Development bank pros

In Budget 2021 the Government has proposed setting up a development bank, which the private sector has largely applauded, as it could fund a range of economic activities including Small and Medium Enterprises (SMEs), start-ups and other entrepreneurship ventures far more readily than conventional banks.

Development banks around the world are also well looked upon for their ability to anchor private-public sector partnerships, particularly for infrastructure financing.

However, misusing development banks can lead to fiscal risks and credit market distortions. To avoid these potential pitfalls, development banks need a well-defined mandate, operate without political influence, focus on addressing significant market failures, concentrate on areas where the private sector is not present, monitor and evaluate interventions and adjust as necessary to ensure impact, and, finally, be transparent and accountable.

This is easier said than done in Sri Lanka. For example, Lankaputhra Bank was initially established as a development bank, but ran into huge financial trouble after it was used to fund Mihin Lanka. Lankaputhra Bank’s license was finally cancelled after it was merged with the Regional Development Bank (RDB) in 2019. The new development bank cannot follow the same fate.

For years, Lankaputhra Bank was dogged by allegations of mismanagement and the financial fortunes of RDB did not improve with the merger. In fact, neither the presence of Lankaputhra Bank nor the RDB did much to reduce questionable practices of micro finance companies and many people in rural areas, particularly women, struggle to have access to affordable capital. It is therefore essential that any new development bank, in addition to being professionally run, also has a gendered approach to finance. 

Development banks can also bring in private sector financing to fund developments and focus on providing technical assistance, consulting, management and technical advice.

There are many reasons why a development bank would be a positive. For starters it would direct funding to commercially-viable and “safe” projects rather than giving out funds based on political motives. Such an entity could also direct lending or direct equity investment with discretion and with complementary policies to stimulate both entrepreneurship and the development of private capital markets that can alleviate credit constraints for private firms. 

In Germany, for example development banks have focused on supporting tech adaption and find solutions for aging population challenges. They can also provide credit guarantee schemes, credit enhancements on capital market instruments, or matching private equity funds as done in Brazil or provide the private sector with incentives to take more responsibility for operations and maintain long-term finance for infrastructure projects.

If set up right, a development bank can also solve public-private coordination problems that increase the social returns of investment projects in cases where social returns exceed private returns, and the private returns aren’t sufficient to induce investment. Given Sri Lanka’s serious fiscal constraints, there would clearly be multiple benefits from having a genuinely focused development bank set up to better manage the financing issues of both the public and private sectors. 

Given COVID-19 and other related troubles the Government will have to find the right time to set up the development bank, but the industry consensus appears to prefer a quick roll out.