metadata: authors: 0: author: Vicente,Carlos Leonardo
1: author: De Luna-Martinez,Jose
count: World
docna: 0: docna: Global survey of development banks
docty: Policy Research Working Paper
subtopic: Multinational & Corporate Governance,Urban Housing and Land Settlements,Corporate Governance,Legal Institutions of the Market Economy,Urban Governance and Management,Urban Housing,Banks & Banking Reform,Capital Markets and Capital Flows,Capital Flows,Food Security,Municipal Management and Reform,Civic Participation and Corporate Governance
teratopic: Private Sector Development,Finance and Financial Sector Development
abstracts: cdata!: Historically, development banks have
            been an important instrument of governments to promote
            economic growth by providing credit and a wide range of
            advisory and capacity building programs to households, small
            and medium enterprises, and even large private corporations,
            whose financial needs are not sufficiently served by private
            commercial banks or local capital markets. During the
            current financial crisis, most development banks in Latin
            America, followed by Asia, Africa, and Europe, have assumed
            a countercyclical role by scaling up their lending
            operations exactly when private banks experienced temporary
            difficulties in granting credit to the private sector.
            Despite the importance of development banks during crisis
            and non-crisis periods, little is known about them. This
            survey examines how development banks operate, what their
            policy mandates are, what financial services they offer,
            which type of clients they target, how they are regulated
            and supervised, what business models they have adopted, what
            governance framework they have, and what challenges they
            face. It also examines the countercyclical role played by
            development banks during the recent financial crisis. This
            survey is based on new data that have been collected from 90
            national development banks in 61 countries.
repnme: repnme: Global survey of development banks
display_title: Global survey of development banks
listing_relative_url: /research/2012/02/15806593/global-survey-development-banks
topicv3: Commercial Banking m1326069 1236,Agriculture and Food Security m1326205 435,Corporate Governance m1326968 417,Land and Housing m1327648 817,Financial Institutions m1505015 3797
publishtoextweb_dt: 2012-02-01T00:00:00Z
historic_topic: Private Sector Development,Finance and Financial Sector Development
no_of_pages: 41
author_keys: 0: author_key: 1008941
1: author_key: 177792
model_extractions: WPS5969 Policy Research Working Paper 5969 Global Survey of Development Banks _José de Luna-Martínez Carlos Leonardo Vicente_ The World Bank Financial and Private Sector Development Financial Systems Practice February 2012
Policy Research Working Paper 5969

# **Abstract**

Historically, development banks have been an important instrument of governments to promote economic growth by providing credit and a wide range of advisory and capacity building programs to households, small and medium enterprises , and even large private corporations, whose financial needs are not sufficiently served by private commercial banks or local capital markets. During the current financial crisis, most development banks in Latin America, followed by Asia, Africa, and Europe, have assumed a countercyclical role by scaling up their lending operations exactly when private banks experienced temporary difficulties in granting credit to the private sector. Despite the importance of development banks during crisis and non-crisis periods, little is known about them. This survey examines how development banks operate, what their policy mandates are, what financial services they offer, which type of clients they target, how they are regulated and supervised, what business models they have adopted, what governance framework they have, and what challenges they face. It also examines the countercyclical role played by development banks during the recent financial crisis. This survey is based on new data that have been collected from 90 national development banks in 61 countries.

This paper is a product of the Financial Systems Practice, Financial and Private Sector Development Vice Presidency. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at http://econ.worldbank. org. The authors may be contacted at jdelunamartinez@worldbank.org or cvicente@worldbank.org.

_The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent._ Produced by the Research Support Team
# **Global Survey of Development Banks**

José de Luna-Martínez and Carlos Leonardo Vicente<sup>1</sup>

**Keywords** : development banks, banking, emerging economies **JEL Classification** : G21, G28, H11, H81 FSE

> 1 José de Luna-Martínez (Jdelunamartinez@worldbank.org) is a Senior Financial Economist at the Financial and Private Sector Development Vicepresidency of the World Bank Group.  Carlos Leonardo Vicente (cvicente@worldbank.org) is a Financial Sector Specialist at the Financial and Private Sector Vicepresidency of the World Bank Group.
# **Table of Contents**

|Ack|nowledgements....................................................................................................................................... 1|
|---|---|
|Intr|oduction................................................................................................................................................... 2|
|1.|Sample and Methodological Notes....................................................................................................... 4|
||DBs by year of establishment............................................................................................................... 6|
||Size of DBs........................................................................................................................................... 6|
||Countercyclical Role of DBs................................................................................................................ 8|
|3.|Ownership and Funding........................................................................................................................ 9|
||Funding............................................................................................................................................... 10|
|4.|Mandates, Business Models and Financial Products.......................................................................... 11|
||Mandates............................................................................................................................................. 11|
||Economic Sectors and Clients Targeted by DBs................................................................................ 12|
||Lending Models: First-Tier and Second-Tier Lending....................................................................... 14|
|5.|Asset Quality and Return.................................................................................................................... 17|
|6.|Corporate governance arrangements.................................................................................................. 19|
|7.|Regulation and Supervision of DBs.................................................................................................... 21|
|8.|Challenges for DBs............................................................................................................................. 22|
|Con|clusions................................................................................................................................................. 23|
|Ref|erences................................................................................................................................................... 26|
|Ann|ex.......................................................................................................................................................... 27|
# **List of Figures**

|Figure 1. DBs by Year of Establishment..................................................................................................... 6|
|---|
|Figure 2. DBs by Assets in 2009.................................................................................................................. 7|
|Figure 3. Loan Portfolio of DBs.................................................................................................................. 8|
|Figure 4. Percentage of State Ownership in DBs......................................................................................... 9|
|Figure 5. Economic Sectors Targeted by DBs........................................................................................... 13|
|Figure 6. Types of Clients Served by DBs................................................................................................. 13|
|Figure 7. DBs‟ lending models.................................................................................................................. 14|
|Figure 8. Lending Products Offered by DBs............................................................................................. 15|
|Figure 9. Distribution of DBs by levels of NPLs...................................................................................... 18|
|Figure 10. Return of Assets and Equity..................................................................................................... 19|

# **List of Tables**

|Table 1. Survey Respondents by Region and Country................................................................................. 4|
|---|
|Table 2. Market Share of Selected DBs in 2009.......................................................................................... 7|
|Table 3. Credit Growth Rate in DBs (2007-2009)....................................................................................... 9|
|Table 4. Funding Features of DBs............................................................................................................. 10|
|Table 5. Mandates of DBs......................................................................................................................... 11|
|Table 6. Maximum Loan Term Offered by DBs......................................................................................... 16|
|Table 7. Transparency of DBs................................................................................................................... 21|
|Table 8. Challenges Faced by DBs............................................................................................................ 23|
# **Acknowledgements**

We wish to acknowledge the invaluable contribution of Octavio Peralta, the Secretary General of the World Federation of Development Financial Institutions (WFDFI), who enthusiastically supported us in all stages of this project and provided us access to the development banks affiliated with the WFDFI. We would like thank all the senior officials of the development banks who participated in this survey and shared their data and valuable insights with us. We express our gratitude to our World Bank colleagues - Mario Guadamillas, Martin Cihak, Cesar Calderon, James Seward, Consolate Rusagara, David Scott, and Roberto Rocha -, as well as to Romy Calderon (Latin American Association of Development Banks), Fernando de Olloqui (Inter-American Development Bank), Enrique Florencio (WFDFI), and Miriam Roemers (European Association of Public Banks) for their comments and feedback. Any errors or omissions in the data or interpretations are only attributable to us.

1
# **Introduction**

In spite of the wave of privatizations of state-owned financial institutions (SFIs) that has taken place over the past 30 years, SFIs still constitute an important part in the financial system. On average, they account for 25% of total assets in banking systems around the world. In the European Union, for example, SFIs represent 30% of the total financial system (Schmit, 2011). In the so-called BRIC countries alone – Brazil, Russia, India, and China – the market share of SFIs is substantially higher.

SFIs include a wide variety of institutions, such as commercial banks, development banks, postal banks, insurance companies, credit guarantee funds, leasing firms, etc. Development banks (DBs), also called development financial institutions or policy banks, are typically the largest type of SFI. Historically, governments established DBs to provide credit and other financial services to individuals, firms and strategic sectors of the economy that private financial institutions were unable or unwilling to serve to the extent desired by policy-makers.

During the global financial crisis of 2008-2010, most DBs played a countercyclical role by providing credit to private firms that were temporarily unable to access funding from private commercial banks or capital markets. This has renewed the interest of policy-makers in various jurisdictions on the role of DBs during periods of economic distress. Moreover, the financial crisis triggered new debates on the role of the state in the economy and, in particular, the financial sector.

Despite their size and importance, little is known about DBs. Past research on DBs has focused on examining their performance and comparing them to private financial institutions (Hanson 2003, Laporta 2000). Other studies have examined the reasons for the failure of select DBs (Viral, 2011). But apart from few case studies of a small number of individual institutions or specific regions (Rudolph 2009; Schmit, 2011), little is known about how DBs operate, what their policy mandates are, what financial services they offer, which type of clients they target, how they are regulated and supervised, what business models they have adopted, what governance framework they have, and what challenges they face.

The World Bank has received an increasing number of requests for data and new studies about DBs. These requests are motivated by ongoing efforts in various countries to strengthen their own DBs by insulating them from undue political interference, transforming them into more profitable and financially self-sustainable organizations, and adopting innovative governance arrangements.

In response to this demand, the World Bank and the World Federation of Development Financial Institutions (WFDFI) launched a survey to analyze the features and challenges faced by existing DBs, particularly those in low- and middle-income countries. The survey contained 72 questions (see Annex for the full list of questions) grouped into seven specific areas: size, funding, business models and products, profitability and asset quality, corporate governance, regulation and supervision, and challenges. The survey was conducted between January and June 2011 with the members of the WFDFI and the regional associations of development banks in Africa, Asia, Europe, and Latin America.

This report summarizes the key findings of the survey. Although the survey answers some questions and provides new data of DBs, it also raises new questions and concerns. We expect that the findings of the 2
survey will encourage others to use the database, explore further the issues discussed, and continue to advance our understanding of DBs.

3
# **1. Sample and Methodological Notes**

For the purpose of this survey, a DB is defined as _a bank or financial institution with at least 30 percent state-owned equity that has been given an explicit legal mandate to reach socioeconomic goals in a region, sector or particular market segment_ .

The survey is based on a questionnaire that was sent to the 280 members of the World Federation of Development Financial Institutions and the regional associations of development banks in Africa, Asia, Europe, Latin America, and Middle East. The diversity of DBs that participated in the survey, in terms of size, type, region, and performance suggests that the sampled DBs will likely share important characteristics with all the other existing DBs.

A total of 106 responses were received, however, 16 did not meet the survey‟s definition of a DB and were therefore excluded. The remaining responses from 90 DBs in 61 countries served as the basis for this report (see Annex for the list of respondent DBs). Participation in the survey was purely voluntary, with no bias against any type or jurisdiction of DB.

**Table 1. Survey Respondents by Region and Country**

||**Africa**|**Americas**|**Asia**|**Europe and**<br>**Central Asia**|**Middle East**<br>**and North**<br>**Africa**|
|---|---|---|---|---|---|
|1. <br>2. <br>3. <br>4. <br>5. <br>6. <br>7. <br>8. <br>9. <br>10. <br>11.|Angola<br>Côte d'Ivoire<br>Democratic<br>Republic of<br>Congo<br>Ghana<br>Kenya<br>Nigeria<br>Rwanda<br>South Africa<br>Sudan<br> Tanzania<br> Uganda|12. Antigua and<br>Barbuda<br>13. Bolivia<br>14. Brazil<br>15. Canada<br>16. Colombia<br>17. Costa Rica<br>18. Curacao<br>19. Dominican<br>Republic<br>20. Ecuador<br>21. Guatemala<br>22. Mexico<br>23. Paraguay<br>24. Peru<br>25. Uruguay<br>26. Venezuela<br>27. <br>28. <br>29. <br>30. <br>31. <br>32. <br>33. <br>34. <br>35. <br>36. <br>37. <br>38. <br>39. <br>40. <br>41. <br>42. <br>43. <br>44. <br>45. <br>46. <br>47.|Bangladesh<br>Bhutan<br>Cambodia<br>China,<br>People's Rep.<br>Cook Islands<br>Fiji<br>India<br>Malaysia<br>Micronesia<br>Mongolia<br>Nepal<br>Niue Island<br>Pakistan<br>Palau<br>Philippines<br>Samoa<br>Sri Lanka<br>Thailand<br>Tonga<br>Vanuatu<br>Vietnam|48. Bulgaria<br>49. Croatia<br>50. Finland<br>51. Germany<br>52. Hungary<br>53. Latvia<br>54. North Cyprus<br>55. Norway<br>56. Poland<br>57. Slovakia<br>58. Slovenia<br>59. Turkey|60. Egypt<br>61. Oman|

4
With the exception of the Middle East and North Africa regions, from where only two responses were received, a satisfactory response rate was achieved in all other regions of the world. Additional responses may arrive and will be reflected in an updated publication.

There are four important caveats with regard to the data in the survey. First, the data come directly from responses by senior managers of each DB. There was no third-party assessment of the data. These senior managers had the opportunity to review and validate their institution‟s data.

Secondly, several topics were intentionally omitted from the scope of the survey. For instance, the survey does not explore the effectiveness of DBs in terms of fulfilling their mandates, nor does the survey examine the impact of DBs‟ operations in the development of local private financial systems. These are all important topics, but given their complexity they should be treated separately using a different methodology.

Thirdly, the distinction between a development bank and a commercial bank is not always clear. A few institutions included in the survey, such as Banco Nacional de Costa Rica which sees itself as a development bank, are considered by some observers as a commercial bank because of the scale of their commercial banking operations. The authors decided to keep these types of institutions in the survey, as long as they complied with the definition of DBs described earlier.

Finally, multilateral, regional, and sub-regional development banks were excluded from the survey in order to concentrate the focus on national development banks, in particular of DBs in low- and middleincome countries.

# **2. Establishment, Size, and Countercyclical Role of DBs**

Historically, DBs have been an important instrument used by governments to promote economic development in practically all countries around the world, regardless of their stage of development. DBs have been established in former socialist economies, advanced capitalist countries and emerging economies to finance the construction of roads, highways, energy plants, dams, and telecommunication infrastructure; foster incipient industries and small and medium enterprises (SMEs); and provide financial services to low-income households.

In emerging market economies, for instance, DBs usually constitute the main source of long term credit, loan guarantees, and other financial services in the infrastructure, housing and agriculture sectors. Even in some advanced economies, where private financial institutions and capital markets satisfy the financial needs of firms and individuals, several DBs continue to play an active role in providing financial services to so called strategic sectors of the economy.<sup>2</sup>

> 2 Examples include Kreditanstalt fuer Wiederaufbau (KfW) in Germany, Japan Development Bank, and Business Development Bank of Canada.

5
# **DBs by Year of Establishment**

As illustrated in Figure 1, 12% of DBs examined in the survey were established before 1946, 49% between 1946 (after the end of World War II) and 1989, and 39% between 1990 and 2011. These figures reveal two interesting features of DBs.

First, a large number of the surveyed DBs were established more than three decades ago and are currently still in operation, despite the strong criticism against DBs in the 1980s and 1990s and the growing role of private financial institutions. This suggests that most governments still see in their DBs a relevant tool to promote economic growth.

**Figure 1.  DBs by Year of Establishment**

_(percent of DBs)_ Secondly, during the past 21 years, as governments around the world were privatizing state-owned financial institutions, several countries were establishing new DBs. Examples of DBs established in the recent past include: Bulgarian Development Bank, SME Development Bank of Thailand, Financiera Rural (Mexico), Export Credit Guarantee Agency of Oman, Small Industries Development Bank of India, and Banco de Poupanca e Credito (Angola), to name a few. As this report is being written, new DBs are being established in Serbia, Bosnia and Herzegovina, Malawi, and Mozambique, among other countries. Even in the UK, the media has recently reported plans to establish a new development bank.<sup>3</sup>

# **Size of DBs**

At the end of 2009, the DBs in the survey reported total assets in the amount of US $2.01 trillion dollars and a combined loan portfolio of US $1.59 trillion dollars. Figure 2 groups the DBs into small (less than US$1 billion dollars in assets), medium ($1 to $9.9 billion dollars), large ($10 to $99 billion dollars) and mega-banks (more than $100 billion dollars in assets). So, by the end of 2009, 51% of the surveyed DBs

> 3 In the UK, a new “Green Bank” will be established in 2012 to finance environmental projects. In the USA, the Obama administration is discussing the possibility of establishing a new national infrastructure bank.

6
were grouped as small, 33% medium, 11% large and 5% were megabanks. The megabank group includes China Development Bank, Brazil Development Bank (BNDES), North Rhine-Westphalia Bank (Germany), and Kreditanstalt fuer Wiederaufbfau (Germany). In terms of assets, China Development Bank, Brazil Development Bank and Kreditanstalt fuer Wiederaufbfau (KfW) are larger than the World Bank Group.

**Figure 2.  DBs by Assets in 2009**

_(percent of DBs)_ <!-- Start of picture text --> 100%<br>5%<br>90% 11%<br>80% More than US $100<br>billion dollars<br>70%<br>33%<br>60% US$10 to $99 billion<br>50%<br>40%<br>US$1 to $9.9 billion<br>30%<br>51%<br>20%<br>Less than US$1<br>10% billion<br>0%<br><!-- End of picture text --> From a country perspective, most individual DBs tend to be relatively small institutions, holding a small share of the market in terms of assets. In 80% of cases, individual DBs account for less than 3% of the assets of the banking systems of the countries in which they operate.

There is, however, a small group of DBs that have become large players in their banking systems, particularly in small economies. For example, the Development Bank of the Cook Islands accounts for 11% of total assets in the banking system, Fiji Development Bank for 11%, and Rwanda Development Bank for 12%. In a few large economies, some individual DBs also have a significant share of the market. For instance, T.C. Ziraat Bankasi (Agriculture Bank) in Turkey, Brazil National Development Bank, and Land Bank of Philippines account for 15%, 10% and 9% respectively of the total assets in their banking systems.

**Table 2.  Market Share of Selected DBs in 2009**

_(percentage of total assets of their banking systems)_

|**DBs**|**Market** **Share**|
|---|---|
|1. Agriculture Bank of Turkey|15%|
|2. Rwanda Development Bank|12%|
|3. Fiji Development Bank|11%|
|4. Brazil National Development Bank|10%|
|5. Land Bank of Philippines|9%|

7
# **Countercyclical Role of DBs**

Another interesting finding is that between the end of 2007 and the end of 2009, the combined loan portfolio of DBs increased from US $1.16 trillion to US $1.58 trillion dollars. In nominal terms, this 36% increase, in just three years, is well above the 10% increase in private bank credit for the countries surveyed during the same period. Most DBs in the survey assumed a countercyclical role by increasing their supply of credit to private firms in their jurisdictions to partially mitigate the credit crunch associated with the global financial crisis (Figure 3).

DBs increased short and long term lending, not only to their existing customers, but also to new customers from private commercial banks which faced temporary difficulties in refinancing their loans or acquiring new lines of credit. Even large multinationals, like the auto-maker Chrysler, benefited from loans provided by DBs in middle income countries.<sup>4</sup> However, it remains to be seen how the new loans will perform.

**Figure 3.  Loan Portfolio of DBs**

_(per trillion $U.S.)_ As shown in Table 3, between the end of 2007 and 2009, only 16% of the institutions in the survey experienced a negative growth in their loan portfolios; 27% of DBs recorded a loan portfolio growth between 0% and 20%, 33% between 20% and 50%, 15% between 50% and 100%, and 9% of DBs experienced a growth above 100% in their loan portfolios.

> 4 In early 2010, NAFIN granted a loan in the amount of $400 million dollars to support Chrysler‟s operations in Mexico.

8
**Table 3.  Credit Growth Rate in DBs (2007-2009)**

|**Growth Rate**|**% of DBs**|
|---|---|
|Negativegrowth|16%|
|0 to 20%|27%|
|20% to 50%|33%|
|50% to 100%|15%|
|More than 100%|9%|
|**Total**|**100%**|

The highest growth rates were recorded by the Bulgarian Development Bank (275%), Corporacion Financiera Nacional of Ecuador (174%), Slovene Export and Development Bank (145%), Agencia Financiera de Desarrollo of Paraguay (128%) and Banco del Estado of Ecuador (122%). Regionally, the loan portfolios of the DBs in Asia experienced the highest growth rate (72%) in this period, followed by Americas (70%), Africa (60%), and Europe (12%).

# **3. Ownership and Funding**

Typically DBs are institutions owned, administered, and controlled by the government (state), which provides the strategic direction of the DB and appoints their senior management and board members. The extent of government ownership in DBs, however, can vary. As illustrated in Figure 4, while 74% of the DBs surveyed are entirely government owned and controlled, in another 21% the private sector participates as minority shareholder, holding between one and 49% of the total shares. Some institutions in this category are Credit Guarantee Corporation (Malaysia), Banque de l'Habitat de Côte d'Ivoire, and Finagro (Colombia). In this type of DB, the government maintains control of the institution, while the private sector owns part of its capital. Interestingly, in 5% of these DBs the government owns less than 50% of the capital of the DB. An example of this type of DB is DFCC of Sri Lanka, which, despite being partially privatized and fully managed by the private sector, retains its focus on developmental activities.

**Figure 4.  Percentage of State Ownership in DBs**

<!-- Start of picture text --> 5%<br>State owns 100%<br>21%<br>State owns 50% to<br>99%<br>74% State owns less than<br>50%<br><!-- End of picture text --> 9
# **Funding**

There are different options for DBs to fund their business operations, including (i) taking savings and deposits from the public, (ii) borrowing from other financial institutions, (iii) raising money in the domestic or international capital markets, (iv) using their own equity, and (v) receiving budget allocations from the government. Most DBs combine all these funding options.

Except in situations where the mandate of the DB is to promote savings, some authors (Rudolph 2007) argue that it is undesirable for DBs to take deposits from the general public. Avoiding this allows the DBs to focus on their lending operations while avoiding competition with private banks and, at the same time limit potential taxpayers‟ exposure to losses. Moreover, the distinction between a development bank and a commercial bank might become blurred when DBs are allowed to offer savings and deposits accounts to the general public. As shown in Table 4, 41% of DBs raise deposits from the public while the other 59% does not. All deposit-taking DBs in the survey are retail lenders, that is, they lend directly to customers; no second-tier institution (DBs that lend through to other private financial institutions to reach end customers) takes deposits from the general public.

**Table 4.  Funding Features of DBs**

|**Features**|**Yes**|**No**|
|---|---|---|
|Doesyour institution take deposits from thegeneralpublic?|41%|59%|
|Can your institution borrow from other financial institutions or issue<br>debt in local markets?|89%|11%|
|Does your institution receive direct budget transfers from the<br>government?|40%|60%|
|Does thegovernmentguaranteeyour institution‟s debt?|64%|36%|

When asked whether they can borrow from other financial institutions or raise money in capital markets, 89% of the DBs surveyed responded positively. Nevertheless, most institutions require governmental approval to do so, particularly if the debt is to be guaranteed by the government. However, there are some interesting findings in the small group of DBs that are restricted from borrowing from other financial institutions or capital markets. For example, Financiera Rural of Mexico, established in 2002, was obliged by law to fund its operations solely through its own capital. In 2002, the Mexican government liquidated its old agriculture development bank and established a new agriculture DB, Financiera Rural, which was banned from borrowing from the market and taking deposits from the public. This end result was to minimize any liability to the government in the event of failure.<sup>5</sup> Generally, DBs are expected to be profitable and financially self-sustainable, and non-reliant on government subsidies or transfers to (partially) fund their operations. The survey found that 40% of institutions receive government transfers to partially fund their operations. It should be noted that receiving direct transfers from the government does not necessarily mean dependence on government

> 5 In 2009, this provision was relaxed, allowing Financiera Rural to borrow from other domestic or international DBs. Prohibition to take deposits from the public and issue debt in local capital markets remain in effect.

10
funds. Sometimes, DBs – such as KfW in Germany -- receive transfers from the government to fund interest rate subsidies to a particular type of borrower.

Nevertheless, some DBs, like the Vietnam Bank for Social Policies (VBSP), have become highly dependent on government transfers to operate. VBSP prices most of its lending products at interest rates well below market rates. For some of its lending products, interest rates are even lower than the interest rates for its saving products. As a result, it operates with a negative interest rate spread, making it unable to survive without government subsidies. In fact, 18% of the DBs that receive transfers claimed that if transfers were canceled, they would not be able to operate on a sustainable basis.

As government-owned institutions, 64% of all DBs enjoy the support of their governments who explicitly guarantee their debt and other liabilities. Given that 89% of the DBs can borrow from other financial institutions or issue debt, these guarantees allow them to borrow at a relatively lower cost and eventually transfer that lower cost to final borrowers. The provision of guarantees can be regarded as an effective way of funding DBs, provided that the “guaranteed” DBs play a complementary role, that is, they do not compete with the private banks. Otherwise guarantees become a source of unfair competitive advantage.

# **4. Mandates, Business Models and Financial Products**

## **Mandates**

DBs have been established with a wide range of policy or developmental mandates. On the basis of their mandates, DBs can be divided into two groups: (i) institutions with a narrow and specific mandate, which explicitly refers to the sector(s), type of customers or activities that a DB is expected to support, and (ii) institutions with broad mandates that are formulated in general terms without reference to any particular sector or activity. Examples of this type of mandates are _“...to promote the country’s economic development” or the “well-being of citizens”_ .

**Table 5.  Mandates of DBs**

|**DBs by Type of**<br>**Mandate**|**Market niche**|**Percent of DBs in**<br>**the survey**|
|---|---|---|
|**1. Specific**||**53%**|
||Agriculture|_13%_|
||SMEs|_12%_|
||International trade|_9%_|
||Housing|_6%_|
||Infrastructure|_4%_|
||Localgovernments|_3%_|
||Industrial and other|_6%_|
|**2. Broad**||**47%**|
|**Total**||**100%**|

11
As shown in Table 5, 53% of DBs surveyed are institutions with specific policy mandates. They include institutions that were specifically established to support the agriculture sector (13% of all DBs), SMEs through their lending, guarantee or advisory services (12%), export and import activities (9%), housing (6%), infrastructure projects (4%), local governments (3%), and other sectors (6%). Examples of this group are: National Agriculture and Rural Development Bank of India, the Credit Guarantee Corporation of Malaysia, Hungarian Export-Import Bank, Ecuadorian Housing Bank, Banobras of Mexico (which specializes in large infrastructure projects), and Kenya Tourist Development Corporation.

On the other hand, the other 47% of DBs are institutions with broader legal mandates and are expected to support a broader range of activities and sectors. Examples of these institutions include the Development Bank of Philippines, an institution established to “ _influence and accelerate sustainable economic growth through the provision of medium and long-term resources for the continued well-being of the Filipino people_ ”, Uganda Development Bank, which was established to “ _provide financial support to short, medium, and long term projects geared toward economic development of the nation_ ”, Fiji Development Bank, Development Bank of Turkey, and Development Bank of China.

There are pros and cons in adopting narrow versus broad mandates. On the one hand, narrow mandates encourage institutions to adhere to their original mandates and gain specialization in their target market. Monitoring and performance evaluation becomes easier in DBs with a narrow rather than a broad focus. However, institutions with narrow mandates do not have the flexibility to target various sectors, in some cases limiting their ability to manage risk through diversification.

On the other hand, institutions with broad mandates provide flexibility to DBs to finance a wide range of activities and sectors deemed important by the government. However, if not properly managed, DBs might quickly lose focus and effectiveness, be subject to different and competing demands from different Ministries and other government institutions, or simply have its policy mandate crept into diffuse tasks and activities.

# **Economic Sectors and Clients Targeted by DBs**

The surveyed DBs operate in several sectors of the economy and serve different types of clients, creating a wide range of intervention modes through which governments provide credit and other financial services in the economy. A DB specializing in SME lending, for example, may target a wide range of sectors in the economy as long as its clients remain SMEs. A specialized agriculture bank may target all types of clients (smallholder farmers, SMEs, large private corporations, and even other state-owned enterprises), provided that they operate in the agriculture sector. The survey tried to examine the operations of DBs from both sectoral and client perspectives.

DBs were asked to select which economic sectors they target from a list of nine sectors - services and trade, industry and manufacturing, agriculture, housing and construction, infrastructure, energy, health, mining, and education. As shown in Figure 5, 86% of DBs targeted the trade and services sectors, 84% industry and manufacturing, 83% agriculture, 74% construction and housing, 66% energy, and 65% 12
infrastructure. On the opposite side, only 48% of the DBs targeted the health sector, 45% education, and 43% mining.<sup>6</sup>

**Figure 5.  Economic Sectors Targeted by DBs**

_(percentage of DBs targeting each sector)_ <!-- Start of picture text --> Mining 43%<br>Education 45%<br>Health 48%<br>Infrastructure 65%<br>Energy 66%<br>Construction 74%<br>Agribusiness 83%<br>Industry/Manufacturing 84%<br>Services 86%<br>0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%<br>Germany and Canada, DBs surveyed in those jurisdictions also target the SME sector.<br>Figure 6. Types of Clients Served by DBs<br>(percentage of DBs targeting each type of client)<br>Other financial institutions 46%<br>Other state-owned<br>54%<br>enterprises<br>Individuals and households 55%<br>Large private corporations 60%<br>SMEs 92%<br>0% 50% 100%<br><!-- End of picture text --> Similarly, DBs were asked which type of clients they target: 92% of DBs responded that they target small and medium enterprises, 60% large private corporations, 55% individuals and households, 54% other state-owned enterprises (SOEs) and 46% private financial intermediaries. It is interesting to note that for most DBs, regardless of their size or mandate, SMEs constitute the type of client they are trying to serve and support. This is not a surprise, since for most low- and middle-income countries; access to finance by SMEs remains one of the key challenges for the financial sector. Even in high-income countries, such as Germany and Canada, DBs surveyed in those jurisdictions also target the SME sector.

6 The survey did not collect data on the factual allocation of credit by sectors. This will be done in a revised version of the survey.

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# **Lending Models: First-Tier and Second-Tier Lending**

In practice, DBs have developed and adopted different business models to carry out their lending operations. A total of 52% of DBs lend through a combination of first-tier (lending directly to endcustomers) and second-tier operations (lending to other private financial institutions which subsequently on-lend to end-customers), while 36% of DBs in the survey only lend through first-tier (or retail) operations and 12% of DBs only through second-tier (or wholesale) operations.

Examples of “first-tier-only” DBs include Al-Amanah Islamic Investment Bank of the Philippines, Bank Pembangunan Malaysia Berhad, Bhutan Development Finance Corporation, Nepal Industrial Development Corporation, Slovak Guarantee and Development Bank, and SME Development Bank of Thailand. Interestingly, a large number of “second-tier-only” DBs are located in Latin America, and include among others BNDES (Brazil), FIRA (Mexico), Ecuadorian Housing Bank, COFIDE (Peru) and FINAGRO (Colombia). Outside Latin America, “second-tier-only” institutions are National Bank of Agriculture and Rural Development (NABARD) of India, and KfW of Germany (for domestic customers).<sup>7</sup>

**Figure 7.  DBs’ lending models**

<!-- Start of picture text --> How does your institution lend?<br>Only<br>wholesale<br>12%<br>Both retail<br>and<br>wholesale<br>52%<br>Only retail<br>36%<br><!-- End of picture text --> There are various advantages and disadvantages of first versus second-tier lending. Under the first-tier (retail) lending model, DBs deal directly with the end-customers. Often, this requires the DB to have a large number of branches to access its target customers. This can pose enormous pressure for agriculture, housing, and SME banks whose clientele is usually large and geographically dispersed throughout a country. In this model, the interest rate offered to end-customers can be lower, other things being equal, because resources are not intermediated through other financial institutions. In addition, the credit risk stays completely with the DB.

> 7 For international customers, KfW lends through retail and wholesale operations.

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Under the second-tier (or wholesale) lending model, DBs tend to have lower operating costs because financing is provided by the DB to private financial institutions which subsequently select and assess the loan applications of end-customers. Under this model, the DB can reach more end-customers and cover more locations without incurring high operating costs. This model also promotes the growth of private financial intermediaries that become the arms of DBs that reach under-served sectors and clients. Moreover, the credit risk is partially absorbed by the private financial institution that intermediates the DBs‟ funds. As discussed below, second-tier DBs tend to report lower non-performing loan ratios than first-tier DBs. However, interest rates for end-customers tend to be higher because private financial institutions pass on to them their cost of financial intermediation plus any other margins.

# **_Lending Products and Maturity of Loans_**

The survey also inquired about the types of lending products that DBs offer to their customers. As illustrated in Figure 8, the majority of loans offered by DBs are long-term loans (90%) followed by working capital loans (85%), whereas syndicated loans consisted of 52% of all DBs, and unsecured loans 25%.

**Figure 8.  Lending Products Offered by DBs**

_(Percentage of DBs offering each product)_ <!-- Start of picture text --> Unsecured loans (for intangible assets) 25%<br>Loans for new product launch activities 41%<br>Syndicated loans 52%<br>Bridge or short-term loans 74%<br>Loans for working capital 85%<br>Long-term loans 90%<br>0% 20% 40% 60% 80% 100%<br><!-- End of picture text --> The survey examined the maximum maturity of the long-term loans that DBs offer to their customers. Often, the lack or limited availability of long-term financing in developing countries has been a strong justification for the existence of DBs. As shown in the following table, only 13% of DBs offer loans with a maturity of more than 20 years whereas for most DBs, the maximum maturity is less than 20 years.

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**Table 6. Maximum Loan Term Offered by DBs**

|**Maximum loan term**||**Percent**<br>**of DBs**|
|---|---|---|
|Upto 5years||16%|
|6 to 10years||29%|
|11 to 15years||19%|
|16 to 20years||22%|
|21 to 25years||7%|
|26 to 30years||6%|
||**Total**|**100%**|

# **_Use of subsidized interest rates_**

The provision of credit at subsidized interest rates by DBs has been a controversial issue. For some authors, this practice might undermine the solvency and profitability of DBs and distort the competitive environment. For others, the use of subsidized interest rates might be justifiable to support nascent enterprises provided that subsidies are transparent and used for their intended purposes (Scott 2007).

The provision of credit at subsidized interest rates is a practice adopted by 50% of DBs covered in the survey. In this category, 66% of DBs fund these subsidies using transfers from their respective governments. In some countries however, this practice has become unsustainable given the large fiscal pressures it causes. Other means of funding subsidies include cross-subsidization from profitable areas of business and also access to cheaper funds from large international financial institutions, such as the World Bank, European Investment Bank or any of the regional development banks.

# **_Other financial and non-financial services_**

Supplementing their lending operations, DBs also offer a wide range of financial and non-financial products to their customers. In terms of financial products, the survey found that 73% of all DBs offer loan guarantee products to partially offset the losses faced by a private financial intermediary when a customer defaults. The guarantees usually take different modalities in terms of coverage and pricing, that were not explored in the survey. However, an interesting point is that most DBs see this type of financial product as a useful instrument to encourage private commercial banks and other financial institutions to lend with their own resources to the same clients and sectors that DBs target. For some DBs such as FIRA, loan guarantees have become almost as important in terms of value as their own lending portfolios. A useful exercise beyond the scope of this survey, would be to compare the different modalities of credit guarantees and assess their impact, pricing and financial sustainability.

Of the DBs surveyed, 30% offer leasing services and 16% factoring services. A well known factoring program is provided by NAFIN of Mexico (see Klapper 2006) which offers online reverse factoring services to a large number of SMEs. Securitization services are also offered by 16% of the institutions. In terms of non-financial products, the survey found that a large number of institutions offer several advisory services, capacity building, and training programs for their existing and prospective clients. In most cases, the costs of these services are absorbed directly by the DBs. In practically all second tier institutions, the scale of these offerings is quite large. They include a wide range of activities to support 16
their own network of private financial intermediaries that borrow from them to lend to their end customers. These customers can then use the funds to finance new business development, capital enhancement, training for staff, interest rate subsidies, IT equipment, etc. The scope and performance of advisory services provided by DBs could be the topic of a separate study.

# **5. Asset Quality and Return**

A common criticism against DBs is they are institutions that are prone to experience asset quality problems. DBs are often portrayed as institutions with a limited capacity to assess borrowers‟ capability and willingness to repay their loans. They are also portrayed as having a limited capacity for debt collection on loans, resulting in a high amount of non-performing loans, debt forgiveness programs, and financial losses that are ultimately borne by taxpayers.

The survey collected data on the non-performing loan (NPL) ratios of DBs. As shown in Figure 9, at the end of 2009, 55% of DBs reported NPL ratios of less than 5%; 30% of DBs reported NPL ratios between 5% and 30% and 15% of DBs reported ratios of more than 30%. This distribution remained almost unchanged over the 2006-2009 period.<sup>8</sup> Second-tier-only DBs reported lower NPL ratios than “retail-only DBs”. Indeed, all “second-tier-only” DBs fell within the less than 5% bracket while only 27% of “retailonly” DBs were in this bracket.

A comparison of the NPL ratios of DBs with the NPL ratios of their respective banking systems<sup>9</sup> shows that 39% of DBs exceeded the national average in 2009, while the other 64% of DBs was below the national average. For the years 2006 and 2008, the percentage of DBs with NPL ratios below the average in their banking systems was 57%, and in 2007 it was 58%.

> 8 Rules for the definition and classification of NPLs differ across countries. Therefore, one should be cautious when interpreting and comparing them.

> 9 Average NPLs of banking systems were obtained from the International Financial Statistics online database.

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**Figure 9.   Distribution of DBs by levels of NPLs**

_(Percentage of DBs in each NPL range)_ <!-- Start of picture text --> 100%<br>90% 16% 17% 15% 15%<br>80% 4% 4% 8% 5%<br>8%<br>70% 14% 11% 16%<br>60% 14% 18% 14% 10%<br>50%<br>40%<br>30%<br>53% 53% 53% 55%<br>20%<br>10%<br>0%<br>2006 2007 2008 2009<br>Less than 5% 5% to 9.9% 10% to 19.9% 20% to 29.9% More than 30%<br><!-- End of picture text --> The survey found that in 2009, 14% of the surveyed DBs reported losses. The remaining 86% were profitable or broke even. The percentage of DBs reporting losses in 2006, 2007 and 2008 was 15%, 8%, and 9%, respectively.

Given that profit maximization is not the main objective of DBs, their returns tend to underperform the average return of the banking system. In 2009, 53% of the surveyed DBs had a Return on Assets (ROA) exceeding the average of their banking systems. This was up from 42% in 2006 and 2007, and 46% in 2008. In terms of the Return on Equity (ROE), 19% of DBs exceeded the national average in 2009 (up from 15% in 2006, 13% in 2007, and 18% in 2008).

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**Figure 10.  Return of Assets and Equity**

_(percentage, 2009)_ <!-- Start of picture text --> ROA ROE<br>80%<br>15%<br>60%<br>10%<br>40%<br>5%<br>20%<br>0%<br>0%<br>0 20 40 60 80 100<br>0 20 40 60 80 100<br>-5%<br>-20%<br>-10% -40%<br>-15% -60%<br>-80%<br>-20%<br>DFIs DFIs<br><!-- End of picture text -->

# **6. Corporate Governance Arrangements**

Good corporate governance is a critical component for the success of DBs. In broad terms, corporate governance refers to _“...the process and structure for overseeing the direction and management of a corporation so that it carries out its mandate and objectives effectively_ ”.

The governance in a DB can be more challenging than in private financial intermediaries. To begin with, the structure of DB ownership and control can be more complex, involving a large number of governmental institutions (ministries of finance, agriculture, housing, trade, labor, etc.), and sometimes even the legislature. These entities all have their own legitimate (and sometimes conflicting) expectations regarding the goals the DB should accomplish.

When the mandate of the DB is stated only in general and broad terms, senior government officials or elected politicians have more room to influence the direction and activities that a DB pursues. Unless the institutional framework of a DB is strong enough to withstand undue political pressure, a DB can become vulnerable to political interference or be captured by interest groups exerting pressure on it to take excessive credit risks, thus causing future financial losses for the DB.

Moreover, as government owned institutions, DBs rarely face the risk of takeover. This, combined with the absence of a sound monitoring and evaluation framework, can cause the board and management of DBs to become progressively tolerant with DBs‟ inefficiencies and weak performance.

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Many of the problems that commonly afflict state financial institutions, such as weak performance, financial problems, diffuse mandates, unfair competition with the private sector, capture by interest groups, etc. can be associated with, if not attributed directly to, weaknesses in corporate governance. The survey tried to examine a few characteristics of the corporate governance framework of DBs, keeping in mind that an extensive review of this topic is beyond the scope of this survey. First, participating DBs were asked about the size and composition of their boards. The results show that, on average, the boards of DBs are composed of 8 members, with 22% of DBs having more than 10 members on their boards.

Results also show most boards consist of government representatives, including members representing ministries of finance, labor, trade, housing, social affairs, and even the central bank. Interestingly, 75% of DBs allow the participation of independent (non-government affiliated) members. In 30% of those cases, such as Bank of Cook Islands or Credit Guarantee Corporation of Malaysia, independent members constitute the majority of the board. In a few cases, such as Slovak Guarantee and Development Bank and Antigua and Barbuda Development Bank, boards are comprised entirely of independent members.

Examining governance issues in DBs can lead one to question whether public servants should serve on the boards of DBs. Arguments can be made for and against this issue. The main argument in favor of this is that as representatives of the government public servants can provide strategic direction and ensure the DB fulfills its mandate in an efficient and effective manner. The main argument against this is that public servants might be seen by other board members as having inordinate powers, and therefore be in a position to inappropriately influence the decisions and direction of the board. While the issue remains unresolved, there is a general consensus that when public servants are appointed to the board, their numbers should be limited, they should meet the necessary qualifications and they should have the same obligations and roles as any other board member (Scott, 2007).

The survey found that a large percentage of DBs have adopted a series of minimum requirements for board members. As much as 91% of DBs require that board members have a minimum level of education, 87% require minimum technical qualifications in the banking field, and 75% require board members not to have bankruptcy records. In all the DBs the government retains the ultimate power to appoint and remove board members and CEOs.

# **_Transparency_**

Effective corporate governance depends on the flow of accurate, timely and relevant information within the DB, and externally to the government, legislature and the public. The survey looked at the transparency of DBs with regard to the information disclosed to the public in select areas. Table 7 shows that 96% of DBs prepare and publish their annual reports, most of which are available online on their own websites; 93% also disclose their audited financial statements. However, only 71% of DBs disclose offbalance sheet items, when applicable. A smaller percentage of DBs (63%) disclose their governance and risk management framework, and 64% their regulatory capital and capital adequacy ratio (CAR).

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**Table 7.  Transparency of DBs**

|**Disclosed Information**|**Percentage of DFIs**|
|---|---|
|Annual report|96%|
|Audited financial statements|93%|
|Off-balance sheet items|71%|
|Governance and risk management framework|63%|
|Regulatorycapital and capital adequacyratio|64%|

The capacity of DBs to identify, measure, and manage their risks is a critical element for adequate governance and overall performance. A total of 88% of DBs indicated they have in place risk management units. Their effectiveness is a measurement that needs to be done separately. Of those DBs that have risk management units, only 53% have procedures allowing them to report directly to the Boards.

To encourage DBs to remain financially sound some DBs are legally obliged to achieve a minimum return on capital, such as:

- Maintaining real capital constant (earn a return not lower than inflation), such as Financiera Rural of Mexico and Credit Bank of Turkey

- Achieving a rate of return not lower than the government‟s long-term borrowing cost, such as the Business Development Bank of Canada.

- Explicit return on capital (ranging from 7% - 11% annually), such as the Development Bank of Samoa, Samoa Housing Corporation, the EXIM Bank of India, Tonga Development Bank, and Kommunalbanken of Norway.

# **7. Regulation and Supervision of DBs**

There is a broad international consensus that DBs and other financial institutions owned or controlled by the government or state, should have the regulation and supervisory standards of private financial institutions.<sup>10</sup> By doing so, DBs will be subjected to the same solvency, liquidity, governance, accounting, and transparency standards of private sector institutions, whenever applicable. Moreover, in the event of financial problems in DBs, the regulator is expected to act and take the same preventive or remedial actions normally undertaken with private financial institutions.

The survey found that 76% of DBs are in fact regulated and supervised by the same institution that supervises private commercial banks in their countries, such as the central bank or the bank supervisory agency. The remaining 24% are supervised by the same ministries and government agencies providing their strategic direction, such as the Ministries of Industry, Trade, Housing, Agriculture, Energy, Labor,

> 10 See Basel Core Principles for Effective Bank Supervision.

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etc. Examples of DBs supervised by ministries include National Development Bank of Palau, Samoa Housing Corporation, Export Credit Guarantee Agency of Oman, SME Development Bank of Thailand, and Uganda Development Bank.

Prudential supervision by the ministry providing the strategic direction raises multiple problems. First, the ministry or agency exercising the supervisory function usually does not have the same expertise to monitor and assess the risks associated with the business of the DBs under their umbrella as a central bank or bank supervisory agency. Secondly, it is frequently the case that conflicts of interest arise, and in the event of financial problems the supervising institution becomes forbearing, delaying prompt corrective action or even the simple recognition and disclosure of problems.

The results show 78% of DBs indicated they are required to comply with the same standards of prudential supervision (minimum capital, minimum capital adequacy requirements, loan classification and provisioning, etc.) of private commercial banks or any other private financial institution. The remaining 22% are subjected to other standards, which are usually more lenient than the standards applicable to private banks. For example, some DBs in Africa (e.g. the Uganda Development Bank) indicated that they follow the prudential standards of the African Association of Development Finance Institutions. Deposittaking DBs (98%) tend to comply more with the same prudential standards as commercial banks than non-deposit-taking DBs (68%).

In complement to a sound and effective regulatory system, 45% of DBs in the sample are required to be rated by an internationally recognized rating agency. The remaining 55% are not. Most of the unrated DBs tend to be small in terms of assets, although that does not constitute a strong argument against the need for a rating. Almost all DBs (97%) reported that they are legally required to be audited by a professional external auditor.

# **8. Challenges for DBs**

Table 8 shows some of the main weaknesses and challenges being faced by DBs. For 71% of DBs the most important challenge was the need to improve their risk management capacity. This reflects the difficulties they face throughout the entire lending cycle, which includes the assessment of their prospective clients‟ creditworthiness, the way they assess risks, the type of credit policies they follow, and the capability they have to collect on loans or execute collateral, whenever applicable.

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**Table 8.  Challenges Faced by DBs**

|**What are the most important challenges facing your institution going forward?**|**Percentage of DBs**|
|---|---|
|Improve risk-management capacity|71%|
|Become financially self-sustainable?|59%|
|Improve corporategovernance and transparency|50%|
|Acquire more flexibility to hire and retain highly qualified staff|40%|
|Reduce undue political interference|31%|

As many as 59% of the DBs indicated that the need to become a financially self-sustainable organization was a key challenge, reflecting perhaps a need to reduce their reliance on governmental budget transfers and to improve their own profitability. Moreover, 50% saw the need to improve corporate governance and transparency as a major challenge; 40% need more flexibility to hire and retain highly qualified staff and 31% felt that reducing undue political interference was another major challenge.

# **Conclusions**

Historically, DBs have been an important instrument of governments to promote economic growth by providing credit, loan guarantees, other financial services and a wide range of advisory and capacity building programs to low-income households, SMEs, and even large corporations whose financial needs are not sufficiently served by private commercial banks or local capital markets.

Even in advanced economies, where private financial institutions and capital markets cover the financial needs of households and enterprises, DBs continue to play an active role in the economy by providing credit to select sectors and fostering new investments in priority activities such as clean energy, biotechnology, and environmental projects, as well as traditional sectors and activities.

The ongoing global financial crisis has given DBs an exciting new role. The survey has shown that in most countries in Asia, Latin America, Africa, and Europe, DBs have assumed a counter cyclical role by scaling up their lending operations exactly when private banks experienced temporary difficulties in granting credit to the private sector. This has helped private firms refinance or roll over their liabilities and even access additional lines of credit.

Despite the importance of DBs during both crisis and non-crisis periods, so far, little is known about the role they play. The survey‟s results reveal that the universe of DBs is heterogeneous and, as a result, they cannot and should not be treated as a uniform group of institutions. DBs differ among themselves in various areas, such as:

- Ownership structure (fully vs. partially owned by government)

- Policy mandates (narrow vs. broad mandates)

- Funding mechanisms (deposit taking vs. non-deposit taking institutions)

- Target sectors and clients (narrow vs. wide focus)

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- Lending models (first-tier vs. second-tier)

- Pricing of lending products (subsidized vs. market interest rates)

- Regulation and supervision (special regime vs. same regime applicable to private banks)

- Corporate governance (independent vs. government controlled boards)

- Transparency standards (wide vs. limited disclosure)

Across countries and regions, DBs exhibit various differences and patterns. Specialized and profitable DBs with a strong commercial orientation coexist with other DBs that are highly dependent on government subsidies. They pursue multiple and sometimes conflicting economic and social objectives. New generations of DBs characterized by high standards of transparency, accountability, and operational autonomy coexist with institutions that continue to operate under the powerful influence and interference of single individuals and politicians. Deposit-taking DBs with large branch networks coexist with DBs that are only funded through capital markets and lend only through second-tier operations.

In practice, the different institutional features and modalities adopted by individual DBs do matter, because they can determine to a large extent a DB‟s ability to become financially-self-sustainable and, more importantly, fulfill their objectives and policy mandates in an efficient manner.

Adopting the best possible institutional design for DBs is important since they operate in difficult and challenging environments. DBs are expected to serve clients and segments of the market with a high risk profile that are usually not being served by private financial institutions. At the same time, as government-owned and controlled institutions, DBs could be vulnerable to undue political pressure, unless strong safeguards are put in place.

In the past, international experience has revealed that only DBs with clearly defined mandates, high corporate governance standards, strong risk management capability, proper regulation and supervision, and a strong management team have been successful. In fact, in the past several DBs around the world have failed due to poor lending decisions, high amount of non-performing loans, undue political interference, capture by interest groups, and lack of well-defined mandates.

The survey revealed that there is enormous room to improve the performance and effectiveness of DBs:

- 18% of DBs that receive government transfers claimed that if these transfers were canceled, they would be unable to operate on a sustainable basis.

- 24% of all DBs are under-supervised and without the reporting standards applicable to private financial institutions.

- 36%% of DBs do not disclose their regulatory capital on a regular basis.

- 25%% of DBs do not include independent members in their boards.

- 15% of DBs reported NPL ratios of 30% or more.

- 13% of DBs do not have minimum requirements in terms of technical skills

- 25% do not require board members and senior management to demonstrate lack of bankruptcy records.

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- 78% of DBs have recognized the need to improve risk management as one of their key challenges going forward.

At the same time, the survey found that in various jurisdictions innovative procedures have been put in place to help DBs operate in an effective manner. For instance, some DBs are legally obliged to achieve a minimum return on capital, measured in terms of the inflation rate or the government‟s cost of borrowing. Moreover, certain DBs have been partially privatized and the management has been transferred to the private sector under management contracts. Certain governments have also adopted legislation that prevents them from bailing out DBs in case of failure. In other jurisdictions, DBs lend only through second-tier operations and share with the private sector the risk of lending to underserved segments of the market. Some DBs are also governed by boards fully comprised of independent members. It is worth exploring all these innovations as they may be part of the solutions needed to strengthen those weak institutions covered in the survey, in particular those operating in difficult institutional environments.

Because of their strong focus on SMEs and individuals not served by other financial institutions, DBs are clearly an essential part of the financial inclusion agenda. They play an important role in serving new clients directly or through a network of private financial intermediaries, mitigating credit risks, and even developing innovative financial instruments to finance promising business ventures.

As this report is being finalized, the global financial crisis continues to pose major risks for the world economy. There might be a role for DBs to play again as turbulence in financial markets continues and the ability and cost of borrowing of firms is seriously affected. Thus, in the short or medium terms, there are strong reasons for governments to continue modernizing their DBs and giving them tools to become more effective and successful in fulfilling their policy mandates.

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