House of Commons - The Future of UK Development Co-operation: Phase 1: Development Finance

The Future of UK Development Co-operation: Phase 1: Development Finance - International Development Committee Contents

6 A UK development bank

The potential role of a UK development bank

70. The UK is unusual in not having a development bank. Witnesses have suggested that there could potentially be a niche for certain bilateral financial products such as concessional loans, either for the public sector or the private sector or both.[143] In Chapters 3, 4 and 5 we noted that despite the emergence of new sources of finance, there is still a need for different types of funding for development projects, and that for some of these projects, loans or other forms of returnable capital could potentially be more appropriate than grants.

71. Development banks provide credit and other financial services to individuals, firms and strategic sectors of the economy that private financial institutions are unable or unwilling fully to service. The world's largest development banks include the China Development Bank, the Brazil Development Bank (BNDES) and the German Development Bank (KfW). At least thirteen G20 countries have some form of development bank, with combined assets amounting to more than USD 3 trillion.[144] There are different options for development banks to fund their business operations, including taking savings and deposits from the public; borrowing from other financial institutions; raising money in the domestic or international capital markets; using their own equity; and receiving budget allocations from the government. Most development banks combine all these funding options. Development banks are expected to be profitable and financially sustainable, and can have specific or broad mandates.[145] Development banks address market failures in the availability of long term finance, ensure that long term savings are allocated to the long term finance needs and can be used to raise funds on the capital markets and allocate those funds to developing countries. Development banks can also use innovative instruments to leverage funds from other sources, including private citizens and diaspora communities. The table below shows the functions of existing development banks, indicating which financial instruments they provide and which fund public and which the private sectoras well as the functions a UK development bank might undertake.
Table 2 Financial instruments of leading development finance institutions, including possible functions of a UK development bank [146]

Financial instrument Finance for the public sector Finance for the private sector

Concessional loans (ODA) Bilateral: KfW (Germany), AfD (France), JICA (Japan)
Regional: EIB, AsDB, AfDB
Multilateral: IDA (World Bank)

UKDB?
Interest rate subsidies (eg by EIB)
FMO(Netherlands) government funds
JICA (private sector investment finance)

UKDB?

Non-concessional loans (Other Official Flows) IBRD (World Bank)
EIB
AfDB,AsDB,EBRD,IADB
KfW (promotional loans)

UKDB?
CDC's new mandate allows loans (it also manages the Impact Investment Fund)
EIB
Bilateral: DEG (Germany), Proparco (france) , core FMO
Multilateral: IFC (World Bank)

Grants IDA (World Bank)
DFID
DFID challenge funds (eg AECF, TGVCI)

Direct equity and equity funds CDC

Guarantees UK export finance (ECGD) for UK exporters and investors
MIGA (World Bank)

Abbreviations:

AECF: Africa Enterprise Challenge FundAfDB: African Development Bank

AfD: Agence Française de Développement - France's public development finance institution

AsDB,: Asian Development Bank

CDC: UK's Development Finance Institution

DEG: the German development bank for the private sector ECGD: Export Credits Guarantee Department (UK)

EBRD: The European Bank for Reconstruction and Development

EIB: The European Investment Bank

FMO: The Netherlands Development Finance Company

IADB: The Inter-American Development Bank

IBRD: The International Bank for Reconstruction and Development (World Bank)

IDA: International Development Association (World Bank)

IFC: The International Finance Corporation (World Bank)

JICA: Japan International Cooperation Agency

KfW: the German, government-owned development bank

MIGA: The Multilateral Investment Guarantee Agency (World Bank)

Proparco: French finance institution, part owned by AfD, which promotes private investment in developing countries

TGVCI: The Trade in Global Value Chains Initiative

POTENTIAL BENEFITS OF A UK DEVELOPMENT BANK

72. In order to assess the potential benefits of established a UKDB, there are a number of questions which would first have to be considered. These include whether the new instruments offered by a UKDB would be more effective in terms of fostering growth, reducing poverty and addressing global public goods; whether there was a demand for the additional finance instruments which could be provided by a UKDB; what would be the additional benefits of setting up this new institution rather than providing instruments through existing entities; and how a new UKDB would relate to existing UK Government objectives, obligations and laws.[147] The establishment of a UKDB could reduce the amount of ODA that the taxpayer would need to fund, if the bank raised funds from capital markets and if it were able to increase the value of its loan book. Holger Rothenbusch, CDC, pointed out that this was a model used by France and Germany, and which was compliant with the current calculation of ODA.[148]

73. Marc Englehardt, KfW suggested that having a UKDB would provide the potential for new joint ventures between DFID, KfW and other donors, and that the UK "would be a highly welcome partner, as an additional European development bank in EU blending".[149] Professor Griffith-Jones agreed, saying that KfW, AFD and EIB had an informal consortium where each one took a lead in particular projects, and that the model could perhaps be replicated with a UKDB joining them".[150] JICA indicated in informal meetings that it would be interested in joint ventures with the UK; the establishment of a UKDB with a wider range of financial instruments could facilitate this sort of cooperation. Professor Griffith-Jones said that if a UKDB were to borrow money, it could borrow more cheaply and transfer that cheapness to developing countries.[151] Diana Noble, CDC, suggested that a UKDB could play an important role "but not obviously at the expense of retaining a significant aid budget. There will always be areas of public sector good that can only be funded through grants."[152]

74. In addition, the creation of a new UK institution with the capacity to provide a range of bilateral finance instruments and technical assistance and the ability to work in partnership with other development banks and multilaterals could enable it to deliver a range of longer term support to build on its humanitarian and rapid response to emergencies, such as that to Typhoon Haiyan in the Philippines. The Philippines is a lower middle income country with which the UK has no bilateral aid programme. It will need substantial investment to enable it to rebuild essential infrastructure and services. DFID has promised to assist in the reconstruction of the Philippines[153]; the technical assistance, guarantees and loan finance which will be needed might best be delivered through a development bank.

POTENTIAL DRAWBACKS

75. Several witnesses raised the question of the setup costs and effort of establishing a new UKDB.[154] Matthew Martin suggested that, given the current severe budget constraints, setting up a whole new UK development bank institution "would seem really likely to undermine public support for development assistance in this country".[155] Andrew Rogerson, ODI, said that DFID would need to be very careful not to lose its current advantage of "combining a very large portion of the UK's external aid effort under one roof and then being present in-country with that same sort of unified voice". He added that:

We should be careful. If the answer to a problem is concessional loans or guarantees, then DFID already has the powers ... but it should be very careful not to throw away that advantage by creating something apart from DFID that then adds to the general fragmentation in-country and does not necessarily dovetail with how taxpayers' money is being used in other forms.

156

76. UKAN and BOND argued that evidence from other OECD development finance institutions suggested that their priorities and performance measurements were more often weighted towards financial return and evidence of contribution to financial growth rather than social development impacts.[157] Peter Chowla questioned the capability of a new UKDB to focus, control and monitor the development outcomes of its investments, saying that:

158

77. Other witnesses suggested that a UKDB would not necessarily be responsive enough to meet the needs of developing countries. Adam Smith International said that development banks tended to be slow and risk-averse and overly focused on process.[159] Matthew Martin suggested that low income countries would rate bilateral development banks and development financing institutions "in the last place" and would prefer donors instead to give good replenishments to existing multilateral institutions.[160] The TUC expressed doubts about the wisdom of establishing another development bank when there were already a considerable number in existence.[161] UKAN and BOND concluded that "there is currently insufficient evidence to suggest that a new UKDB or loan facility would provide true development additionality or that it would be an effective modality to deliver UK aid".[162]

Other options

78. Witnesses commented on some of the alternatives to a new UKDB. Caroline Ashley suggested that DFID had five broad options for managing an expanded range of development finance: running it from within DFID; contracting out programmes to external organisations; expanding the focus of CDC; setting up a development bank; and channelling money via multilateral institutions, and described some of the main advantages and disadvantages of each option.[163]

79. Matthew Martin proposed that DFID could create an implementing agency within DFID, which would act as a virtual bank, and assess credit-worthiness, provide grants, loans and equities and organise co-financing with other organisations:

164

However, Tamsyn Barton questioned whether such an arrangement would provide DFID with the necessary expertise, and stressed the need for appropriately skilled staff to be available throughout the duration of the loan period.[165] Another option would be to expand the remit of CDC. Diana Noble said that if a separate UKDB were established, "there would need to be a huge amount of cooperation and clarity between the institutions [CDC and the UKDB]", and that "we at CDC would be extremely cooperative, constructive and helpful". She explained that "If it [the UKDB] is outside CDC, it would be very important to have absolute clarity of mission between the two organisations to avoid confusing the market and creating unhealthy competition between teams".[166]

80. In terms of DFID's current range of instruments, the Secretary of State made it clear that in the case of countries such as India which were transitioning from grant based bilateral country programmes, DFID aimed to use a range of different finance instruments, including loans as well as grants.[167] For example, a portion of DFID's recently launched Impact Investment Fund is available to invest in businesses which focus on pro-poor projects in India.[168] The Secretary of State told us that:

169

More generally, she explained that DFID was reviewing its investment policies and instruments, including the possibility of using more loans and that "it may well be that the most effective thing for us to do is to see whether we can achieve those outcomes through existing channels".[170] She also told us that "any move to set up a development bank is not going to happen overnight. It is a significant undertaking. ... I would describe any discussions around setting up a development bank as at a very early stage."[171] Professor Dercon said that the case for either lending instruments or a development bank was "clearly something that we have to keep live and keep on thinking about. ... The choice at the moment to be a bit cautious and not jump into it seems to be the right one."[172]

81. The UK is unusual in the G20 in not having its own development bank. Establishing a UK development bank could give the DFID bilateral programme a way of providing a wider range of finance instruments, to complement its grant aided programmes which we would expect to continue for the poorest countries. A UK development bank could offer a range of new instruments, including concessional loans, together with technical expertise which is often valued as much as finance. However, there is a real danger that establishing a new UK development agency outside DFID would fragment UK development policy. Great care would need to be taken to avoid this danger and to ensure that a new development bank would work closely with existing institutions.

82. We recognise that establishing a new UK development bank would be a major undertaking, which would need careful planning and a measured implementation, but believe that DFID should plan for the long term. Creating new institutions is challenging but not impossible; for example the Government has created the Green Investment Bank in less than three years. The 'do nothing now' option carries the risk that DFID's bilateral approach becomes less effective over time and that it is unable to play a key role in the future.

83. We recommend that DFID establish a financial instrument team that can prepare a development finance strategy; coordinate the various finance initiatives that are currently being piloted by DFID; draw together the different bilateral and multilateral approaches; design new instruments and build up the necessary skills for future innovation and development. Without this effort, DFID may not be in a position to establish a development bank if and when it were deemed advantageous to do so.

84. We recommend that DFID considers the following questions in its finance strategy:

· What are the development financing gaps in terms of instruments, sectors and countries? What niche could a new UK development bank fill? Would the new instruments be more effective in terms of fostering growth, reducing poverty and addressing global public goods?

· What would be the potential advantages and disadvantages of establishing a UK development bank? What could be achieved, or achieved better, through a new UK development bank compared to existing institutions? What comparative advantages would a UK development bank have over existing institutions?

· What are the pros and cons of other alternatives, including no change; developing closer working arrangements with multilaterals; providing concessional loans through the existing DFID structure; and expanding the scope of CDC?

· How would a UK development bank cooperate with other UK finance institutions and other development finance institutions?

· What are the institutional and legal issues which would need to be addressed?

· What would be the costs and possible timetable for establishing a UK development bank?

· What new skills would DFID need to acquire and how would it do so?

· What is the potential role of new finance instruments, such as Development Impact Bonds and Diaspora Bonds?

143 Eg Q 30, Ev 100 Back

144 Annex 2 Back

145 Annex 2 Back

146 Annex 2 Back

147 Annex 2 Back

148 Q 184 Back

149 Q 104 Back