The crisis adjusts development banks’ mandates
Niko Vardapetyan
Forbes Contributor
Development banks are being re-formatted from a source of finance for political megaprojects into players in the loan market.
What does a common corporate borrower need to apply to a development bank for? It’s for long and cheap money, of course. On the other hand, development banks have specific and not always transparent requirements for projects, as well as complicated and bureaucratised review procedures with unpredictable results. Development banks have been traditionally viewed as a source of finance for politically important megaprojects with unapparent returns and not as market players. Borrowers went to commercial banks for market loans.
The crisis has changed this situation unexpectedly. Some experts consider the current monetary policy of the Russian central bank to be professional and relevant, claiming that the declining inflation confirms this, while others compare this fight against inflation with stopping a nosebleed with a tourniquet applied around the neck. What is definite is that, at the current rouble rates, commercial banks are turning from a source of long-term finance into a source of short-term loans and refinancing. According to the central bank, the amount of corporate rouble loans extended by banks has grown by 7% from November 2014 to November 2016, while the rouble has devalued by approximately 50% over the same period. The weak growth in loans is understandable: if an industrial investment project envisions a return of 12-15% there’s no sense in attracting long-term finance, the servicing of which will neutralise the return.
It seemed that in this situation development banks have got an opportunity to step in as governmental or intergovernmental institutions with high credit ratings and capability to raise cheap capital in international markets. There are two restraints, however. The crisis has seriously decreased the number of development banks. VEB has been hit by three adverse factors: the impairment of loans extended earlier for non-economic reasons coincided with the lost ability to raise money abroad and a sharp decline in government support. The World Bank Group – the EBRD and IFC – has discontinued to consider new projects in Russia for political reasons. The new players such as the Asian Infrastructure Investment Bank and the New Development Bank BRICS cannot substitute them as they are only deploying their operations and focus on a narrow range of projects (infrastructure, green energy, etc.) with possible government participation.
Because of their status, all international development banks have a foreign currency balance sheet and may only attract the roubles at the same rates as large commercial banks. Therefore, the international development banks that remain active in Russia can provide finance primarily in foreign currencies. However, due to their credit ratings it is easier for these banks to make their loans cheaper by raising funds abroad and obtaining guarantees from export credit agencies. The lack of the need to maximise their profits makes it possible for them to extend loans almost at cost.
However, the borrowers that can reliably service long-term currency loans without fearing devaluation of the rouble include only those businesses that have projects in export-orientated sectors or in spheres where product prices are tied to export parity. This group of companies was expanded recently with businesses involved in import substitution where product prices are linked to imported analogues, which become more expensive in the event of devaluation, and this can be regarded as a natural foreign exchange hedge. Devaluation has resulted in that the number of viable import substitution projects in different sectors has surged.
To expand the range of borrowers, development banks begin to pay more attention to non-recourse project finance – a product, which has been of low availability even before the crisis. The fact that development banks do not report to national regulators provides them with flexibility in extending such loans.
Each development bank has its specific tasks and projects that correspond to these conditions can count on preferential lending terms. For EDB, for example, these are investment projects aimed at fostering trade and investments between the Eurasian Economic Union countries as well as promoting economic development in the region.
Development banks will need to change. According to stereotypes, they are clumsy mechanisms where one has nothing to do without a strong administrative resource and a project worth billions of dollars. VEB has recently approved a strategy, according to which it intends to turn into VEB 2.0 by 2018 and abandon unprofitable megaprojects. EDB approved its revised strategy in the spring of 2016 and is working actively to increase the number of projects in different sectors.
Development banks that have a clear strategy and a professional team to pursue it try to meet borrowers’ demand for long-term investment loans and begin, to a certain extent, to supersede commercial banks by fulfilling the counter-cyclicality function in the crisis conditions. It is an unexpected, but economically justifiable addition to their initial mandate.