Matching Risks with Instruments in Development Banks

ABSTRACT

This paper explores how development banks should deploy appropriate financial instruments to encourage real economic risk-taking while minimizing financial engineering risks. We distinguish real economic risks from financial engineering or intermediary risks and argue that using complex financial instruments to leverage additional private financing may undermine policy steer and lead to too much risk being taken by development banks. We then explore comparative advantages of different financial instruments such as loans, guarantees, equity, and insurance in tackling risks in normal times. Then we synthesize common features of development banks’ responses to the COVID-19 crisis. Finally, we propose future research directions.

KEYWORDS:

• Development banks
• risk
• financial instruments
• COVID-19

JEL CODES:

• G23
• H81
• O16
• Q01
• D02

Acknowledgements

We greatly thank all the senior officials of development banks we interviewed for valuable insights and information provided, as well as our commentators, on a previous draft, Jose Antonio Ocampo and Daniel Titelman.

Disclosure Statement

No potential conflict of interest was reported by the author(s).

Notes

1 The Institute of New Structural Economics at Peking University (INSE) has built a comprehensive database on development finance institutions worldwide (Xu, Ren, and Wu 2019). In total, 378 NDBs have been identified worldwide. In order to use the basic financial indicators, we have rigorously matched these NDBs from the INSE list with banks from Bank focus — a very comprehensive bank-level database based on publicly available annual reports and financial statements. Out of 263 matched NDBs, 220 have information on total assets as we need to use total assets as a proxy of bank size to select representative NDBs.

2 The content of this chapter is the result of semi-structured interviews with the top-level management of Appendix mentioned Development Banks.

3 In this context, DBs are increasingly worried that regulators and rating agencies are not making any discount for long-term holding in the requirements for equity of DBs. The horizon at which DBs mark to market is usually longer, and in the long term DBs are better at bearing this type of risk.

4 https://www.kfw.de/inlandsfoerderung/Companies/KfW-Corona-Hilfe/.

5 https://www.kfw.de/KfW-Group/Newsroom/Latest-News/Pressemitteilungen-Details_583809.html (accessed on 8 June 2020).

6 https://en.mercopress.com/2020/05/28/idb-us-1-7bn-loan-for-uruguay-to-address-the-covid-19-pandemic (accessed on 7 June 2020).

7 https://www.iadb.org/en/news/idb-approves-loan-support-belizes-covid-19-immediate-health-response (accessed on 20 May 2020).

8 https://www.afdb.org/en/news-and-events/press-releases/african-development-bank-group-unveils-10-billion-response-facility-curb-covid-19-35174 (accessed on 3 June 2020).

9 https://www.almg.gov.br/consulte/legislacao/completa/completa.html?tipo=DEC&num=47939&comp=&ano=2020 (accessed on 10 June 2020).

Additional information

Funding

We are deeply grateful for the financial and intellectual support provided by AFD, and in particular by Regis Marodon for the writing of this paper.