I.3 TREASURY FINANCE AND DEVELOPMENT BANKING

The core of this book has two sides, debt management and development banking. The focus on development is not only for its own sake, but particularly because development banking, as an example of a simple banking activity that nonetheless maintains all the essential characteristics, allows the reader to understand concepts which apply to all banking but are easier to see in a simpler situation. Development banking will be introduced and then presented mainly through specific and yet theoretical financial examples. In the chapter on emerging markets we look at a few case studies in which we relate financial activity to realistic and practical development projects.

The type of development banking we are going to discuss is the one that uses the tools of investment banking–borrowing and lending–with the goal of assisting countries or institutions that would struggle to obtain the same type of assistance in the financial markets. Although the tools are the same, there are many differences that are important to stress. Earlier we mentioned the prism of the asset swap as the nexus between risky discounting and funding level. We will portray development banking as the prism through which to view credit going from the financial markets–open to everyone–to the bespoke lending (developed) markets where only development institutions dare to venture. A development bank, by lending at a level which is essentially (minus costs of operation) the one at which it can borrow, acts as a sort of transformer, enabling risky borrowers to access liquidity at rates they could never otherwise obtain. Throughout the book we stress the technical and formal elements differentiating the two types of banking (with the assumption that, unless stated otherwise, things are identical). At first one might be surprised that both types of institutions, only as far as borrowing is concerned of course, are not very different; however, when differences will appear (for example, in the case of the prepayment option in loans or the passing on of the institution's borrowing costs to the subsequent borrower) they will be as startling.

The development banking world is particularly interesting because it straddles the separation between a financial institution and a sovereign entity. A development institution borrows, lends, and invests more or less like a traditional bank, yet it has some of the constraints and limitations of a sovereign entity. The instruments used for investments are fairly simple–they do not borrow to fund financial investment, they do not seek exposure to exotic financial risks, and so on. Moreover, a development institution, or at least those that are known as supranational, has constraints that go beyond those of a sovereign entity, exemplified, as we shall see, in the view that a development institution can be seen as a credit cooperative.

In the volatile times following the 2007 to 2009 financial crisis it is particularly difficult to forecast the direction of finance. It is clear that a few issues seem to gain in importance and will likely remain in focus for a long time. Credit will probably never leave the center of any financial consideration; sovereign debt will be treated with more interest going forward; financial transactions will probably move toward plainer structures; the developing world with its mixture of need and growth will play a larger role in the financial world. Development banking, and we shall try to treat it in a way that will make this clearer, sits at the intersection of all these issues in the sense that each one of these can be illustrated and better understood if seen in the context of banking with the goal of development.