In an interview with Pritha Hariram, the role of development banks to support governments to make progress towards the Sustainable Development Goals.was discussed. The interview explored some of the nuances of working with development banks and this article takes a step back to explore what development banks are, what they do, and how they differ from traditional banks.
Development banks are defined as “a bank or financial institution with at least 30 per cent State-owned equity that has been given an explicit legal mandate to reach socioeconomic goals in a region, sector or particular market segment.”
These banks clearly play a very important role in development work, funding projects that may not otherwise receive investment.
Each development bank has its own mandate, generally focusing on sustainable development and economy. The World Bank, for example, has a mandate to “end extreme poverty within a generation and boost shared prosperity.”
What is the difference between a development bank and a private financial institution?
Traditional banks, or private financial institutions, usually focus on commercial activities rather than investing in socioeconomic goals. Private banks may not be interested in the medium to long term maturity that many development loans require, too, as the risk is too high.
While a private bank offers money and generally stays out of the project, a development bank often requires equity participation as part of the loan or grant, so they will monitor projects and share expertise and resources to ensure a funded endeavour is as successful as possible. Where a traditional bank is mostly hands-off, development banks may generate capital for a project, offer analytics, and work to share knowledge between funding recipients to ensure more effective use of the funds loaned.
The project cycle of projects receiving funds from a development bank
A typical project cycle involves the identification of a suitable project, which may involve a pre-feasibility study. Next, design and preparation take place, done by the recipient of the funding — this could include studies and assessments.
The development bank appraises the project and all parties negotiate the funding agreement and implementation plans. Funded projects have to follow the rules and policies of the funder. When the negotiations are successful, funds can be disbursed and the project is implemented and supervised.
Ideally, the project cycle ends with monitoring and evaluation and some analysis and reporting to ensure it was successful.
Typical funding arrangements offered by development banks
Development banks often focus on offering low-interest loans, credits, and grants for development work, in areas that improve socioeconomic health such as water, education, health, public administration, infrastructure, and agriculture.
The Overseas Development Institute guide to multilateral development banks says that “Loans are the most common instrument, followed by technical assistance, guarantees and equity… The terms and conditions are very diverse and depend on the status of the borrowing country and the type of instrument. Terms can vary from a minimum maturity of five to 40 years, with a minimum grace period of between three and ten years.”
Development banks may work in partnership with other financiers, such as governments, other multilateral institutions, commercial banks, and private sector investors or donors.