A case for successful framework for development bank: the Ghanaian example (part ten)

Banks see deposits fluctuate over slow private sector recovery
Dr. Richmond Atuahene is a banking consultant

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.

  1. 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.

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