors and crowd in private investment for achieving development goals, such as clean energy for all, then they will serve their purpose well and will continue to be very relevant.

JA: What would be your reaction to the view that the concessionary interest rates of the DFIs create distortions in the local credit market – even when the intervention funds are quite needed, for instance in agriculture?
    
AR: You have mentioned a very important sector of the economy: agriculture. So please allow me to address this one first. Though agriculture is perhaps the oldest sector, which received attention by the DFIs, it has not reached the level where one can comfortably say that commercial banks can fully take over. Agriculture still needs some kind of government intervention. This could be through the DFIs, offering more affordable and tailored financial services than are otherwise available in the market, and provide these services in geographic areas, which are not catered by the private sector.
    
If we look at some countries, there are big investments being made by the international corporate giants in the agriculture sector. Is it really good for the local economy? Well, initially the firms could be friendly, also price-wise; but when they dominate the market or control the entire agriculture value-chain, there is obviously a problem for the society and the economy. Government needs to intervene and support the small and medium-sized farmers so that they can continue to exist, because these farmers are of existential importance to the society.

There are not only social and economic risks but also serious environmental risks to the operations of the mega firms. For instance, they tend to cultivate many hectares of land to produce only one crop. They also use a lot of chemical interventions. Both are not good for the soil, the environment in general and the health of consumers.

And when there is significant loss to agricultural assets for reasons sometimes including natural causes, farmers would require government's intervention. In the advanced economies of Europe and elsewhere, the governments also often come to the aid of the farmers when they experience large scale loss of produce. The farmers can't always absorb the loss without intervention. In this regard, the commercial banks are counted out.

So, the experience of agriculture sector demonstrates that development finance is also a good tool to use in times of crisis for saving an economic sector, which is of existential importance for a country. And here is, for example, where the concessionary rates, which you referred to can be justified. However, the DFIs have to deliver in an efficient manner.

And to achieve cost-effectiveness, one of the steps DFIs can take is to cooperate, wherever possible, with other financial sector players, including the commercial banks where they have superior expertise, better business processes, or for example where they are closer to the businesses that need the intervention. As I noted in my speech, the DFIs should consider the commercial banks as partners rather than competitors.

One more important point: even in terms of agriculture, the DFIs have to digitize their operations. If they don't, they won't be cost-effective for the farmers who cannot afford to pay for the time-intensive and cost-prohibitive processes.

By the way, if the Nigerian DFIs can come forward and have a 3-5 years plan of transforming the entire agriculture sector, making it organic, you will not have any foreign exchange crisis the way you had, because of the skyrocketing demand of organic food in Europe and worldwide. Imagine the size of addressable market. But a word of caution here: I am not suggesting everything be exported, because it would lead to hunger here and perhaps refugees in Europe.

Now to the issue of market distortion which you raised. Let me say that when a particular industry sector or sub-sector that DFI intervene becomes attractive to commercial lending and other investors, it will be the time for DFIs to exit. Ironically, therefore, the success of the DFIs can make them irrelevant in some particular areas of activity. But that is the goal of DFIs and the nature of their business.

Therefore, whenever DFIs enter any sector, they must enter with a clear exit strategy. Problem arises when the exit strategy is not there. When DFIs have helped to take certain industries to the level that the private financial institutions can come in, it is time for the DFIs to focus on other sectors or segments that are under-served. Then there will be no question of market distortion.

This is how DFIs can continue to play a meaningful role. And there are many industry sectors, sub-sectors, geographic locations and demographic segments that will be in need of development finance. There is no dearth of business opportunities for the DFIs.

JA: Your keynote presentation touched on the issue of corporate governance of the DFIs. How serious is this issue and what solutions can be explored?

AR: Yes, this is a serious issue and merits a detailed response. Since this is not possible right now, I will try to share a few comments.

If you look at the composition of the board of any DFI, you would find popularly acclaimed expertise, on taxation, legal, finance, regulation and so on. That's good. However, the times are changing. We need to look into the possibility of re-composition of the governance structure and identify in the given society individuals who are forward-looking, futuristic and have the understanding of this age of disruptive innovation and include such persons in the boards. At the same time, these individuals must bring into their roles the insights of the social and environmental challenges of the country.

I think that the boards of directors should reflect the changing needs of the society and the economy. If this is done, then the chief executive officers and management of the DFIs will be in a better position to achieve their mandates.

And yes, I am aware of the concerns over the profitability of the DFIs, and I agree that development banks should not be a burden on the taxpayers. But there are areas that the government, as a shareholder, should ask: “what is the cost of not intervening?” For example, what is the cost of not providing intervention in agriculture? The cost of it will be far too high than intervening through efficient development financing institutions.

You know that the DFIs are asked to go and achieve some development goals, and then complaints arise that they are losing money. This is a conflict. I believe the losses can be absorbed, if the DFI de-risks the sectors and help develop businesses which could thereafter be funded by commercial banks and private investors. If this is done efficiently the productivity gains will far exceed the initial losses through the DFIs. Not to forget that these “losses” are in fact public investments and must be recognized as such.

The shareholders, which are mostly governments in the case of DFIs, need to be more informed about the cost-benefit analysis and the limitations of DFIs as it will help address a number of governance and management challenges.

And not to forget that boards of directors of DFIs need to provide guidelines for creating organizational culture in which transparency, agility, creativity and innovation are actively promoted and supported.  After all, this is the age of innovation economy.

JA: What is your view on the central bank getting closely involved with the development finance institutions and directly administering some intervention funds?

AR: I have some issues with that, because regulators are supposed to always stay neutral and should stay with regulating and not owning market operators. Self-regulation is a very difficult task. Even if you are doing it professionally, there would still be issues around transparency and perception. The perception in the market can be that you, as a regulator, has soft spot for your own institution. I think it is better that central banks stay out of doing business; they should focus on regulating.