Abstract
The post- independence failure of development finance institutions 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, outlines globally accepted and tested macro- 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, disclosure and transparency 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
1.0 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 such as Ghana, 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. In Brazil 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.
According to the Africa report ( 05/2021) opine that the development finance institutions have long played an important role in financing Africa’s private sector. With patient capital and a high -risk tolerance, development finance institutions hold Africa’s largest portfolio, directing significant resources to enable the continent banks and private sector to finance corporate growth. According to Africa report data at Asoko Insight, Europe’s 15 development finance institutions, the International Finance Corporation, Canadian FinDev and the US Development Finance Corporation have deployed over US $48 billion to Africa alone between 2015 and first quarter of 2021.
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 facilitated in 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 Development Finance Institutions Act, 2020 Act 1032 was passed by the Ghanaian Parliament and received Presidential assent on 27th October, 2020. Development finance business is defined in the Act to mean the provision of short, medium and long- term funding, guarantees and other credit enhancement structures to key sectors of the Ghanaian economy in a financially sustainable manner.
2.0 BACKGROUND
Review of Development Finance Policies and Experience in Ghana
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 changed their mandate into 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.
3.0 THE PREVIOUS FAILURES OF DEVELOPMENT FINANCE INSTITUTIONS IN GHANA
A major challenge for development finance 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; and · 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, development 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, banks’ 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 in development finance, project management in key sectors of the economy
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 finance institutions 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 project 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 had their mandates changed from development banks into 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 assessed risks, the type of project finance 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.
- DEVELOPMENT BANK GHANA LTD
National Development Bank was established under Development Finance Institution Act 2020 Act 1032 to provide innovate and long -term financing instruments for specific sectors of the economy, particularly the agriculture and industrial sectors. In Ghana, development bank has been established and funded by the Government with seed capital or equity of US$ 200 million; and additional funding from the German KFW with Euro 46.5 million; European Investment Bank with Euro 170 million and World Bank from International Development Agency (IDA) US$ 250 million 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.
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 including effective and independent board, Disclosure and transparency; robust regulatory and supervisory framework, definitive mandate, stable macroeconomic stability, strong and robust risk management practices, financial sustainability and performance contract. 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 universal 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 project 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 including independent and effective board of directors, definitive and flexible 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
5.0 GLOBALLY TRIED AND TESTED FRAMEWORK FOR SUCCESSFUL DEVELOPMENT BANKS OR FINANCE INSTITUTIONS.
First, good corporate governance practices are paramount for survival and sustainability of development bank in Ghana. The aim of the governance of a development finance institution is to ensure that it meets its developmental objectives while remaining financially sustainable. 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 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 Management; (ii) a majority of the Board to be comprised of independent, highly qualified in development finance, 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 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”.
The aim of the governance of a development finance institution is to ensure that it meets its developmental objectives while remaining financially sustainable. Good corporate governance structure has to be embedded in the legislation in Company Act 2019 Act (992) to enhance the performance of the development bank. This would be demonstrated through appointment of qualified and experienced Board of Directors (BOD) in project management and development finance, sensitivity analysis and project-modelling reinforced with proper checks and balances through an effective risk and audit functions. Bank of Ghana Notice No. BG/GOV/SEC/2021/04 on development finance institution requires that the proposed board of directors and key management staff should be qualified and experienced in development finance business, and with business and professional history for the preceding ten years this addresses skills in competencies in development finance business.
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 board and 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, independent and 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 Board appointment process is one of the key factors to ensure that the Development bank fulfils its objectives. A key challenge in Board composition is to ensure that the Board collectively has the mix of skills, experience in development finance, project management and finance and capacity needed to conduct the business of the National Development Bank in an efficient and professional way. 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 executive 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 Development Bank; 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 (World Bank, 2016).
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 Ghana’s national development bank to succeed it needs have an appropriate mandate to ensure that it is correctly positioned within the environment. Ghanaian development bank needs definitive mandate 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. National 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 bank should its mission become less relevant. The mandate or the strategic focus of the National Development Bank will be to provide access to long-term finance in key sectors including agric-businesses, manufacturing and high value services. By offering long-term wholesale financing, credit guarantees and other services, the Development bank will help increase overall lending to priority sectors and market segments. From the above mandate, could be described as definitive and flexible and this could prevent the mission creep. The latter is particularly important to the public/private approach to development finance institution – making sure that Ghana national development bank 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 Enterprises 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. 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.
Regulatory and supervisory arrangements for Development finance institutions should be very similar to standards as applied to universal banks, but modified to take into consideration the business model of the National Development Bank. In the case of second-tier, as recommended here, the risk exposure will be considerably lower than that of universal banks and Development bank that lend directly: on the asset side, wholesale DFIs do not undertake any direct lending and only perform second-tier, wholesale functions; and on the liability side, risk exposures are considerably less than those of commercial banks, because wholesale Development bank do not solicit deposits from the public.
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’. Their preconditions for successful supervision are sustainable macroeconomic policies, a well-developed legal system, a robust accounting profession and a strong and independent supervisor such as Bank of Ghana’s Specialised Unit for development finance institutions. 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 subject to the Basel 111 principles.
Tenth, performance management contract 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 of Ghana should conclude some form of performance contract with the bank directors and executive management team that sets out clear objectives, and then give the bank the operational autonomy to work towards achieving these so that it never turns be part of the existing State -Owned Enterprises (SOEs) which continued to be drain on the taxpayers.
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.
- 0 C0NCLUSION
Ghana’s development bank will be an important instrument of government to promote economic growth by providing long-term financing, 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.
Policy 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 skills, expertise and competencies in development finance or bank 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 based on project gestation period etc.) of 23 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 regulatory and supervisory authority 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 Enterprises 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).
Recommendation 8
Financial sustainability is critical to survival and success of any development finance institution or bank. The board of directors should constantly review the operational and financial sustainability of the development bank regularly as most of development finance institutions have collapsed after being in business of short period. Confining development bank to second-tier (wholesale only) operations contributes to improved performance and leverages the expertise of private sector, capital market and emerging pension funds. his 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 Financial 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’. Financial sustainability is understood as the ability of business to grow present and in the future policies without causing the debt to rise continuously.
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