JEDDAH, 6 September 2004 — Development banking is defined as a form of financial intermediary providing financing to high priority investment projects in a developing economy. It is a form of financial intermediation that must be designed to help any country, such as Saudi Arabia, reach a higher and sustainable level of development toward socio-economic progress.
On one hand, development bank is a “bank” in the business of “development”. On the other, it is a financial intermediary which facilitates the transfer of economic resources from the surplus (saving) sector to the deficit (investment) sector, it is operating just like any other bank.
However, in general, development bank is supposed to invest in “development” projects” earning it a name development bank. It is classified as a development finance institution whose business is to help a country in its development efforts.
This bring us to the first dilemma confronting all development banks: Two functions with different operating strategies and investment objectives. It is a product of the marriage between a development financing institution and a commercial bank. Its godfather is the government. Unless it is able to define its role and determine its playing field, it will always bump into problems of institutional identification and unwarranted competition from its relatives.
The biggest challenge facing development banks is how to reconcile the above-mentioned conflicting functions.
The objectives of development banks must be twofold: 1) to increase the saving rate and 2) to increase the investment rate.
The first objective could be achieved by raising capital from capital markets abroad, inviting foreign direct investment, developing domestic financial markets, and mobilizing the non-traditional sources of capital.
The second objective could be achieved by investing in projects that commercial banks would be unwilling to enter. These are the “development” projects that require large volume of capital, risky, needs long-term financing, and are low in the bankability scale. Commercial banks will invest in these projects when they become “commercialized” or have been proven to be financially profitable.
The two objectives are mutually exclusive. The success of one does not depend on the other, although in the long run more savings would lead to more investment and more investment could result to more savings. If these objectives sound like government objectives, the truth of the matter is: they are. Development banks and other non-bank development financing institutions are “government tools” and partners to achieve these objectives.
The primary role of development banks is to supply the “missing ingredients” needed to sustain the current level of economic development and to bring the country into a higher level. The missing ingredients for many developing countries such as Saudi Arabia include capital, technology, foreign exchange, and entrepreneurship. Moreso, in the case of Saudi Arabia, which is non-existant in other developing nations, (local) labor is an additional missing ingredient in that production function.
Development banks must play a “supply leading” role in providing the missing ingredients. They must develop new methodologies, techniques, and system in raising capital and increasing investments in non-traditional areas.
The lending strategy of development banks must always consider development contributions as an integral part of the scheme. After all, it is in the business of development. Development benefits include employment generation, utilization of domestic resources, increasing wages for labor, saving and earning of foreign exchange, transfer of new technology, and improving entrepreneurial skills, and other benefit.
In the case of Saudi Arabia, in order to attain optimal level in agriculture and industry, there must be adequate and efficient supply of transportation, communication, education, health and other infrastructure. It is the ultimate responsibility of the private sector to supply and improve the agriculture and industrial base, and for the government to supply transportation, communication, education, health and other infrastructure in a highly efficient and cost effective environment throughout the Kingdom.
Saudi development banks and non-bank development financing institutions must participate in financing the above-mentioned infrastructure industries and lead the way for private investors and commercial banks to invest in agriculture and industry.
There is an urgent need for all development financing institutions in Saudi Arabia to redefine their role in light of the technological advances and globalization. Market-oriented policies and reforms must be their priority. Most of these institutions were established in the 1970’s and early 1980’s in line with the old philosophy at that time that only government could be involved in development activities at a time when the Saudi private sector was weak. But the main reason was the perception that the desired development process could only be achieved by directing subsidized capital to all sectors of the economy. The time has come now to create privately-owned development financing institutions. As a future member of WTO and a major player in the global village, there are strong incentives for these Saudi institutions to become innovative in developing new services for their clients and to diversify their resources mobilization. They must reduce their dependence on the government and undertake most of their activities on a commercial basis. But at the same time, they must maintain the close relationship with the government and be able to serve the government in achieving certain development projects.
Saudi development financing institutions must be prepared to meet competition, both in lending and investment operations and in mobilizing funds. Therefore, a high level of efficiency, accountability, and sound management must be maintained in order to survive. As part of the Saudi privatization program, these institutions must be at the forefront of such program.
In this new century, the definition of development financing institution will not be according to the type of product, type of financing they provide but the type of projects they support. In the past they were considered to be project financing or lending institutions. But now, they must venture into a wide range of services, e.g., short-term financing, leasing, capital markets products, investment banking products, etc.
What will differentiate them from commercial banks is that these development financing institutions should select and support projects which will have significant development contribution to the country. Whereas, commercial banks lend to any creditworthy clients.
These kinds of development will help Saudi development financing institutions mobilize resources worldwide. However, they must be ready to adapt to a variety of situations and become strong to react quickly and efficiently to whatever changes that might occur, they must become first and foremost “self-supporting” institutions.