A Case for successful framework for development bank: the Ghanaian example

The post- independence failure of development banks in Ghana in the 1980s and 1990s meant that they all but disappeared from the development agenda. However, there are still a large number of development banks worldwide in countries such as Brazil, India and Chile that operate with various degrees of success. The Ghanaian government is looking to re-establish such another development banks to address the shortage of finance for higher-risk market segments. To avoid a repeat of the earlier failures, government policy needs to be informed by an objective framework for the success of this bank. This article, based on theories of development banks and outlines such a framework for successful bank or development finance institution.  It addresses the following seven dimensions of these banks: enabling economic environment, definitive mandate, robust and resilient regulation and supervision, good corporate governance practises, robust risk management, financial sustainability and performance assessment. Development banking remains a risky initiative but, managed appropriately, and using this framework, it can help achieve development objectives of economic growth and transformation. 

1. Introduction

After the much-publicised failure of many national development banks in the 1970s and 1980s, the future of this type of development finance was in question (World Bank, 1989). Poorly controlled spending by development banks and other state-owned finance institutions delivered little in terms of development but contributed to fiscal crises in several developing countries (Nellis, 1986). As the policy trend shifted towards financial liberalisation in some developing countries, many of these countries privatised, restructured or closed their development banks or development finance institutions (Fitzgerald, 2006). Ghana has been no exception to the failure of development finance institutions in the 1980s and 1990s where Bank for Housing and Construction and Ghana Cooperative Bank failed as a result of massive cheque fraud (A’LIFE Cheque kitting) while Social Security Bank was restructured in 1992 and the Agricultural Development Bank and National Investment Bank had their developmental mandates changed from development banks into universal banks in 2004 (Bawumia,2010). The then prevailing view of development banks is summed up particularly well by Krahnen and Schmidt (1994): ‘Development banks still have to find their proper role in a world where financial repression is on the retreat. This has rekindled interest in national development banks, which raises the possibility that, if there is no clear understanding of the role of these banks, the problems that beset the early ones may well recur (Yirga-Hall, 1998; Yaron, 2004; Bruck, 2005).

However, literature had shown that well-functioning financial sector, both national and international, needs for development finance institutions to play important roles to achieve the aims of sustained and inclusive growth. To achieve this key positive role, the financial sector needs to encourage and mobilise savings, intermediate these savings at low cost, ensure savings are channelled into efficient investment, including in innovation and structural change, as well as helping manage the risks for individuals and enterprises.

Because the financial sector has such important effects throughout the economy it also needs to adhere to a key principle of the Hippocratic oath that medical doctors swear to, which is to do no harm to the rest of the economy. Therefore, there should be as few and as small crises that stem from the financial sector, as these have huge costs, both fiscal and on growth, employment and investment. In recent decades the private financial system has not performed any of these functions well. It has created risk, instead of managing it, leading to many major crises. It has been deeply pro-cyclical in that it tends to over-lend in boom times, and ration credit during –and long after-crises, limiting both working capital and long- term finance crucial for investment. In both tranquil, but even more in turbulent times, it has not funded sufficiently the long-term investment in innovation and skills which businesses need to grow and create jobs; key sectors like infrastructure, renewable energy and energy efficiency have also been insufficiently funded.

National development banks are financial institutions that are at least 30% state-owned with an explicit legal mandate to provide long-term financing to – or facilitating the financing of – projects that contribute to achieving socio-economic goals in a region, country or a particular sector of an economy (UNDESA, 2005; World Bank, 2012). At a national European level, Germany’s public development bank, KFW, now the second largest development German bank, has played a very positive role in increasing lending counter-cyclically – for example to SMEs-, during the crisis, as well as funding on a significant scale key sectors-such as investment in renewables and for innovation more broadly.

The favourable experience of many development banks in emerging economies, such as BNDES in Brazil, and CAF in the Andean region, spreading increasingly in Latin America, are very important, as are positive Asian experiences, as in China, South Korea and India, which have had effective development banks. BNDES for example has taken important risks in financing important new sectors, like biotechnology and renewable energy. Furthermore, countries like Chile have in the past used their development banks for promoting and funding private investment in sectors, such as for example massive expansion of forestry in Chile, that generated major exports of paper and cellulose, as well as wood. In all these experiences, development banks have pioneered investment in new sectors and new technologies, following national or regional priorities, defined by government often in consultation with the private sector.

The value of development banks, at a multilateral, regional, and national level, to help implement and finance development strategies and visions (by funding both the public and private sector) has thus received greater support. It is also interesting that the role of development banks has not just been highlighted as important in developing and emerging economies, but also in developed ones. There are four valuable functions that seem crucial for national development banks to play: a) providing counter-cyclical finance, especially for supporting investment; b) supporting, through funding, a dynamic vision and strategy of growth and structural transformation c) mobilizing broader resources, for example by leverage and targeted subsidies d) financing public goods (Culpeper et al, 2016). Thus, the Ecowas Bank of West Africa-the bank of the Ecowas member states- has played a prominent role in the provision of long- term lending and infrastructural development in the region.

In the Ghanaian context, government-owned development finance institution can play a useful complementary role to fill existing gaps in the provision of long-term finance, especially in infrastructure, housing, agriculture and the SME segment. Ghanaian development banks have historically played an important developmental role, taking higher-than-average risks to perform their mandates and reducing credit pro-cyclicality. However, the track record of Ghanaian development finance institutions is mixed, and their developmental contribution has frequently come with a cost in terms of relatively low efficiency and effectiveness. A growing body of empirical evidence indicates that once DFIs are provided with strong governance structures and the right incentives they can play an effective role in expanding financial access, ultimately contributing to economic and social development. This usually involves clear and focused mandates, robust corporate governance standards with independent boards, proper performance assessment criteria, appropriate lending and risk management technologies, the requirement to be financially sustainable, and the ability to recruit and retain qualified staff. It is therefore important to assess compliance with those best practices

As part of the developmental agenda of using the banking system to drive the development agenda. At the 2020 budget presentation to the Ghanaian parliament that Government through the Bank of Ghana has been facilitating the establishment of national development bank with support from the German KFW and the World Bank to provide counter-cyclical finance; b) supporting a dynamic vision and strategy of growth and structural transformation c) mobilizing broader resources, and d) financing public goods.

The article is structured as follows. Section 1 deals with the introduction while Section 2 defines rationale for and definition of development banks and Section 3 outlines the theories of development banks, and  Section 4 reviews the role of development banking in emerging economies, while Section 5 assesses the post- independence of development finance institutions in Ghana while Section 6 discusses the causes of failures of development finance institutions in Ghana; Section 7 discusses the globally tried and tested framework for development finance institutions  and Section 8 deals with a case for tested framework for the Ghanaian development banks while Section 9 deals the conclusion while 10  by making recommendations. 

2. Rationale for and definition of national development banks

While there is no universally accepted definition of what a development bank is, development banks are often described as financial institutions that are primarily concerned with offering long-term capital finance to projects that are deemed to generate positive externalities and hence would be underfinanced by private creditors. Development finance can broadly be defined as the provision of finance to those market segments (such as projects, sectors or sections of the population) that are not well served by the financial system. These segments include projects whose social benefits exceed their commercial ones; long-term projects or projects with a long lead time; new or risky ventures, such as new technologies; and small and new borrowers who lack collateral (Diamond, 1996). Standard objectives of development banks also include financing the agriculture sector and reducing regional economic disparities.

A standard argument for why development banks should be promoted is that such banks can fill the gaps left by private financial institutions, which are often geared towards commercial activities. The main gap is usually insufficient finance for economic transformation. The latter typically involves large-scale projects with long maturation periods, which require long-term finance and thus imply risks that banks are unwilling to undertake. In addition, many large-scale projects generate positive externalities and therefore social returns that are greater than private returns. The provision of long-term finance is also lacking due to the funding of financial institutions, which is often short-term. That is, long-term finance requires maturity transformation, which involves a risk that banks usually prefer to avoid. For these reasons, development banks are designed and mandated to fulfil this role. At the national level, development banks can be instrumental not only in addressing market failures, such as the lack of provision of long-term finance due to the risks and uncertainties involved, but as a critical tool in supporting a proactive development strategy

 

3. The Theories of Development finance institution/ Development bank

Development banks are financial institutions typically offering subsidized, long-term financing for industrial development. Although there are many multilateral development banks focusing on distinct areas and countries, our emphasis here will be the so-called “state-owned” development banks, controlled by a local government. The tools employed by each bank vary, but in general include medium- to long-term credit, subsidized interest rates, credit guarantees, equity, and technical assistance. While it is widely understood that development banks target industrial production, intense discussion exists around the methodologies employed by each bank and the motivation behind them (Lazzarini, Musacchio, Bandeira-de-Mello and Marcon 2015). From the vast body of literature encompassing this discussion we identify three main views on the purpose and role of development banks: the industrial policy view, the social view, and the political view (Musacchio and Lazzarini 2014, Yeyati, Micco and Panizza 2004). In brief, the industrial policy view holds that development banks were formed in response to failures of the capital markets to provide the financing necessary for entrepreneurial activity and industrialization (Armendáriz de Aghion 1999, Gerschenkron 1962). The social view holds that the government intervenes in the capital markets to address specific social issues (i.e., unemployment, lack of housing, energy dependency, etc.) (Shapiro and Willig 1990, Shirley 1989).

The political view depicts development banks largely as instruments serving politicians’ personal objectives or as conduits for rewarding politically involved industrialists (Ades and Di Tella 1997, Shleifer and Vishny 1994). Each view presents a different perspective on the role of government (through the bank) in addressing market failures. Similarly, each view lends itself to a different set of expectations regarding which financial instruments are best able to achieve the specific objectives and the effects that would be seen in the subsequent impact metrics. There are three theories concerning development finance institutions or development banks covered in this article: industrial policy view, social view and political view that could either contribute to the successes or failures of the institutions

1. INDUSTRIAL POLICY VIEW

The industrial policy view, as the name might suggest, is built on the assumption that industrialization—and entrepreneurial activity more generally—will lead to economic growth in a country and subsequent improvements in overall welfare. In this view, capital market constraints are seen as the prohibitive factor to entrepreneurship, often directly, but also indirectly as financing for the infrastructure necessary to support industrialization may also be seriously deficient. The direst constraint here is a lack of long-term lending not only for large industrial and infrastructure projects (Gerschenkron 1962), but also for the new ventures needed to bear the costs of discovery of new technologies and productive processes (Hausmann and Rodrik 2003).

Additionally, information asymmetries and the inherent riskiness of such projects, result in high interest rates deterring otherwise willing investors. High information asymmetry is most severe in the case of small investors seeking capital from the private sector. Medium- to long-term loans null the duration constraint on financing, while government funding for development banks provides lower-than-market interest rates essentially subsidizing the cost of the infrastructure or industrial projects. Development banks have also deployed equity financing in support of both state-owned enterprises (SOEs) and private firms; however, this has been seen to be an effective use of state capital only in the case of credit-constrained firms (Inoue, Lazzarini and Musacchio 2013). To leverage the capabilities of the private sector, banks often have specialized structures to identify potential projects and even in some cases offer technical assistance (Armendáriz de Aghion 1999). In addition to patient capital, development banks may also offer guarantees, which serve to unlock additional capital from the private sector for development projects (Riding and Haines Jr. 2001, Zecchini and Ventura 2009).

Government intervention, under the industrial policy view, is largely seen as positive. The direct benefit then lies in enabling the country’s industrial sector to unleash latent capabilities and thereby increase productivity and competitiveness (Rodrik 2004). The main insight of this view is that these latent capabilities are either too risky to be developed through the private financial system or too difficult to recognize. Indirect benefits of government involvement through development banks and the subsequent industrialization include creation of new streams of employment (through funding labour-intensive infrastructure projects), infrastructure projects with positive externalities (such as creation of new roads or water sources), and extending capital markets to support entrepreneurial activity. Proponents of the industrial policy view also cite increased investment in innovation and discovery as a key benefit of development banks.

As entrepreneurs develop new capabilities, they generate learning externalities that subsequent firms could imitate or upon which they could build. The presence of those externalities, some argue, will likely lead to underinvestment in new private capabilities (Amsden 1989, Hausmann and Rodrik 2003). Additionally, development banks can promote coordination to develop projects that require the orchestration of many actors and/or sectors (Murphy, Shleifer and Vishny 1989). Typically, this is the case of large, complex infrastructure projects or projects that require building local supply chains. A controversial issue that is defended by some proponents of industrial policy is the so- called role of banks in supporting strategic trade. Throughout the world, banks have created “national champions” with heavy use of subsidies and even market protection (Fogel, Morck and Yeung 2011). In a context of global competition, firms that are heavily subsidized tend to distort markets and create negative externalities for competitors that lack those subsidies. Although these distortions are increasingly condemned by the World Trade Organization (Buiges and Sekkat 2009), government support for export activities and international expansion remains widespread. Development banks have also been used to support the strategic expansion of global firms, especially in contexts in which competition is heavily affected by non-market policies.

1. SOCIAL POLICY VIEW

In social view, the development bank will try to leverage its competitive financing to ensure that firms recognize their roles in contributing to social issues, adopting sufficient constraints on activities contributing to the worsening of these issues and implementing initiatives to reduce or reverse the negative impact. In this regard, like any other state-owned policy bank, a development bank may actually finance projects with negative net present value but which offer significant positive externalities on the social side (Shapiro and Willig 1990, Yeyati, Micco and Panizza 2004). Long-term, subsidized debt financing is an important tool of the development bank in promoting this focus on social issues. In particular, the duration and subsidies incentivize socially beneficial projects with either too long a time horizon or capital costs too high to ensure the hurdle rates of investors are met.

Equity financing, in turn, may be deployed to finance the establishment and growth of firms with a primary objective of addressing relevant social issues; this may include funding a new venture in an underdeveloped region or financing the expansion of firms with 10 significant job creation potential. There is some evidence that development banks do care about creating new employment, regardless of the productive structure of the new jobs (De Negri, Maffioli, Rodriguez and Vázquez 2011). Both through debt-financing terms and equity, development banks may make funds available to a firm contingent on prioritization of various social objective

III. POLITICAL POLICY VIEW

The political view presents a more negative perspective on industrial policy as a whole. Under the political view, the investment criteria for development banks are shifted from alleviating gaps in the capital market or directing financing towards social aims to funding the preferred projects of politicians. These projects may lack the objectives laid out in the industrial policy and social views. The result is misallocation of funding which leads to distortions in the financial and labour markets. There are two hypotheses as to how this misallocation occurs: the soft-budget constraint hypothesis and the rent-seeking hypothesis. The soft-budget constraint hypothesis is fairly straightforward and surmises that under the political view, development banks are used to “bail out” failing firms (Kornai 1979).

In contrast to the industrial policy view that presents government subsidies as productive for investment and development, here the subsidy, guarantees, and/or long-duration lending serve to direct funds to inefficient market players rather than efficient firms. This subverts capital that could be used more productively and weakens incentives for firms to reach the industrial and/or social objectives laid out under the other two views (Shleifer and Vishny 1998). The rent-seeking hypothesis presents a slightly more nuanced form of misallocation. Under the policy view the subsidies and long-term lending, which under both the industrial policy view and the social view enable development banks to facilitate optimal productive investment, are instead subverted to projects that are not inhibited by gaps in the capital markets. The funded projects could access capital from investors in the private markets, but through “cronyism,” a behaviour that rewards political supporters with easier access to government resources or inversely enables high-powered industrialists to benefit from strategic political leveraging, industrialists are able to access the more competitive terms of the development banks’ loans (Ades and Di Tella 1997, Claessens, Feijen and Laeven 2008).

In the presence of rent seeking, a primary recommendation from the literature is to establish clear targets for the policy objectives, monitor the performance of investments, and cease support if firms fail to meet the objectives (Amsden 1989, Lazzarini 2015, Rodrik 2004). Absent of these controls, development banks may end up providing capital to low-productivity firms or firms that do not need subsidized capital in the first place (Cull, Li, Sun and Xu 2013, Lazzarini, Musacchio, Bandeira-de-Mello and Marcon 2015). In other words, while banks can reduce market failure, they may also create government failure, that is, policies that end up reducing welfare and efficiency (Coase 1960, Krueger 1990).  if firms fail to meet the objectives (Amsden 1989, Lazzarini 2015, Rodrik 2004). Absent of these controls, development banks may end up providing capital to low-productivity firms or firms that do not need subsidized capital in the first place (Cull, Li, Sun and Xu 2013, Lazzarini, Musacchio, Bandeira-de-Mello and Marcon 2015). In other words, while banks can reduce market failure, they may also create government failure, that is, policies that end up reducing welfare and efficiency (Coase 1960, Krueger 1990). 

4. Role of development banks in the emerging economies

Development banking institution is a specialised financial institution established with specific mandate to develop and promote key sectors of the economy considered to be of strategic importance to the overall socio-economic development objectives of the country. Development banks are a form of government intervention in the financial system, with the aim of addressing market failures in the provision of finance. They provide finance to those market segments that are not well served by the financial system. These segments include projects whose social benefits exceed their commercial ones; long-term projects or projects with a long lead time; new or risky ventures, such as new technologies; projects in poor or distant regions; and small and new borrowers who lack collateral. In principle, government funding is allocated to projects on which no cost recovery is possible, while private funding is allocated to projects that can generate profits.

There is a niche between these two, which is filled by development banks. They focus on projects that can generate limited revenue, are high-risk or have long lead times, for example. The aim is to lower the risks of investment in these projects and crowd in investment by the private sector. In addition to finance, development banks also provide developmental services such as research, advocacy and technical assistance. The Dominican Republic, Argentina, and Brazil have the largest number of development institutions (more than 10) and development banks are particularly important in Uruguay, Brazil, Panama, the Dominican Republic, and Costa Rica (where in 2001 loans totaled more than 15 percent of GDP) and relatively less important in Ecuador, Venezuela, Honduras, Peru, and El Salvador. The second and third largest development banks are also Brazilian (Banco do Brasil and Caixa Econômica Federal), followed by two Mexican banks (NAFIN and BANOBRAS) and an Argentine institution (Banco de la Nación Argentina). 

5. OVERVIEW OF THE DEVELOPMENT FINANCE INSTITUTIONS IN GHANA POST-INDEPENDENCE

Ghana’s approach to development was state-led in the post-Independence period through the mid-1960s, and highly interventionist during the 1970s and early 1980s, after a brief period of stabilization. Controls were gradually removed in the late 1980s, and financial policies were liberalized. During the period 1985-2006, the government and the Bank of Ghana established a number of institutions to promote and finance MSMEs and exports, especially in agricultural value chains. While the majority operate through private financial institutions, some of these institutions provide finance directly, increasing the cost and risks and reducing effectiveness. Although some of these institutions managed or benefited from donor-supported government projects in the past, little such funding remains available, especially for MSMEs, resulting in low cost-effectiveness and sustainability for some DFIs.

As part of the Dr Nkrumah’s post-independence developmental agenda of using the banking system to drive economic development and transformation, government through the Bank of Ghana facilitated the establishment of a number of development banks, established for specific purposes. In fact, some of these development finance institutions were established in 1960s and were wholly or majority owned by the government. These included the National Investment Bank in 1963 to assist industry, and the Agriculture Credit and Cooperative Bank (now Agricultural Development Bank) in 1965 to support agriculture (Bawumia, 2010). Both ADB and NIB became universal banks in 2004, when Bank of Ghana removed distinctions between commercial, development and merchant banks. Under General Kutu Acheampong continued with the developmental agenda interventionist in financial sector by establishing of Merchant Bank in 1972 with partnership of ANZ Grindlays to support industry. In 1974 under the General Acheampong regime, Bank for Housing and Construction to set up to housing infrastructure, industrial construction and companies producing building materials and in 1977 Social Security Bank was set up loan term loans and credits to companies and individuals (Bawumia, 2010).

The Eximguaranty Company (Ghana) Ltd (ECL) was promoted by Bank of Ghana in 1994 to complement in financing non-traditional exports (NTEs), with a broader mandate to serve small and medium scale enterprises (SMEs) more generally, not exclusively exports. The Export Finance Company (EFCL) was incorporated in 1989 as a company limited by shares, promoted by the Bank of Ghana with the intention of devolving responsibility for export development finance to a private company that could raise funds. The primary focus was on developing non-traditional exports (NTEs). Like ECFL, ownership of ECL is predominantly by government institutions. The Export Development and Investment Fund (EDIF) was set up in 2000 as a statutory corporation in part to address the funding shortcomings of EFCL. Its mandate was extended in 2011 to promoting development of agro-processing, as well as exports, and in 2013 to include industrial development and equity financing, and it was renamed as the Export Trade, Agricultural and Industrial Development Fund (EDAIF). Parliament passed the Ghana Export-Import Bank Act, 2015 on March 2, 2016, establishing the Exim Bank as a ‘quasi-governmental’ corporate institution, replacing EDAIF; the expectation is that it will absorb the EFCL and ECL. A very recent idea put forward by the Savannah Accelerated Development Authority (SADA) is to establish a wholesale development bank with an exclusive focus on the SADA region.

SADA was established by an Act of Parliament (Act 805) in 2010 and became operational in 2012, with a goal to facilitate economic development of the Northern Savannah Ecological Zone. Given the limited funding from government, SADA proposed to establish a wholesale development bank, licensed and supervised by Bank of Ghana, aimed at facilitating long-term funding for regional development. In terms of governance, the proposal suggests minority government/public share of up to 20 percent and majority ownership by a mix of private and/or international financial institutions. This proposal is conceptually aligned with recommended good practices, but it requires further elaboration, and most importantly, a feasibility assessment of setting up a new bank exclusively focused on a specific region. 

6. GHANA’S EXPERIENCES WITH THE FAILURES OF DEVELOPMENT FINANCE INSTITUTIONS

A major challenge for development bank institutions in Ghana was finding a balance between the State’s responsibility for actively exercising its ownership functions (such as the nomination and election of the Board) and refraining from imposing undue interference on the management of the development finance institutions. Many of the problems commonly recognized to afflict development finance institutions can be associated with, we attributed directly to, weaknesses in corporate governance such as:

Poor corporate governance practises such as lack of skills, inexperienced and in competencies of board members and executive teams in the development finance institutions. Identified examples of such weaknesses include:

• Government officials acting in the capacity of shareholders directly intervening in day-to-day operational decisions
• Government in all its forms (even without a formal role) directing development finance institutions’ lending (e.g., to whom to lend, on what terms to lend, and when to forgive indebtedness): i.e., “political intervention” or “political capture”.
• Executives acting almost autonomously (without clear reporting lines), pursuing unintended objectives (“mission creep”); or taking decisions contrary to commercial and/or financial management principles, thus eroding the institution’s “self-sustainability”.
• Board members lacking the necessary experience, skills and capacities to effectively and properly exercise their functions according to the institution’s objectives.
• Lack of accurate and complete reporting (on financial and non-financial matters alike), giving rise to uninformed decision-making by those who rely on reporting, and thereby misleading shareholder, investors, legislatures, and society in general.

Another criticism levied against development banks was that they were poorly managed and that their lending activities are politically motivated. Governance malpractices within development banks, went on unchecked, became a way of life in large parts of the sector, enriching a few at the expense of tax payer and investors. Corporate governance in development banks failed because boards ignored these practices for reasons including being misled by executive management, participating themselves in obtaining un-secured loans at the expense of tax payer and not having the qualifications to enforce good governance on bank management. In addition, the audit process at all banks appeared not to have taken fully into account the rapid deterioration of the economy and hence of the need for aggressive provisioning against risk assets.

The institutional environment in Ghana was weak and critical skills in project management, finance and operations were limited and the development banks’ mandates were rigid and often inappropriate, and they were stand-alone banks instead of being integrated into the financial system. The then development banks struggled to reconcile their conflicting objectives of maintaining financial sustainability while pursuing socially desirable outcomes. As the development banks grew in numbers and complexity in the 1970s and 1980s, bank boards often did not fulfil their function and were lulled into a sense of well-being by the apparent year-over year growth in assets and profits. In hindsight, boards and executive management in development banks such as Bank for Housing and Construction were not equipped to run their institutions.

The bank chairman/CEO often had an overbearing influence because of their political connection on the board, and some boards lacked independence; directors often failed to make meaningful contributions to safeguard the growth and development of the bank and had weak ethical standards; the board committees were also often ineffective or dormant. The lack of fit and proper person test for directors and senior management team contributed the failure of development finance institutions in the 70s and 80s. The that the integrity of the persons appointed in to directorship positions were not established and the lack of qualifications and experience of the person are appropriate for the position in the light of the business plan and activities of the entity which the person serves, or is likely to serve, taking into account the size, nature and complexity of the institution. Most appointees were based on political connection or affiliation but not based on experiences and competencies.

The then existing regulatory and supervisory framework was governed by the Banking Act of 1970. This Act however did not provide clear guidelines on minimum capital requirement, risk exposure limits, prudential limits for development finance institutions and provisioning loan losses. Regulatory and supervisory arrangements for development bank were not very similar to standards as applied to commercial banks, but not also modified to take into consideration the business model of the development bank. Uneven supervision and inadequate enforcement also played a significant role in exacerbating the problems associated with the failure of these institutions. Regulators were ineffective in foreseeing and supervising the massive changes in the industry or in eliminating the pervasive corporate governance failures. The Supervision Department within the Bank of Ghana was not structured to supervise effectively and to enforce regulation on the development finance institutions.  No one was held accountable for addressing the key industry issues such as poor risk management, weak corporate governance, massive cheque-fraud at BHC, Ghana Coop Bank and Ghana Commercial Bank, cross-regulatory co-ordination, lack of enforcement, lack of legal prosecution for culprits which caused the collapse of BHC and Ghana Coop Bank or for ensuring examination policies and procedures were well adapted to the prevailing environment. Moreover, the geographic separation of on-site and off-site examiners hindered the building of integrated and effective supervisory teams. Critical processes, like enforcement, pre-examination planning and people development were not delivering the results required to effectively supervise and engage banks to enforce good conduct.

Previous development banks such as Bank for Housing and Construction, National Investment Bank and Agricultural Development Bank faced some weaknesses and challenges in areas of poor corporate governance practices, lack of in-depth knowledge in project management and financing and weak risk management. The development banks were saddled with high non-performing assets which made them financially distressed institution which were later restructured. These development banks were distressed because they were not applying stricter commercial criteria in their lending decisions and also partly due to political interferences and pressures. The experience in Ghana is that politicians were generally not able to approach the foreign banks with they knew would be rejected because their propositions were not commercially viable. The development banks were characterised by poor credit decisions which resulted high non-performing loans and saw reduction in their capital adequacy ratios which undertook as part of Financial Sector Adjustment Programme in 1992 to divest its shares in Social Security Bank, the divesture of National Investment Bank and Agricultural Development Bank stalled  while Bank for Housing and Construction and Ghana Cooperative Bank were liquidated following a cheque kitting fraud in 1998 (A-Life Cheque kitting scandal) (Bawumia,2010). Later in 2004, National Investment Bank and Agricultural Development were relicensed as universal banks without considering developmental agenda set up by Dr Nkrumah. The most important challenge was the need to improve their risk management capacity. This reflected 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

Finally, a lack of a sufficiently developed infrastructure and business environment had a negative influence on the banking industry. The legal process, an absence of reliable credit rating agencies and poor infrastructure all contributed to non-standard banking practices. Ghana’s legal process is long and expensive and banks seldom pursue borrowers in court. Few banks were able to foreclose on borrowers, and this led to borrowers abusing the system. Basic lack of credit information on customers, largely because there is no uniform way to identify customers, has held back the development of credit bureaus and hampered customer credit assessment at banks, increasing the stock of bad debt in the system. 

7. Globally tried and tested framework for successful development bank

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. A Development banking institution is a specialised financial institution established with specific mandate to develop and promote key sectors of the economy considered to be of strategic importance to the overall socio-economic development objectives of the country.

The global financial crisis had a particularly severe effect on developing countries. Even those that were in good financial health were dramatically affected by the sudden withdrawal of foreign investment and the escalating costs of funding worldwide. The effect on their fragile economies was devastating. As the environment grew increasingly risky, banks needed to strengthen their financial positions. This led them to curtail lending, often sharply, leaving firms without access to finance. The shortage of finance for firms exacerbated the economic downturns in these countries. Governments recognised the need for a countercyclical source of finance that would continue to provide finance to firms during recessionary times. Several of them turned to national development banks – government-owned banks that are tasked with addressing market failures in the financial system. Being supported by the government, they are able to provide countercyclical funding, assisting firms at exactly the time that private banks are forced to curtail their lending. But this strategy is not without risks. National development banks have a long history of failure, although there have been some successes more recently and these banks are starting to play an important role in the development of some emerging economies. In the 1970s and 1980s, many governments in developing countries established development banks patterned on the successful development banks of the post-World War II era. However, these banks were poorly controlled and managed, and their profligate spending contributed to fiscal crises in several developing countries, while delivering little in the way of development.

De Aghion (1999:3) points to ‘[high arrear ratios, poor cost-benefit evaluations, and widespread evidence of mismanagement and corruption’ among development banks. They were often used to pursue overtly political rather than developmental goals. As a result, many of these banks failed. Some were privatised, restructured or closed, and the future of development banking seemed uncertain. According to Krahnen and Schmidt (1994), ‘Development banks still have to find their proper role in a world where financial repression is on the retreat… They might not find such a role and gradually die.

However, despite the failures in the second half of the 20th century, governments have been reluctant to let go of this policy instrument: there are still over 500 development banks worldwide. The main reason given for their continued role is the persistence of market failures, such as a shortage of long-term funding, funding for poorer regions or groups, or funding for high-risk sectors such as new technologies or small and medium enterprises. Governments have remained keen to have some source of funding under their control, the risks notwithstanding. Against this backdrop, there is a clear need for an objective framework for development banking, which can inform government policy and help to prevent a repeat of the problems of earlier development banks. There is no universal model for development banking: it is influenced by a variety of factors, such as a country’s level of development and the sophistication of its financial system. Still, a general framework may be derived for the role of national development banks. The application of this framework then depends on a country’s particular developmental and financial needs. The framework does not address private development banks, deposit-taking institutions, multilateral or regional banks or microfinance institutions. It draws on economic theory and case studies of development banks in Africa, Asia and Latin America (Thorne, 2008). The framework sets out principles for seven dimensions of development banking: a stable macro-economic environment, definitive mandate, strong and resilient regulation and supervision framework, good corporate governance practises, robust risk management practices, financial sustainability and performance assessment.

7.1 FRAMEWORK FOR SUCCESSFUL DEVELOPMENT BANKS: (DIMENSIONS AND PRINCIPLES)

For the development bank or development finance institution to be successful there is a need to adopt globally accepted principles such as good corporate governance practises, robust regulatory and supervisory framework, definitive and flexible mandate, stable macroeconomic stability, strong and robust risk management practices, financial sustainability and performance contract.  The success of the early development banks and the failure of many of the later ones are a rich source of lessons for development banking. Based on these lessons, this section outlines six (interdependent) dimensions of the success of development banks and identify the principle involved in each of these dimensions (Thorne and Du Toit,2009).

First, for development bank or development finance institution to be successful according to theoretical literature there is a need for a stable and enabling macro-economic environment with low inflation, low interest rates and stable exchange rate. Fischer (1993) defines a stable macroeconomic framework as being characterized by low and predictable inflation and sustainable fiscal policy, and shows that both these factors increase capital accumulation and productivity growth.

A development bank requires an enabling environment where there is sustained disinflation, reduced exchange rate stability and downward inflationary expectations. Its role is determined primarily by a country’s socio-economic environment and its particular development needs and priorities. However, this environment, in turn, affects the bank’s ability to carry out its functions. In the words of Diamond (1996), ‘no factor is more important in influencing a development bank’s “success” than the situation of the economy in which it operates’. While the mandate of a development bank may require it to address problems in the economy, it cannot operate in a largely dysfunctional environment. This is one of the paradoxes of development banking – these banks are needed most in poor countries, but the weak economic and political systems in these countries make it harder for them to succeed. The following aspects are critical to the success of development banks: macroeconomic stability is a prerequisite for the development of the financial system, as instability increases the risks associated with finance, especially long-term finance. This negatively affects both the price and the availability of such finance.

Traditionally underserved market segments are even less likely to obtain funding in a volatile macroeconomic environment. Stability is also crucial for development banks, particularly if they are exposed to currency risk – macroeconomic instability contributed to the failure of 16 development banks in Francophone Africa during the 1980s (Yirga-Hall, 1998). Similarly, development banks are less likely to raise sufficient funds on the capital market or leverage co-finance from the private sector during periods of macroeconomic instability. Critical elements of macroeconomic stability include the following: — Sound fiscal discipline — Balanced economic growth — Balance of payments stability — Price stability and limited external and internal price distortions — The absence of financial repression However, previous Ghanaian experience with development banks proved unable to succeed without a reasonably functional microeconomic environment with proper regulation. Critical structural requirements include the following: — Efficient resource allocation in the economy — A regulatory environment that supports investment — Sufficient industrial capacity — Appropriate and well-maintained infrastructure — A developing private commercial and financial sector — Adequate competition and market discipline — Sufficient skills in the economy, including management skills — Reasonable levels of technological development. For the national development bank to succeed there is the need for stable political environment. Bank need a stable political environment with adequate capacity. Important elements of the political environment include the following: — Political stability — Political leadership and support for the development bank — De-politicisation of the role of the development bank — Absence of strong interest group activity — Absence of corruption — A reasonable level of overall government capacity — Reasonable capacity in other organs of state

Second, for development bank to succeed there is requirement for a well-functioning legal and regulatory institutions are as much a prerequisite for development banks as for the rest of the private sector. Critical aspects of the institutional environment include the following: — Legal system:  A comprehensive and effective legal system, adequate protection of property and creditor rights, and a reliable, efficient and independent justice system — accounting and auditing: Internationally accepted accounting principles, independent audits for larger companies, and proper regulation of the accounting and auditing professions — Financial infrastructure: An efficient and secure settlement system, and adequate information flows (e.g. well-functioning credit bureaux) — Regulation and supervision: A market-based regulatory and supervisory framework, good corporate governance and transparency, and procedures for dealing with problem banks — A public safety net (i.e. systemic protection)

Third, definitive and flexible mandate for the national development bank is a prerequisite for its future survival.  A development bank needs an appropriate mandate to ensure that it is correctly positioned within the environment.  Development finance institutions with a well-defined mandate are less likely to be affected by mission creep and conflicting objectives. Having a well-defined objective may also prevent managers of development banks from continuously switching between trying to fulfil their social mandate and trying to maximize profits. The lessons drawn from the experience of development banking have highlighted the disastrous effects of inappropriate mandates, but countries such as Canada, Malaysia, Brazil and Rwanda show that banks with appropriate and flexible mandates can contribute significantly to development (BAR, 2006; Rudolph, 2009). Several principles can be identified for setting a mandate: mandate clarity, local relevance, institutional fit, complementarity of funding, flexibility and an appropriate scope.  There must be mandate clarity for the Ghanaian development bank. The first principle is the precise articulation of the mandate of the development bank. A vaguely defined mandate creates uncertainty for both the bank and other institutions, such as the private sector. This has the following disadvantages: — It allows the bank to pursue activities not intended by the government (‘mission drift’), which can increase the risks faced by the government and reduce the effectiveness of the development bank in pursuing its intended goals. — On the other hand, it gives the bank more scope to avoid difficult or costly activities that the government expected it to undertake (‘mission shrink’). — It reduces accountability by undermining the basis for an objective assessment of the development bank’s performance. — It leaves the commercial sector unclear about the role of the development bank, which reduces the incentive of private sector banks to expand into grey areas of funding where they could face (unfair) competition. — It increases the opportunities for political interference in the activities of the development bank. The development bank fills the niche between the public and the private provision of finance. The mandate of the bank should consider at least the following aspects, as the interplay between them determines the particular niche for the bank: — The country’s development needs and priorities — The local financial system’s ability to provide finance for underserved segments, as well as its general level of efficiency and effectiveness — The role of foreign financial or donor institutions in providing such finance — The government’s view of its role in addressing any remaining financing gaps. The third, related, mandate principle is institutional fit: the development bank must operate within the local economic, political and institutional environment. There are two important considerations in this regard.

First, the development bank cannot operate on its own: the lack of integration with the rest of the financial system contributed to the failure of the early development banks. Diamond (1957) puts it well: ‘A development bank is one instrument among many, all of which need to be used consistently and in conjunction.’ The bank must therefore be structured to complement other local institutions. Second, the institutional structure should be ‘home-grown’. Transplanting successful models from elsewhere is likely to fail, as their success is due in part to complementary institutions, such as legal or supervisory systems. It is almost impossible to duplicate such complementary institutions, as these, in turn, depend on local factors such as norms, values, skills and technology.

Fourth, for development bank or development finance institution to succeed in  the economic development and transformation agenda,  there  an urgent need for complementary funding. This leads naturally to the fourth principle: complementarity of funding, which is linked to the concept of comparative advantage. As an integral part of the larger financial system, the development bank should restrict itself to funding only those activities in which it has a comparative advantage. Typically, the comparative advantages of a development bank are a better understanding of high-risk markets and an in-depth knowledge of the clients in these markets. By restricting itself to funding based on its comparative advantage, the development bank is less likely to compete with and crowd out the private financial sector, and more likely to play a complementary role. There are two other aspects to complementarity: first, the development bank should aim to mobilise private sector co-funding of its projects, whether through a demonstration effect coupled with the dissemination of knowledge or more concretely through risk mitigation measures. Petersen and Crihfield (2000) note that development finance institutions ‘should always be looking for an exit strategy and a shifting of obligations to the commercial credit markets. Second, the development bank should assist borrowers only until they are financially strong enough to graduate to commercial funding. In the words of UN-ECLAC (2002:160): ‘they should be run in a way designed to avoid building up a permanent, stable customer base’. This will help to ensure that the development bank’s scarce resources are not captured by stronger borrowers at the expense of weaker ones.

While this sounds reasonable in theory, development banks have found it difficult to adhere to this principle in practice. The reasons for this are mainly related to the moral hazard effect of concessionary finance. Examples of the moral hazard effect include the following: — Development banks, not least through their advisory role, build up a strong bank-client relationship with their clients, which both may be keen to preserve. — The client may be disinclined to graduate to market funding. In fact, it may have a perverse incentive to understate its financial strength to ensure continued access to finance on concessionary terms. — The performance of the development bank may be measured in terms of the volume of its funding rather than its development impact. Hulme and Mosley (1996) note that ‘lenders who are under strong pressure to meet lending targets have no incentive to be rigorous in refusing a promising borrower’. — Related to this, since existing borrowers are cheaper to finance because information costs are lower, a bank faces a strong incentive to fund existing larger clients rather than spend time and money developing new clients who have a lower capacity to absorb loans. In this regard, Hulme and Mosley (1996) refer to their reluctance, after having built a portfolio of stable customers, to ‘walk the tightrope’ again to find new clients. — The development bank may likewise be unwilling to expose itself to the higher risk of dealing with less capacitated clients. — The bank may be restricted to a particular sector in terms of its mandate, although the private sector may in the interim have built sufficient capacity to fund that sector. — Finally, the requirement for development banks to be financially self-sustainable creates a powerful incentive for them to compete with the private sector for profitable projects that can cross-subsidise losses on their more developmental projects.

Fifth, another principle for future success of the development bank is mandate flexibility in the economic development and transformation. A development bank that encourages private sector participation in its projects will change its own environment: the private sector will eventually be able to provide funding for higher-risk projects without assistance from the bank. The environment may also change because of a deepening of the financial system or new directions in public policy. Therefore, the mandates of development banks should be reviewed on a regular basis to ensure that they operate according to their competitive advantage (Diamond & Raghavan (eds), 1982). There is an increasing awareness of the need to adjust mandates on a regular basis. Malaysia recently reviewed the mandates of its development finance institutions to ensure that they focus on ‘niche’ sectors, while South Africa regularly reviews the mandates of its development finance institutions.

The role of a development bank in changing its own environment is captured in the life cycle theory for development finance institutions. This theory holds that, once the market failure for which it was designed has been addressed, whether by changes in the environment, in policy or in private sector capacity, the role of the development bank should be reduced and eventually eliminated. Stanton (1999:16) summarises the theory as follows: ‘The missing element… is the notion of a life cycle for government sponsorship. [These institutions] are created to increase the flow of funds to socially desirable activities. If successful, they grow and mature as the market develops. At some point, the private sector may be able to meet the funding needs of the particular market segment. If so, a sunset may be appropriate.’ (Emphasis in the original.) Given the difficulties of building institutional capacity, the best use of the scarce institutional capacity of a successful development bank may be either to privatise it or to refocus its mandate to another underserved sector, rather than to close it down. Still, the institutional costs of ‘refocusing’ a development finance institution should not be underestimated. The transformation of the institution is more than likely to result in at least temporary reductions in efficiency, staff morale and development impact, and probably also in the loss of experienced staff. However, these costs are arguably less and the disruption shorter than when a new institution has to be established from scratch. 

 The sixth mandate principle relates to the scope and level of specialisation of the development finance institution. There are no easy answers as to whether a development bank should be narrowly focused (specialised) or multi-sectoral. Specialised development banks are likely to be smaller and multi-sectoral banks larger, given the extent of their activities. Each form has its advantages and disadvantages, although Diamond (1996) pointed out that most ‘successful’ development banks provided a broad range of services Multi-sectoral banks may have the following disadvantages: — Their operations run the risk of being ineffective and unfocused, and they may even ‘spread [their financial resources] too thinly’ (Diamond 1957). — Given the volume of their activities, they may be unable to give equal or sufficient attention to all aspects of their work, and thus neglect certain regions or sectors. — Similarly, they may be able to avoid certain functions that are costly or difficult and hard for the government to monitor. — They may have difficulty monitoring clients effectively, as they have more clients and it may therefore take them longer to get to know their clients well. — They may have more corporate governance problems, be less transparent and therefore more prone to political interference. — The absence of clear boundaries for their activities may lead to mission drift and concomitantly reduce their incentive to build sound working relationships with the private sector. — Their multiple roles also make it more difficult for the private sector to assess the risk of investing in the institution, which may increase its cost of capital. — With multiple objectives, they are less likely to be held accountable for the underachievement of any particular oof these development objectives. — The failure of a large development bank in a weak financial system could have drastic systemic consequences, both financial and fiscal. Even in big countries, the fiscal implications could still be considerable.

 Regulation and supervision

The seventh principle is the independent and effective regulation and supervision of development finance institution is a basic condition for the sound governance and for ensuring good performance and financial sustainability. It is critical that DFIs be well regulated and supervised, and this function is best performed by Bank of Ghana. Regulatory and supervisory arrangements for development bank should be very similar to standards as applied to commercial banks, but modified to take into consideration the business model of the development bank

Even as recently as 2006, members of the Association of African Development Finance Institutions (AADFI, 2006) still regarded the policies and practices of their owners (i.e. the government) as their biggest single problem. A primary concern here is that the ownership role of the state creates a potential conflict of interest in the regulation and supervision of development banks. Caprio et al. (2004) warn that this ‘inherent conflict of interest in both owning and supervising banks is difficult to resolve’. The discussion below examines ways of addressing this issue.

1. State as owner

The corporate governance guidelines for state-owned enterprises of the Organisation for Economic Co-operation and Development (OECD) focus specifically on this potential conflict of interest. Calling on the government to act as an ‘informed, accountable and active owner’ (OECD, 2004), the guidelines suggest that a government should: — ensure that its ownership role does not distort its policy decisions — create a clear and simple set of legal rules governing state-owned enterprises — make the developmental roles of these institutions and any funding for such roles clear and transparent — ensure that state-owned institutions do not enjoy special privileges. In addition to such legal rules, best practice is moving towards a formal, published ownership policy that defines the objectives of the state as owner, the legal forms of the enterprises under its control, its role in governance, and how it will implement its ownership role. Several European countries, including Finland, France, Poland and Sweden, have adopted formal ownership policies (Scott, 2007)

The legal rules or ownership policy must establish checks and balances in the way the government exercises its ownership role, generally by sharing the responsibility between different departments. In this process, care should be taken to avoid a regulatory ‘overburden’ (Reddy, 2006): if state owned institutions are overseen by a range of entities with different requirements, such as the treasury, a line ministry, the legislative assembly, the auditor general or even special commissions, they face a heavy reporting burden or, worse, conflicting instructions.

ii State as supervisor

The counterpart of the ownership entity is the supervisory entity, which should be separate and independent from the ownership function. Fletcher and Kupiec (2004) apply the Basel principles for banking supervision (BCBS, 2006) to state-owned financial institutions. They suggest the establishment of an independent supervisory capacity, which can protect the state against both credit and reputational risk, while also protecting the private sector from unfair competition from state-owned financial institutions. Their preconditions for successful supervision are sustainable macroeconomic policies, a well-developed legal system, a robust accounting profession and a strong and independent supervisor. The authorising legislation of the state-owned financial institution should set the mission of the organisation; the method of funding, government capital and/or subsidies; prudential standards and accounting and auditing requirements; specific standards for operations, where required; and performance criteria and the method of assessment. To be effective, the supervisor should have operational independence, sufficient resources, an appropriate legal framework and enforcement capacity, and adequate information-sharing arrangements. They see the role of the supervisor as setting criteria for activities, monitoring operations, evaluating activities in line with the mandate, and instituting corrective measures if required. The supervisor also has to do the following:

— Capital adequacy: Define regulatory capital and set capital adequacy requirements

. — Evaluations: Ensure independent evaluations of policies and operations, independent internal and external audit and compliance, formal plans with clear responsibility for internal oversight, and appropriate internal separation of duties to avoid conflicts of interest.

— Transparency: Ensure adequate financial policies, practices and procedures; the use of appropriate record keeping and accepted accounting policies; regular publication of audited financial statements; and the use of separate accounts for commercial and developmental operations, with the former being subject to the Basel II principles.

Fletcher and Kupiec (2004) argue that the bulk of the supervision and regulation should be along the same lines as the private sector. But should state-owned development finance institutions be subject to the same rules as the private sector? On the one hand, they pose more regulatory challenges than do private firms: for the state, the conflict of interest noted above, and for the institution, the problems of political interference, weak management capacity, and the state’s poor regulatory capacity. On the other hand, given that they operate in underserved markets and under difficult conditions, overregulation may be counterproductive as it could inhibit innovation and risk-taking. Thus, the International Monetary Fund and the World Bank (2003) call for regulation of specialised financial institutions that has ‘a sufficiently light touch so as not to crush them’

— Risk management: Ensure a comprehensive risk management process for all material risks and appropriate risk-modelling techniques for interest rate, credit, market, currency and operational risk, for example.

— Monitoring:

Conduct on-site supervision and independent verification of governance procedures and information accuracy, as well as off-site monitoring of the financial situation based on prudential reports.

— Corrective action:

Obligate institutions to publish annual reports on safety or soundness issues and take remedial action when institutions fail to meet requirements. There is a need for a mechanism to ensure that the supervisor’s recommendations are implemented, and a need for the supervisor to have appropriate legal authority. Fletcher and Kupiec (2004) argue that the bulk of the supervision and regulation should be along the same lines as the private sector. But should state-owned development finance institutions be subject to the same rules as the private sector? On the one hand, they pose more regulatory challenges than do private firms: for the state, the conflict of interest noted above, and for the institution, the problems of political interference, weak management capacity, and the state’s poor regulatory capacity. On the other hand, given that they operate in underserved markets and under difficult conditions, overregulation may be counterproductive as it could inhibit innovation and risk-taking. Thus, the International Monetary Fund and the World Bank (2003:4) call for regulation of specialised financial institutions that has ‘a sufficiently light touch so as not to crush them’

4. Disclosure and transparency are key aspects of governance involving: (i) efficient internal audit procedures and audit function monitored by the Board and the audit committee; (ii) an annual independent external audit based on international standards—i.e. the same high quality accounting and auditing standards as listed companies; and (iii) disclosure of financial and non-financial information according to high quality internationally-recognized standards.

Good corporate governance practices are paramount for survival and sustainability of development banks both in developed and developing economies. The most effective way to control potential weaknesses and prevent abuses is to put in place measures aimed at strengthening the governance arrangements around Board and Management, including: (i) a formal, merit-based, transparent process for appointing independent directors to the Board, as well as performance-based assessment and salaries of DFI Management; (ii) a majority of the Board to be comprised of independent, highly qualified, professional and experienced directors who are competitively selected; (iii) encouraging minority shareholder representation and reputable international investors’ participation on the Board of the DFI; and (iv) competitive selection and appointment of key executives (including the CEO) by the Board with the participation, to the extent possible, of all shareholders. Good corporate governance is as important for state-owned institutions as for private sector institutions and can contribute to improve their performance. Given their public policy role, it is all the more important that development finance institutions have a proper framework in place to ensure that they carry out their mandate and meet their objectives effectively.

According to the OECD (2004), corporate governance refers to “a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined. Good corporate governance should provide proper incentives for the board and management to pursue objectives that are in the interests of the company and its shareholders and should facilitate effective monitoring”. Evidence suggests that most of the poor performance of DFIs is explained by shortcomings in corporate governance structures, which are instrumental to political interference and poor managerial skills (Dinc, 2005; Caprio et al, 2004; La Porta et al, 2002). Yet putting in place a proper governance system in place for DFIs is not an easy task. This is because the exercise of direction and control is complicated by the multitude of institutions usually involved in the ownership of a DFI. Moreover, given the leverage involved in their operations, DFIs have the potential to create contingent fiscal liabilities for the government. Finally, DFIs have to balance a trade-off between the two potentially conflicting objectives of fulfilling their policy mandate and being financially sustainable (Scott, 2007). For all these reasons, introducing and enforcing a sound corporate governance system requires a significant investment in resources and, most importantly continued commitment by the shareholders.

8. A case for successful framework for development bank in Ghana

In Ghana, development bank has been established and funded by the Government with financial support from the German KFW and World Bank to develop and promote certain strategic sectors of the economy, and to achieve social goals. The important sectors of the economy will be supported by the development bank is to promote industrialisation, particularly the export-oriented industries, infrastructure development and highly capital-intensive investments and the agriculture sector. The development bank also intended play a crucial role in the development of SMEs and agriculture sectors. The development bank is expected primarily to fill in the gaps in the supply of financial services that are not normally provided by the banking institutions. Such development institutions are generally specialised in provision of medium and long-term financing of projects, which require specialised skills and focus, and may carry higher credit risks or market risks due to the longer investment tenures. In some cases, the mandated roles of the development bank include the promotion and achievement of Government’s specific social and economic objectives. From theoretical literature perspective, good corporate governance practices, fit and proper person test criteria, clarity of mandate, stable macro-economic environment, strong and robust risk management practices, financial sustainability for commercial role, robust regulatory and supervisory framework, and performance contract arrangement would contribute significantly to the success of the Ghanaian development bank. Studies from other jurisdictions some development banks that used the above framework have succeeded in stimulating development, especially in countries such as India, Brazil and South Africa, and are poised to play a growing role in the development of these economies

First, good corporate governance is a critical component for the success of development bank in Ghana. Good corporate governance structure has to be embedded in the legislation to enhance the performance of the development bank. This would be demonstrated through appointment of qualified and experienced Board of Directors (BOD), reinforced with proper checks and balances through an effective risk and audit functions.  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 development bank can be more challenging than in private financial intermediaries. To begin with, the structure of development bank, ownership and control can be more complex, involving a large number of governmental institutions (ministries of finance, agriculture, housing, trade, labour, etc.), and sometimes even the legislature. These entities all have their own legitimate (and sometimes conflicting) expectations regarding the goals the DB should accomplish. The quality of governance and management has often meant the difference between the success and failure of development banks functioning in the same environment. For example, while the Brazilian development bank, BNDES, is seen to be successful owing to its strong management, the perception of the management of the Caixa Econômica Federal is far more critical (UN, 2006a). The analysis below does not deal with the general principles of governance and management in any detail, but focuses on aspects that are specific to development banks.

Second, effective role of the board of directors is key component of successful development bank. A final key ownership task is to appoint the board of directors. An appropriately constituted, qualified and empowered board of directors is an essential pillar of good corporate governance. The government should have in place a well-established and transparent board nomination process, which ensures that the board of directors has the relevant capacity to perform its role.  A second dimension of the corporate governance framework of a development bank is the role and functioning of the board of directors. In principle the board should carry out its functions of strategic guidance and management monitoring within the performance agreement between the government and the development finance institution. One key function of the board is to appoint and dismiss the chief executive officer (CEO). Without this authority it is difficult for the board to exercise its oversight function and hold the CEO and executive management accountable.

Third, for a successful national development bank it will require the full implementation of  the Bank of Ghana’s Fit and Proper Person Directive (2018) for both directors and executive management team to cover (a) the probity, competence and soundness of judgment of the person for purposes of fulfilling the responsibilities of that person; (b) the diligence with which that person fulfils or is likely to fulfil those responsibilities; (c) whether the interest of depositors or potential depositors of the entity are threatened, be likely to be, in any way threatened by the person holding that position; and (d) that the integrity of the person is established and the qualifications and experience of the person are appropriate for the position in the light of the business plan and activities of the entity which the person serves, or is likely to serve, taking into account the size, nature and complexity of the institution.

A final dimension of corporate governance of development finance institution is the information, reporting and disclosure regime. Effective governance is based on information sharing internally within the development finance institution and externally with the government and the public in general. This includes management information systems, management reporting to the board of directors, board reporting to the shareholder representative, shareholder representative reporting to the government and public reporting via published accounts. Ensuring adequate reporting requires investment in accounting and information systems as well as in policies and procedures. A properly functioning board is a critical success factor for a development finance institution. Its first role is to prevent undue political interference. In this regard, Diamond (1957) calls it ‘a very useful screen and protection for management’. The board contracts with the government, annually, on the objectives that the institution should achieve. In terms of its fiduciary duties, the board is then held accountable to the government for performance against those objectives. Its primary functions are therefore to provide strategic guidance and to oversee the management of the institution. Scott (2007) summarises the functions of the board as follows: — Appoint executives, evaluate their performance and make succession plans. — Assist in setting and monitoring the strategy of the organisation — Approve important policies. — Oversee internal financial and operational controls. — Establish performance indicators and benchmarks. — Ensure that the organisation’s performance is fairly reflected and communicated. The oversight and monitoring function of the board is particularly important. The board is accountable to both the government and the stakeholders to ensure that the development bank adheres to high standards of corporate governance. It needs to ensure that the bank has a clear performance contract with the government, a strategic plan on how to achieve the objectives of this contract, proper financial controls (including independent auditing) and a high level of transparency and disclosure. It also needs to oversee the ethical functioning of the organisation, and hence should ensure that the bank has a written code of ethics and adequate measures to prevent corruption.

To fulfil this critical role, board members need to be objective and independent, act in the best interest of the bank and all its shareholders, and have the highest levels of integrity and competence. A board also needs an enabling environment, including a well-defined mandate or charter independence from government, an appropriate balance of skills and experience, a clear legal exposition of its functions and fiduciary duties, written job descriptions, clear procedures, and a code of ethics for board members. These can be combined into a board charter. In addition, the board very specifically needs training. The development bank can provide or fund formal training in corporate governance requirements, and also provide some exposure to the specific needs of development finance institutions and their particular areas of operation. The performance of the board should be evaluated annually, whether through a self-evaluation (e.g. through a peer review process) or else by the shareholder(s). Where weaknesses are identified, further training should be provided.

To fulfil this critical role, board members need to be objective and independent, act in the best interest of the bank and all its shareholders, and have the highest levels of integrity and competence. A board also needs an enabling environment, including a well-defined mandate, independence from government, an appropriate balance of skills and experience, a clear legal exposition of its functions and fiduciary duties, written job descriptions, clear procedures, and a code of ethics for board members. These can be combined into a board charter. In addition, the board very specifically needs training. The development bank can provide or fund formal training in corporate governance requirements, and also provide some exposure to the specific needs of development finance institutions and their particular areas of operation. The performance of the board should be evaluated annually, whether through a self-evaluation (e.g. through a peer review process) or else by the shareholder(s). Where weaknesses are identified, further training should be provided. The usual membership of a board should be 7 to 13 members, as per the Bank of Ghana Corporate Governance Directive (2018). Boards may be supported by specialised committees, the most common ones being the audit, risk management and remuneration committees. External board members with specialised skills can be co-opted onto these committees.

The principles for board membership in development finance institutions are as follows: board members should preferably be independent from government, to reduce political pressures on the bank. Where government officials are appointed, they should be in the minority, and have the same skills and powers as other board members. They should also not be former members of legislative assemblies (e.g. Parliament). Board members should represent different constituencies to ensure that the bank pays adequate attention to marginalised sectors of society. Employee representation on the board can be considered.

Board members should be appointed after a transparent nomination process and according to clear and objective criteria. They should have a sufficient understanding of financial and commercial matters, as well as government policy and development needs. The government could establish a database of appropriately qualified individuals for board membership or use a specialised agency to advise on nominations. Board members should not hold too many concurrent directorships, to ensure that they can carry out their fiduciary duties appropriately. Board members should have a term of about three to five years but their terms should be staggered to ensure continuity. To ensure that the board members have high quality skills, remuneration should be competitive. Concerning the chairperson of the board, the position of chairperson and Chief Executive Officer should be separate.

The chairperson should not be a government official. He/she should have the requisite skills and competencies. The term of the appointment should be stipulated upfront and adhered to; a term of three to five years is the norm. He/she could be required to obtain an annual vote of confidence from the board. As for the Chief Executive Officer, he/she should also have the requisite commercial skills and competencies. The board should appoint him/her in a transparent manner according to a clearly defined job description. The term should be three to five years. He/she should be accountable to the board only and not to politicians or officials.

 

Fourth, executive management of the development bank, overseen by the board, must set up appropriate internal governance systems to ensure that the institution achieves its financial and developmental objectives while meeting regulatory requirements. The executive management must be experienced in project management, financing, risk management including analysing and planning risk, monitoring and controlling project and schedule and costs as part of the Bank of Ghana’s Fit and Proper Test directive (2018). Executive management team must ensure project management thus involve increased demand for quality, delivery on time, strict adherence to budget and also ensure regulatory controls.  From a corporate governance perspective, this implies professionalism in all aspects of operations, project management and funding as well as fairness, transparency, accountability and responsibility towards staff, government and stakeholders. The principles for the management of development finance institutions are as follows:

— Transparent process of selection of top management with the requisite skills — Managerial accountability to board for organisational performance, but independence from the board for day-to-day operations — Performance-based contracts for the Chief Executive Officer and executive management (their terms should not coincide with political cycles), as well as the rest of the staff — Appropriate financial and non-financial rewards to retain scarce skills.

The principles for the operations of the development bank, including human resources, monitoring and evaluation, management information, accounting and control and disclosure are summarised in the table in the annexure. Sound financial management is clearly critical to the achievement of a development bank’s financial objectives, especially the objective of financial sustainability. The primary requirement is that development finance institutions and other state-owned enterprises should adhere to the general principles of sound financial management. At the very least, these include the requirements of their charter or founding legislation. They must also adhere to any relevant central bank requirements and, as far as possible, to international norms or best practice. In this regard, the Basel core principles state that ‘in principle, all banks should be subject to the same operational and supervisory standards regardless of their ownership; however, the unique nature of government-owned commercial banks should be recognized’ (Marston & Narain, 2004). The next section briefly lists some principles for the financial management of development finance institutions. On the understanding that these institutions should adhere to financial best practice, aspects that apply equally to commercial entities, such as financial administration and liquidity management, are not listed here.

The requirements are as follows: — Capital adequacy: Appropriate capital adequacy standards, and sufficient profit to preserve capital adequacy (adequate interest margin) — Asset quality and diversity: Loan-loss provisioning according to international norms, appropriate single exposure limits and limits on sectoral or geographical concentration — Funding: Mobilisation of donor funding and private funding (e.g. bond issues); investment-grade credit ratings, wherever feasible; and indirect financing as appropriate (e.g. securitisation of assets) — Risk management: Strong culture of enterprise-wide risk management; a comprehensive risk management system, overseen at a high level; commercial principles for determining interest rates; proper asset and liability management policies; appropriate use of financial instruments to mitigate against various risks; and a clear separation of project approval and disbursement functions. The aim of the governance of a development finance institution is to ensure that it meets its developmental objectives while remaining financially sustainable. The next two sections deal with these two issues – how can the government ensure that the development bank delivers on its developmental mandate, and how can it ensure that the development bank makes the best use of its financial resources in this process?

Fifth, for the Ghanaian development bank to be successful it requires to operate in stable macro-economic environment with low inflation, low interest rates and durable price stability. Ghana’s fiscal and monetary policy framework must be consistent with fiscal discipline and low and durable price stability. Ghana must be able to attain medium to long term periods of macro-economic stability not punctuated by periods of macroeconomic instability not driven by fiscal excesses. The Ghanaian development bank requires an enabling environment within which to operate. Its role is determined primarily by a country’s socio-economic environment and its particular development needs and priorities. Macroeconomic stability is a prerequisite for the development of the financial system, as instability increases the risks associated with finance, especially long-term finance. This negatively affects both the price and the availability of such finance. Traditionally underserved market segments are even less likely to obtain funding in a volatile macroeconomic environment. Critical elements of macroeconomic stability include the following: — Sound fiscal discipline — Balanced economic growth — Balance of payments stability — Price stability and limited external and internal price distortions — The absence of financial repression

However, this environment, in turn, affects the bank’s ability to carry out its functions. In the words of Diamond (1996), ‘no factor is more important in influencing a development bank’s “success” than the situation of the economy in which it operates’. While the mandate of a development bank may require it to address problems in the economy, it cannot operate in a largely dysfunctional environment. This is one of the paradoxes of development banking – these banks are needed most in poor countries, but the weak economic and political systems in these countries make it harder for them to succeed. For example, Malawi has been described as a ‘fundamentally flawed contextual basis’ for development banking owing to its poor economic prospects, high levels of corruption and limited political will to foster good governance.

Sixth, for the national development bank to succeed it needs have an appropriate mandate to ensure that it is correctly positioned within the environment. The lessons drawn from the experience of development banking have highlighted the disastrous effects of inappropriate mandates, but countries such as Canada, Malaysia, Brazil and Rwanda show that banks with appropriate and flexible mandates can contribute significantly to development (BAR, 2006; Rudolph, 2009). The national development bank to succeed it needs to clarity of mandate, local relevance, institutional fit, complementarity of funding, flexibility and an appropriate scope. the development bank must operate within the local economic, political and institutional environment.

Seventh, performance management will be a key component to successful national development bank.  One of the most intractable features of the supervision of development finance institution is the balance between accountability and autonomy. Failure to achieve such a balance could lead to political interference and/or poor funding decisions. This makes performance management a critical part of the governance process. It is generally agreed that the government should conclude some form of performance contract with the bank (or any state-owned enterprise) that sets out clear objectives, and then give the bank the operational autonomy to work towards achieving these. Shirley and Xu (1998:1) define performance contracts as ‘written agreements between managers who promise to achieve specified targets in a given time frame, and government which (usually) promises to award achievement with a bonus or other incentives.

They therefore set out the ‘intentions, obligations and responsibilities’ of both parties (Nellis 1989). Performance contracts are intuitively attractive. Shirley and Nellis (1991) find the idea ‘simple, appealing, and essential’. Contracts are seen to have a variety of benefits: — Contracts incentivise additional effort and improve performance, and thereby assist in achieving the government’s development priorities. They enable the institution to clarify the requirements of different stakeholders (e.g. line ministries) and reduce the effect of multiple objectives. — They assist the government and other stakeholders in monitoring and evaluating the performance of the institution. — They increase the transparency of the operations of the institution and reduce the opportunity for political interference in its activities. — They assist both parties in understanding the challenges and opportunities facing the institution. — They set development objectives up front, ensuring that the institution is not assessed on financial grounds only.

The eighth principle of success is financial sustainability which is critical for future growth of the national development bank.   Diamond (1996) defines the financial sustainability of development finance institutions as ‘the capacity to attract, on the basis of their own performance, the capital they required to pay their creditors, sustain their shareholders’ interest, and support their own growth’. Financial sustainability is understood as the ability of business to grow present and in the future policies without causing the debt to rise continuously. A financial sustainability requirement protects the government against losses and forces a bank to make better use of scarce financial resources. Early on, Diamond (1957) argued that a development bank needed some investments to be profitable since it has to cover losses on socially desirable but commercially less viable investments. These profits would strengthen its balance sheet, which would facilitate future lending; assist it in attracting private funding; and safeguard its independence. Also, by demonstrating that development investment could be profitable, the development bank would be better able to attract private sector investment into socially desirable projects. But for a development finance institution to be financially sustainable, the cost to its individual borrowers would need to be higher. This would probably be outweighed by the broader benefits to society: a financially self-sustainable institution would have a longer life span and hence be able to serve more customers or offer more or better products. It would also eventually be able to mobilise funding at a lower cost, which it could then pass on to borrowers

Ninth, a good risk management process helps development bank reduce the likelihood and severity of adverse events and enhance management’s ability to realise opportunities. The ability of development bank to identify, measure, monitor and control the risks they face as well as to determine that they hold adequate capital against those risks is a critical component of the overall corporate governance framework and ultimately an essential determinant of performance. Credit risk will be the main risk faced by development bank. In addition to shortcomings in corporate governance, lax credit standards and poor portfolio risk management have been recurrent causes of failure for development finance institutions around the world (Yaron, 2004 and Titelman, 2003). It is therefore essential that development finance institutions have in place an appropriate credit risk environment, operate under a sound credit granting process, maintain adequate credit administration and ensure controls over credit risk. While specific credit risk management practices may differ depending on the specific nature of the development finance institutions, a comprehensive credit risk management framework is expected to cover the areas mentioned above.

These principles should also be applied in conjunction with sound practices related to the assessment of asset quality, the adequacy of provisions and reserves, and the disclosure of credit risk. The Development Bank has to establish and executes various policies and procedures to reduce or limit exposure to risks assumed in the normal course of providing development banking services. Such policies and processes reduce the Bank’s exposure to interest rate, currency, liquidity, legal, and operational risks, while maximizing its capacity to assume the risks of extending credit to its public sector and private sector clients within its approved risk limits. The processes and procedures by which the Bank manages its risk profile continually evolve as its activities change in response to market, credit, product, and other developments. The highest level of risk management is assured by the Bank’s Board of risk committee, which is chaired by the independent director with experienced in development finance institutions. In addition to approving all risk management policies, the board risk committee must periodically review trends in the Bank’s risk profiles and performance to ensure compliance with those policies. The senior-most management forum for risk management is the asset and liability management committee (ALCO).

The consequences of inadequate risk management include investment losses and even bankruptcy. Other costly consequences are also possible, such as sanctions for the breach of regulations, loss of licenses to provide financial services, and damage to the company’s reputation and the reputations of its employees. A risk management process provides a framework for identifying and prioritising risks; assessing their likelihood and potential severity; taking preventive or mitigating actions, if necessary; and constantly monitoring and making adjustments. A development bank’s risk management process is not always consistently planned; it often evolves in response to crises, incorporating the lessons learned and the new regulatory requirements that sometimes follow these crises. Well-run development bank, however, benefit from people and processes that enable forward-looking attention to emerging risks.

Risk management is an iterative process used by organisations to support the identification and management of risk (or uncertainty) and reduce the changes and/or effects of adverse events while enhancing the realisation of opportunities and the ability to achieve company objectives. These objectives may take different forms, but they are typically driven by a company’s mission and strategy. A common corporate objective is to create value in a business environment that is usually fraught with uncertainty. So, an important objective of the risk management process is to help managers deal with this uncertainty and identify the threats and opportunities their company faces. One of the main functions of risk management is to find the right balance between risk and return. Shareholders in a company or investors in a fund have invested their money for the promise of a return at some risk level. By limiting the effect of events that may derail the company’s ability to achieve its objectives while benefiting from opportunities to grow the company profitably, risk management plays an important role in delivering value for these shareholders and investors. The involvement of the board of directors and senior management in risk management is critical because they set corporate strategy and strategic business objectives. Although directors and senior managers are in charge of setting the appropriate level of risk to support the corporate strategy, risk management should involve all employees. One employee making an inaccurate or fraudulent assessment can damage the reputation of his or her company and even lead to its demise. Reputations take years to build but they can be lost in an instant. Markets are increasingly interdependent, and media and the internet can spread the news of a mistake or scandal across the globe in a matter of minutes. Thus, risk management is critical to protecting reputations as well as maintaining confidence among market participants and trust in the financial system.

Risk management provides a wide range of benefits to a development bank. It can help by ■ supporting strategic and business planning; ■ incorporating risk considerations in all business decisions to ensure that the company’s risk profile is aligned with its risk tolerance; ■ limiting the amount of risk a company takes, preventing excessive risk taking and potential related losses, and lowering the likelihood of bankruptcy; ■ bringing greater discipline to the company’s operations, which leads to more effective business processes, better controls, and a more efficient allocation of capital; ■ recognising responsibility and accountability; ■ improving performance assessment and making sure that the compensation system is consistent with the company’s risk tolerance; ■ enhancing the flow of information within the company, which results in better communication, increased transparency, and improved awareness and understanding of risk; and ■ assisting with the early detection of unlawful and fraudulent activities, thus complementing compliance procedures and audit testing.

9. Conclusion

Ghana’s development bank will be an important instrument of government 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. The failure of many national development banks in the 1970s and 1980s led to them all but disappearing from the development agenda. However, many governments persisted with these banks, with mixed results. However, the Ghanaian development bank will have to be set up based on the tried and tested framework of good corporate governance practices, strong and robust risk management principles, good and definitive mandate, strong and resilient regulatory and supervisory framework, well set out performance contract operating within stable macro-economic environment with low inflation, low interest rate and stable currency these would stimulate economic growth and transformation and create employment for the teeming youth unemployment in the country.

Some development banks or finance institutions have succeeded in stimulating development, especially in countries such as Brazil. India and South Africa, and are poised to play a growing role in the development of these economies. Also, the 2008/2009 global financial crisis has rekindled interest in national development bank concept, in particular their role in countercyclical spending. However, without a clear understanding of the role of these banks, more failures could occur. This paper offers a starting point for understanding development banks by providing a macro-framework for their successful functioning in Ghana. The analysis focused specifically on case studies on national development banks from the emerging economies such as Brazil and India. The framework sets out principles for seven dimensions and principle of successful development banking: an enabling macro- economic environment, definitive mandate, strong regulation and supervision, good corporate governance practices, robust risk management practices, financial sustainability and performance assessment. Since development banks operate under different conditions and in different markets, the framework can be adjusted to suit the development priorities in Ghanaian context

10. Recommendations

As part of the strategies to promote improvement in the efficiency and effectiveness of the development bank, a number of recommendations are proposed focusing on measures to build the capabilities of the development finance institution and to improve the supervisory framework. These are elaborated below: 

Recommendation 1:

Define clearly the strategic focus and role of the development bank to ensure that the new institution complement the existing banking institutions effectively, in providing financial services to those activities not serviced by the banking institutions, the role of the development bank should be clearly outlined and defined. It is proposed that the focus of the development bank be as follows: • As development institutions should continue to meet the socioeconomic and developmental goals set by the Government; • As financial intermediaries, the development bank should not be involved in sectors that have matured and are able to obtain financing on their own from the banking system. The development bank should complement the banking sector through extension of credit in:- • Priority and/or new growth areas specified and identified by the Government, such as, information technology and infrastructure development, services and agriculture.

Recommendation 2:

Strengthen corporate governance:

Bank of Ghana’s Corporate Governance Directive (2018) and BCBS (2015) Corporate governance principles for banks must be strictly complied with, as they provide framework which banks should operate to achieve robust and transparent risk management and decision making and, in doing so promote public confidence and uphold the safety and soundness of the banking system. Corporate governance centres on an effective board of directors, strong corporate responsibility, accountability and transparency in line with best practices. The corporate governance in development bank can be improved by undertaking the following measures:

• Increase clarity of Government’s expectation as the main stakeholder by determining the role and objectives of development bank in line with the nation’s developmental policies and goals;
• Appoint qualified and experienced board of directors with sufficient skill and expertise in development or project finance, and with appropriate balance of executive and non-executive directors; board size should have minimum of 5 and maximum of 13 members as per the Bank of Ghana’s Corporate Governance Directive (2018).
• Establish effective audit and risk management committees supported by strong internal audit function;
• Ensure sufficient review and measurement of directors’ performance on periodic basis;
• Provide external checks and balances in development bank operations; and
• Increase disclosure requirements of development bank activities to render greater transparency and accountability.

           Recommendation 3:

The government should establish a legislative framework to provide for regulation and supervision of development bank. It is proposed that a legal and regulatory framework be established for the development finance institution. A single legislation to regulate the development bank with due consideration of the unique roles and function of each individual DFI. The new legislation will have to ensure that the development bank policies and objectives are consistent with the Government initiatives and direction and that Government policies are implemented effectively. The regulatory framework will take into account that development finance institution will be expected to serve public purposes and would be given special benefits and privileges to do so to achieve the national interest and the socio-economic agenda. The regulatory framework will be concerned with the safety and soundness of the development bank so as to minimise the need for financial assistance from the Government. The legislation should also incorporate prudential rules, disclosure and reporting requirements, rules on corporate governance, as well as powers to be granted to the regulatory and supervisory authority in the case of mismanagement or malpractice in the development finance institution. 

Recommendation 4:

Robust Regulation and Supervision Framework:

The supervisory process, functions and roles of a single supervisory authority responsible for development bank needs to be clearly defined and specified.  Bank of Ghana in exercising the supervisory function usually need to have the same expertise and competencies to monitor and assess the risks associated with the business of the development bank. Bank of Ghana will require development bank to comply with the same standards of prudential supervision (minimum capital, minimum capital adequacy requirements, loan classification and provisioning, etc.) of commercial banks or any other universal banks in the country.

The primary objective of supervision is to ensure that the development bank’s roles and functions are in accordance with the objectives for which they were established and that their activities are carried out prudently, efficiently and effectively. Prudential regulation, as well as the supervisory process, both in terms of on-site and offsite surveillance and monitoring of development, need to be put in place.

A single regulatory agency would not only supervise to ensure the safety and soundness of the development bank but also needs to be in a position to assess the extent to which the development bank have met the objectives for which the institutions were established as well as the economic implications of the development finance institution activities.

Independent and effective regulation and supervision of development bank is a basic condition for the sound governance and for ensuring good performance and financial sustainability. It is critical that the development bank should be well regulated and supervised, and this function is best performed by central banks such as Bank of Ghana. Regulatory and supervisory arrangements for development finance institution should be very similar to standards as applied to universal banks, but modified to take into consideration the business model of the specific development finance institution

Government should establish a single regulatory and supervisory authority to strengthen the supervision of development finance institution. An effective RSA should have the following attributes:

• Ability to regulate and supervise activities of development bank in meeting their strategic focus towards achievement of Government developmental objectives and goals;
• Ability and capacity in terms of manpower, skills, knowledge and expertise, and system capabilities to implement regulatory and supervisory measures to ensure the safety and soundness of development bank. This includes capacity for ongoing supervisory efforts, both off-site supervision and on-site examination;
• Competency in evaluating and measuring the performance and impact of development bank activities and in assessing the institution achievement of the Government developmental goals;
• Formulate sufficient reporting requirements for development bank to facilitate supervision as well as coordinate overall development bank’s performance reporting to Government and public; and Facilitate effective coordination and communication among policy makers and the development bank. The regulatory and supervisory needs to play a strong coordination role in the overall supervision by carrying out the supervision process. In supervising the development finance institution, efforts should be focused on enhancing the corporate governance practices supported by strong commitment and active participation of the relevant ministries. In addition, external checks and balances from external auditors and the budgetary process can be incorporated as part and parcel of the supervisory process. Bank of Ghana should address the safety and soundness of the development banks, individually and collectively, as well as public purpose and the economic implications of the activities of the development finance institution on the financial system and economy.

 

Recommendation 5

Definitive Mandate:

 

The Ghanaian development bank mandates need to be tight enough so as to prevent ‘mission creep’ and flexible enough to give room to adjust the path of the development finance institution should its mission become less relevant. The latter is particularly important to the public/private approach to development finance institution – making sure that DFIs preserve their “additionality” by continually seeking to push the frontier of the production possibilities of the financial system. An example of focused DFI mandate could be the provision of funds for on-lending to MSMEs on a wholesale basis. These funds would be on-lent only through financial intermediaries that comply with specific eligibility criteria (i.e. financial, governance) for on-lending to SMEs and Medium Enterprises. Such a mandate targets Medium Small Enterprisess while leveraging the credit assessment skills of private financial intermediaries, thereby focusing these intermediaries on building skills in assessing and managing credit provided to this underserved client group.

Recommendation 6

Disclosure and transparency:

Disclosure and transparency are key aspects of governance involving: (i) efficient internal audit procedures and audit function monitored by the Board and the audit committee; (ii) an annual independent external audit based on international standards—i.e. the same high-quality accounting and auditing standards as listed companies; and (iii) disclosure of financial and non-financial information according to high quality internationally-recognized standards.

Recommendation 7

Market supervision of development bank

Finally, Bank of Ghana’s regulation and supervision could usefully be supplemented by market-based measures such as credit ratings. Although credit ratings are not a formal element of external governance, they help both the government and the development bank to gauge the quality of the bank’s financial management. There is growing consensus that development banks should submit themselves to the discipline of credit ratings, while also encouraging their clients to obtain such ratings to help them access private capital markets. Few development banks would initially qualify for a commercial rating, but they can take measures to improve their financial standing (Thorne, J. and du Toit, C,2009).

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