The new Development Bank Ghana: a case for globally accepted and tested macro- framework (part 4)

Banks can’t be blamed – Dr. Atuahene
Dr. Richmond ATUAHENE

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.

Fourth, the success and survival of the National Development Bank is about financial sustainability.  In the management science literature, the concept of corporate financial sustainability refers to the ability of the Ghana’s development bank to create value and continue working over a long period of time. Aras and Crowther (2007) argue that both corporate governance and financial sustainability is essential for continuous operation for any corporation and that therefore much attention should be paid to these concepts and their applications. Confining Development bank to second-tier (wholesale only) operations contributes to improved performance and leverages the expertise of private sector.

This contributes both to more cost-effective utilization of scarce public funds and to reducing the risk that Development bank expands their activities into areas, such as managing credit risk, where they would in effect be duplicating rather than supplementing the capacity of private sector intermediaries.  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’. Government of Ghana must ensure 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. The danger for Ghana’s National Development Bank on financial sustainability is that if the borrowed funds from KFw, IDA and European Development Bank are not put in projects that principally look up to cashflows and earnings as the source of funds for repayment in the longer term that could impact negatively on future Debt to GDP ratio. The financing of major capital project such as Agriculture or Housing project the National Development Bank should look principally to the cashflows and earnings of the projects as the source of funds for repayment of debt. Whether on wholesale or retailing of long -term financing the independent and effective board and executive management should have strict oversight of the funds to ensure that future cashflows and earnings of the various projects.

Sixth, a good risk management process helps development bank reduce the likelihood and severity of adverse events and enhance management’s ability to realise opportunities. Risk management is a critical component of the overall accountability framework, and ultimately an essential determinant of performance. It is also an important governance tool with a direct impact on sustainability. Risk management should be incorporated as an integral part of the accountability framework, whereby the performance of National Development Bank is assessed according to a performance contract established between the shareholders and the Board. 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.

The development banks’ project risk management must be categorised risks under the following: (i) completion or cost overrun risk; (ii) reserve or feedstock risk; (iii) production or operating risk (iv) political, legislative or regulatory risk; (v) marketing or sale risk and social and environmental risk. In each project adopted the board of directors they will have to assist in determining the capacity of the project to generate cashflow and repay debt, in quantifying the effect of an identified risks, and in designing appropriate financing terms and conditions, the development bank builds a cashflow forecast model of the project. 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.

Seventh, 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.

Eighth, higher disclosure and transparency are key aspects of governance involving: (i) efficient internal audit procedures and audit function monitored by the Board and the project monitoring 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. 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.

Ninth, on the globally accepted and tested frame an 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 Ghana Development Bank 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 different supervisory and regulatory methodologies from those applied to universal banks, but modified to take into consideration the business model of the development bank. For example, the Bank of Ghana’s loan classification of Current, OLEM, Standard, Doubtful and Losses could not be applied to Development bank because the gestation period or lifespan of various projects.

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